Startups and entrepreneurs need to be realists. You need to accept the fact that the down economy over the last couple of years has changed the way in which venture capitalists see the world, so you should adjust your strategy and expectations in dealing with them.

While the amounts were down, the number of startups that took slices of the pie went up by 9 percent (780 total), perhaps signaling that investors are trying to be more economical with their funds. Despite the third-quarter funding drop, though, funding for the full year still looks to be higher than it was in 2009.

So the venture process isn’t dead yet, despite all the rumors. But the amount invested did decline 7 percent to $4.8 billion in the July-September period, compared with $5.2 billion invested during the same three-month period in 2009, according to the National Venture Capital Association (NVCA).

There is no doubt that many VCs are still holding onto their cash while they wait for conditions to improve — a lemming-like mindset of cash conservation that won’t help pull us out of the downturn. Many of the large endowments that invest in the venture industry have seen their net worth plummet. The market is coming back, but it is still well under water.

So what can you do to optimize your chances of getting a chunk of the money? Here are some recommendations I have heard from the experts:

• Move your company to Silicon Valley or Boston. VCs have pulled closer to home and hunkered down. Like angels, they like to touch and feel their investments. About half of the VC dollars and deals come from these two corridors, so it helps to be there.

• Move your company to China, India, or Israel. Amazingly, it you can’t be where VCs live, the next best thing is to be way out in the new frontiers of investment. Overall, venture capital investment fell in the United States last year but rose elsewhere. This is called overseas speculation in big growth opportunities.

• Get in a recession-proof sector. Many sectors where VCs have traditionally made the biggest home runs have faded or matured. These include chips, computers, software, telecom, and the Internet. Last quarter winners were clean tech, biotech, and medical.

• Personal networking is key. Unless you know a VC personally, the chance of getting them on the phone and pitching them, before they have had a chance to look over some kind of summary, is zero. An entrepreneur should use advisors to find someone “on the inside” who can make personal introductions to investors.

• Hone your executive summary. Once introduced, your best entre is hitting the VC with a well-honed executive summary. Here are the “big four” that must be in the summary – what you do and what space you are in, how you make money, your competitive advantage and your funding plans.

Make no mistake, the first priority for VCs this year will be to provide more monetary support towards existing investments and companies, As a result, young, innovative companies are being hit hard. Many believe that investing in new technologies and paradigm shift products is too risky a move in today’s down economy.

The upside of the down economy is that it opens prospects to obtain great deals. Luckily, some VCs feel that the best time to invest is during a struggling market, when both valuations and competition are at an all time low.

I believe that startups and venture capital firms that struggle but survive in 2010 will emerge stronger in 2011, making that a year of recovery and renewal in the investment world. Be there.

What if your Google search for ‘Paris Hilton’ listed your top result as the Hilton Hotel in Paris, because it knew your interests were not in the other direction? This is the current dream of Tim Berners-Lee, the man who invented the (first) World Wide Web.

He calls his dream ‘Web 3.0’ or the ‘Semantic Web,’ meaning it understands user context. He and many other experts believe that the Web 3.0 browser will act more like a personal assistant than a search engine. As you search the Web, the browser records your interests in your local storage. The more you use the Web, the more your browser learns about you, and the more relevant will be your results.

Current advertising and public relations startups are already thinking along these lines in fields all the way from clothes shopping, art galleries, online advertising, to managing press releases. In some ways, these aren’t that different from the old Amazon.com “recommendation engine,” which suggests new products based on your surfing and buying habits, but they go much further.

Someday you will be able to ask your browser open questions like “Where should I take my wife for a good movie and dinner?” Your browser would consult its intelligence of what you and she like and dislike, take into account your current location, and then suggest the right movies and restaurants. If you are the first to deliver this, your startup can be the next Google success!

But some are skeptical about whether the Semantic Web – or at least, Berners-Lee’s view of it – will actually take hold. They reference other technologies also trying to reinvent the online world as we know it, from 3D virtual worlds to intelligent avatars. Web 3.0 could mean many things, and most of the possibilities have not yet been invented.

The Semantic Web isn’t really even a new idea. This notion of a Web where machines can better read, understand, and process all the data floating through cyberspace first surfaced in 2001, when a story appeared in Scientific American. This article describes a brave new world where software “agents” lead the way in performing Web-based tasks that elude most humans.

A current example is the GetGlue from AdaptiveBlue. If you visit a movie blog, and read about a particular film, it immediately links to sites where you can buy or rent that film. Another example is WolframAlpha, an amazing computational engine that went live recently, which creates intelligent results, graphs, and reports from any natural language question.

But we are a long way from agents that can do full natural language processing and think on their own (artificial intelligence). A recent startup, Alitora Systems, provides software to enterprises based on a natural language processing (NLP) engine.

It builds knowledge statements from unstructured media files – that’s a particular challenge for the life sciences where high-value knowledge about many things, such as the relationship between genetics and disease, lies hidden within journal articles, research papers, clinical trial data, FDA websites, and even graphical data.

But extracting information from even less structured data such as Twitter feeds is a very different and sometimes more difficult knowledge extraction problem. The objective is the same; assimilating unstructured data, giving it some robust analysis, and offering the extracted knowledge across a collaborative network.

Just think of the fertile ground all this opens for startups! If you’re looking for that ‘million dollar idea’ to build a plan around, here is your chance. But don’t wait too long, because the din for Web 3.0 is getting louder and louder. Catch the wave soon or it will pass you by!

When someone asks me for the best way to fund a startup, I always say bootstrap it, meaning fund it yourself and grow organically. Bootstrapping avoids all the cost, pain, and distractions of finding angels or VCs, and allows you to keep control and all your hard-earned equity for yourself.

Last year I interviewed a serial entrepreneur, Rich Christiansen, who has done almost 30 businesses wholly by bootstrapping. He published a book with Ron Porter on the subject, titled “Bootstrap Business”, that provides a wealth of practical examples and advice on this subject.

The essence of his approach is to dedicate yourself to becoming a frugal minimalist in everything you do. I like his approach, and have extracted some tips from his book and other sources on how to do it:

1. Use a virtual office. Rent is one of the biggest expenses for any business. If you can, start your business in your home office, basement or garage (Bill Gates, Steve Jobs, and many other legends used this approach).
2. Think minimum spending. Spend the absolute minimum for what you need (equipment, software, and services) to keep your business running. Don’t justify over-spending initially with “long-run” thinking. If you do, there probably won’t ever be a long run!
3. Reinvest gross profit. Most startup founders already do this, rather than take a salary, to improve their offering. Take little to no net profit. Simply take enough to live on, but not to the point of your detriment.
4. Act big, behave small. Create the illusion of ‘big’ without the large building and large staff. Use voicemail, a world-class website, and personal customer service, with small expenses, to beat your big competitors.
5. Do it yourself. Network big to get connections and ideas, but do the work yourself. Every outside hire increases your cost and risk. Hire experts, not help. Low paid help isn’t cheaper if it takes them twice as long to do the job, or they do the job wrong.
6. Don’t plan for failure. Planning for failure almost invariably leads to failure, or at least has a way of undermining your resolve. The tough times are what separate the survivors from the many strewn casualties lying alongside the startup highway.
7. Creative marketing. One of the keys to keeping start-up costs low is to find creative and affordable ways of doing what you need to get done, rather than just spending cash. All you need is a blog, Twitter, email, some business card stock, and a little creativity.
8. Don’t think about the exit. As soon as you bring in investors, they force you to plan for an exit (merger or sale) in three to five years. It’s critical to them, since that’s the only way they can realize a return on investment, but it limits your options for growth and change.

Sometimes the tiniest details will throw your startup company into disaster. Understanding your business totally will give you much better operational control. In most cases there is a direct correlation between the quality of your decisions and the size of your revenue stream. For minimum risk, you must understand fully this cause-and-effect correlation.

In summary, watch your costs, trust your gut, and drive forward with all the passion in your dream. The growth may be slower with bootstrapping, but it’s all yours.

Remember, the goal is to keep venture capitalists or any investors from sinking their teeth into your business. When you let them on board, you lose control of your destiny. Isn’t this contrary to why you signed up to be an entrepreneur in the first place?

Remember a term sheet agreement is not a deal until the check clears. Entrepreneurs sometimes assume an initial agreement with an angel is a commitment, so they start spending before any money is received. But due diligence and paperwork take time, and can change everything.

It’s true that angel investors typically do not present entrepreneurs with overly complicated deal structures, especially when compared to venture capitalists. However, there is no set pattern of terms an entrepreneur might be able to anticipate from an angel, either. Your best strategy is to bring your own term sheet to the negotiation as a starting point.

When a company is at its earliest seed stage, the terms tend to be the least complex. As the company grows and the second or third group of investors comes in, the terms of each subsequent financing grow in size, scope, and the number of lawyers’ fingerprints on them.

According to Attracting Capital from Angels by Brian Hill and Dee Powers, here are some key clauses that angel investors expect on the first term sheet for the investment you need:

• Set the price. The price is the percent of ownership given to the investor, calculated as “investment/post-money valuation.” The pre-money valuation is company value today, while the post-money valuation is the pre-money valuation plus the investment amount.

• Seat on the board. This does not mean that if you have eight angels in your company, you will have to seat all eight of them on your board. But the lead angel would certainly ask to be given a seat.

• Define equity type. The first capital a young company receives usually takes the form of common stock, the same class of shares the founders hold. Venture capitalists and later round investors like the preferred convertible shares.

• Outline multiple tranches. Investors may provide money in stages or tranches, based on defined milestones, to decrease investment risk. These “IV drip” financings may reduce risk for investors, but put more pressure on founders.

• Anti-dilution protection. This clause attempts to protect the conversion price of stock of angel investors, prior to additional financing, from being reduced to a price equal to the price per share paid in a later “down” round. But some dilution is almost inevitable.

• Right of first refusal. Angels may want the first right to purchase shares held by the other angels in the deal before they are sold to an outside party. This allows a committed angel to consolidate his ownership, rather than see it scattered to the wind.

• Liquidation preference. These are terms which basically say for the investor, “give me the option to get my investment back or my negotiated ownership, whichever is more”. It prevents the entrepreneur from selling early, at a loss to the investor.

Remember that due diligence and negotiation takes time. Not allowing enough time is one of the major mistakes made by entrepreneurs. You can end up becoming very frustrated with the investors, or cause the venture to fail if you run out of seed capital before the angel round can be completed.

In a survey for the above book, angels reported that it takes them an average of 67 days to close, while the average closing time for venture capitalists was 80 days. This time does not include finding the right angels, which is the first and longer part of the effort.

You should expect that both parts, when combined, can take three, six, or nine months – or more. Don’t wait till your last dollar is gone before you start looking for the next one. The check won’t clear in time to save you.

It is no secret that the world of venture capital (VCs) has been turned upside down by the recession, and the many other changes in the marketplace. I see now emerging a new wave of investors, popularly known as “super angels,” micro-VCs, or “super-seed” investors. Every early-stage startup should explore this new funding alternative.

Business Week ran a more thorough analysis of this movement a while back, which I am summarizing here. I conclude that the genesis of this trend seems to come from several forces, including the following:

1. Less investment capital available due to the recession. Venture capital dispensed quarterly to startups continues to decline, down to about $3 billion in the first quarter, which is the lowest level since 1997. Due to the economy as well, traditional individual angel investors haven’t been able to fill the gap.
2. New “up-and-comer” VCs focus on early-stage companies. VCs are finding that they don’t need the “large” funds of $100M to $500M to support a portfolio, if they focus on early-stage startups. It’s higher risk, but higher return, to pick the big winners early, before angels have set unreasonable valuations and restrictive terms.
3. Technology costs are plummeting, meaning you can do more with less. Twenty years ago, it cost $5 million to really launch a high-tech startup, when the same thing can be done today for $500 thousand. So, in effect, VCs need to come in at what was formerly the angel stage to grab the gems and hold them.
4. Many old-line VC firms have grown too big and unwieldy. More are realizing that they have forgotten how to build innovative companies, so they are going back to their roots, when firms were smaller and more nimble. They can plant more seeds, and place less dependency on the big win.
5. Being “lifecycle investment partners” has a downside. As venture funds grew bigger during the dotcom bubble, and sized themselves to invest in every round of selected startups, they found it was very hard to stop investing in the underperforming companies. That model doesn’t seem to work any more.
6. Great companies are made, not born. Conventional wisdom is changing from startups being born a winner (execution doesn’t matter), to being made a winner (more chances and more help early on). This means smaller amounts given to more entrepreneurs who get a chance to prove that they can build great businesses.

Of course there a couple of potential down sides to this movement:

• As more startups are funded, without the big VCs on the other end, more companies will be looking for growth dollars and may languish trying to differentiate themselves in a crowded, but slow spending, consumer marketplace.

• More sources of funding for early-stage startups may drive up valuations on these deals, which will lower the returns for the angels and super-angels willing to do these deals. That could cause this bubble to burst and hurt everyone.

I applaud the direction of investors who want to re-invigorate venture capital by taking it back to the real entrepreneur who needs help getting his venture off the ground. Too many founders today face the conundrum that they need capital to get started, and even angels defer until after you have your product built, business model proven, and a real revenue stream.

Examples of some leaders in this super-angel space include First Round Capital, Baseline Venture, Maples Investments, and Felicis Ventures. Check them out, and find others, so maybe you too can be super-blessed by a super-angel.

I’m a strong believer that investors invest in people, before they invest in a business plan, or an idea. But until now, I’ve never seen a study of exactly how that plays out for startup founders for current venture-backed companies, specifically: race, age, experience and the number of founders per company.

A new study, just published by CB Insights, titled Venture Capital Human Capital Report, summarizes these three characteristics for private early-stage Internet ventures funded in the US during the first six months of 2010. The significant findings include the following:

• Founders need to live in the right place. No surprises here. California (Silicon Valley), New York (NYC), and Massachusetts (Boston) are the places to be in the US for venture capital attention. Almost 80% of the funding handed out in the US consistently comes from these three locations.

• Whites and Asians lead the race. 87% of funded founders are white, which is not too far above the US population of 77% white. More notably, the second largest group receiving funding was Asians, at 12%, despite comprising only 4% of the population.

• All-Asian founding teams raise the largest rounds. Asian teams in California raised median funding rounds of $4.4M, significantly higher than the $3M raised by mixed or all-white founding teams. In other locations, the trend was more equal, even somewhat reversed in New York and Boston.

• Wunderkinds don’t have the magic touch. The average age of founding teams getting funded is in the Gen-X 35-44 year age range. However, the highest median funding did go to those in age range 26-34 years old. Amazingly, no founding teams in the Gen-Y 18-25 year range received any funding in California.

• Experience does count. Fully 39% of founders funded were formerly CEOs or had founded prior companies. Other common previous roles were executives in Sales, Marketing, and Product Management, all suggesting that VCs back experience.

• More founders generally means more money. Overall the majority of companies have two or more founders, but over a third are led by one founder. More founders does not necessarily result in larger funding rounds, but the highest median funding generally goes to companies which have two or more founders.

• Going solo works better on the East Coast. Co-founder companies are the norm in California, but 40-50% of the startups in New York and Massachusetts have only one founder. In New York, these solo efforts even raised more money, with a median of $4M.

If you don’t live in these corridors, don’t assume that you can simply incorporate in the state, or email your proposals there and be considered like a local. At minimum, you need to get an introduction from a local player, or better yet, set up a local office and network there. Investing is all about people-to-people relationships.

If you are from outside the US, especially Asia, experts tell me that the focus is even more on relationships. George Wang, founder and chairman of the Beijing-based Chinese Professional Network (CPN), recommends that anyone from the West wanting to get involved in Chinese start-ups slow the pace down and “Spend six months and get to know the place and the people.”

If you need funding, focus first on the human side of venture capital, before you rush to pitch your plan. The evidence confirms that from a funding perspective, a successful startup is more about the right people being in the right place at the right time, versus the technology or solution.