Startups downshift to survive downturn

SAN FRANCISCO — Silicon Valley has always been a land of big, bold dreams. In the first Internet boom, startups either grew fast or died trying. The casualties of the bust, like Pets.com and Webvan, became legendary.

In this downturn, say investors and entrepreneurs, startups are adopting a strategy they hope will let them hang on.

To preserve cash, many are rushing to lay off employees and cut expenses. They are shelving their dreams of Google-sized riches and getting small, humble and thrifty, all with the goal of surviving the coming economic winter.

Once upon a time, an unprofitable Internet startup like Zivity, a social site that revolves around photos of models, might have turned into just another dot-bomb. Though it has paltry revenues, the company pays only $8,000 a month to rent its San Francisco offices and has $8 million from investors. It laid off eight of its 22 employees, saving it enough money to stay alive through 2011 and survive even a prolonged recession.

Even in normal economic times, a majority of startups fail. But the same factors that have made it so easy to create Web 2.0-style startups — low fixed costs, access to inexpensive overseas programmers and cheap ways to advertise online — also make it relatively easy to cut back operations to the bare minimum.

Web startups "don't fail in the same way they used to fail," said Brad Burnham, a partner at the venture-capital firm Union Square Ventures, who noted the previous generation of Internet companies lived hard and died young.

Knowing when to pull the plug on the current crop of more frugal companies is now "different, more subtle, more problematic," he said. "They don't run into a wall."

The only certainty in Silicon Valley is that survival is becoming more challenging. The growth in online display advertising is declining. Venture capitalists and other investors in startups, like hedge funds, are cutting back. The market for initial public offerings remains closed and potential acquirers — Google, Yahoo and the rest — are deep in their own problems. Many entrepreneurs and deal-makers agree a shakeout is indeed coming.

Venture capitalists have begun preaching frugality, urging the startups they have invested in to cut costs and become profitable. Their advice shares themes: Cut employees, do not count on raising more money and move quickly.

The entrepreneurs appear to be listening. AdBrite, an online advertising network in San Francisco that raised $35 million in venture capital, recently laid off one-third of its staff, or 40 employees, to get to profitability next year.

The company's chief executive, Iggy Fanlo, ran the e-commerce site Shopping.com during the first dot-com bust. He said he recalled how wave after wave of layoffs sank company morale.

"I had gone through this before and we had death by a thousand cuts," Fanlo said. "I wanted to credibly look people in the eye this time and say we are profitable."

Every day seems to bring a new round of layoffs. In the last two weeks, the music site Imeem, the social search site Mahalo, the visual search engine Searchme, Seattle-based real-estate site Zillow, the Internet radio site Pandora and the social network Hi5 all cut as much as a quarter of their staffs.

For many entrepreneurs, the lone goal has become survival. At Seesmic, a video blogging service, the day of reckoning — when it runs out of $6 million it raised in May — will come in three years. To make the money last, Seesmic laid off seven workers, one-third of the staff, and cut all projects not related to the video service.

"If I can't make this work in three years it will be a failure," CEO Loic Le Meur said. "If I can and I get through this, it will be much stronger."

If startups do succumb, firms like Sherwood Partners, which specializes in shutting down companies, will be waiting. Sherwood has not yet seen the kind of activity it witnessed during the last bust, but partner Martin D. Pichinson said it is preparing for a burst of new business as many startups acknowledge that just because they can survive does not mean they should.