* Illustration: Christoph Niemann * By some measures, 2007 was a great year to be a venture capitalist. VCs raised $35 billion in new funds, invested nearly $30 billion, and best of all cashed in a tidy $53 billion.

Those are good numbers, but they hide the fact that when it comes to the Internet, venture capitalists are facing the toughest investing environment in recent history. As companies become cheaper to launch, fewer entrepreneurs need the kind of cash infusions that VCs provide. And angel investors are encroaching on VCs' turf by throwing more money at early-stage companies; in 2006, angels pumped a total of $26 billion into 51,000 startups, up from $18 billion in 2003. At the same time, large companies are snapping up Web businesses before these startups ever see a second or third round of funding.

"Right now, honestly? This time sucks for us," says Paul Kedrosky, a partner with Ventures West. "It's a bad time."

Savvy VCs are finding ways to compete. One gambit: doling out perks to entrepreneurs. San Francisco-based Founders Fund, started by ex-PayPal CEO Peter Thiel, lets entrepreneurs trade some of their equity for cash, something they usually can't do until their companies are purchased or go public. Other VCs are competing with angels by investing like them — with small amounts and at early stages. In 2007, the average VC-led seed round was less than $1 million. "Half of the deals we do are either seed or A round," says Roger Lee, a general partner at Battery Ventures. "The companies VCs are putting $500,000 into this year we might have been putting $20 million into in 2000."

Meanwhile, the grim economy is an unlikely source of solace. Venture firms usually have 10 years to invest the money they raise, making them better prepared than angels to weather market dips. And as the bad economy starts to cut into startups' growth, entrepreneurs will need to raise more funding at lower valuations. Best of all for VCs, a coming wave of tech layoffs may yield more investing opportunities than ever: "Economic slowdowns tend to coincide with bright people leaving big companies to do their own thing," says Stu Phillips, managing partner of Ridgelift Ventures. "For early-stage investors, a recession can be a great time."

Related Wired 2008 Business Trends: Sure, there's bad news out there, what with the panicky Fed and people whispering the R-word. But somehow, the wired world continues to churn out smart, useful, occasionally game-changing ideas. From the rise in instant manufacturing to the growth of open-source business models, these trends show that innovation can bloom even in a grim economic climate. Here's a look at nine trends driving business in 2008 — and a deeper explanation of the surprising secrets to Apple's success. 1: Open Source Tycoons 2: Social Networks Grow Up 3: Green on the Outside 4: Invisible Internet 5: Rise of the Instapreneur 6: Building a Better Banner 7: Invented in China 8: VCs Look for a New Life 9: The Human Touch