Feb. 12 (Bloomberg) -- Redpoint Ventures, the venture- capital firm that backed MySpace Inc., is tightening funding and telling its startups to cut their staffs by as much as 10 percent to cope with a drought of mergers and initial public offerings.

The Silicon Valley firm, whose current investments include mobile search-engine developer JumpTap Inc. and the virtual-world site Gaia Interactive Inc., gave the job-cutting advice at a conference of its portfolio companies and limited partners last week, Redpoint General Partner Geoff Yang said in an interview.

Redpoint is girding its startup companies for a plunge in venture funding, which could be down 50 percent from 2007 levels, Yang said. He doesn’t expect a rebound in financing this year, making cutbacks the only option. Startups shouldn’t invest too much in research or marketing if they don’t have the revenue to back it up, even if it means delaying products or losing market share, he said.

“If you invest early, and the sales growth doesn’t come, you run out of money at the worst possible time,” said Yang, 49, who founded Redpoint in 1999. “They all seemed to understand that kind of logic.”

Redpoint recommends that startups rank the performance of their staff and eliminate the bottom 10 percent. The firm also told entrepreneurs to impose “zero-based” personnel decisions during performance reviews, asking whether each employee would be hired again if he or she were applying for the first time.

World Is Flat

Most companies shouldn’t expect sales growth this year and will have to delay spending until they see whether they’re meeting or beating their goals for the year, Yang said. “Flat is the new up,” since companies should be happy just to keep sales steady, he said.

“We’re pretty much following that advice,” said Craig Donato, chief executive officer of Oodle Inc., which sells classified ads for sites such as MySpace and Facebook Inc. The company cut 10 of its 40 staffers last fall, slashing marketing and account management, Donato said. That made way for more engineers to work on the Facebook partnership, who could generate revenue faster.

Last week, San Mateo, California-based Oodle raised $5.6 million from investors, including Redpoint, bringing its total funding to $24 million. The round was half the size of the $11 million the company raised in 2007. Donato declined to say whether the deal reflected a smaller company valuation.

Oodle sought an amount of funding that would help it get to profitability, possibly by the end of the year, Donato said. This is “not the time to be raising gobs and gobs of money if you don’t need it, because it’s expensive.”

Slow Rebound

Redpoint is the latest venture firm to tell portfolio companies to cut spending to ride out the recession. In October, Sequoia Capital warned companies that the housing slump would spill into the technology business, with no quick recovery.

Venture capitalists have been cutting back since then. Investment in startups fell 33 percent in the fourth quarter, compared with the year-earlier period. The value of funds raised by venture firms declined 71 percent in the fourth quarter, bringing the full-year drop to 21 percent, according to the National Venture Capital Association.

Venture firms are struggling to earn a return on their investments. Only six venture-backed companies were able to go public last year in the U.S., according to the NVCA. Just 260 venture-backed businesses sold out to larger companies, the first time in five years that the number has been less than 300.

No Quick Rebound

The fundraising drop could continue until 2011, Yang said. This year’s commitments may be half the $35.5 billion that U.S. venture funds raised two years ago, he said. That would be the lowest level since 2004.

The drop will force venture investors from the business, and produce a “dramatic increase in mortality over the next six to nine months as companies run out of cash,” Yang said. As many as half of venture-backed startups could vanish, he said.

“More money will get concentrated in fewer venture firm names,” Yang said. “You will see more veterans retire, people who rode out the last one. They’re thinking this will be a long one.”

To keep its own companies in business, Redpoint is reallocating money from the $400 million venture fund it raised in 2006, Yang said. That leaves less money for new companies.

Most venture funds trying to raise money will have to answer for their subpar returns since the 2000 dot-com bust, said Brooks Zug, co-founder of Boston-based Harbourvest Partners, which invests institutional clients’ money in venture and private- equity funds. Only a handful of firms have outperformed public markets by enough to justify the extra risk, he said.

“The experienced institutions who have been in venture for years will invest, if they possibly can, in the firms they consider absolutely top-tier,” Zug said. “It will be about paring off the bottom end of groups they invested in before.”

Many institutions can’t put more money into venture capital because of policies that limit the percentage they invest in private firms, Zug said. The drop in the value of stocks last year increased the relative size of their venture investments, he said.

To contact the reporter on this story: Tim Mullaney in New York at tmullaney1@bloomberg.net

Last Updated: February 12, 2009 00:01 EST