(FORTUNE Magazine) – In the go-go '90s venture capitalists were compared, favorably, to the junk-bond merchants of the '80s. Now, saddled with startups worth no more than a bottle of Advil, and with fewer opportunities to sell or take public other investments, these latter-day Masters of the Universe are looking at a fall from grace that promises to be almost as spectacular. This year the industry's heavyweights will cut back on the amount of money they collect from investors, and a handful of smaller funds will shut their doors. A few VCs may even face their own investors in court in cases that promise to be acrimonious blowups. Individually, these events will grab a smattering of headlines. Together, they represent nothing short of a monumental shift in the VC industry.

The biggest problem the VCs face, paradoxically, is that they took in too much money over the past few years. When IPOs and buyouts were plentiful, VCs raised ever larger funds to fuel their startups. By the end of last year, 36 firms had raised ten-year funds worth more than $1 billion, an unthinkable figure in an industry in which $200 million funds were considered large a decade ago. But with the IPO market and acquirers like Cisco and Nortel defanged, VCs are finding it tough even to invest what they've got. That undeployed capital ("overhang" in VC jargon) amounts to about $100 billion.

Why don't VCs just, say, refund some money? It seems that some VCs are still stuck in a 20th-century dot-com mindset, which is angering their investors, typically university endowments and pension funds. Says one fund manager for a limited partner in several venture funds: "There are some funds that don't get it. They still think it's 1999."

Already investors in 12 Entrepreneuring, co-founded by CNET's Halsey Minor, and in Idealab, started by business-incubator pioneer Bill Gross, have filed suit to recover portions of lost investments. (Gross has said that Idealab, as a corporation, can't liquidate itself like a traditional venture fund.) At other firms there are tense discussions as the sides try to avoid court. "We've had a whole range of conversations with firms that vary from those who are considering addressing these problems to firms that remain convinced they can continue to invest the funds wisely and get good returns," says Michael G. McCaffery, president and CEO of Stanford Management Co., which manages Stanford University's $10 billion endowment.

Limited partners don't have a strong claim in court when it comes to getting money back because the contracts they signed as investors are virtually ironclad. (VCs charge investors a management fee of about 2.5% and take a 20% to 30% cut of the fund's profits.) Still, these days VCs need all the friends they can get. "If we are out to be in business for ten years plus, then it behooves us to think about doing something," says Michael Orsak, a general partner with Worldview Technology Partners in Palo Alto, whose 2001 fund raised $1 billion, about 10% of which is invested. "However, no one's come at us with an ax to tell us to give the money back." Adds Yogen Dalal, a general partner of the Mayfield fund, which raised $1 billion in 2000: "It's not worth jeopardizing a long-term relationship."

VCs do have a model for what steps they might take. At least one firm had the foresight not to take excess cash. Crosspoint Venture Partners in Woodside, Calif., raised a $1 billion fund in early 2001--and then decided not to collect it. "We didn't want to take it until we could look them in the eye and say we could make them money," says John Mumford, Crosspoint's founding partner. He's still not ready to look those investors in the eye--not while many of his brethren struggle. "Everyone's sitting around wringing their hands trying to figure out how you give it back once you've got it."