Which startup laid off some folks recently, but had planned to make much deeper cuts? They went as far as having their outsourced HR firm send out final paperwork and checks to a number of employees — and then changed their mind. The CEO was so spacey he wasn't sure who got sent the paperwork. So he sent an email out to the entire company saying, "Please ignore any package and letter you might get from our HR firm - you're not fired." Ouch.

It's actually not surprising that Calacanis has attracted a small group of loyal followers who hang on his every word. Let's review the evidence: He ran a tech magazine in the '90s but failed to cash out big. Dumb! He sold a bunch of blogs to AOL for $25 million in 2005, before everyone figured out blogs weren't worth very much. Smart! He squeezed $40 million out of Sequoia Capital, a notoriously tightfisted venture-capital firm, before things went bust in the Valley and Sequoia started telling everyone to lay people off. Smart! He stopped blogging when he realized that it just gave angry people on the Internet a platform to bash him. Smart!

Flipping startups is one thing. Saving the country is another. Calacanis believes we can all just work our way out of the recession. That's a horribly bad idea, blogger Nick Baily explains.

Calacanis's "120 percent solution," boiled down, tells us to work 20 percent harder and cut up our credit cards. But he doesn't take basic supply and demand into account.

Let's say we work more and produce more. Who's going to consume whatever it is we're producing — cars, cell phones, useless Web-directory pages? Us, right? But wait — we followed Jason's advice and stopped buying things. More stuff, fewer people buying it leads to a massive deflationary price spiral. Japan tried this, and it did not work out very well.

Calacanis's U.S.-first scheme could work, I suppose, if we could find someone else to do all the buying. But it turns out most people overseas hate buying things. China, the next great consumer marketplace? Notoriously cheap. Likewise most of the rest of Asia. Russia, the home of so many new millionaires? If gas goes to $1, they're all broke, too. Same for the Middle East. Shoppers in India might buy things, but — oh, right — we just fired all of the outsourcing workers we decided we no longer needed.

So what do we do? Repairing bridges and roads and building high-speed trains sounds like a good idea. But spinning our wheels 20 percent harder, as Calacanis proposes? That gets us nowhere fast. The best part of this market implosion surely must be that Internet CEOs are no longer regarded as economic savants.

That insider is Adeo Ressi, the lanky, geeky founder of TheFunded.com, a site which lets entrepreneurs rate venture capitalists on everything from smarts to etiquette. (One effect of the site: Entrepreneurs say they no longer see as many VCs rudely pecking away at their BlackBerrys during pitch meetings.) Ressi recently gave a presentation to faculty members at the Harvard Business School. His message: venture capital has crossed a line.

That line is the amount of money venture-backed companies have generated when sold, either to public-market investors in an IPO, or to larger companies in an acquisition. Historically, that has exceeded the amount invested in venture capital by pension funds, college endowments, and other institutions. Put dollars in, get more dollars out: that's the magical money machine that drove a multibillion-dollar boom in venture capital since the mid-'90s. In the first half of this year, that ground to a halt: Venture capitalists raised approximately $22 billion from investors, but their companies only generated $19 billion when sold.

The reasons are many, but they amount to this: Venture capitalists are clubby, insular, and unimaginative, passing up 9 out of 10 deserving companies. And as a result, hundreds of their funds return no money to investors.

If anything, the situation is far worse than Ressi posits; some of the profits from startup sales go to their founders, after all. And a large chunk goes to the VCs themselves, who typically take 3 percent of the money they invest each year as a management fee, and 20 percent of the profits they distribute to investors. One venture capitalist I know estimates that the actual venture-capital deficit — the difference between money invested in funds and money returned — has been running at $6 billion a year for years.

Not all of that goes into VCs' pockets; some of it is simply wasted on businesses which will never turn a profit. But still: $6 billion a year, up in smoke. What is this — the automotive industry? Where's the bailout for venture-capital investors? The truth is they haven't been that outraged, if only because venture capital is such a piddling business for them, compared to their other investments.

Those larger investments are in peril, however, and are jeopardizing VCs' fortunes. Some pension funds are running short on cash, their money locked up in securities they cannot easily sell — and their managers are turning down venture capitalists' requests for more cash. That, in turn, is spilling over to startups, which are being told they cannot raise more money.

The consequence: There will be a slow-motion bloodbath. Slow, because the partnerships which tie venture-capital firms and their investors together are notoriously tricky to unwind; slow, too, because the extent to which VCs' startup portfolios are worth less — or just plain worthless — will take years to unfold.

The problem has been an excess of optimism. To a bullish venture capitalist, every investment looks like it might be the next Google; to a pension fund manager, every VC firm might be the next Kleiner Perkins or Sequoia Capital. That optimism has been turned from liquid cash into illiquid hope, to the tune of billions of dollars.

Bleeding out that hope — finding the deep, despairing bottom — is a process which might take a decade. Ressi thinks that the number of venture-capital firms should drop from 4,800 to 1,000 — while funding a larger number of startups. This will require painful changes in how they do business. But the venture-capital industry has hid its sickness for a long time, making a recovery all the more prolonged.

Ressi will no doubt watch gleefully: He feels VCs mistreated him at his last company, Game Trust. "I will not rest until there is balance in the force," he told The Deal last year. Revenge is a dish best served cold, via PowerPoint.

Ressi's presentation:

All in the family? If Sequoia is a family, it is surely the Borgias. The venture-capital firm has become known more for its ruthlessness than its nurturing. The partners there are obsessively concerned with making a mistake that causes them to lose face among their peers, and don't hesitate to jettison a CEO just to calm their nerves. And entrepreneurs? They know Sequoia well enough to trumpet its brand name — and watch their backs. No wonder family reunions, like Sequoia's crisis summit, prove to be awkward.

Aside from showing up to accept the award, Valentine has become press-shy. He inexplicably turned down a friendly cover story from Venture Capital Journal. Perhaps he realizes he's out of touch. His biography page has a picture of him dated 1967. Since then, Sequoia has grown far too large to be the family operation Valentine recalls from its founding years, and Silicon Valley has changed beyond recognition. Valentine's career in semiconductors is little help to the companies he invests in now. And entrepreneurs are far more gossipy than they were in his heyday. Valentine's lament — that Sequoia's presentation spread beyond the VC firm's control — just shows how lost a chip guy is in a world of information networks.

Okay, okay — there's an error on the Internet! But far more boring than thinking this is a glitch in Google's database is making up a conspiracy theory that this has something to do with Google CEO Eric Schmidt, who maneuvered to get Sequoia partner Michael Moritz off Google's board last year.

Because, Sequoia partner Jim Goetz says, mobile advertising is potentially a large market, and the startup, he claims, already generates more cash from its operations than it spends. Never mind that Goetz, shown here, was spewing a grow-at-all-costs investment philosophy a year ago; mental flexibility is the hallmark of a venture capitalist.

Goetz's indecisiveness shouldn't matter to AdMob's founder, Omar Hamoui, who didn't need a flip-flopping VC to know he had to run his business like a business. For entrepreneurs more used to spending someone else's money freely, this must all seem a puzzle on the order of a Zen koan: How do you raise venture capital? By not needing it.

Sequoia, which recently summoned the CEOs of startups it invests in to an emergency meeting and told them to cut costs, is doing the same with its own portfolio. Rather than continuing to invest in the losers, it's culling the herd now. This despite the fact it just raised $1.7 billion in new funds — money that's destined for new ideas, not old ones.

AlwaysOn founder Tony Perkins, my old boss at the Red Herring, has a trenchant analysis of Sequoia's message to entrepreneurs, disguised only thinly as satire. His point, as a longtime observer of Sequoia, is that the venture capital firm's sudden panic is as much about its partners' losing face in front of their investors — the endowments, pension funds, and wealthy individuals from which they raise funds. Appearances matter, now more than ever. And if keeping up appearances means dropping a company? Sequoia's newly hungry partners will do it in a heartbeat.

Venture capital firms raise separate funds over time. Typically, investments in the same startup come from the same fund; VCs don't invest all of a fund at once, reserving some money in the original fund for these follow-up financings.

So the new fund is a separate pool of money from the one Sequoia will use to fund its current portfolio — the companies whose CEOs were recently summoned by Sequoia to a summit meeting to hear all about the need to cut costs and become self-sustaining. This advice was the complete opposite of what Sequoia was telling CEOs earlier this year, which was to grow at all costs and emulate Mahalo CEO Jason Calacanis, who freely admits his company isn't worrying about revenues.

What Sequoia really should have been telling its startups: We told you to spend what you have, as aggressively as possible. Now we have money, and you don't. That's your problem.

Today, Sequoia Capital hosted a mandatory CEO All-Hands Meeting on Sand Hill Road (where else?). There were about 100 CEO's in attendance and let me tell you, the mood was somber. I'm not one to perpetuate doom and gloom or bad news, but let me underscore this for you: We are in a serious economic downturn and this is just the beginning. Immediate, decisive and swift action is required, along with frugal, day-to-day management of expenses and our business is required.

***Here are my notes from the meeting. Keep this note in your in-box and read it every day. I'm serious folks, this is for our survival.***

Speakers:

· Mike Moritz, General Partner, Sequoia Capital (he moderated the speakers).

· Eric Upin, Partner, Sequoia Capital (Eric ran the $26-Billion Stanford Endowment Fund and knows a few things about Economics and investing.)

· Michael Beckwith, Sequoia Capital (Michael was recruited to start Sequoia's very first hedge fund, coming from Maverick Capital and Robertson Stephens. I know him from my BEA days.)

· Doug Leone, , General Partner, Sequoia Capital

Slide projected on the huge conference room screen as people assembled inside the conference center to take their seats: a gravestone with the inscription: RIP, Good Times.

Mike Moritz:

· The only time Sequoia's assembled all CEO's like this was during the dot.com crash.

· We are in drastic times. Drastic times mean drastic measures must be taken to survive. Forget about getting ahead, we're talking survive. Get this point into your heads.

· For those of you that are not cash-flow positive, get there now. Raising capital is nearly impossible if you're too far off of cash flow positive.

· There will be consequences for those who hesitate. Act now.

Eric Upin:

· It's always darkest before it's pitch black.

· Survival of this storm means drastic measures must be taken now, so you will have the opportunity to capitalize on this down turn in the future.

· We are in the beginning of a long cycle, what we call a "Secular Bear Market." This could be a 15 year problem. [many slides on historical charts of previous recessions, averaging 17 year cycles.]

· The credit market [versus the Equity markets] are the issue and will take time to recover.

· Inflection point: Make changes, slash expenses, cut deep and keep marching. You can't be a general if you turn back.

· This is a global issue and not a 'normal' time.

· There is significant risk to growth and your personal wealth.

· Advice:

o Manage what you can control. You can't control the economy, but you can control everything else.

§ Cut spending. Cut fat. Preserve Capital.

§ Don't trust your models and spreadsheets. All assumptions prior to today are wrong.

§ Focus on quality.

§ Reduce risk.

Michael Beckwith:

· Note: Michael had a lot of slides that were charts, data points and comparisons.

· A "V" shaped recovery is unlikely [√]

· Cuts in spending will accelerate in Q4/Q1. Look at eBay-this is just the beginning.

Doug Leone:

· This is a different animal and will take years to recover.

· Getting another round if you're not profitable will be rough.

· Do everything possible to get to cash flow positive. Now.

· Nail your Sales and Marketing message.

· Pound your competitors shortcomings. They're hurting and they will be quiet. Take the offensive.

· In a downturn, aggressive PR and Communications strategy is key.

· M&A will decrease dramatically and only lean companies, with proven sales models will be acquired.

· Spectrum discussion:

o Capital Preservation ß—————————————————à Grab Market

o Everyone should be far to the left (capital preservation)

· Requirements of our companies:

o You must have a proven product

o You must cut expenses. Now and deep.

o Your product should reduce expenses and drive revenue [NOTE: I want to revisit this with the Management team. Our solution does both, we need to quickly and crisply define the sound bite here.]

o Honestly assess your solution vs. your competitors.

o Cash is king [have you gotten this message yet?]

o You must get to profitability as soon as possible to weather this storm and be self-sustaining.

· Operations review:

o Engineering: Since you already have a product, strongly consider reducing the number of engineers that you have.

o Product: What features are absolutely essential? Choose carefully and focus.

o Marketing: Measure everything and cut what is not working. You don't need large Product Marketing, Product Management teams.

o Sales & Business Development: What is your return on this investment? The Valley has gotten fat with Sales people: Big bases, big variables. Cut base salaries on sales people, highly leverage them with upside (increase variable) and make people pay for themselves via increased sales productivity. Don't add sales people until you've achieved your goals with sales productivity. Be disciplined.

o Pipeline: Scrub the shit out of it and be honest with yourself.

o Finance: Defer payments, what is essential? Kill cash burn.

· Death Spiral (Nobody moves fast enough in times like these, so get going and research later.)

o The death spiral sucks you in, you're in it before you know it and then you die.

o Survival of the quickest.

o Cutting deeper is the formula for survival.

o You should have at least one year's worth of cash on hand.

o Tactics:

§ Assess your situation. Drop your assumptions, start with a blank page and start zero-based budgeting.

§ Adapt quickly

§ Make your cuts

§ Review all salaries

§ Change sales comp

§ Bolster your balance sheet-if you can add $5M to your coffers, take it and save it.

§ Spend like it's your last dollar.

· Get Real or Go Home.

I would be more impressed if Sequoia hadn't pulled this act before when the last bubble burst. True, they called the movement of the market. But it's conventional wisdom today that the economy is tanking.

But what does the economy have to do with the startups Sequoia funds? The whole point of venture capital is to nurture companies that need capital. Part of the art of investing in startups is knowing when to push them out of the nest. Templated cost-cutting advice, applied across Sequoia's portfolio, is hardly a value-add.

And it's not clear how this was bad advice a year ago. Sequoia's portfolio should have been keeping a close eye on costs then as now. The IPO market is definitely ailing now, but it's hardly been healthy over the last few years. Large acquisitions have been scant since MySpace and YouTube got bought. The chaos on Wall Street doesn't change the bleak outlook for exiting startup investments profitably that existed beforehand.

So what's really going on here? Consider two of the companies that heard Sequoia's speeches last time around: PayPal and Google. They both spent and grew aggressively in the face of a local recession. They both managed to IPO when few tech companies were going public. And they both delivered handsome profits to Sequoia.

I'm just guessing at Moritz's game, but here's what I suspect is going through his head: He could have delivered a cost-cutting sermon a year ago, true. But his entrepreneurs are far more likely to listen to it now. And the rest of Silicon Valley is listening, too. He's made his bit of noise, knowing full well word would leak out, and put a scare in all his competitors.

How convenient that this scare-tactics summit was held just a month after Sequoia raised $1.7 billion in new funds. While everyone else is hunkering down, Sequoia will cull the weaklings from its portfolio, double down on the winners — and profit before anyone realizes the good times are back. Well played, Michael, well played.