In the race to attract attention from startups and entrepreneurs, angel investors appear to be winning, and that’s accelerating an ongoing shift in the venture capital market — what some would argue is an evolution of the startup-funding model. A new survey from Dorsey & Whitney (PDF), a Silicon Valley law firm that specializes in advising startups, shows that startups are increasingly turning to angels, not just for their initial rounds of funding but for subsequent rounds as well. Meanwhile, the most recent data on the VC industry shows that traditional venture funds have only raised $9 billion so far this year, a significant drop from the amount raised in previous years. Insiders have been arguing for some time that the VC business needed to get smaller, and it appears to be doing that in more ways than one.

The latest figures from the National Venture Capital Association show that the amount raised by traditional funds in the first three quarters of 2010 is just a little over half the $16 billion they accumulated in all of 2009, and dramatically lower than the $28 billion that was raised in 2008, or the $35 billion that traditional funds managed to pull in during 2007. NVCA President Mark Heesen said the industry was “experiencing a period of time in which venture capital investment is consistently outpacing fundraising, creating an industry that will be considerably smaller in the next decade.”

As a thumb rule, try to get enough validation so that you can get to at least a $2 million pre-money valuation before raising equity capital. Sub-$2 million pre-money, it is better to bootstrap. If you have to raise money, try to do so as convertible notes. That is debt financing that converts into equity at the Series A valuation once the price for that is set. (I believe Jeff Clavier and many other seed investors are in agreement with me on this issue.) Also, extremely important is that you need to raise enough money to be able to reach the next major milestone.

So with that preamble, let us look at some examples:

Ford Motors dominated the auto market in the early 20th century with a single car model, the Model T.  At the time, customers were seeking low-cost, functional cars, and were satisfied by an extremely standardized product (Ford famously quipped that “customers can choose it in any color, as long as it’s black”).

But as technology improved and serious competitors emerged, customers began wanting cars that were tailored to their specific needs and desires. The basis of competition shifted from price and basic functionality to ”style, power, and prestige“. General Motors surpassed Ford by capitalizing on this desire for segmentation. They created Cadillacs for wealthy older folks, Pontiacs for hipsters, and so on.

Today, the venture financing industry is going through a similar segmentation process. Venture capital has only existed in its modern form for about 35 years.  In the early days there were relatively few VCs. Entrepreneurs were happy simply getting money and general business guidance.  Today, there is a surplus of venture capital and entrepreneurs have become increasingly savvy “shoppers.”  As a result, competition amongst venture financiers has increased and their “customers” (entrepreneurs) have flocked to more specialized “products.”

The first question most people seem to ask when contemplating a new startup is where they will get the money.

That’s certainly a valid question, but all the money in the world won’t make your business a success if you hate what you are doing, and you aren’t prepared to do the job. I suggest that there are several other questions even more important than the money one.

The best way to assure the success of your startup is to do something you love, as opposed to something that will make you a lot of money. Of course, all these things and many more are critical, so it’s important that you keep your priorities straight. Here are the right questions to ask yourself, in the right order, before asking others about money:

1. Do you understand and aspire to entrepreneur lifestyle? Being a startup founder is not a job, but a lifestyle, like getting married versus staying single. In fact, it’s more like being single, since founders usually have no one to lean on, no one to make decisions for them, no one to blame, and no vision to follow but their own.
2. Do you have a passion for your idea and business opportunity? There is no joy in starting a business, if you can’t stand the people, business climate, or the day-to-day responsibilities of the job. Some people relate to service businesses, while others are more comfortable with manufacturing or construction.

Coming off the TechCrunch Disrupt conference this week, one of the interviews that sticks out most in my mind was that of Yuri Milner, CEO of the Russian Internet holding company Digital Sky Technologies, by veteran TV host Charlie Rose. Milner has quickly made a name for himself by investing hundreds of millions of dollars in hot tech properties Facebook, Zynga and Groupon. But it didn’t seem like Milner had any sort of overarching philosophy, agenda or insight into the technology market.

Thanks to the most devastating recession in decades and dramatic shifts in the venture industry, finding investors to write those first checks is a frustrating, time-sucking process for entrepreneurs – but that doesn’t mean they can’t be particular.

If you’re startup owner, it’s important to remember that you don’t need to take money from just any VC.

Venture capital, at its core, is the business world’s equivalent of a long-term, nearly inseparable, relationship.  You are marrying your investor.

Like any good relationship, it’s best if the two parties have a lot in common. They should have experience in the same areas. They should be good communicators. There should also have good give-and-take skills, as well as mutual tolerance, because periodic disagreements are inevitable. What counts when that happens is whether those disagreements can be resolved amicably and successfully. If these situations aren’t met, the venture capital you attract is just fool’s gold.

Here are four tips to keep in mind before you take any venture capital:

It’s official. Yelp is raising a huge chunk of change from Elevation Partners. According to a release, Elevation will invest as much as $100 million in the startup. For now, Yelp will be raising a $25 million in a Series E round from the firm. We broke the news last week here, when talk of the round was in the $50 million range. The initial infusion is half that, but Elevation could end up investing much more over time.

Elevation co-founder Marc Bodnick will be joining Yelp’s Board of Directors. We originally hear that Bono, an Elevation Partners partner, was to be the board representative for Yelp but it looks like Bodnick got the seat in the end.

The investment comes on the heels of dissolved buyout deal with Google. Yelp walked away from an all but signed deal to buy the startup for $550 million.

The investment includes both a primary investment component as well as a secondary offering for long time employees. These deals are now being referred to as “DST deals,” since DST first invested in Facebook in May 2009 at a $10 billion valuation and later funded employee buyouts at a $6.5 billion valuation. They did a similar deal with Zynga.

The release also revealed that traffic on the site increased to more than 26 million unique visitors in the month of December 2009 and the site now has 9 million reviews.

CrunchBase Information

Yelp

Information provided by CrunchBase

Irish software startup Goshido completed its first round of fundraising in eight days.

More remarkable: all of it was done through the social network LinkedIn.

According to an article in the Irish Times, the company set out to "sell off 10 slots to investors at €25,000 each – each equivalent to a 2 per cent stake in the company."

Via LinkedIn, they sent out 700 messages to possible investors, and garnered 200 responses in just over a week -- resulting in a fast €162,500 (about $230,000) raised.

Executive Chairman Frank Hannigan told the Irish Times, "I’m blown away by it and it gives the lie to people who say social networking is just about Facebook.”

Clearly, LinkedIn can be used for more than just making contacts and recruiting -- it's a lucrative opportunity for business growth as well.

Read the entire article at the Irish Times >