Fueled by faith in Web 2.0 start-ups and new technologies in the medical-device and alternative-energy fields, venture capitalists invested $25.5 billion in 2006, marking the highest level investment since the dot-com bust in 2001.

VC investment last year increased 12 percent over the $22.8 billion invested in 2005, according to figures released Jan. 23 by PricewaterhouseCoopers, Thomson Financial, and the National Venture Capital Association.

"Investment has increased, but not at an alarming rate," said Emily Mendell, vice president of strategic affairs for National Venture Capital Association, noting that most analysts do not see the increase in investment as a sign that VCs have returned to the unrealistic expectations of the late 1990s. "The current venture-capitalist community is composed of people who survived the bubble, which is a good thing because they learned an awful lot."

While VCs continue to invest in traditional growth areas such as the Internet and software industries, 2006 investment also increased in life sciences and energy ventures. VCs poured $7.2 billion -- 28 percent of all venture capital invested last year -- into the fields of biotechnology and medical devices. Led by investment in alternative energy companies, the industrial/energy sector received $1.8 billion, a gain of more than 107 percent over the level of investment in 2005.

The media-and-entertainment sector received $1.6 billion, while software investment remained relatively flat at $5 billion. Internet-specific companies received $4 billion, accounting for 16 percent of all VC investment.

"A lot of venture capitalists are getting into the industrial/energy sector because there is a lot of innovation to be leveraged there," Mendell said. "VCs invest in areas where they can change the status quo through technology, but also where people will actually pay for that technology."

Mendell explained that the increased interest in alternative energy is only partially due to current global-resource issues. "It's not a short-term play," she said. "People are not making decisions based on whether oil prices go up or down."

In 2006, financing deals for companies in the expansion stage increased, and first-time financing also reached the highest levels since 2001. "We've seen an increase in seed and early-stage deals in 2006," Mendell said. "These are the deals that are pre-revenue, typically two guys or gals in a garage who want to make something out of nothing. That's the bread and butter of venture capitalism."

The deal for VC-funded YouTube, which sold to Google last year for $1.65 billion, may have helped keep the money flowing. Because Sarbanes-Oxley regulatory requirements have dissuaded many companies from taking the IPO route, and because investors have been wary of technology stocks since the dot-com bust, the IPO market for VC-funded companies has not been good, Mendell explained.

"The YouTube acquisition is extremely helpful because it shows that venture capitalists can get good return on investment by acquisition as opposed to an IPO," she said. The sale "helps the psychology of the market. It buoys it, but doesn't necessarily catapult the venture capital market into something that will not be sustainable."