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Foundation Capital Warns Its Startups

The Silicon Valley venture capital firm tells its portfolio companies to cut costs and spending because funding is likely to dwindle

Over the last few weeks, Silicon Valley has been jolted out of its fantasy that it could escape the wrath of the financial meltdown. Venture capitalists across startup land are advising portfolio companies to batten down the hatches.

The blogosphere was riveted by GigaOm's Oct. 8 report that Sequoia Capital, one of the Silicon Valley's most successful firms, held a meeting the previous day to tell its portfolio companies to "get real or go home." The same day, The New York Times Bits blog ran a letter from Ron Conway, Silicon Valley's most prominent angel investor, advising his companies to reduce their cash burn rates.

Turns out that at least one other respected firm, Foundation Capital, had sounded its warning at the end of September. On Sept. 29, Adam Grosser, a general partner at Foundation Capital, a 13-year-old venture capital firm that has backed NetFlix (NFLX), Documentum (now owned by EMC), and Perabit Networks, sent an e-mail to the CEOs of the 70 or so companies funded by his Menlo Park (Calif.) firm with a similar message.

Layoffs a Possibility

In a missive gingerly titled "Thoughts on the Economic Environment," Grosser strongly advised the startups to rethink their operating plans for 2009 with a focus on cutting unnecessary costs, raising money, and curtailing the use of debt. "It is likely that there will be extremely limited liquidity opportunities for the next two years," Grosser wrote. In a separate e-mail he noted that his portfolio companies are performing well.

Grosser, a former executive of onetime high-flier Excite@Home before becoming a venture capitalist, also stressed the importance of controlling costs. "Expense management will be the key to success for most private companies," he continued. "If you cannot get to cash flow positive with cash-on-hand, we need to think carefully about the expectations for future financing, both from a cash availability standpoint as well as to make sure that valuation expectations are well understood."

Then Grosser urged CEOs to consider layoffs. "I think we all need to review staffing levels—and make sure that every hire is absolutely crucial, or to see if there are opportunities for reductions," he wrote.

The Meltdown Offers Opportunities, Too

Finally, Grosser warned that capital and credit are drying up, including from hedge funds. "We all need to be extremely cautious about venture debt—banks are starting to sweep accounts aggressively," he wrote. "We have seen hedge fund co-investors pull back from participation in the past week, which has interjected a level of uncertainty into follow-on financings."

Grosser ended on a positive note by pointing out that the financial meltdown might present some opportunities. "Foundation is a long-term investor, and believes that out of chaos will also come opportunity," he wrote. "That could be in the form of acquisition candidates, or a contraction of the competitive landscape."

In his note, angel king pin Conway focused on expenses. "You should lower your 'burn rate' to raise at least 3-6 months or more of funding via cost reductions, even if it means staff reductions and reduced marketing and G&A [general and administrative] expenses," he wrote.

"R.I.P. Good Times"

At the Sequoia Capital meeting, the firm's partners used more dramatic means to get their message across. On Oct. 10, tech blog VentureBeat published what it believed was the 56-page slide show in its chillingly detailed entirety. The presentation, which opened with the image of a tombstone inscribed with the words "R.I.P. Good Times," presented a sophisticated yet sobering analysis of the financial crisis and a survival plan for Sequoia's venture-backed startups. Sequoia Capital declined to comment about the meeting.

Evidently, Sequoia's partners have a pretty dark sense of humor. The third slide shows a hog sliced in half lengthwise with a knife stuck in its belly.

Ante is an associate editor for BusinessWeek.

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