In just about every Silicon Valley boardroom the conversation inevitably turns to cutting costs. Once the pleasantries are exchanged and election handicapping subsides, executives eventually ask a variant of "How bad can it get?" and "How much should we cut?"

Those are the right questions to be asking, given the dour market news and that superb but gloomy and widely publicized analysis by Sequoia Capital, the leading technology venture capital firm. Indeed, the world has endured a financial shock significantly greater in magnitude than the 2000 collapse. And while Silicon Valley is at its edge and not the epicenter, the consequences of this shock to the Valley are real. Investment capital will be scarce and expensive, exits will take longer, and revenue growth will be tough. In this environment, cutting expenses may be necessary to survive.

But don't forget that surviving is not winning—and winning requires more than cutting. In fact, sometimes cutting eliminates the possibility you can win. Winning requires three things: a business proposition that customers embrace even when customer spending is down; enough cash to fund the business appropriately when cash is scarce; and great execution by the team. Let's look at each in turn.

First, will customers come calling when the chips are down? Customers reorder priorities quickly in a recession. U.S. companies that are shutting factories will not have the budget for experimental social media advertising. Every worker not hired is $5,000 worth of IT spending that will not happen. Consumers who are failing to pay their mortgage don't upgrade cell-phone plans. However, customer anxiety and cost-cutting can be your friend. In a downturn, people will think the unthinkable, reexamine existing commitments, and allocate budget to what works now—not what worked in the past.

MUST-HAVES PREVAIL
Look at the 2000 crash. Internet direct response and keyword search exploded as marketing executives who had to justify their budgets turned to media that could deliver and prove it. The result: Google (GOOG) is now worth $116 billion. Productivity-enhancing tools like Research In Motion's (RIMM) BlackBerry wormed their way into corporations, despite IT resistance; having your employees available 24/7 is handy if you have just halved your staff. Little wonder that RIM is worth $26 billion. Open-source software, or low-cost software delivered over the Web, as a service, might not be as ready for your business as you'd like, but the IT director who has been told to cut 80% from a software budget might have no choice. Witness Salesforce.com's (CRM) $3.5 billion valuation. On the consumer side, Amazon.com (AMZN)and eBay (EBAY) exploded despite the recession. Must-haves rise to the top.

Nice-to-haves fall to the bottom. Which are you?

Now, let's assume you have the right idea. Then the question becomes, Do you have the cash? If you did not raise money last year when it was easy, then you have to understand the postdownturn fundraising reality. Now even the credulous are suspicious. It's here that the Sequoia Capital presentation is spot on.

Essentially, Sequoia is saying what's always true but rarely stated about investing: If you run out of money before you have proven that your business model works, then the terms of any new investment round will be unattractive for the entrepreneur at best; in a worst-case scenario, there will be no more money. Proof in a downturn does not mean trial customers. It means real revenue and preferably accelerating growth. If your company has already raised a first round but does not yet have revenue—or worse, has low growth or flat revenue—cutting expenses is the only way to survive. Cut now, cut hard, and figure out something different to do with the rest of the cash.

However, there will be many companies that have a great product and have early revenue traction but still need capital. For every Google, which spewed cash once it locked on the right business model, there are five others that will continue to consume cash for an extended period, even after developing a clear and validated business model. This is a point worth repeating. There is a lot of nonsense spoken by venture capitalists about getting by without spending more, and I am guilty of it, too. Of course it would be great if our companies could build great technology businesses without investing in research and development or sales and marketing. It would also be great if we could build cars without using steel. But we cannot. The system is called capitalism because making it work requires capital, and often a decision not to invest is a decision not to grow.

WINNING BETS IN A DOWNTURN
Consider some of the top venture-backed exits since the last recession. Many have created huge value, but could not have done so without the foresight and perseverance to keep investing in the face of the 2001-2002 recession. Wireless carrier MetroPCS (PCS) endured bankruptcy, software provider Salesforce.com burned through $70 million in equity capital as a private company, and medical device maker Kyphon certainly did not have cash flow while the Food & Drug Administration was determining whether to approve its therapy. All these required equity capital and thus investors with the guts to finance big ideas in a tough market. Although it went public in 2000, RIM burned through more than $219 million building the BlackBerry business. Amazon's bonds were downgraded in 2002 as "likely to default" by many investment banks because the e-tailer was still losing money. Many of those investment banks are no longer independent, and some have failed; Amazon continues strong. Not only did all these companies continue to invest in the downturn, but there was no way to build them without the investments. An earlier focus on profit at the expense of growth would have resulted in a less exciting and, ironically, less profitable outcome.

Startups are still getting money—but for the right idea, with the right execution. Although the world is bleak, venture investors will plow $28 billion into 3,500 different companies this year. Many of the firms that are talking gloom and doom are also raising large new funds. You may need their money, but remember they also need your idea. It is precisely when mediocre deals are failing that investors most need great ones. If you can show your existing money has been well-invested and that new money can accelerate the upside rather than simply postpone the downside, the chances are greater you will get funded. If you create healthy competition for the deal, then you will more likely get funded on attractive terms. If you are just fooling yourself about how far along you really are, then you will not be able to raise the money. Then again, that is the way the system is meant to work. Recessions just make it real.

Rory O'Driscoll, a managing director of Scale Venture Partners, is a veteran venture capitalist who focuses on mobile, Internet, and enterprise software and services. He has contributed to the evolution of business models at companies such as Frontbridge, Omniture, and PlaceWare. O'Driscoll holds a bachelor of science degree from the London School of Economics.