(FORTUNE Magazine) – Some of my best friends are venture capitalists! Sure, venture capitalists are now seen as villains. My colleagues and I are charged with being inept, corrupt moneychangers who are only interested in short-term profits. Well, I say forget that--I still believe venture capitalists are the heroes of the new economy. As with any business, there have been excesses and stupidities in the past few years. But this business shouldn't be judged solely by the extremes any more than any other one.

Venture capital firms take chances on financing new companies that traditional sources of money wouldn't and shouldn't touch. In return for taking that extraordinary risk, the theory goes, VCs stand to gain extraordinary returns by owning shares of companies that increase in value much faster than the average publicly held company. It's a hard business to characterize because it depends so much on a combination of individual judgment and luck. But as we learned once again during the past four years, there is a right way and a wrong way to do it.

THE WRONG WAY

Pretend there isn't any risk: I've been a venture investor since 1996, shortly before I started writing this column for FORTUNE. During the first four years, everyone around me acted as though venture capital was a sure thing. From 1984 to 2000, venture capital firms almost always made really good money: Returns averaged 18% to 20% a year (and 30% or better for top firms). But risk, by definition, means that the value of your investment may decline. We found out in the past 18 months that the definition applies even to venture capitalists.

Don't worry about valuations: Venture investors make money by buying shares of private companies early and then helping management use that cash to turn the startups into businesses with revenues, profitability, cash flow, and so on. If you want to get really good returns, your hits generally have to earn ten times your money in three to five years. If you invest in a company worth $5 million, it has to eventually be worth $50 million. Back in the bubble, investors were willing to give brand-new companies valuations of more than $50 million. It's really really hard to make money if you pay that kind of price going in.

Act as if you can reinvent the business: Several "bold" people decided they could ignore the rules of venture capital that were developed over 40 years, and invent new ways to do it. Some decided to specialize, investing only in Internet companies. Some decided to get more control over the startups by creating incubators. Some decided to try to mix venture investing and operating companies. All of them failed. All of them. That's because the organization of a venture capital firm, a limited partnership, works. It's designed so that institutional investors don't make venture investment decisions, and so that venture capitalists don't operate the companies. It is designed to make sure each party plays its part well.

THE RIGHT WAY

Let entrepreneurs run the companies: See above. Investors and entrepreneurs are different kinds of people. Investors shouldn't run companies, and entrepreneurs shouldn't invest capital.

Create real value: It's hard to start new companies. The really good ones know who their customers are and do something these customers are willing to pay for. There are no shortcuts for this. The real crime from the Internet bubble is the number of investors and entrepreneurs who got real cash out without leaving anything of value behind.

Treat your limited partners as partners: Venture capital firms get the bulk of their money from large pools of institutional capital, mostly pension funds and college endowments. Right now those investors are worried about getting any of their 1999-2001 investments back, much less earning a rate of return on that money. So they are paying more attention to the terms of their investments and the quality of the venture firms. VC firms need to openly share risk with limited partners, rather than rely on fixed management fees or play games with distributions of appreciated stock.

Assuming we venture capitalists have relearned these lessons, this one of the best times ever to invest in startups. Entrepreneurs now take investments at low valuation. Executives now have been battle-tested. The stock market will, eventually, welcome new issues of startup stocks. In sum: These are the perfect conditions for venture capitalists looking to create great new companies.

STEWART ALSOP is a partner with New Enterprise Associates, a venture capital firm. Except as noted, neither he nor his partnership has a financial interest in the companies mentioned. He can be reached at alsop_infotech@fortunemail.com. His column may be bookmarked online at www.fortune.com/technology/alsop.