The Internet isn't the only thing that's enjoying exploding growth these days: More and more venture capitalists are chasing entrepreneurs and offering them more and more cash. That's a boon for startups, but it also makes choosing the right group to finance your company a lot tougher.

For example, one young entrepreneur, who wishes to remain anonymous, recently found himself with multiple offers when he shopped for financing. "We had lots of people offering us millions of dollars more than what we finally chose," he says. He went with a group that offered less "because they had expertise in our area and because they had great contacts in our field." In other words, picking the right venture partner today involves a lot more than taking the money and running. You're exchanging an equity stake in your company for contacts and knowhow as much as for money.

One venture capital group that has been especially active over the past few years is Sprout Group, the venture capital affiliate of investment bank Donaldson, Lufkin & Jenrette. With nearly $2 billion in invested capital and an additional $1 billion in cash, Sprout is one of the bigger players in the industry. It has put money into everything from router manufacturers to electronic-commerce Web sites to medical device companies. Business Week Online's Sam Jaffe recently spoke with Stephen Diamond, a general partner in Sprout, about how the firm functions and what it looks for in an investment. Here's an edited version of their conversation:

Q: Venture capitalists invested as much as $14 billion last year, which is almost a 25% increase over 1997. Can this growth continue?
A: The amount of money that venture capitalists have been raising has been increasing at a fairly rapid rate over the past few years, and given the opportunities to invest in startups in new areas, I would expect to see that trend continue at least for the foreseeable future.

Q: Does the flood of money water down the potential attractiveness of investments?
A: The market is definitely becoming more competitive. It's more difficult to find attractive deals at attractive valuations.

Q: Is that true just in technology or across the board?
A: I think it's more of an issue in hot technology sectors, but it's also true across most of the areas we would invest in.

Q: Has the competition for investments gotten so heated that you find yourself offering terms that you wouldn't have just a couple of years ago?
A: I think that there is some tendency in that direction, but we're not finding that to be widespread.

Q: You're on the West Coast, but you have offices on the East Coast. Do you have an equal chance of finding a good technology startup on either?
A: We have offices in three locations: New York, Menlo Park, Calif., and Chicago, and we invest on a national basis. Even though I invest on the West Coast, I serve on three boards on the East Coast, and we're active across the country. It's increasingly important that venture capitalists have a national presence because attractive startups are no longer restricted to Silicon Valley.

Q: How much does Sprout have to invest now? Is that figure growing?

A: We have about a billion dollars of uninvested capital. We'll invest that capital over the next three to five years.

Q: Everyone is talking about the Internet these days. Are there other sectors for venture capitalists that are just as attractive?

A: I think the most attractive areas are all related to the Internet in some manner. The Internet will become such a fundamental driver of our economy that it will touch almost every aspect of the way we live and the way we work. Whether it's health care or information services, whether it's electronic commerce, or whether it's the underlying telecommunications infrastructure, most of the attractive investment opportunities are in some way being driven by the Internet.

Q: Is a venture capitalist's role to be a silent investor or to be a management partner?

A: We're very much active investors. We generally take a board seat with the companies that we invest in. We generally are the lead investors in most of the companies that we invest in. We act as a partner to our startups in building their businesses.

Q: Is there ever an occasion where a startup is better off left untouched by venture capital activism?

A: The best way a venture capitalist can add value is to hire a strong management team that can build the business. Venture capitalists can also add value through their networks, through their other relationships with other portfolio companies, and can open doors for management teams that may not be otherwise available to them. But the less you have to interfere with management, the more successful the company will be.

Q: How many business proposals to you read on a daily basis?

A: In my area of information technology, we probably receive 10 to 15 plans a day.

Q: Which plans stand out?

A: The key things we are looking for are an experienced management team that has been successful in the past that is targeting a large and fast-growing market opportunity with some defensible or proprietary technology. Those are the three most important areas as we're scanning business plans.

Q: When you establish a deal with a startup, do you always structure the deal in the same way, or is it different with each investment?

A: It varies from investment to investment.

Q: What are the factors that would cause it to vary?

A: The stage of the company that we're investing in. The way the deal has been structured in prior financing rounds. The desires of the management team and founders. The nature of where the company is in the development process. How much technical risk remains in the deal.

Q: At what point does a venture capitalist get out of an investment, assuming the investment is successful? After the IPO, or do you hold it for the next 20 years?

A: We would not hold it for 20 years. But we oftentimes remain with an investment for some period of time following an IPO.

Q: Do you have any pet areas of development that you like to be involved with?

A: The hot areas for us right now are companies that are involved in rebuilding the public telecom structure. Telecom infrastructure has been built for voice, and it needs to be transformed into a broadband data network. That's creating opportunities to build new access networks to the home and business, such as DSL and cable.

[Our companies are also] upgrading the core switching infrastructure with new fiber-optic technologies and providing new products to enable Internet service providers and [telecommunications] service providers to deliver value-added services to their customers rather than just providing raw pipes. In the area of electronic commerce, there has been a lot of attention paid to consumer sites such as eBay and Amazon.com. I think there's tremendous opportunity in business-to-business electronic commerce. Using the Internet and information technologies to improve the efficiency of the country's health-care delivery systems creates a number of opportunities as well.

Q: What should entrepreneurs know when they walk into a venture capitalist's office with business plan in hand?

A: They should be prepared to very succinctly describe the opportunity they are chasing, why the team that they have put together is uniquely suited to capitalize on the opportunity, and how they are going to grow their business and achieve competitive differentiation that will enable them to be successful. If they can convince us of those things, then they have a very good chance of being funded by a venture capitalist.

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