Proposals by India’s government to ratchet up taxes on local companies is raising concern among Silicon Valley venture capitalists, just as they seem poised to double their investments in the country’s burgeoning technology sector.

U.S. lawyers and overseas tax experts said recent statements by Finance Minister Palaniappan Chidambaram, who proposed a 35 percent tax on stock options issued by Indian companies and threatened to shut down an offshore tax haven, could stifle growing VC interest in the country.

“Hopefully someone will say something, because they’re shooting themselves in the foot,” said Tahir Naim, a senior associate at law firm Fenwick & West’s offices in Menlo Park, California.

Mr. Chidambaram’s comments come just as VC investment in India is poised to ramp up. Venture capital firms pumped $508 million into Indian startups during 2006, according a new report from Venture Intelligence and the US-India Venture Capital Association. That was up 124 percent from 2005 when VCs invested $224 million.

The National Venture Capital Association has forecast that VC investment in India will rise to $1 billion in 2007. One of the largest VCs, New Enterprise Associates, recently announced a new $200- million fund to invest in Indian technology startups, particularly in telecommunications, media, and outsourcing.

Optimistic Forecasts?

But some observers said that forecast could prove optimistic if the Indian government acts on the finance minister’s proposal to tax stock options. Under the proposal, employers in India would be required to pay a 35 percent levy on all outstanding stock options issued to employees. The law, if passed, would be retroactive, affecting not just options issued after April 1, but those that are currently issued but unexercised.

Another key issue is the Indian government’s proposal to clamp down on the Indian Ocean nation of Mauritius as an offshore tax haven. The two nations have a double tax avoidance treaty, which has made Mauritius the top source of foreign investment into India and the primary route for the majority of U.S. venture capital entering India. Critics have long argued the agreement allows Indian companies to avoid paying capital gains tax in India.

Observers at this point are unclear whether the two proposals will become law. The government has still not even released a formal budget proposal, but Mr. Naim said Delhi’s parliamentary process makes it likely the proposals will go into effect without substantial change.

Others including Raj Judge, a partner at Silicon Valley law firm Wilson Sonsini Goodrich & Rosati, and head of the firm’s India practice, said it was far too early to predict the shape the final budget.

“The dust hasn’t settled yet,” said Mr. Judge. “It’s difficult to figure out what the rule will be based on one quote from the finance minister. There has to be compromise. Many parties have their own agendas.”

Others said they would not be dissuaded from investing in India, regardless of whether the tax proposals become law. Said Rob Chandra, managing partner at Bessemer Venture Partners: "The long-term opportunity in India is too compelling to be materially impacted by some tax changes.”

It was another shot heard around the world.

Statements made Wednesday by India’s Union Finance Minister P. Chidambaram kept tax attorneys in Silicon Valley up late, firing off emails and alerts.

“Every exemption that has to be removed will be removed,” Mr. Chidambaram said, noting that India’s government would take another look at all of its tax exemptions with an eye to killing off most of them.

The objective, he said, was to establish a new exemption-free tax regime. But what worries attorneys the most are those related to stock options granted by foreign companies that have operations in India.

Of most concern to VCs are new regulations contemplated for options granted to employees in India after India’s 2007-2008 budget plan goes into effect April 1.

The new budget plan would tax outstanding options as “fringe benefits,” at a rate of 35 percent, to be paid by the employer.

Last-Minute Email

When Tahir Naim, a senior associate at Fenwick & West, learned about the contemplated changes, he had just finished penning an option agreement for a client operating in India.

He had to send an email to the client telling them to hold their horses. The law, if passed, would affect not just options issued after April 1, but those that have already been issued but had remained unexercised.

As in the United States, options in a company are a key way to attract and retain talent, and a way to reward entrepreneurial teams at software, biotech, and other technology companies. An overly onerous tax, many fear, will cap the boom in venture capital investing in India. VC investment had been projected to double in 2007 and perhaps break the $1-billion mark.

Mr. Naim, who is half-Indian, sounded both perplexed and resigned on learning the news.

“From my understanding, their budget process is much like the U.K.’s,” he said. “Deals are cut beforehand and the coalition behind the budget is put together, so it just goes on to pass. It’s likely to be a done deal. Hopefully someone will say something, because they’re shooting themselves in the foot here.”

He compared the situation to the United Kingdom’s effort to tax employers on exercises of options in order to fund its national healthcare plan. “That didn’t apply, fortunately, to already outstanding options, so this is potentially much worse,” he said.

Getting Tough with Taxes

The Indian government has been progressively tightening its legal system to ensure it gets what it deems its fair share of tax revenues.

Because most venture-backed companies operate from offshore—the African island of Mauritius is the favorite offshore location for VCs, with Cyprus and Singapore as runners-up—India has been changing its tax structure to lure companies onshore.

Part of that program taxes companies in key industries—biotech, software, nanotech, and others—the same as if they were incorporated offshore.

VCs Launching Funds

All this comes at a time when U.S. VCs are launching new funds in India. One of the largest VCs, New Enterprise Associates, recently announced a $200-million fund to invest in Indian technology startups, particularly in the telecommunications, media, and outsourcing industries (see NEA to Invest $200M in India).

Venture capital firms tucked $508 million into Indian startups, according to a recent report from Venture Intelligence and the U.S.-India Venture Capital Association. That was up 124 percent from the 2005 levels in terms of dollars, when VCs ponied up $224 million. Deal count rose proportionally as well, with 92 deals in 2006, up 109 percent from 2005.

Vector Capital on Tuesday said it had struck a $634 million agreement to acquire SafeNet, the troubled security software firm that has sacked senior management and faces Nasdaq delisting as a result of an ongoing investigation into its stock options backdating practices.

Vector’s $29 per share offer was agreed to by senior management and the company’s board, but shareholders have yet to approve the transaction. Lazard Asset Management, which holds 6 percent of the company, said the company was worth $34 per share. Lazard also cautioned that new suitors could emerge if Vector didn’t increase its bid.

Belcamp, Maryland-based SafeNet has developed a portfolio of hardware and software security products to protect communications, intellectual property, and information networks. The firm appeared poised for rapid growth in 2005, snapping up smaller security firms Eracom Technologies, MediaSentry, and DMDsecure.com.

But the company’s fortunes turned in early 2006 when the U.S. Securities Exchange Commission began investigating whether SafeNet improperly backdated stock options it granted to executives. Improper accounting issues then forced the company to acknowledge it would restate its earnings for 2004 and 2005.

That eventually prompted the October resignations of SafeNet CEO Anthony Caputo and president Carole Argo. SafeNet board chair Walter Straub stepped in as interim CEO, and the CFO was replaced by promoting the firm’s controller. Ultimately, fixing its financials cost the company around $14 million, the company said.

All that tumult spelled opportunity to San Francisco-based Vector Capital, which typically purchases troubled tech companies it considers undervalued, and in some cases, takes them private. Vector in 2006 sold LANDesk Group to Avocent for $416 million, a 10-fold return on investment for Vector.

Mr. Straub said in a statement that the company had evaluated its strategic options, and that being acquired by Vector was the most compelling opportunity. "In Vector, we have identified a partner that is committed to assisting the Company to fully realize its opportunities while we continue to address our issues and build momentum in our business," he said.

David Fishman, a principal at Vector said he was limited in what he could say about the deal which is pending, but said he believed that the pressures and expense of being public can limit growth, and that taking the firm private was the best solution.

SafeNet shareholders were expected to vote on the Vector offer by the end of the month.

Life sciences venture firm MPM Capital announced Monday it had closed its fourth fund at $550 million, a step back for the Boston-based firm that was rocked by the departure of six key executives in 2005.

MPM’s last fund, a $940 million whopper in 2002, gave the firm bragging rights to “biggest life science fund” ever raised. But MPM was shaken when a handful of managing directors bolted to found rival Clarus Ventures.

“We have something to prove this time around,” said Luke Evnin, managing director at MPM. “The LPs had to learn some new names and new faces, and that took some time.”

Ultimately, it took the full nine months to raise the new fund, a big change. Its first fund which raised $230 million in 1997 was the largest biotech venture fund at the time. That was eclipsed by its second fund, which quickly hit $600 million in 2000 and allowed MPM to retain its heavyweight title. MPM third fund swelled to a record $940 million.

MPM’s latest fund has been outstripped by a handful of larger rivals.In January, international life sciences investment firm Abingworth raised $600 million dedicated to life sciences investing in Europe. And in February, SV Life Sciences raised its fourth fund at $570 million, surpassing MPM.At least the firm can claim it remains larger than Clarus Ventures, which raised $500 million last December.

Scaling back was a necessary change in strategy, Mr. Evnin said, in part because the firm’s third fund went to more small deals than anticipated.

“That put pressure on.We have 37-plus companies in our fund three portfolio. If we did the same thing, that would be too big to manage year-in and year-out. You don’t want to be on ten, going on fifteen boards,” he said.

So why not make the partnership bigger? Culture and size, he explained.

“The whole issue of partnership dynamics comes in when you think about scaling up. You really can’t have 20 partners at the table and still have a good discussion,” he said.

James Clarke, head of private equity for the Kauffman Foundation, was among the limited partners who tripled his prior investment in MPM for this new fund.He said initially, the 2005 departures of MPM managing directors Robert W. Liptak, Dennis Henner, Nicholas Simon, Michael Steinmetz, Kurt Wheeler and Nicholas Galakatos were cause for concern.

“That rattled us, honestly,” he said. “But at the end of the day, it was clear there were a number of super smart guys in both camps. It was also clear that Luke (Evnin) and Ansbert (Gadicke) weren’t going to be content to live off past successes,” he said.Mr. Clarke said he was also reassured by MPM’s approach to the life sciences market, as well as its remaining GPs and those who moved up the ranks.

“They have a fully rounded view of the entire cycle—from soup to nuts. And they probably have the strongest scientific advisory board I’ve ever seen,” he said.

But when it came to choosing between the new MPM, and the Clarus teams, Mr. Clarke didn’t play favorites, and took stakes in both firms.

Menlo Ventures announced Friday it led a $21 million third round of financing for AeroScout, a company that develops radio frequency ID tags to help track objects in businesses.

This latest round, intended to last the company until profitability, brings the company’s total financing to $51 million.

The market for RFID tags is split into active tags—those that broadcast information wirelessly like AeroScout does—and passive tags, those that only broadcast information when they receive a radio signal. Menlo’s backing brings further validation of the niche that promises to give large organizations tags to keep track of expensive assets—not just to deter theft—but to make sure expensive assets are used efficiently.

San Mateo-based AeroScout touts its software programs that not only track objects, but also issue system alerts for how those objects should be distributed throughout a building, factory, or other facility, when groups of objects are ready for a new process.The concept is to save businesses time that might be spent looking for a piece of diagnostic equipment on a crowded factory floor or communicate to workers when a batch of medical devices are ready to be sanitized for new waves of patients.

The company is targeting the healthcare, manufacturing, and logistics markets, any one of which, noted AeroScout CEO Yuval Bar-Gil, would be enough to sustain the company. By going after all three, the company is looking to become a significant global player.

IDTechEx issued a report in January that said that while active RFID systems now amount to about 20 percent of the overall market, it remains the slice with the most growth potential.It noted that in the short term large “closed loop” markets—including the three AeroScout is pursuing—will “remain very profitable,” and that the race is now on for companies to position themselves as market leaders within different vertical markets. The report also predicts that by 2016, the value of the total market, including systems and services, will rocket to $26.2 billion, about ten times 2006 levels.

Mr. Bar-Gil said the latest round of financing will be used for research and development as well as sales and marketing.The company is working to simplify what it offers for a number of its high-profile partners, which include Intel, Cisco, and IBM.Intel Capital is also a strategic investor in AeroScout, which is also backed by Greylock Ventures, and Israeli VCs Pitango Venture Capital and Star Ventures.

Like many others, AeroScout is betting that wireless local area networks using Internet protocol will continue to be the standard most popular with enterprises. Mr. Bar-Gil said that standard is key to its sales story because customers looking at total cost of ownership often bridle at the notion of paying for yet another networking solution that may or may not tie in with their existing system.

Doug Carlisle, managing director at Menlo Ventures, said he thinks that’s a safe gamble.

It’s tempting for entrepreneurs and venture capitalists to design a company today with a notion of who will want to buy it tomorrow.But that irritates deep-pocketed acquirers, who would prefer companies simply innovate, and let buyers worry about what’s worth spending money on.

At a San Francisco venture capital conference Wednesday, the heads of corporate development at Google and Microsoft said firms shaping themselves expressly to be attractive acquisition targets were in for a rude awakening.

“The people that say they should build their companies to be bought by Google—I don’t think that’s a good idea,” said Salman Ullah, Google’s director of corporate development. “To be focused purely on liquidity paths isn’t very useful. When VCs ask what we should build, that’s not very useful, either.”

It’s understandable that big buyers like Mr. Ullah can get testy. VCs and their portfolio companies are eager to be appealing to companies like Microsoft and Google which have shown a healthy appetite for acquisition, and substantial war chests.Google, for instance, bought roughly thirty companies in the past three years. Microsoft buys between 15-20 companies per year.

To understand the attraction of getting bought, look no further than Google’s move last year to acquire YouTube for $1.65 billion—a healthy price for a company with no profit. At the same time, knowing how to appeal to a big buyer is an essential skill at a time when a company with $10-$50 million in revenues still has a difficult time going public on Nasdaq. To illustrate, there were 56 venture-backed IPOs in 2006 raising just $3.7 billion. Mergers and acquisitions, by comparison, raised $31.2 billion for 404 transactions during the same period.

Bruce Jaffe, vice-president of corporate development at Microsoft echoed Mr. Ullah’s comments. His take is that companies should do what they do best, and innovate.

“At the appropriate time we do talk about what we’re doing, and then they (potential acquirees) fit, or they don’t fit,” he said.

Suggestions for what makes a fit vary. Mr. Jaffe said he has a preference for management teams that are looking beyond just selling the company.

“Are these people that are looking to build a huge business? It’s okay for them to say help me grow. But there’s a balance between that and how they can utilize the assets that Microsoft brings, like our sales channel, and how they complement with our own R&D,” he said.

“There are many franchises that have been created that are the foundations of the companies we buy,” he said. Examples include Bungie Software Products, a game company bought in 2000 that created the successful Halo first-person shooter game. Along the same lines, Microsoft more recently bought Massive, a network for video game advertising that delivers ads for Microsoft’s Xbox Live and MSN Games.

Fitting in at Google is somewhat simpler. Google doesn’t care where teams are located, Mr. Ullah said, because software can be coded anywhere in the world. But the product that is being developed by the team should leverage Google’s core architecture. One of Google’s earliest acquisitions, DejaNews had built a Web-based interface to Usenet—one of the Internet’s earliest threaded messaging applications. Purchased in 2001, DejaNews ultimately became the core of Google Groups, which also allowed users to create their own private groups. One of its more recent buys, Writely had developed a word processing application, which became part of Google’s Docs and Spreadsheets service, and an open challenge to Microsoft’s Office software suite.

“If you look at the 30 acquisitions we’ve made over the past two or three years, you can see what kinds of products come out of those acquisitions. The products are new, but the deep infrastructure is ours,” he said.

Location is everything. That rule applies not just to real estate—it’s also what companies and their investors are counting on as the mobile and Internet spaces converge.

One case in point is the recent funding of Eagan, Minnesota-based Gearworks, which recently got $21.4 in a third round of financing from new investors Rho Ventures and Split Rock. The bet there is is that businesses will want to use location-based mobile applications to supervise mobile workforces and field-based activities.

The business case is twofold: Because the applications can be deployed through off-the-shelf cellular phones, carriers realize more revenue per user.In turn, Gearworks realizes returning revenues from its software-as-a-service model.

The company already has three major carriers as partners­—including Verizon Wireless Sprint, and SouthernLinc. Application vendors for Gearworks include software-as-a-service players like Salesforce.com, Points North, and TLMLink.

On the customer front, companies like Pepsi Bottling Group, Select Comfort and Roto-Rooter are using Gearworks’ technologies and services to route deliveries and deploy service workers to customers.

“There are a number of companies that are all focused on building the new mobile Internet, and I think we’re at an inflection point in the market where it’s finally attracting a lot of attention and capital,” noted Todd Krautkremer, Gearworks’ CEO. “Right now, we’re at a place where anybody that has the desire to deliver mobility and location-intelligent mobility to the mass of white, grey, and blue collar workers will be either a collaborator or a potential competitor of ours.”

By that measure, count Airclic, another recently funded firm, as potential competitor or collaborator. The Newtown, Pennsylvania-based firm raised $12.5 million in a third round of funding from JMI Equity along with prior investorsMotorola, and Zon Capital Partners.Airclic’s idea is to equip wireless devices like mobile phones and PDAs with barcode readers, add on global positioning tracking and connect those inputs to their backend systems that allows companies to track who scanned an item, when, and where they were at the time. Again, it’s a software-as-a-service model, and Airclic sees in supply-chain management, service technicians, and retail.

“We’re making the cellular phone into a business tool,” noted Airclic CEO Tim Bradley. “We’re trying to take all those issues keeping companies from adopting this model, by taking away the cost of hardware and the infrastructure. We can deliver it to businesses now for $300 or less per user, and applications can be delivered to a customer over the air, literally in days. Ultimately we think the cell phone will be the main transaction vehicle for customers in the field.”

Both Gearworks and Airclic have managed to attract a healthy amount of attention from venture capitalists. Airclic has raised a total of $23 million to date, and believes this will be its last round.Similarly, Gearworks has managed to attract $56.4 million in total capital, also likely to be the last it needs.

Both companies face execution challenges in terms of rolling out new services to meet customer demands quickly enough, and to that end are using the funds to build out products and sales and marketing teams.

What’s clear is that the the market for handset-based LBS (location based service) applications is likely to grow quickly over the next three years.A recent study by ABI Research notes that worldwide carrier deployments of LBS handset applications will top 144 million subscribers by 2010, with 76 million expected to be deployed within business customer environments.

There’s always room for a few more limited partners. Early-stage venture firm OVP Venture Partners announced over the weekend it had enlarged its latest fund, OVP VII, to $250 million, bringing in an additional $43 million since its first close last May.

While OVP is primarily West Coast focused, the new money is all East Coast. Meketa Investment Group, of Westwood, Massachusetts, and the endowment of the College of the Holy Cross in Worcester both participated, as did GKM Generation Funds (for the New

York State Common Fund,Olin College of Engineering, andthe Alfred I. DuPont Testamentary Trust in Jacksonville, Florida).

The new LPs join returning investors and long-time OVP backers Oregon Public Employees Retirement Fund, the Washington State Investment Board and the endowments of IndianaUniversity and KenyonCollege.

“We are always looking for top-tier groups with differential advantage,” College of the Holy Cross’ treasurer William Durgin said in a statement. “OVP’s leadership in the Northwest and its track record of proven performance meant they were the right choice for us as we expand our private equity program.”

OVP General Partner Chad Waite said he took the new investors and increased fund size as a vote of confidence that “speaks to the strength others see in the technological advances coming out of our region.”

The new fund tops its prior fund, OVP VI, which raised north of $190 million in 2002. OVP now boasts in the neighborhood of $750 million in capital under management.

The company has already put some of its 2006 close to work, leading a syndicate of investors to tuck a $10.5 million first round into GainSpan, a still-largely stealth spinout of Intel Corp. that develops low-power wireless applications.It also participated in a $20 million funding for Talyst, of Bellevue, Washington, which makes a number of medical technology products, mostly oriented around tracking drug inventories within a hospital setting. Finally, it has also backed fabless semiconductor shop Tzero, whose silicon and software products are used in products that deliver high-definition video for consumers.

The strategy for this latest fund remains consistent with OVP’s past practice, namely: pick 20-25 pre-revenue companies, back them with $1-5 million each, and look to invest between $8-$15 million in total over the life of each deal.From a sector perspective, OVP said it will continue to go after opportunities in communications, software, security, semiconductors, digital biology, and

nanotechnology. Geographically, it has a Pacific Northwest preference, but dabbles in the California market ­— GainSpan, for example is Silicon Valley-based, but is sufficiently under wraps the company has yet to say what city they hang their hats in.

London’s Index Ventures, an early stage investor in Europe, said Tuesday it closed a fourth fund round at more than $400 million.

That brings Index’s total capital under management to over $1.3 billion, which the firm invests in the information technology, life sciences, and clean tech sectors.

“What’s happening now, is that Europe has gotten to the point where it can support a number of great VC funds, and sophisticated LPs recognize that,” said David Rimer, co-founder and general partner at Index.

The firm also has brought aboard serial entrepreneur Saul Klein as a venture partner. Mr. Klein was formerly global marketing vice president at Skype, and before that he founded VideoIsland, Europe’s answer to Netflix for online DVD rentals.

It also hired Mark De Boer, former founder of PanGenetics, an Index portfolio company that develops and licenses antibodies to treat pain, arthritis, and other ailments. Index announced it had promoted principal Michèle Ollier, formerly with LCF Rothschild Venture Partners, to partner status, a move to build up its life sciences practice.

Online video company GoFish said Monday it has agreed to acquire New York-based Bolt Media in a stock transaction valued at up to $30 million.

The combined audience should create the largest independent online video company, outside of Google-YouTube, on the web with roughly 7 million monthly unique visitors in the U.S., according to Comscore Media Metrix, and over 19 million globally.

It also offers a chance for Bolt to put a lawsuit for copyright infringement behind it, filed last October by music giant Universal Music Group.

GoFish CEO Michael Downing said conversations have been ongoing with UMG’s lawyers, and he expects to put that to rest as soon as possible—likely through settlement, but the exact figure remains in negotiation.

Whether GoFish has the capital to pay up on a multimillion-dollar lawsuit is an open question. It went public last October through a reverse merger into Canadian firm Unibio, shortly after it raised $12 million from a consortium of hedge funds, micro cap and individual investors.Given that the acquisition is an all-stock transaction, GoFish’s cash reserves remain largely untapped. Presumably a revenue-sharing agreement with UMG might sweeten the deal as the negotiations continue.

Mr. Downing said he has a good relationship with UMG, owing to his prior experience founding MusicBank, a San Francisco-based music-sharing service he co-founded in 1999 that ultimately tanked for lack of funding in 2001.He took his lumps, but he has since maintained his connections.

“With MusicBank, we were making the first legal subscription model for music, so as a result, I got to sit with all the major labels and designed and constructed the first subscription license model for music,” he said. “We learned from that, and where I think we could be of some assistance with Bolt’s litigation, because GoFish has had a partnership and licensing arrangement with UMG since 2005.”

He also evidently learned a bit about fundraising from his MusicBank experience. That company had been backed by $20 million from music giant Bertelsmann, but it failed to raise a second round.

With GoFish, Mr. Downing elected to avoid VCs, and he chose to work directly with private investors.

Intel Capital on Wednesday announced a bet in the ongoing Internet telephony battle.

The chip maker led a $7 million third round of financing for Los Angeles-based Fonality, a company that makes Internet phone systems for small businesses. Previous investor Azure Capital Partners also participated in the round, which brings the firm’s total funding to $12.5 million.

It’s a market that’s already crowded with a number of players ranging from the very large, such as Avaya and Siemens, to the small to midsize, such as Shoretel, Switchvox, TalkSwitch, and others.

It’s a packed space for a good reason. Industry watcher IDC forecasts the market for Internet-powered private branch exchanges (IP PBX) as growing 23 percent per year, with the U.S. market hitting $8.9 billion by 2009.The global market is expected to be about two to three times that size.

But Intel estimates Fonality’s chances are good. The company, which boasts 80 employees, hit black ink last year, and it currently serves more than 1,600 businesses in 25 countries.

Intel Capital senior investment manager Venu Pemmaraju said he thinks Fonality’s line of IP PBX equipment is just the ticket for Intel’s small and midsize business area. He also likes Fonality’s 1,700 customers and its plans to use the funding to grow rapidly.

“Everyone knows that selling to the SMB (small and midsize business) market is one of the hardest things to do,” Mr. Pemmaraju said.

And there’s another reason Intel went for Fonality: CEO Chris Lyman’s earlier experience running hosting company Virtualis, which showed how he could serve 100,000 hosting customers without losing his shirt. The similarities of IP PBX service and web-hosting networks are close enough to make that experience really count, Mr. Pemmaraju said.

For Mr. Lyman’s part, the Virtualis experience offered a few lessons about how and when to raise money.

“What I learned from that is that the pioneer doesn’t always win,” he said.

Notable among Fonality’s competitors is Huntsville, Alabama-based venture-backed startup Digium, which in August drew $13.8 million in a first round of funding from Matrix Partners.Both it and Fonality offer systems at $995, but Digium’s product is software based while Fonality’s is a mix of software and hardware.

European companies sucked in venture capital in excess of $5.3 billion in 2006, hitting a four-year high, according to a report released Tuesday.

The numbers from Dow Jones VentureOne and Ernst & Young suggest investors have taken more risks in early stage rounds and emerging industries.

As it did in the U.S., investment in communications, networking, and alternative energy sectors escalated in 2006. Communications and networking investments jumped 98.7 percent, from $322 million in 2005 to $640.1 million in 2006.

Energy investments climbed 14.4 percent between 2005 and 2006. Semiconductor investments climbed 32.7 percent to $540.7 million for the year.

The biggest losers were in medical devices and equipment, with investment in that sector falling 32 percent to $311.6 million in 2006. Consumer and business products investing also fell sharply, dropping 44.9 percent to $34.6 million year to year.

Stephen Harmston, VentureOne’s director of global research, said in a statement that the VC environment in Europe is becoming very selective and when VCs find a company they like, they tend to bet big. He added that is increasing competition for a limited supply of sound deals, thereby pushing median round sizes up to new heights.For instance, information technology investing saw median round sizes topping $2.6 million each quarter of the year, the first time that has happened since 2000, he said. “Additionally, the median size of health care deals, at ($3.6 million) overall for the year, was an all-time high,” he said in the statement.

Investor choosiness had a number of downsides, shrinking overall deal numbers in all stages save seed rounds. Later stage rounds fell most sharply for the year, down 37 percent from 2005 levels to total 284 deals for the year. Second rounds also had a sharp fall, off 34 percent from 2005, to tally up 168 deals in 2006. First rounds, which saw 317 deals in 2006, were still off 11.4 percent from 2005 levels. Seed rounds escalated a meager 3.7 percent to 28 deals for the year.

The amount of venture capital flowing into European companies hit a four-year high, topping $5.3 billion in 2006.But instead of VCs deploying capital in tried-and-true sectors, the latest numbers from Dow Jones VentureOne and Ernst & Young show investors taking more risks in early stage rounds, and emerging industries.

As in the U.S., investment levels in communications and networking, and alternative energy sectors escalated in 2006.Communications and networking investments exploded 98.7 percent, from $322 million in 2005 to $640.1 million in 2006.Energy investments climbed 14.4 percent between 2005 and 2006. Semiconductor investments also showed gains, up 32.7 percent to $540.7 million for the year.

The biggest losers were in medical devices and equipment, with investment in that sector falling 32 percent to $311.6 million in 2006. Consumer and business products investing also fell sharply, dropping 44.9 percent to $34.6 million year to year.

Stephen Harmston, VentureOne’s director of global research said the VC environment in Europe is becoming very selective and when VCs find a company they like, they tend to bet big. He added that is increasing competition for a limited supply of sound deals, thereby pushing median round sizes up to new heights.For instance, information technology investing saw median round sizes topping $2.6 million each quarter of the year, the first time that has happened since 2000, according to Hamston. “Additionally, the median size of healthcare deals, at ($3.6 million) overall for the year, was an all-time high,” he noted in a statement.

Investor choosiness had a number of downsides, shrinking overall deal numbers in all stages save seed rounds. Later stage rounds fell most sharply for the year, down 37 percent from 2005 levels to total up 284 deals for the year. Second rounds also had a sharp fall, off 34 percent, from 2005, to tally up 168 deals in 2006. First rounds, which saw 317 deals in 2006, were still off 11.4 percent from 2005 levels. Seed rounds escalated a meager 3.7 percent to 28 deals for the year.

VCs were also picky about geography—pulling out of Switzerland, Sweden, and Ireland particularly, and putting significantly more money into companies based in France and the United Kingdom.France was the biggest winner, with investment escalating 19.5 percent from $843.8 million in 2005 to more than a billion dollars in 2006.Investment in the UK shot up 13.4 percent between 2005 and 2006 hitting $1.7 billion, the most since 2002.

Renewed interest in semiconductors, and a preference for England’s green and pleasant land fueled the largest deal of the fourth quarter and among the largest of the year for semiconductor firm Plastic Logic of Cambridge, which took in $107.8 million in a later stage round.The UK was also a sweet spot for energy deals with tidal energy firm Ocean Power Delivery of Edinburgh, bringing in $24.7 million for one of the largest energy deals of the year.

It's not often a venture capitalist invests in a telecommunications infrastructure company, which is why Onset Ventures announcement today of a $7.1 million first round of financing for a Campbell-based company is so unusual.

The company, Brilliant Telecommunications makes a device that measure time down to the picosecond, and its aim is to disrupt markets dominated by companies like Symmetricom, IDT, and others.Asset Management, Draper Associates, Draper Richards and Intellect Capital Ventures also participated in the round.

Tier 1 telecommunication firms and cable companies use time-synchronization solutions to support applications related to network security, billing systems, electronic transactions.As major carriers contemplate advanced services like media delivery using Internet protocols, timing and synchronization become even more important.

Onset’s bet is that the need for infrastructure upgrades will fuel demand for Brilliant’s products.Susan Mason, general partner at Onset, said the opportunity is spurred by the need for traditional networks to interface to Internet Protocol-based networks, without dropping calls.That Brilliant has been able to pull that off is a key achievement.

“The networks have discovered that the users of the world want things instantly, so batch or delay in signal isn’t possible,” she said. “The carriers know there’s a need for timing synchronization, and the question they ask is ‘is this the right one for me?’ With Brilliant, the checkout time is really rapid, less than 90 days, so they can get it through lab trials and into operation quickly.”

That plug and play aspect is key, because telecom and cable companies are (again) trying to beat each other to market with advanced services.

“They have a lot of these cool applications coming down the pipeline, and the infrastructure needs to be upgraded quickly, because what has been used in the past is really archaic.”

“The players in space been around for 50 years, and there hasn’t been a tremendous amount of competition or strong advances in the space. They’re big, they have a captive audience, but we intend to be a disruptive influence,” said Link Verstegen, VP of sales at Brilliant.

Besides vying to offer greater accuracy than its competitors, Brilliant’s other selling point is ease of installation. Providers like Symmetricom typically uses a product that comes in two parts—a global positioning receiver antenna, typically shielded by a weatherproof enclosure, and a massive cable that drops from the antenna to a rack-mounted server.

“It’s a rigid cable, it’s tough to install, it has a wide bend-radius, and you have to bore huge holes through floors just to get the GPS signal inside,” Mr. Verstegen said.

“Ours has zero-footprint. It’s a standard Ethernet cable that goes direct to the datacenter, which you can toss over rafters or drop down a heating duct.”

But disrupting the businesses of established players won’t be easy. For one, Symmetricom has a market cap of around $400 million, and a price to earnings ratio of 433.5, indicating investors are expecting exceptional earnings growth in the future.The annual (2006) figures for Symmetricom show a company whose revenues have been largely flat year-to-year, hovering around $188 million. But its cash flow has fallen off dramatically, from $17.9 million in 2005, to $3.8 million in 2006.

Earlier this month, the company acquired Camarillo, California-based QoSmetrics for $16 million.That company makes testing equipment used to monitor IPTV, VoIP and video-on-demand streams.Prior to the sale, QoSMetrics had received venture backing from CDC Enterprises Innovation, Innovacom, and TechFund Capital.