Cybersecurity startups start to see slump in VC spending

Sector still attractive, but investors more cautious about where they put their dollars

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Ven­ture cap­i­tal fund­ing in cyber­se­cu­ri­ty is cool­ing. And it’s show-me time for star­tups bat­tling for the dwin­dling pool of funds.

While the cyber­se­cu­ri­ty mar­ket is matur­ing, star­tups are still inno­va­tion dri­vers and ven­ture cap­i­tal­ists are keen on find­ing the next big uni­corns. Large enter­pris­es’ ten­den­cy to jug­gle prod­ucts from mul­ti­ple vendors—despite their wish­es for seam­less, one-ven­dor-only solutions—leave the mar­ket per­pet­u­al­ly frag­ment­ed. And the fact that cyber­se­cu­ri­ty threats are ever­green enables ven­ture cap­i­tal­ists who spe­cial­ize in the sec­tor to oper­ate with lit­tle regard for broad­er macro­eco­nom­ic conditions.

Relat­ed pod­cast: VC firm seeks port­fo­lio of star­tups to sup­press cyber adversaries

Still, the ample oppor­tu­ni­ties afford­ed by the frag­ment­ed, con­stant­ly shift­ing mar­ket have bred too many me-too com­pa­nies and fast fol­low­ers, dri­ving some ven­ture cap­i­tal­ists to pause and reflect on the next phase. “It’s def­i­nite­ly over­fund­ed, mas­sive­ly so,” Ravi Viswanathan of New Enter­prise Asso­ciates told a pan­el at CB Insights’ Future of Fin­tech Con­fer­ence last year.

Bob Ack­er­man,
Allegis Cap­i­tal founder and man­ag­ing director

You saw a mate­r­i­al pause in the fourth quar­ter,” says Bob Ack­er­man, founder and man­ag­ing direc­tor of Allegis Cap­i­tal, which spe­cial­izes in the sec­tor. “You have too many undif­fer­en­ti­at­ed com­pa­nies. There’s a lev­el of noise that devel­ops as a result of that. … Cyber­se­cu­ri­ty is one of those areas where expe­ri­ence and domain knowl­edge mat­ter a great deal.”

After grow­ing steadi­ly since 2012, ven­ture cap­i­tal fund­ing in cyber­se­cu­ri­ty dipped in 2016, alarm­ing entre­pre­neurs. The cyber­se­cu­ri­ty mar­ket cap­tured rough­ly $3.1 bil­lion of ven­ture fund­ing in 2016, down from $3.8 bil­lion a year ear­li­er, accord­ing to research firm CB Insights.

The cyber­se­cu­ri­ty mar­ket will under­go a few years of retrench­ment with a host of com­pa­nies shut­ting down, VCs say.

More judi­cious spending

But the mar­ket is hard­ly mature. Mon­ey will still be spent, just more selec­tive­ly. At this phase, few­er deals will be struck. But those deals will be reserved for larg­er com­pa­nies, with proven prod­ucts fur­ther along in development.

The deal size and val­u­a­tion is com­ing down a bit,” says Sean Cun­ning­ham, man­ag­ing direc­tor of Tri­dent Cap­i­tal Cyber­se­cu­ri­ty, which raised $300 mil­lion this month for a fund to invest in cyber­se­cu­ri­ty star­tups. “I don’t think there’s any short­age of cap­i­tal for the right type of com­pa­nies. But the dol­lars being invest­ed are smaller.”

Appthor­i­ty is one of the com­pa­nies that made Trident’s cut. Appthor­i­ty, which devel­ops mobile threat pro­tec­tion soft­ware for cor­po­ra­tions, didn’t land its first pay­ing cus­tomer until more than a year after it was found­ed in 2011.

Four years lat­er, its cus­tomer renew­al rate stands at 98 per­cent, with about 20 per­cent of its rev­enue com­ing from the gov­ern­ment sec­tor. Heart­ened by sol­id proof of growth, ven­ture cap­i­tal­ists poured in anoth­er $7 mil­lion in Series B fund­ing last July, led by Tri­dent Cap­i­tal Cybersecurity.

Sean Cun­ning­ham. Tri­dent Cap­i­tal Cyber­se­cu­ri­ty man­ag­ing director

You’re going to see a lot of star­tups out there, and good ones will rise to the top,” Cun­ning­ham says. “There’s ample sup­ply of cap­i­tal to fund them. They can get traction.”

Inno­va­tion niches

As seen in the ear­ly days of the inter­net, the cyber­se­cu­ri­ty mar­ket is recal­i­brat­ing for a sec­ond wave of inno­v­a­tive tech­nol­o­gy that’s more com­pre­hen­sive and cohe­sive. And that means more seam­less prod­ucts for large clients who are eager to cut down on the num­ber of vendors.

Com­pa­nies that can stand on their own two feet, deliv­er val­ue, and have deep knowl­edge will do fine,” Ack­er­man says, cit­ing one of the com­pa­nies he’s invest­ed in, EnVeil, which uses “homo­mor­phic encryp­tion” to secure data in operation.

As more com­pa­nies employ automa­tion and “big data” to enhance effi­cien­cy and find new mar­kets, data encryp­tion prod­ucts will con­tin­ue to be in heavy demand.

The emer­gence of the indus­tri­al internet—the inte­gra­tion of com­plex machines to net­work sen­sors and software—also will breed star­tups eager to pro­vide cyber­se­cu­ri­ty solu­tions to pow­er and water grids, refiner­ies and pipelines.

In May, Tri­dent helped raise $6.6 mil­lion in Series A fund­ing for Bayshore Net­works, which devel­ops cloud-based soft­ware that offers “vis­i­bil­i­ty” into oper­a­tional tech­nol­o­gy infra­struc­ture, net­works, machines and workers.

Mean­while, the pro­lif­er­a­tion of enter­prise mobile devices will con­tin­ue to see vul­ner­a­bil­i­ties and pose a ripe mar­ket for star­tups like Appthor­i­ty, Cun­ning­ham says.

Ear­ly investors haven’t gone away

That VC dol­lars are chas­ing more evolved com­pa­nies doesn’t mean ear­ly-stage invest­ing is passé, Ack­er­man says. “That’s where the new things get started.”

But cyber­se­cu­ri­ty, unlike more con­sumer-ori­ent­ed tech­nol­o­gy sec­tors, is a com­pet­i­tive and dif­fi­cult mar­ket, rife with star­tups strug­gling to recruit and mar­ket products.

That’s part­ly why Allegis fund­ed Data­Tribe, a start­up stu­dio based in Ful­ton, Mary­land. It was designed to tap into the wealth of cyber­se­cu­ri­ty-savvy tech­nol­o­gists in the region with expe­ri­ence or ties to the fed­er­al gov­ern­ment and intel­li­gence agencies.

Ack­er­man also antic­i­pates more merg­ers and acqui­si­tions activ­i­ty from large cyber­se­cu­ri­ty com­pa­nies that may find it eas­i­er to acquire small­er niche play­ers as they seek to add new prod­uct lines.

As ven­ture cap­i­tal­ists squeeze their wal­lets, star­tups lucky enough to land Series A fund­ing also will have to jus­ti­fy more vig­or­ous­ly their pur­suit of Series B fund­ing, Cun­ning­ham says. “And uni­corns are in trou­ble,” he says, refer­ring to star­tups val­ued at over $1 billion.

The Trump factor

Mean­while, ven­ture cap­i­tal­ists are hope­ful that the fed­er­al gov­ern­ment, with Pres­i­dent Trump at the helm and promis­ing a roll­back in reg­u­la­tions, will cut steps in fed­er­al pro­cure­ment and stay engaged in secur­ing networks.

We think the admin­is­tra­tion under­stands the val­ue of nation­al cyber­se­cu­ri­ty,” Cun­ning­ham says. “We’re not count­ing on incre­men­tal increas­es in spend­ing. But we’re excit­ed about the aware­ness level.”

More sto­ries relat­ed to cyber­se­cu­ri­ty investments:
Ven­ture cap­i­tal­ists start to tap into cyber­se­cu­ri­ty potential
Despite cyber­se­cu­ri­ty boom, few­er firms acquired or go public

Posted in Cybersecurity, Featured Story