Funds shrink as venture capitalists lose their nerve

— -- As the financial crisis deepens, venture capital for some start-ups has fallen to the lowest level since before the dot-com boom and 2001 bust, while more young firms cut costs and brace for tougher times.

Over the past month or so, venture capitalists have even been walking away from deals or trying to renegotiate new funding terms with start-ups, says Peter Astiz, chair of global technology practices at the DLA Piper law firm in Palo Alto.

"If there's less money out there chasing deals, there's less competition, and that brings down valuations in a transaction," Astiz says. "We're seeing much more significant weakness going into the fourth quarter for venture funding."

U.S. venture capital in the third quarter dropped to $7.4 billion — a 7% fall from the same quarter last year, says Dow Jones VentureSource.

The 270 information technology deals in the third quarter were the lowest quarterly numbers since 1996, when only 260 deals were funded in the first quarter of that year, says Dow Jones VentureSource spokesman Adam Wade.

Another grim number: The Silicon Valley venture capitalist confidence index hit 2.9 — the lowest reading in the five-year history of the index by University of San Francisco business professor Mark Cannice.

Venture-capital firms and attorneys are advising their start-ups to trim costs and to brace for tighter funding and less revenue. In a recent slide presentation, the Sequoia Capital firm in Silicon Valley warned its start-up executives with an image of a gravestone inscribed: "R.I.P. GOOD TIMES."

Electric-carmaker Tesla Motors in San Carlos, Calif., online real estate firms Redfin and Zillow, online advertising firm AdBrite and other promising young companies recently have announced layoffs.

Worried venture investors — wealthy individuals, public pension funds and others — are starting to sell their venture fund holdings on the secondary market to firms such as Industry Ventures, a San Francisco firm that buys holdings at a discount.

"There's no panic yet," says founder Hans Swildens. "But there's a flight to safety, and we're seeing the first wave of individuals trying to get cash out of their venture fund holdings."

One bright spot: Funding still is strong for some companies. Biotech companies in the third quarter received $1.4 billion, a 21% rise from last year, while clean tech raised a 17% increase to $1 billion, according to PricewaterhouseCoopers and the National Venture Capital Association.