The problem with current venture funding is that so much money has been lost that many investors are reluctant to get back into the "murky" water with conditions so uncertain. Additionally, they feel much poorer than they did 18 months ago. There is a big overhang of inventory (some salvageable and some not) from the latest era of irrational exuberance. On the professional side, many VCs are struggling to keep the companies they have already invested in alive. A public apology from managers at legendary firms such as Hummer Winblad Venture Partners and Benchmark Capital Partners to their investors is testimony to this.

In the meantime another dynamic is at work. Why invest in a start-up when there are dozens of public companies trading for under $5 and even under $1.00-or even below net cash? Firms like InterNap, Kana Communications, or Global Crossing come to mind. A $25,000 - $100,000 investment in these companies can buy a lot of stock. These companies and their management have already been through the fire. This is one view being expressed by disciplined investors such as Art Lutzke, a former managing director of S.G. Cowan, who now privately invests in early stage companies.

This is not to say that there is no room for the new and the rewards of building something valuable. But this also must be tempered against down valuation rounds (sometimes called "cram downs"), which dilute early investor value. This has been happening frequently because cash-starved companies are "forced" to take whatever they can get in order to stay alive. This also adds risk to early investments.

For other investors, however, this is an opportunity to put money to work. For example, the savvy Adrian Alexander, principal of Technology Seed Capital Partners, LP, is doing this aggressively. According to Mr. Alexander, "the key to making investments in this climate is: 1) to provide sufficient financing for a company to achieve self-sustainability without dependence on an additional round, and, 2) to obtain terms that are so compelling that they can't be left on the table."

So, the message here is that while some entrepreneurs feel bewildered or depressed because the streets are no longer lined with lollipops and gold, smart people are focusing on having the fortitude to develop a very strong combination of 1) a good idea, 2) a strong management team that is really dedicated to the project, 3) providing proof of concept, 4) an openness to outside suggestion, 5) creating real value not just a get rich quick scheme, and, *6) real revenues that are not based on vendor financing or projected earnings but grounded in real sales.

This last point is particularly important because it validates that people are willing to pay what you project for your widget. According to Ben Goodman, Manager of the New York New Media Angel Investors Program, "Get beyond beta. Real revenues both give credibility to your financial models and help reduce your ongoing cash needs." This will make you more attractive to investors.

I recently heard a pitch from someone that wanted to give people waiting in line at restaurants a small screen device that would beam advertising to them. "Why," I asked "would anyone want to spend their time that way?" "Well," this man explained, "most people don't want to make idle conversation while they wait!" If you don't understand why this is a lame idea then you should definitely look into municipal employment instead of entrepreneurship.

Another idea that I recently heard was a web site for "makeovers." It would give women an opportunity to receive suggestions about hair color, make-up, jewelry and outfits. This idea is a perfect example of confusing the Internet with television. I'd sooner buy stock in AOL/Time Warner, Viacom or Fox. They know how to do this type of "programming" very well-whether it's on the Net or on TV.

Just because you can do it doesn't mean it should be done - especially with other people's money. Don't confuse a school project or a cool project with a business venture.

And don't get suckered in by media that thrive on making music that drives entrepreneurs to get up and dance. One new venture newsletter that I got today screams:

"Friends: over the past six weeks we've seen an amazingly surprising trend: despite economic concerns and the ongoing war on terrorism, venture capital investing has not only stabilized, but is robust, reaching over $500 million a week for the past six weeks. Today alone [our] database and email alert system tracked over $230 million in investments setting us up again for a big week."

Then, a pitch for subscriptions and conferences--it's deja vu all over again.

The truth is that investment is substantially down - for all reasons that have been discussed. In the record first quarter of 2000, for example, VCs invested $22.7 billion, according to a study by Venture Economics and the National Venture Capital Association. VCs backed more than half of the 139 companies that went public in that quarter, raising more than $7.1 billion. The fact is that there is now no easy exit strategy. This makes investors more nervous and more cautious.

Recent stock market turmoil shows that start-ups have had a BIG dependence on IPOs. That is why many VC firms have had a liquidity crisis-their capital is stranded in companies bought at high valuations that they can't get out of. That is why they are choosing to let some investments die and to support only the most promising businesses.

To some extent this has made VCs turn to strategies based on mergers and acquisitions. Your new company may be more attractive in this light than it is as a stand-alone enterprise. But some of that is being complicated by new rules concerning "the pooling of interests." This limits the ability of acquiring and acquired firms to blend their books because it also makes it harder for investors to determine valuations and performance. Overall, the nurturing period is now much longer than many investment funds had anticipated.

Also, don't be fooled into thinking that lower interest rates and added liquidity by the Fed will necessarily translate into easy lines of credit from banks. In fact, the opposite is true. The U.S Treasury Department regulates banks and examiners have been encouraging them to tighten their lending standards and to mark down their loan losses. This has made them scrutinize loan applications more aggressively than at any time in the last half dozen years.

Now it is true that the markets anticipate the economy and that there are signs that we have bottomed. But P/E ratios have a long way to go before they are at traditional levels of, say 15. The markets have almost returned to their pre-September 11 levels, but new investment certainly has not. There are, however, some signs of life. Things will eventually get better. New generations of products will be needed and invention will drive productivity and investment cycles.

Right now, entrepreneurs will need to do some things the old fashioned way: develop a service or a product and find customers who want to buy it. Then, build up the business and show that it can make money. I know this is boring and "plain vanilla." But if you think that, for example, we will soon need more fiber optic cables when the tiny glass strands that conduct light can be multiplexed into 70 colors then you're still living in the dark. Or, as more than one successful politician said: "It's the economy, stupid."

To read part one click here.