Venture capital firms continue to make a steady stream of investments in network startups, particularly software, Internet and wireless technologies.

During the second quarter, VCs invested just under US$3 billion in network startups, completing 423 deals nationwide. This follows on the heels of $2.8 billion invested in 399 network startups during the first quarter.

Overall, early-stage investments in the network industry are holding steady. For the last eight quarters, VC investments in network hardware, software and telecommunications services have ranged between $2.5 billion and $3 billion, with anywhere from 350 to 435 deals completed.

These figures are from the quarterly MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association, which is based on data from Thomson Financial. Network World receives a special cut of the MoneyTree report that is focused on the network industry.

"We've seen a relatively flat quarter again,'' says Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers. "We haven't really recovered from the meltdown following 2001.''

At its peak in the second quarter of 2000, VCs invested $18 billion in network-related ventures.

Several factors are holding back network startups:

* Industry consolidation: Major telecommunications carriers such as AT&T and BellSouth have announced plans to merge, along with network hardware vendors Alcatel and Lucent Technologies. That means there will be fewer service providers to purchase network equipment, and fewer network equipment vendors to buy components.

* Top-heavy M&A market: Network industry merger and acquisition activity is focused on very large deals. VCs are looking for more activity on the low end, with more small businesses getting acquired.

* Weak IPO market: Vonage, a once high-flying VoIP service provider, held its initial public offering this spring, and it was a huge disappointment. Network industry experts looked to Vonage as a bellwether to generate interest in the telecom area, but it has failed to do so.

Nonetheless, Lefteroff remains optimistic about the long-term opportunities for network startups.

"As Internet use continues to grow and as entrepreneurs continue to develop new ways to deploy some of the network capacity that was developed over the last few years, we will see some return to the activity levels we saw a few years back,'' he says. "I don't know when that will be. Everybody's waiting to see what is going to be the next wave of new technology or use that's going to re-kindle interest.''

Software remains hot, with 187 deals completed in that area for a total of $1 billion. It was the largest single industry category, with many of the deals involving software-as-service startups that are dependent on the Internet.

Another strong area is Internet-specific ventures, where a company's business model is dependent on the Internet. Startups in this segment captured $916 million in funding during the second quarter, and 143 deals were closed.

Promising Internet startups include Jingle Networks, a Menlo Park, California company offering free directory assistance services that raised $26 million this year, and Xoom, a San Francisco newcomer that raised $15 million to expand its Web-based service for international money transfers.

"Internet deals represent 14 percent of the dollars and 17 percent of the deals,'' Lefteroff says. "There's still a great deal of interest in this sector, and we expect interest to continue.''

Wireless remains popular, too. Altogether, VCs invested $329 million in 48 wireless startups, including four of the top 10 network deals of the quarter. Wireless represented 11 percent of the dollars and deals in the network industry.

One wireless venture that received funding is SiteExcell Tower Partners, a Little Rock, Ark., holding company for communications tower assets. SiteExcell, which raised $15 million in March 2006, develops towers for Cingular, T-Mobile and other wireless carriers in southern states such as Oklahoma, Arkansas and Alabama.

"One of our advantages is that it's much less expensive to develop towers in the Midsouth,'' says CEO Todd Lewellen. "It costs less than in urban areas on the West Coast or the Northeast. Labour is a bit cheaper, and we don't have the expense of prolonged zoning battles. We still have the same grade-A tenants going into our towers.''

Lewellen hopes to sell the individual tower assets or the company within three to five years. The lead investor on the deal was M/C Venture Partners, a Boston firm that has backed other wireless startups including Metro PCS, TeleCorp PCS and Triad Cellular.

Lefteroff predicts the rest of 2006 will remain flat for network deals. "With the Fed increasing interest rates, the IPO market will be fairly muted,'' he says. "There are not going to be a lot of exits, so VCs will have to carry their best prospects.''