VCs Stocking Up on Security Deals

The first few years may best be remembered as a boon for VC-backed security startups. After all, there were 46 different startups funded with nearly $480 million in the first three months alone, as firms such as Benchmark Capital, ComVentures, GreyLock, JPMorgan Partners, Menlo Ventures, Sequoia Capital, Sevin Rosen, 3i and Walden International made multiple investments in the security space, according to original research by PE Week.

If the investment pace continues, it will be on par with the last couple of years. Thomson Venture Economics (publisher of PE Week) reports that private equity investors pumped more than $3 billion into security providers in 2003, up from $2.7 billion in 2002.

Activity in the sector reached a peak during the middle of last month, when six security startups received funding.

Among those recently funded were Trusted Networks, an eight-year-old Atlanta-based company, which received $12 million in a Series B round from JK&B Capital, Charles River Ventures and Flagship Ventures. Trusted Networks makes identity management software that enables network security enforcement at a packet level.

Tasha Seitz, a partner at JK&B and a former Gartner Research analyst who oversaw her venture firm’s investment in Trusted Networks, says that during the same week, JK&B invested $5 million into a Series A round for Intrusec, another Atlanta-based security startup, which makes vulnerability and threat management software. Overall, Seitz says that her firm has made four investments in the security software sector recently.

“We’ve been more active in the last 90 days than we have been in the last two years,” says Seitz. “This is such a robust market. Security is a major spending priority by corporations.”

Meanwhile, Lancope, which is also based in Atlanta, received a $12.5 million Series C round from Canaan Partners, Council Ventures, GMG Capital Partners and H.I.G. Ventures. The company develops intrusion detection software.

At ComVentures in Palo Alto, Calif., Partner Michael Rolnick, who oversaw his firms recent investment of $12 million into Caymas Systems of Petaluma, Calif., which was also backed by Redpoint, says that there are segments of the security market that are over-invested, such as the firewall security space. But Rolnick says that in general the market is growing.

“Corporate networks have opened up to supply chain partners and remote employees,” he says.

Rolnick acknowledges that ongoing threats with networks has created a keen interest in security protection, which has helped to spawn so much investment in the sector. ComVentures has a half-dozen security companies in its portfolio.

Meanwhile, a growing rank of other venture-backed security companies are raising rounds of funding. Earlier this month, Austin, Texas-based WholeSecurity announced it raised an oversubscribed Series B round of $10 million. Last week brought the news that Sensory Networks Inc., a Palo Alto, Calif.-based provider of hardware acceleration technology for network security applications, raised $6 million in Series B funding.

Financial analysts continue to predict a growing security services sector. Research firm IDC estimates that IT security spending will increase by up to 8% in 2004.

A survey by the Yankee Group found that more than half the companies surveyed planned to increase security spending over the next year.

But will the current enthusiasm of VCs for security software bring on another Internet-era like bubble?

Peter Christy, editor of industry newsletter Internet Acceleration says that the current era is not, in fact as bad as the Internet boom, even though he acknowledges there is a lot of money chasing too few opportunities in security.