This week we've invited Peter Kuper to comment. If you've ever met Peter, you won't be surprised that the topic of this week's post is the crisis amongst innovators. Thanks, Peter!

By Peter Kuper

Google made it entirely impossible for anyone to deny the harsh reality: We are pwned. The call for better security solutions has never been greater – it is headline news not in some geek blog, but the New York Times. We’re finally getting the attention the problem deserves! Any day now we should be seeing money raining down all over security as the brains would be getting endless calls from investors worldwide, the big tech providers creating a buying frenzy to snap up and rush the leading products to market and the new solutions and ideas would line up for long as far as the eye could see.

The reality is the exact opposite – the reality is the entire ecosystem for the innovative ideas to solve this undeniable problem is at a critical state: the money has left the building and likely ain’t coming back anytime soon. Venture Capitalists have run from security as the easy money returns showered on them from the Symantec’s and McAfee’s of the tech world let alone the IPO’s has all but disappeared. At a time when our economy needs the VC’s the most, they’re not willing or able to step up.

The latest data from VentureWire confirms these fears:

• - Venture-backed cyber-security start-ups secured just $626 million…in 2009, less than half the amount they raised in 2005
• Buyers are smaller, as are the targets - acquiring entities are mostly “rollups” meaning amassing a portfolio of technologies just for reselling purposes, not advancing the cause (or roadmaps for that matter)
• E.g., Barracuda Networks “made nine acquisitions since taking $40 million in financing from Sequoia Capital and Francisco Partners in 2006”.
• "There's a lot of great technologies that haven't gotten traction and people can't see how to profit from it, that are forced into a position to sell when normally they wouldn't be looking to (sell)," Dean Drako, CEO Barracuda Networks.

It is a simple cycle: The companies need to sell as the capital to sustain operations has largely evaporated – less sales, less funding leads to more distressed EOLs.

But the slippery (ugly) slope doesn’t end for us poor users there. Even worse, the large security and other technology providers that purchase the private companies with the better technologies are then, in most every case killing off the R&D and product road maps. The overall data shows the undeniable trend: Despite the over 388 deals completed by the top 10 tech companies, including 276 between 2005-2007, R&D levels declined. Where did the R&D go?

Source: Publicly reported data

Public companies acquired are no exception either; IBM paid $1.3 Billion for ISS and what has become of those technologies? More distressing perhaps is that the problem will linger as the VC’s aren’t stepping in to replace the nearly 400 companies wiped off the earth in the past 5 years. The main driver of this is the VC’s are looking at the exit valuations. According to the 451 Group, the returns for technology deals are simply lower.

Cooley Godward’s report captures the reality of VC’s risk aversion. Over the past four years, fewer early stage deals are being completed for later stage investments. Later stage rounds have increased to 39% in 2009 from 33% in 2006 – the gains came from the A rounds (30% in 2009 vs. 37% in 2006) as Series B stayed the same (30%).

Source: Cooley Godward Kronish

Who cares if the VC’s aren’t there?! They weren’t much help anyway some have cried. While that may be true in some cases, the dollars for R&D aren’t coming from the larger companies either. As Goldman Sachs illustrates in the table which follows, IT has historically been the largest R&D spender versus any other industry, yet it dropped by 6% in 2009 and is expected to increase just 3% this year.

And the even harsher reality is that VC’s and public vendors provide the lion’s share of research dollars.

So for now anyway we’re screwed. Of course, eventually the market, as it should, will find an answer. “SuperAngels” is fast becoming a recognized term as wealthy individuals and groups of such step in to fund Series A deals that are harder to fulfill in this environment. Boot-strapping is also returning to vogue which has some very useful residual effects. While growth might be hampered from a lack of resources, running a frugal ship from day one avoids the cash burn trap many startups fall into as well as retain higher ownership of the company. But given the overall saturated state of attack surfaces, something’s got to give if we hope to fight back let alone win, anytime soon.