Mirroring a national trend, venture funding for Los Angeles-area companies plummeted to $198.6 million in the second quarter, an 82.5 percent decline from the like quarter a year ago, according to Thomson Financial/Venture Economics, a New York-based research firm.

The drop was even more precipitous than the 61 percent national collapse, and the 66 percent Bay Area crash.

Just 21 L.A. companies received funding during the quarter ended June 30, down from 68 in the year-earlier quarter.

The collapse is largely attributed to entrepreneurs’ short-term unwillingness to accept the new, much-lower valuations on their startups.

“It’s entrepreneur shellshock,” said Stephen Levy, director of the Center for the Continuing Study of the California Economy.

The new environment is a far cry from a year ago, when entrepreneurs were in the catbird seat, subjecting eager VCs to interviews to determine which one would be given the privilege of supplying capital. Over the past 12 months, valuations on early-stage businesses have tumbled 50 to 60 percent, causing a dramatic role reversal that entrepreneurs have not yet adjusted to.

“Entrepreneurs still have an over-inflated sense of the worth of their companies, and VCs are just saying no and walking away,” said Jess Reyes, global product manager for Thomson Financial/Venture Economics.

Local VCs stay busy these days by nurturing their current portfolio companies. But venture capitalists have huge amounts of money at the ready, and remain eager to invest when the right deal comes along at the right price. “Right now is the perfect time (to invest),” said David Cremin, a partner at Zone Ventures, a Los Angeles venture shop. “Down cycles are when you get the best valuations, and there’s not tons of competition to get into the best deals.”

Bigger deals returning

While far fewer deals are getting funded these days, the ones that do get money tend to be for larger amounts and larger equity stakes. VCs generally prefer to buy stakes of at least 30 to 40 percent, but entrepreneurs until recently had been only willing to sell much smaller stakes.

“In 1999 and 2000 you had companies saying, ‘We’re worth $18 million and we’re going to raise $2 million for a 10 percent stake.’ If you tried to negotiate, there would be readily available capital from another source,” said Cremin, whose firm has yet to invest $60 million of the $100 million fund it closed in April 2000.

Today, companies are becoming more willing to sell larger stakes, or they’re not getting funded.

Once entrepreneurs get over their lower-valuation shellshock, the level of venture funding is expected to resume climbing. But the rebound isn’t expected to materialize until early next year. “It looks like we’re in for a bumpy six months,” economist Levy said.

And don’t expect L.A. funding levels to reach anywhere near the $1 billion-plus quarterly amounts invested during late 1999 and early 2000.

“That was a one-time Bacchanalia,” said Reyes. “I think Los Angeles can expect between $500 million and $700 million (in venture funding per quarter). That’s probably sustainable.”

One L.A. sector that will likely be a major magnet: health care.

“The future of L.A. is biotech and health care services those are the places where L.A. will be leading the pack,’ Reyes said. “The area’s population creates a huge demand for health care services, and there is a fairly big biotech research enclave.”

Cremin added that Zone Ventures is seeing a lot of “great technology” coming out of aerospace/defense subcontractors, which is being adapted to various consumer and business applications.

Second-quarter champ

As for the second-quarter activity, the largest L.A. recipient of venture capital was RealEnergy Corp., a Woodland Hills supplier of on-site power generators. It received $50 million, accounting for more than one-fourth of L.A. County’s total.

Upon learning that his company was L.A.’s top recipient, RealEnergy Chairman and Chief Executive Dan Cashdan said, “I had no idea. Our noses are so stuck on this grindstone that we don’t come up for air.”

With the proceeds, RealEnergy plans to buy more “micro power plants,” which the company installs in the basements or rooftops of commercial buildings, including three buildings in L.A. so far. The natural gas-powered generators produce electric and thermal energy, supplying 50 to 60 percent of the buildings’ total needs.

“Energy infrastructure is a very capital-intensive business,” Cashdan said. “Fifty million dollars is a drop in the bucket compared with what we’ll need over the next 10 years, but it’s a healthy drop.”

Despite the dot-com meltdown, the Internet sector received more second-quarter venture funding than any other local sector. Nine of the 21 recipients are Internet outfits, which received a combined $81.9 million, more than 40 percent of L.A.’s second-quarter total.

“It’s just like when the PC sector became overbought in the mid-’80s,” Reyes said. “The Internet is still an important component. It’s still No. 1 in New York, being important to the finance and advertising industries, and in L.A. it’s part of the entertainment business.”

North-south comparison

As for the drop-off in second-quarter funding, the impact on the L.A. economy has been nowhere near as severe as the chill cast over the Bay Area. While the percentage drop in L.A. was greater, the dollar amount in Northern California was much larger. Also, that area’s heavy concentration of large public tech companies (Hewlett-Packard Co., Sun Microsystems, Apple Computer Inc., Cisco Systems, etc.) have suffered big earnings drops and undertaken major layoffs.

“The valuations on Southern California companies never went up that much, so they didn’t have as far to fall,” said Reyes. “Down there (in L.A.), the general malaise, depression, panic the need for prozac is nowhere near what I see here in Northern California.”

Much of that pain comes from the Bay Area’s lack of economic diversity, which L.A. suffered through when it was heavily dependent on aerospace/defense.

“The very synergies that made Silicon Valley so successful are now causing the bad news,” Reyes said. “It’s a micro economy that depends on the company down the street buying components being made up the street.”