Venture capitalists warm up to Internet again

Another danger is the relatively small amount of capital required to fund a Web 2.0-type company, which has started to crowd markets with competitors. "This week alone I've seen four different plays with a social net model for distributing music online," McCall says.

Free IT resource Hear how top CIOs turn change into a competitive advantage. Sponsored by HP Free IT resource Try Sun servers, workstations and storage products free for 60-days. Sponsored by Sun Microsystems

Meanwhile, it's clear that entrepreneurs who relax in this climate of optimism will not get much attention from venture capitalists. "I am looking for entrepreneurs with the drive and vision to take on the enormous challenge of competing with companies many times their size with far more resources. I want business models with clever plans to win over the long haul, and I want markets big enough to justify a DFJ investment," says Timothy Draper, founder and managing director of venture capital firm Draper Fisher Jurvetson (DFJ) in Menlo Park, California, in an e-mail interview.

McCall also sees some venture capitalists, giddy with optimism, overfunding companies, relaxing their due diligence process and lowering the return expectations. "There's an enormous opportunity," McCall says. "But it's critical for startups to have a legitimate business model, understand the domain they're playing in and understand why your customer needs to buy, and buy often and a lot."

While venture capitalists must avoid past mistakes, they can't get overly conservative either. "With the constantly changing environment we face, we cannot get locked into any pattern recognition, since what works keeps changing," Draper says. "If we don’t make mistakes we are not 'venturing'."