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Facebook's IPO Put Chill On VC Spending, Tech IPOs

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Wall Street wasn't the only one who felt the pain when Facebook's IPO flopped last year.

Young companies looking to get funding from venture capitalists also took a hit as investors became more selective on what companies to back.

(Read More: The Innovation Gap: Peter Thiel vs. Marc Andreessen )

"Facebook was a letdown," said Sanjeet Paul Choudary, a venture adviser who analyzes start-up strategies.

While many speculated that Facebook's massive IPO would pave the wave for many big tech IPOs to follow, things didn't exactly shake out that way. Instead, optimism about investing in start-ups generally decreased after the Facebook IPO and VCs began to look beyond social networking companies for more sustainable investments, Choudary said.

Following Facebook's botched public offering, venture capital investments saw a steady decline, according to a MoneyTree report by PricewaterhouseCoopers and the National Venture Capital Association based on data from Thomson Reuters data.

VC investments fell from $7.3 billion in the second quarter—when Facebook had its IPO—to about $6.5 billion in the third quarter. In the fourth quarter total investments fell again to about $6.4 billion, but the number of deals rose slightly.

(Read More: How the Fed's Policy Helps Push Start-Ups to a Billion Bucks )

Things got even worse in the first quarter of this year when VC investments fell again to $5.9 billion.

(Read More: Venture Capital Funding Slows in the First Quarter: Report )

But Facebook's era of post IPO trials didn't just translate to VCs being more selective with investments, it also solidified many entrepreneurs' fears about going public.

"The new running theory among new entrepreneurs is never take your company public or don't do it as long as you possibly can," Marc Andreessen, co-founder of the venture capital firm Andreessen Horowitz, said Tuesday on CNBC while speaking generally of start-ups going public.

(Read More: We Are Living Through a 'Tech Depression': Marc Andreessen )

Because of "over-regulations," Andreessen said that entrepreneurs see the public markets as "incredibly hostile," so there's a big disincentive for young entrepreneurs to take their company's public.

But the negative sentiment in the market and the decline in VC funding wasn't just Facebook's fault, said Tracy Lefteroff, global managing partner of the venture capital practice at PwC.

"I don't think you can single out one company," Lefteroff said. "It was more social networking in general. There were several companies making the Street initially act with irrational exuberance. I think the expectations for social networking was a little bit of irrational exuberance. Now, what they are finding out is you have to have a solid business to regenerate a continuous revenue model. If you don't have that you know people get bored with social sites and they continue to move away."

It's also important to note that the VC business is a cyclical business and recently it has been going through a "bottoming" out phase where VCs have made difficult decisions regarding what companies to eliminate, Lefteroff said.

However, there are already signs that this cycle is ending and that the VC business is starting on a new wave of growth, he said. And one of the big areas VCs are putting money is into software, specifically enterprise software, Lefteroff said.

The software industry has been a bright spot for VC investments during the last several quarters. While 15 of 17 industry categories suffered investment decreases in 2012, software and retail/distribution attracted more capital from VCs, according to the PricewaterhouseCoopers report.

Software investments rose again in the first quarter this year with $2.3 billion invested, an eight percent increase from the previous quarter.

However, while VC investments are likely to grow, it will take a little longer for the public markets to warm up to tech IPOs again, Choudary said.

"I think it will hurt for a bit because the public markets are largely driven by sentiment and there is a negative sentiment for the IPO market," he said. "Now there has been a correction period. It takes at least a year or so to recover from that."

_By CNBC's Cadie Thompson. Follow her on Twitter at @CadieThompson

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