I was surprised to read that a Palo Alto, Calif., venture capital firm had invested in an art business. And perhaps it’s the surprise element that has this one featured recently in Business Week and The New York Times. It’s an $825,000 VC investment in Jen Bekman Projects, an art gallery and online art business.

At first glance, this seems like an exception to the general rules. Venture capital generally wants innovative and high-tech businesses that have a reasonable chance at high growth leading to a lucrative exit three to five years from now. How does an art business fit into that?

Dig deeper, and you see that it’s not that much of a surprise. This is not just art, it’s a new way to gather and market art online. The Times story says:

The popularity and reputation of the site, which has won fans for its affordable collections of quirky work, were enough to grab the attention of Tony Conrad, a partner at True Ventures, which led the financing.

And the Business Week story refers to a “disruptive business model” (emphasis is mine):

Cash flow positive. Growing revenue. Disruptive business model. If you’ve got those three things in place, it may not matter whether you’re the kind of business VCs typically fund.

Ironically, “cash flow positive” and “growing revenue” aren’t always qualities that investors want in a startup, because they can create a company that doesn’t need to go public or get acquired later on. Investors don’t want to get trapped in a minority share of a healthy company that never generates liquidity. They have to be able to sell their share within a few years, which means either a public offering or acquisition by a larger company. And a cash-flow-positive growing company doesn’t automatically do that.

So without actually knowing her or the background, I’d be willing to bet that Jen Bekman, the founder, is personally impressive, dedicated to growth, and that she has a real exit strategy. In the background, she’s working with well-known angel investors. Her capital structure probably gives the angels who invested early some control, too, which also increases the odds of a successful exit later on.

Congratulations to Bekman. And exception or general rule or both, it’s nice to see a bootstrapped company make it to a big-time investment, and positive cash flow show up as one of its better qualities.

(Image: from Jen Bekman Project. Chad Hagen’s “Nonsensical Infographic No. 2?. Linked here from NYTimes.)

Mary comes up with a great idea for an iPhone application. She works on it for three months in her spare time. She develops sketches and designs, trying to figure out how it would work. She looks at other iPhone applications doing related things.

About three months into it, her enthusiasm has waned a bit, but she’s still thinking about it. She’s spent maybe 10 to 20 hours on it so far. Her best friend suggests she talk to Ralph about it. She doesn’t know Ralph, but her friend does. They meet for coffee. Ralph is a programmer. He works for a company in town doing web programming. He’s also an enthusiastic iPhone user and has been thinking about taking an online course on programming the iPhone. Ralph is excited, and his excitement rekindles Mary’s excitement. They agree to be partners in a new business based on this initial iPhone application.

Four months go by. Ralph takes Mary’s initial idea and starts developing. It turns out, as he gets into the code, that what Mary imagined isn’t quite possible on an iPhone. Ralph revises the idea radically, makes it practical and develops a prototype. Mary meets with him three times, they talk, she accepts his changes begrudgingly. At this point Mary’s total hours have gone to 15 to 25, but Ralph has worked a lot, probably 120 hours, on the programming.

At Ralph’s suggestion, he and Mary take the prototype to Terry. Both of them know Terry, but neither knows him well. Terry has been through a failed startup, has a business education and is looking for a startup to do again, this time the way it should be done. Terry’s skill is mostly marketing, but he knows how to develop a plan and seek investment. Terry does a business plan and networks with local business development groups to find angel investors. They win an opportunity to present to an angel investment group.

Another three months have gone by. Mary has now put in more like 40 hours, Ralph 250 hours, and Terry 120 hours.

The three of them meet to plan their approach with angel investors. Ralph wants to quit his job and work full-time on the new thing but needs to get paid. Mary doesn’t want to quit her job but wants to stay involved; she’s not quite sure how. Terry wants to lead the new company as soon as he can get financing.

The business plan indicates it’s going to take $250,000 to develop the business for the first year, after which it will probably need another $750,000 to become cash-flow self-sufficient.

During this meeting, Mary and Ralph and Terry come to an extremely awkward realization: They’ve never really talked about who should own how much of this company, much less how much they are willing to offer to investors in exchange for $250,000.

So what do you think? This is a typical case.

1. How would you suggest that Mary, Ralph and Terry divide up the 100 percent ownership of the company now, before they go to the angel investors. Who owns how much?
2. What do you think of the management team here? Ralph and Terry both want to work full-time on the business when there’s money to pay them. What titles should they take? How much salary?
3. How much of the company should these three offer to the seed investor for $250,000?

And, you guessed it, she won the microphone time instead. The elevator speech she didn’t want to give.

Which was one of the best elevator speeches I’ve seen. And I’ve seen a lot of them.

“I am so nervous,” she started, with a booming theatrical voice laced with excitement. And in that first two seconds, she had everybody in the room–a room full of entrepreneurs, investors, accountants, attorneys and students–on her side.

Then she told the story: how she and her boyfriend Tom Zell, now her husband, made her a cup of European-style drinking chocolate and she said

This is the best thing I have ever tasted–other people need to have this experience–we should start a company.

I consider myself a veteran of the elevator pitch, the quick speech. I’ve done a four-part series on my Planning Startups Stories blog about how to do it. And Clover Earl, without practice, without notes, without reading up on the whole thing, did it about as well as it could be done. She told the story of Sipping Dreams.

Which proves that when you get right down to it, this elevator pitch is about telling your story. Be authentic. Be yourself. And tell your story. There is nothing more important than that.

So they started a company. Along the way they also got married and brought Tom’s two children into it (so that family picture above is also the company picture), plus capital from Clover’s father. They mixed the chocolate up and packaged it and took it to the local stores in their cars. And built sales. As Clover tells it, they started last fall, showed the product at some local trade shows, did a Valentine’s Day flier, gave samples away, got local stores to carry it . . . now they’re nominated for an Oregon State University family business award, looking to organize channels and marketing strategy, and worried about running out of capital.

And Clover’s three minutes ended up as one of the highlights of last week’s Smart-ups meeting. And that software she wanted more than the microphone was Business Plan Pro, so we ended up meeting her afterward and giving her that, too.

So now, in Clover’s own words:

Waiting with bated breath to see what happens next!

I definitely believe the bated breath. She did the entire elevator speech with bated breath. And it worked extremely well.

I was flattered. And I was young. And the company was one of those incredible genius companies that can’t get past the founder doing amazing things with technology. He was always tweaking things, always tinkering and never actually finishing a product. He lived off service contracts and custom stuff for chip manufacturers.

Larry, who later became a venture capitalist, was a true leader. He advised me to take the job in the mornings only, part-time, and to keep the job with Creative Strategies for a few months. He offered to help make that work by giving me special flexibility.

“Work with them for a while, and see how it goes,” he suggested. Good man.

I never got to see the books. My founder entrepreneur friend was offended every time I asked. He would reassure me, “Don’t worry, we’re OK, we’re making it.” And in the meantime, unbeknownst to me, he kept thinking he could cut corners with payroll taxes and make it up when he hit big.

He never hit it big. The company went under. I went back to Creative Strategies, very grateful for Larry’s vision. A bullet dodged.

A year later I was subpoenaed by the IRS for a tax case. I discovered that my friend the founder was being sued by the IRS for $90K in unpaid payroll taxes. The company was bankrupt, but he was still personally liable because he signed the checks.

So I had to testify. It turned out that the IRS could have held me and the other directors liable as well–another bullet dodged–except the founder made it clear that he had been lying to us. And I guessed they checked into the bookkeeping and who signed checks, and decided not to pursue it.

Good lessons. Larry did me a favor and I have reason to believe that I repaid it afterward by staying loyal to my original job with his company. And my friend teaches us all to never, never borrow from payroll taxes by not paying them.

For six weeks, he worked “morning, noon and night”–by day at his job on the Java development team at Sun, and after hours on his side project. In the evenings he would relieve his wife by caring for their two sons, sometimes coding feverishly at his computer with one hand, while the other rocked baby Gavin to sleep or held his toddler, Spencer, on his lap.

Apple approved his shoot-em-up iPhone game last October, and soon after, he made $2,000 on downloads in a single day. But it gets better later on:

In January, he released a free version of the game with fewer features, hoping to spark sales of the paid version. It worked: iShoot Lite has been downloaded more than 2 million times, and many people have upgraded to the paid version, which now costs $2.99. On its peak day–Jan. 11–iShoot sold nearly 17,000 copies, which meant a $35,000 day’s take for Mr. Nicholas.

It reminds me of the (sort of) “good ol’ days” of the personal computer boom, back in the early 1980s, when individual people were making money with early PC software.

Here’s where you get the whole story: Hoping to Make iPhone Toys as a Full-Time Job

I made this mistake the first time: I just worked for free. I didn’t do anything about adjusting the company books. We didn’t have any profits, so not expensing my labor didn’t matter much. We had enough to worry about, anyhow, keeping the mortgage paid and the kids in shoes with consulting revenue. Palo Alto Software was still not much more than me stubbornly working a business plan.

The second time around, I knew better. I recorded my value as a loan owed to founders, and the payroll tax implications of my value as accounts payable. That way, I had two advantages:

First, an accurate rendering of reality of the company. My value is part of normal expenses. It doesn’t do anybody any good to underestimate expenses.

Second, it established an amount to be dealt with later. And also the related tax liabilities.

There are details to watch for with salaries owed to owners, because you can’t deduct them unless you’ve actually paid them; and when you do actually pay them, you owe payroll taxes as well.

When I read business plans for startups, I don’t like to see founders working for free. It understates actual expenses. I do understand the necessities that arise, so I can accept founders discounting themselves to build a company. But I like it better when they document their worth carefully, like I did in the second case of sweat equity.

Imagine then my surprise when a presenter at an angel investor meeting last week bad-mouthed the idea of owners recording lost salaries as debts. I think it’s a good thing. He–and he is in a position to know–made it sound ridiculous. Apparently he took it as a claim for money to be paid to the owners the moment capital is raised from investors.

I disagree. I think recording the value of unpaid sweat equity is better for all, because it’s there, it happened, and–as long as you manage the tax implications correctly–it means your expenses are more accurate. It doesn’t mean you’re demanding to be paid in full the moment you get an investment.

Case in point: After things got better, I swallowed the sweat equity. It disappeared off the books and became de facto capital. Not formal capital, because that would have required different tax treatment; but de facto capital, because capital is assets less liabilities, so when the liabilities shrunk, the equivalent amount became earnings. So taxes were paid.

I’m not going to rule out a venture because its owners have kept track of the value of sweat equity. I’m not going to expect investors to pay them that amount, either.

The chance to pitch– along with a stage and an audience–was the prize Tuesday for five selected startups at the Web 2.0 conference in San Francisco.

I wasn’t there, but I read about it in Five Startups Take Flight At Web 2.0 LaunchPad yesterday on TechCrunch. Jason Kincaid offers a short explanation of each of the five startups, plus–a very nice touch–a sample of the questions and answers.

The Q&As are brief summaries, but they do have a nice feel to them. How do you like this one, as ZeaLOG answers a question about generating leads for its Web app–tracking progress toward personal goals:

What seems to happen is natural virality; people will show it to coworkers, spouse. People seem to come in groups.

Now there’s a great term: virality. Does your Web startup offer virality? And if you can’t guess immediately what that means, you could pick up a book by Seth Godin, or read it in the second half of the sentence.

Over at Small Business Labs, Steve King posts Recession Drives New Businesses. He cites three major-media articles indicating that the startups are coming:

• In Hard Times, Freelancers Turn to the Web (New York Times)
• Weary of Looking for Work, Some Create Their Own (New York Times)
• After Layoffs, Starting a Business From Scratch (Business Week)

Steve’s in a good place to watch this. His company, Emergent Research, does some of the best research around on small business. It recently released  a study on innovation in small business, and my favorite is its 2008 report on the New Artisan Economy.

From what I see, a couple of startup dampers that could be easing up. Those dampers are confidence and credit crunch.

Confidence, as in “what? Start a business now? Isn’t that crazy?” That seems to ease as the news value dwindles, and people get back to work. And then there’s that other factor, the people who don’t have a choice. They look for work and decide starting a business is better.

The credit crunch has been a real factor from what I’ve seen. And I’m assuming that the recent stimulus package will have some positive effect.

There’s potentially a two-birds-with-one-stone effect through the stimulus package, because freeing up commercial credit and getting the SBA moving again, will also improve the general confidence level.

It’s good to see that startups are still coming. KillerStartups.com reminds me of StartupMeme, a steady flow of bright new hopefuls.

This one has the interesting angle of voting. The ones in the top 10 get there because visitors to the site vote them there. Happily, there seem to be enough votes to avoid the problem of self-serving ringer votes, too.

Business goes on, recession or not. People are still coming up with new businesses offering something new to people who want it. What about you? Are you waiting for a better time?

Jason Calcanis, founder of Mahalo,  has a long, detailed, painful picture of the plight of the high-tech, high-visibility startup when it seems to be grinding slowly downward toward failure. That’s What to do if your startup is about to fail. Also called, by the way, “Don’t Stop Believing.”

On a less-well-known-but-just-as-real level: Yesterday I got an e-mail from a man who’d been working on a very interesting project, combining robotics and pneumatics to create a device that would protect older people from breaking their hips. I saw his business plan at several points along the way, also his pitch and presentation, and offered some tips. I’d hoped he’d make it. But it was a very ambitious idea.

Here’s what he told me in his e-mail (with some blanks to protect things that would be awkward, not intended for sharing):

My business idea hit a wall that was simply impossible to overcome. After four years and at least 100 hours of patent searches I stumbled upon a patent that was exactly, and I do mean exactly, my idea. I found it 26 pages down on a Google search concerning [omitted] I literally had written 3 out of 4 paragraphs of their patent myself. There was not one original thought that was new to me. There simply was no work-around as their patent was well written and comprehensive, leaving NO wiggle room. I sat and cried for three days. I moped around for a month and then I pulled myself up and decided to get on with my life.

I have been paying the bills scanning family photo albums and turning them into “family life stories.” I will never make a bunch of money editing photos and video. That said it is enjoyable and it does keep the bills paid leaving me a lot of time to ski. Which is great especially this time of year.

If you hear of a project in need of a good sales and marketing person, please keep me in mind.

So that’s the other side of the startup game. Things don’t always work. And when they don’t, it’s disappointing.

I’ve been involved with failure myself, more times than I want to remember. And I like his response to it: still looking, paying the bills with something else and oh, well, more time for skiing.

There’s a good lesson there.