Despite a period of shrinking venture capital activity during the recent recession, the venture capital industry experienced a good year in 2010. More start up funding was distributed among growing comp businesses and more small companies successfully exited from venture capital backing through IPOs and other strategies.

While the venture capital industry had a growth year in 2010, what is in store for 2011? According to the National Venture Capital Association (NVCA), the future looks bright. Here are a few important  predictions according to the NVCA and Dow Jones survey of venture capitalists for the coming year.

More Investments

During fiscal year 2009, the venture capital industry felt the pains of the national recession. The total number of VC investments in startup companies was significantly down compared to the tremendous growth of investments leading up to 2008.

However, 2010 saw increased activity in startup funding, and according to the NVCA survey, most VC firms expect increased funding in 2011, particularly with later stage investments.  About half look forward to expanding investments in expanding companies and seed development.

IT Will Be a Hit

In previous years, venture capital has found a haven in life sciences and medical technology. However, Information Technology is making a comeback. Startup companies focusing on digital media, consumer internet, and mobile technology will likely find a favored audience with VC firms. And more specifically, cloud computing is becoming all the rage and will likely be the “favorite child” with the most investment dollars.

Medical IT

But don’t think medical technology is on the way out. Technology in the healthcare IT sector will still be on the increase, particularly in medical devices and biopharmaceuticals.

Smaller Firms Favored

According to the survey, 70% of VC firms seem to favor smaller startup companies over larger ones. Perhaps it’s a matter of diversity. Splitting more dollars among a greater number of smaller startup companies protects a VC firm from over investing in unsuccessful larger companies.

Increased Exits

A successful startup company doesn’t stay with a venture capital firm forever. It hopefully exits with a lucrative IPO or acquisition deal. And according to the NVCA survey, about two-thirds of VC firms polled said they are confident that more start ups will go public, and 81 percent said that they expect more start ups to be acquired by private-equity or other public firms.

The Obama administration has proposed new taxation methods that could ultimately change the way venture capitalists do business.  The new proposal introduces a tax to “carried interest,” or the stock shares that a VC firm takes as part of their earned income from their investment. 

The Details of the New VC Taxation Plan

Currently, a VC firm’s carried income is considered capital gains and is taxed at the capital gains rate of 15%.  But with the new proposal, the capital gains from carried interest may be taxed at the regular income tax rate of about 35%.

The new tax procedure has been introduced to help raise about $7 billion in additional revenue from VC firms, real estate partnerships, and other financial industry players.  However, venture capitalists argue that a new higher tax rate on carried interest will result in fewer investments made to new and startup companies.

The new tax wouldn’t be placed into effect until 2011 or 2012, and there is still time before the final details are confirmed. 

Could Venture Capital Firms Invest in Fewer Companies? 

However, if the new tax method does go into effect at the regular income tax rate, this means venture capital firms will be taxed double or more than what they are currently.  And considering that much of a VC’s income or return on investment is through carried interest in stock holdings in a company, it could mean big changes in how they form their exit plans.

Indeed, one possibility is that venture capitalists might start investing in fewer companies.  This could be a big detriment to the economy.  Figures provided by a Global Insight study shows that venture backed capital companies contribute over 17% to the national GPS and employ over 9% of private sector employees.  If there are fewer venture backed companies, this means fewer companies would have the means to expand and grow, thus causing a shift in employment numbers and the overall economic strength to the economy.

How Could the Tax Law Impact the Entrepreneur? 

VCs could also begin investing less into each new company.  That means it will be more difficult for startups and newer existing businesses to reach the growth potential since there will be fewer dollars to utilize.  Growth requires capital for expanding production equipment, employees, and aggressive marketing costs.  Without the money for these important growth factors, a business will either have to change its growth estimates or search for capital in other more difficult avenues – especially in today’s tight credit markets. 

In a more dire prediction, more small businesses could fail without the support of venture capital.  If the tax change is passed, we could see a drop in startups and particularly in innovative new businesses and business models, as venture capital firms will invest more in companies with an already proven business model.  Given that their tax responsibilities will be higher, the firms may look to offset their lower profitability margins by reducing their risk.   

These are just speculations as to how the VC industry may react to a new taxation method.  Ultimately, venture capital firms may just have to bite the proverbial bullet and accept the new tax as a regular part of their business income and little change will be felt by the entrepreneur on the investment side. 

If your startup or small business is ready to make the leaps and bounds into big business with the help of venture capital, review your business for any intellectual property that you should have on file with the proper U.S. government office.  Patents, trademarks, and other copyrights are important legal intellectual property and may be vital to the success of your business, especially if your enterprise consists of invented or creative works.

Here are the main types of intellectual property and where they can be registered:

Securing Patents

A patent may be granted to you, the inventor, by the Patent and Trademark Office.  Patent terms are 20 years from the filing date and are only effective within the U.S.  A patent protects the inventor, or whomever files for the patent, by granting the legal right to prevent or exclude others from “making, using, offering for sale, or selling” the invention in the United States or “importing” the invention into the United States.”

If your business idea is an invention that you have conceived and developed, and you plan to take your business invention to market, apply for a patent as soon as you can.  You may need the assistance of an attorney specializing in intellectual property.  However, having the patent filed before you meet with a VC group shows them that you have the legal right to prevent others from stealing your idea.

Obtaining Trademarks

A trademark is a word, a name, a symbol, or a device which is used to distinguish the source of goods in trade with goods.  McDonalds™, Neiman Marcus™, and Target™ all are distinguished by trademarks that prevent others from using their name and symbol in the trade of goods. 

Trademark rights may also be used to prevent others from using a confusingly similar names or marks, but it does not prevent others from making or selling the same goods under a definite separate mark.

Trademarks are generally used with established businesses that use their name and/or logo as a brand for selling.  Most startups will not have the need for a trademark, but if your small company has been conducting business for a period of time and has a recognizable name or logo, it would be wise to register it with the Patent and Trademark Office.

Using Copyrights

A copyright is a form of protection granted by the Copyright Office of the Library of Congress to the creators of “original works of authorship.”  These include “literary, dramatic, musical, artistic, and other certain intellectual works, both published and unpublished.”  The 1976 Copyright Act gives the owner of copyright the exclusive rights “to reproduce the copyrighted work, to prepare derivative works, to distribute copies of the copyrighted work, to perform the copyrighted work publicly, or to display the copyrighted work publicly.”

The copyright protects only the “form of expression” and not the actual topic matter of the creative work.  As an example, a magazine article could be copyrighted, but it would only prevent others from copying the actual wording of the guide.  It would not stop others from writing and publishing an article on the same topic.

By having your patents, trademarks, and copyrights protected, you show venture capital firms that your ideas are well protected from competitors. 

Producing a new product is not like building a baseball field.  The adage “If I build it, they will come” does not happen in the free market.  While you may have a great product idea, so do thousands of other entrepreneurs who are looking for venture capital backing.  To stand apart from the crowd, consider building your product before meeting with a venture capital firm. 

VC firms are highly particular about the companies in which they invest.  Unless you have a homerun product idea that will obliterate the competition, you will likely face the following attitude:  “It sounds like a good idea.  Why don’t you come back when you have the details fleshed out?” 

Why waste time trying to move forward with your entrepreneurial business venture with just an idea?  Get your idea made and ready to produce for market, and you will have an edge when you go before a VC committee with a concept that’s ready to make money.

Meet Market Needs

If your innovative product or service will be a hit with VC firms, it first needs to meet a current market need.  Do you have a great software idea that will fit an empty business niche?   Perhaps your idea is a gadget that makes cleaning up after babies a cinch. 

If you have a great business idea but do not know where it fits in the market, you need to spend time researching consumer demands.  Do the market research.  Know what consumers will buy your product, and what target demographics it will serve.  You must refine your idea until it becomes one that targeted consumers will want to purchase. 

Prototype Your Product

If you have a product idea, build a prototype that can be used as a demonstration model or sample.  You may be able to build it yourself if you’re handy with tools in the garage, or you may need to spend the money on a professional fabrication outfit to get a prototype made. 

Use the prototype(s) for your market research.  Show it to potential customers.  Get feedback.  Find out what improvements can be made.  A prototype will be one of the most helpful models of what works and what needs further improvement.

Conduct Beta Testing

Particular to software, beta testing is important for refining your product.  Once you have coded and developed your software product to the point where it is ready to be evaluated by consumers, you should implement beta testing to obtain valuable feedback.    

This phase is akin to an advanced prototype that can be used to determine the usability and malfunctions of the product.  If you have a software idea, be sure to get a good number of beta testers, ones who are qualified to provide logical and technical recommendations for improvement.

Using Free Samples

A good way to get market feedback is to produce a large quantity of your product, if production costs allow, and get it into the hands of your target consumer.  People will gladly give you feedback if you give them something for free.  Here you can further find improvement options and bring a ready-to-make product to your potential VC funding firm.

Having a market-ready product takes work, research, and money.  It may mean bootstrapping your startup business and getting by with loans from family and your friendly corner bank.  However, if your idea will be a hit with consumers, the prototype money will be well spent when it comes time for acquiring millions from a VC firm to get your product mass-produced and marketed.

Business is simply the art of selling.  Whether your company sells products or offers services, fundamentally, business is driven by sales.  Selling is what you must do to grow and keep your business alive. 

You may be in the process of selling your business idea to a venture capitalist firm in order to acquiring financing for growth and expansion.  Are you ready to close the deal?  The most successful entrepreneurs will know how to sell effectively and make a closing on the important deals, whether it is securing venture capital funding or a major client.    

Listening to Sell

Listening is the most important part of selling.  You need to know what your customers need by listening to them.  It’s easy to ask a customer in a car lot what they’re looking for in a new automobile.  However, how do you know what your potential VC firm needs for its portfolio?   

Listen carefully to the partners’ comments.  Are they voicing concerns about the rate of return?   Are they commenting about technology differentiation?   What about viral growth?  By honing in on the venture capitalists’ comments, you can easily address their concerns in your presentation.  

Understanding Your Targets

Listening requires more than just hearing.  You must comprehend what the customer is saying.  A car buyer looking for an economical family sedan should not be shown a luxury Cadillac. 

In the world of venture capital, you must go into the presentation room with a solid understanding of who the firm is.  Are they predominantly a technology venture capital firm?   Based upon their recent funding projects, is the venture capital firm looking to diversify its portfolio?  Who are its success stories, and which companies have failed? 

When you understand the context of the venture capital firm, you can then best assess how to frame your presentation and answer their questions to fulfill their needs.  If you can understand why a venture capital partner is asking a particular question, then you are quickly on your way to closing the deal with the firm. 

Delivering a Solution

Presenting a solution to your customers is how your business thrives.  This means you have listened to customer needs, understood their dilemma and problems, and developed a solution that solves the problem.  Whether it is a stronger garbage bag or a widget that surpasses the competition by leaps and bounds, you have developed the way to service the needs of customers. 

This final stage of selling requires your ability to convince your customer or venture capital firm that what you offer is just what they and the market need.  If you will succeed at sales, you must convince the client, either through marketing or face-to-face customer interaction, that you understand their needs and have the perfect solution – your product!

Whether you want to grow your business by acquiring more customers, or are looking for venture capital for big future growth, hone and practice your sales skills.  Then you can know exactly what you need to deliver to your audience.

Entrepreneurs are inherently risk takers, ones who play the roulette of the risk-to-reward ratio audaciously.   While venture capitalists are known to indulge in “high risk” investments, their risk tolerance may not mimic the adventurous entrepreneur. 

When an entrepreneur approaches a venture capital firm with a proposal for financing, the VC must determine whether the risk is too great for the investment.   In the eyes of the venture capital firm, there are three sure signs that a proposal is not worth the risk. 

1. An Unfinished or Sloppy Business Plan

A VC firm will make a first assessment of a proposal based on the submission of a business plan.  Sending in a generic, sloppy, or unfinished business plan will not bode well for your funding efforts. 

Business plan software is readily available at retail stores and even downloadable from the internet.  Templates are also plentiful if an entrepreneur wants to use one as a blueprint.  However, so many entrepreneurs fail to take a software-produced business plan and write in the organic and specific elements that are particular to his or her business.  These plans come off looking generic and unenthusiastic. 

Instead, make sure you take the care to personally write, or hire a writer, to compose the necessary sections of your business plan that need an individual touch.  Before meeting with a venture capital firm, make sure your business plan is perfect – free of spelling errors or mistakes. 

2. Asking for Wrong Amounts

Many entrepreneurs do not even realize what stage is applicable to their business.  An entrepreneur with a great idea but with no feasibility studies or market research may think he’s ready for stage-one production and market penetration.  He’ll ask for a $5 million investment from a VC firm.  Then he hears the laughter as they shut the door behind him.

Others may have an existing business ready for expansion, but are asking for too little for an expansion program.  Knowing the stage that your business is in and how much you need to reach the next level is incredibly important when approaching a VC group.  So many businesses fail because they did not have enough working capital.  Though asking for too much is not recommended, asking for slightly more than you think you need is a good idea.

3. Too Much Debt or Too Many Investors

Some entrepreneurs start out their business idea on their own with the help of family, friends, and bank loans.  At this point, they are quite proud of the fact that they did not need VC funding for start-up costs.  However, when they are ready to get VC backing for market introduction or expansion, many of these entrepreneurs will face rejection because the companies are already too overloaded with debt.

Another potential problem is that an entrepreneur acquires too many start-up investors to get the business off the ground and finds that there is no way to satisfy everyone on how profits are to be distributed.  A venture capital firm that finds an entrepreneurial business with too many investors is likely to move onto the next application.

Don’t make the mistakes that entrepreneurs have made so many times in the past.  Learn from the mistakes and get your business ready to present as a prime candidate to a VC firm.

A startup company, like a small child, needs years of steady nurturing, encouragement, and discovery of what the final product will become.  Unfortunately, there’s no training for first-time parents.  However, a startup company has the benefit of getting nurtured by an experienced set of managers and decision makers – ones who can use their years of experience to steer a small business on the right course.

Do you think a venture capital firm would want to invest hundreds of thousands, possibly millions, into a small startup company with inexperienced managers?  You may as well have a landlover entrepreneur build a cruise vessel, exclaim himself as captain, and have his ditch digging colleagues come on as his crew.  Clearly, the outcome for that venture is not favorable.

However, if the landlover entrepreneur were enterprising and convinced 25-yr veteran cruise captain, along with other experienced engineers, hotel and entertainment staff, to join him in his innovative cruise idea, there is a likely chance that it will succeed and a VC firm would want part of that action.

No matter how good your business idea is, your leadership team will be the essential chemistry that instills confidence in your financial backers.  Venture capitalists want to know about the core people who are the company.  The right mix of experience, personality, and passion in your team can set your startup apart from the rest.

From a venture capitalists’ perspective, what are some important elements that your leadership team should possess?

Experience, Experience, Experience!

Akin to how important location is to real estate, for a startup company, the most crucial factor is “experience, experience, experience.”  Assemble a leadership team who has proven experience.  Of course, the ideal candidates will have been successful in the same roles in a similar startup company. 

However, if you cannot find a candidate with the exact same experience in a startup endeavor, find team members who are experts in their respective fields, such as a CPA for your CFO, an engineer for your chief product technician, and a head marketer with proven success in promotions. 

Business Smarts

Sometimes smarts and intelligence can be a better substitute than experience.  If you can find members of your leadership team who are creative, smart, and full of ideas that can work for your business, then you further strengthen your endeavor in the eyes of a VC firm.

Passion and Drive

Venture capital firms like to back startup companies that have people with resolute passion for the endeavor.  Do you believe in your innovative product with all your heart and are able to convince others of its virtues?  Does your CFO love maximizing the internal rate of return and possessing Ghandi-like ethics?  Has your chief software developer been writing computer programs since his old Commodore 64 in junior high?  These are the people you want standing before a VC committee.

Resounding Commitment

And lastly, is your team committed to your business venture?  Some people, believe it or not, have an alternative motive for joining startups.  It may be just to get out of their current company and career, or simply the chance at more money if your business succeeds. However, the true test of your team is if they are passionate about your entrepreneurial venture and are committed to seeing it through to success.

You, as an entrepreneur, have a monumental job of finding and convincing the right people to join you onboard your metaphorical ship before it sets sail.  But if you have chosen carefully and wisely, your potential VC backing may just say “yes.”

What is innovation to your business?  Is it the how you provide the absolute best in customer service in your industry?  Is it the way you perform business operations efficiently to save money and get the most out of your production dollars?  Are your products your core innovations, with new releases each year?  There are countless ways you can incorporate innovation into your company – and this originality should continue to grow along with your business. 

Entrepreneurs face the challenge of creating and growing businesses that must constantly change as they meet consumer demands.  What worked five years ago may not work this year.  While your business idea may have fit a market niche last year, consumers ask for something different today.

Innovation is not simply just a new spin on an idea.  It is the constant process by which your business meets demands by creating solutions.  But with all the demands put upon you as the entrepreneur and founder of your company, how do you find ideas to continue innovation?

Employee Suggestion

Your employees are one of the greatest assets of your business.  Many entrepreneurs treat employees as a necessary expense, and by doing so, receive the bare minimum of effort from their workers.   However, if you empower your employees with ownership of their tasks and duties, and by giving them the freedom to suggest options for better efficiency and customer service, you have found a potentially bottomless source of business innovation.

Salespeople who work face-to-face with customers daily can offer great suggestions for better packaging or other improvements that meet customer needs.  Who would know better than the salespeople who ask the customer directly how to serve their needs? 

Be choosy when you hire your administrative staff.  The most creative ones can offer ways to save overhead expenses by developing more efficient procedures and inventing new time-saving processes.

Customer Feedback

Listen to your customers.  Solicit their feedback.  Ask them for advice on how you can serve their needs better.  Customers love to tell businesses how to do it better.  While their feedback may not always arrive in the nicest way, by analyzing what your customers say in their complaints and solicited comments, you can continue your innovative process to grow your business.

Follow an Example

Some adages say it’s better to lead than to follow.  However, there is no harm in matching, or even surpassing, your competition by imitating their processes.  Keep a constant finger on the pulse of your industry.  Read trade magazines.  Attend conferences.  Find out what everyone else is doing and what is working.  You can take those ideas and incorporate them into your own business processes to become more efficient and improve product ideas. 

Innovation requires constant creativity, work, and evaluation.  However, in order for your business to succeed for years to come, you must find ways to keep your product and business fresh for your customers.

With the list of US venture capitalists growing year by year, it can seem like an impossible task to find the right ones that are a potential match for your business.  Acquiring venture capital requires a tremendous volume of patience, research, and effort before you finally arrive with money in the bank from a granting VC firm. 

How do you narrow the prospective list of venture capital firms so that you can focus your business idea presentation most effectively?  There are many ways to narrow criteria to find a viable VC list.  Here are the most commonly used focus techniques:

1. Match Criteria

Each VC firm will publish investment criteria that exposes the firm’s desire for certain types of business, tolerance for risk, and average amounts of investment in each business they choose.  If you are looking for $1 or $2 million for growth and expansion, don’t approach a VC firm that only disburses $5 million or more to already established businesses.

By looking at a venture capital firm’s criteria, you can narrow your potential list from hundreds to perhaps a couple of dozen choices.  Read these criteria carefully, and you will have a viable list of potential VC firms.

2. Sector Preference

Many venture capital firms prefer to invest in certain industries, such as software or consumer electronics technology.  Know your potential VC’s preference for their portfolio investments.  Don’t waste your and their valuable time by submitting a business plan for your fashion design business to VC preferring software companies.

3. Stage Preference

Is your business a startup?   Are you an established business now looking to grow nationally?  Many VC firms will state what stage of business they prefer to invest in, whether it is startup, seed capital, or expansion.  Match your stage of business with a potential VC’s preference.

4. Avoid Conflicts

When you have a good and narrow list of potential VC firms, look at each carefully and check for potential conflicts with other companies that the VC has in their investment portfolio.  A VC firm will most likely not want to invest in your company if you are a competitor to one of their portfolio holdings. 

5. Narrow a Location

Most VC firms like to invest in companies that are local to them.  Locally could mean the same metropolitan area, state, or region.  Find out where your potential VC firm prefers to invest its funds and approach the ones in your “local” area.

6. Ask

There is no harm in asking a firm that has declined your business for other venture capital firm suggestions.  VC firms are very familiar with the venture capital community and may know other firms that may be a better match.  Always ask politely and be genuine with your request.  There is usually no reason that members of a VC firm would not want to help your business if you are truly passionate about succeeding.

If you have an existing business and are on your way to acquiring growth funding and support from a venture capitalist, be sure to highlight any customer channels your business has through the use of social networking, or what is known as Web 2.0.  The buzz from online social networking can be a big boost to your business in the form of word-of-mouth recommendations and position your business for big growth potential – something that a potential VC likes to see.

Web 2.0 is the general term associated with the way users of the internet communicate with each other and connect online.  With tens of millions of web users actively posting content every day, Web 2.0 has a huge potential for the success of any business.  If you haven’t already, jump into the metaphorical ocean of social media and get your business noticed.

Blogs / YouTube

Does your small business have a website?  It should.  A website can have much more use that just a static web presence with your business products and location.  A website that is updated frequently has a much better chance of getting noticed by search engines.  You could easily start a blog that you update on a daily basis, or at least 2 or 3 times a week, with the happenings of your business, company highlights, and special promotions. 

Along with blogs are the sensations of viral videos seen on the popular YouTube.  If you have the gumption, the creativity, and the equipment, you could make short, clever videos of your company and post them on YouTube.  It could be as easy as making a “how-to” demonstration videos of a product. 

Facebook / MySpace

Social online sites like Facebook and MySpace are the latest and most hip ways for people from around the world to stay connected to their current friends and family, as well as long-lost classmates.  The power of MySpace among teens and those in their twenties was enough to singlehandedly power many companies offering MySpace related widgets, designs, and tools.  Of course, other businesses jumped on the bandwagon, creating a profile and collecting “friends” to whom they could promote. 

Facebook has gained much popularity with users of all ages and offers a similar way to keep your business name branded by forming “groups” and keeping your contacts posted with events and updates.

Opinion Sites

There are many online sites that allow members to post their opinions and recommendations about other websites.  A mention from some of the most popular sites could get your business noticed by millions of customers at once. 

Check out sites like Yelp, Twitter, Reddit, Digg, StumbleUpon, and Del.icio.us, and get your business name on there.

The popularity of Web 2.0 has helped thrust many businesses and online sites into a frenzy of customers.  You could have a tremendous advantage with VC groups if you can show them that your little business already has big numbers of potential customers.