With VC drying, seed funding grows more selective

SAN FRANCISCO — Seed investors are traditionally the first to make bets on promising start-ups and emerging technologies, giving an early indication of where the tech industry is headed.

Such was the case in the early 2000s, when they poured money into social media, and the last few years, with autonomous vehicles.

The spaces to watch now are augmented and virtual reality, machine learning and yes, cars, according to a new report from market researcher Crunchbase, one of a few recent studies on very early-stage investing.

But there appear to be fewer sure bets in what increasingly has been a downward arc in venture funding.

Nearly 2,000 investors sank $15 billion into 1,796 U.S. companies in the third quarter, according to report from researchers PitchBook and the National Venture Capital Association. It's the fifth straight quarterly decline in the number of companies receiving venture funding and the worst since the fourth quarter of 2011, with 1,629.

Funding, meanwhile, plunged 32% from the previous quarter and is at its lowest since it hit $13.5 billion in the first quarter of 2014, according to the report.

"We're in a period of venture pullback," says Garrett Black, an analyst at PitchBook, which tracks deals in private capital investment.

All isn't gloom and doom in tech. In key categories, fewer start-ups are landing more early funding and increasingly are acquisition targets of cash-rich companies such as Apple and Google, says Gene Teare, head of content at Crunchbase, which was founded by TechCrunch and spun off last year.

“We see seed investors using a mix of approaches when picking focus industries," Crunchbase CEO Jager McConnell says. "When interest in a sector heats up across all stages, like virtual reality this past year, it’s common to see seed investors increase activity to capitalize on heightened demand for talent."

A trio of tech sectors are generating plenty of heat:

Augmented and virtual reality. Forty AR/VR firms have landed $45 million in seed and angel rounds this year. Last year, 39 companies raised $26 million.

Penrose Studios, a VR storytelling start-up founded by former Oculus executive Eugene Chung, received $8.5 million to lead the category. Next-generation video platform Sliver.tv was second, with $6.2 million.

Penrose aims to reinvent movies in VR

Machine learning. Some 88 start-ups have collected $100 million this year, compared to 80 raising $82 million in 2015. Among this year's crop: the maker of a smart baby monitor (Nanit, $6.6 million), learning technology (Volley Labs, $2.3 million) and a "Fitbit for cows" (Connecterra, $1.8 million).

Automotive.  At least 54 companies raised about $52 million this year, compared with 59 receiving $32 million in 2015. While a few work on autonomous driving, a large chunk are looking into ways to buy, sell, share, rent, park and repair cars, according to Crunchbase.

InstaCarro.com, a Brazilian marketplace for selling a car in less than an hour, led in funding, with $3.6 million. Wheelwell, a San Francisco-based online marketplace for auto parts and services, picked up $2 million.

The bigger picture, however, continues to be one of caution.

Investors today are more prudent with their bets, PitchBook analyst Black says, because of concerns over economic growth, the U.S. presidential election and China. "They're looking for companies with more proven metrics, experienced management and sustained market valuations," he said. "There's a natural lull after considerable exuberance (in VC funding the past few years)."

Despite the tempered environment, the biotech and AR/VR sectors continue to "chug along," Black says, pointing to $120 million raised by Thalmic Labs, a maker of wearable technology for "human computer interaction."

Indeed, companies landing large, later-stage deals, on average, are averaging $718 million in valuation — their highest in seven years — according to a ‎Venture Financing Report from Palo Alto, Calif.-based law firm Cooley LLP.

Follow USA TODAY San Francisco Bureau Chief Jon Swartz @jswartz on Twitter.