By Michal Lev-Ram

HALF MOON BAY, Calif. – The next big thing in venture capital is small investments, according to a panel of Silicon Valley investors who appeared at Fortune’s Brainstorm Tech conference on Tuesday.

“There’s no IPO market to speak of right now, big companies like Google (GOOG) and Microsoft (MSFT) are doing far fewer deals than in previous years, so where are the exits coming from?” asked Adam Lashinsky, Fortune senior writer and the panel’s moderator.

The answer, said venture capitalists like Dana Settle, a partner with Greycroft Partners, is investing in companies that don’t require much capital to get going – and therefore don’t require investors to hold out for large-scale acquisitions.

“It’s a different game now – we’re not looking at companies that require $20 million anymore,” said Settle. “But there are big opportunities for smaller funds, and there are a ton of companies that just don’t need that much capital.”

Andrew Braccia from Accel Partners – an early investor in social networking company Facebook – added that the key to investing in a down economy is to find companies that are sustainable.

“These are companies that can stand on their own regardless of the market,” said Braccia.

While Danny Rimer, a partner with Index Ventures, agreed that the IPO market is dead, he also said that there are other ways to make an exit.

“If you build a company with value you will find an exit,” said Rimer, whose firm sold four companies since the beginning of this year, including an Oslo-based startup called Trolltech, acquired by Nokia in June.

“At some point the clouds have to part and there will be a rationale for an IPO market again,” said David Siminoff, a general partner with venture capital firm Venrock.

But the near future may not be all that bright for some.

“At least from the perspective of media [companies], it doesn’t look good for many years,” said Quincy Smith, CEO of CBS Interactive (CBS), which just closed a $1.8 billion acquisition of online media company CNET.

By Michael V. Copeland

Here’s the math problem facing early-stage venture capitalists today. The vast majority of “exits” for venture-backed software companies, those happy events where everyone gets paid, are acquisitions valued at less than $50 million. All those large companies that go shopping for startups — Google (GOOG), Microsoft (MSFT), Cisco (CSCO), eBay (EBAY), Yahoo (YHOO) and AT&T (T) — may be buying up dozens of companies every year, but mostly they arent paying out-sized prices and venture firms consequently aren’t getting out-sized returns.

As an entrepreneur, you might be very happy with someone buying your company for $10 million or $20 million. But if you are the VC who invested $2 million in the first round of financing, a return of 2x or even 3x the venture firm’s money doesnt move the needle much on a fund that might be anywhere from $250 million to $600 million. To compound the problem for venture capitalists, many startups these days simply don’t need much money to get off the ground, thanks to cheap hardware and software tools.

So if there is a tension between the needs of a typical software startup and the needs of a venture capitalist, what do you do? If you are Sequoia Capital, you don’t do anything. Of any early-stage firm on the planet, Sequoia gets first crack at the best ideas and the best entrepreneurs –- everyone wants to work with Sequoia — so the odds of them finding the next YouTube or PayPal along with the big returns they bring are as good as they get. If you are Kleiner Perkins Caufield & Byers you start focusing a good deal of your energy on areas like alternative energy which, unlike software, do need boatloads of cash to get products developed and to market.

The other option is to tweak the traditional VC model. Firms like Union Square Ventures, and First Round Capital size their funds and investments so that a relatively small exit is still a meaningful return. In the past few years, “super angels” like Ron Conway have used a shotgun approach putting small amounts of money into dozens of companies a year. The startup boot camp Y Combinator, and the knockoffs it has spawned also fall into this category — put a little money into a lot of companies. These might be seen more as institutional seed funds.

The latest twist on the VC model is Tandem Entrepreneurs. Started by three former big company guys who cut their teeth at places like Oracle and Xerox Parc and then went on to found their own companies, Tandem is putting small amounts of money, $850,000 per company over two years, into just six companies.