"VCs are now saying, 'I want to invest in businesses that make money,'" says Kaufman.

Get ready for dot-com bomb 2.0.

VCs are showing tough love to their portfolio companies, telling them to slash costs, chase revenue, consider buyout offers — and above all, don't count on more cash from the VC.

Investors, meanwhile, say that with the IPO market dead and the economy turning downward, they expect venture capital partners to increasingly look for ways to get out of funding commitments, and they expect a wave of venture-backed companies and funds to fail or sell assets at a steep discount.

"Every firm I know has gone through the same process," said Alain Harrus, partner at Crosslink Capital, referring to a now infamous hunker-down presentation Sequoia Capital gave Oct. 10 to leaders of companies it has funded.

Silicon Valley eminence grise Ron Conway sent a message last month to about 20 of his portfolio companies that had less than a year of cash for operating expenses, advising them to cut costs or raise money. To make the point, Conway attached a copy of two similar warning advisories he sent in 2000 before the Internet bubble burst.

One immediate result has been layoffs.

One of the firms in Harrus' stable, Internet radio broadcaster Pandora Media of Oakland, cut 20 of its 140 employees in mid-October.

The same day, Sequoia-backed Internet advertising firm AdBrite of San Francisco laid off 40 of its roughly 100 employees. Other Sequoia-backed startups have also had significant reductions as well.

AdBrite CEO Ignacio "Iggy" Fanlo said his experience in the dot-com bust prompted him to act quickly and decisively. As president of Shopping.com, Fanlo presided over three layoff rounds, bringing that company's headcount down from over 300 to 95 between 2000 and 2002 before finally achieving profitability.

"You don't want to do it more than once," said Fanlo, who described the layoff process as "emotionally and mentally" difficult.

AdBrite is now profitable, with October a record revenue month, he said. The company says it had gross revenues of about $32 million in 2007.

The flow of deals has by no means stopped, though the $7.1 billion invested nationwide by venture capital firms in the third quarter was down 9 percent from the previous year, according to a new PricewaterhouseCoopers report. This month ISkoot of San Francisco raised $19 million in venture funding for its Skype-enabling mobile technology, and Redwood City-based Rock You, a social web site, picked up $17 million.

But VC firms are being far more selective — and demanding.

"VCs are now saying, 'I want to invest in businesses that make money.' Six months ago they said they wanted to invest in businesses that were popular," said Ahikam Kaufman, founder and chief operating officer of PageOnce.

His 2-year-old Palo Alto company offers a web based personal finance management service. Kaufman said that he has greatly accelerated his firm's plan to charge customers and sell advertising to facilitate his quest for $5 million in new venture funding.

PageOnce, which previously got $2.5 million in angel funding, has 200,000 Apple iPhone customers and the firm had planned to wait until it collected 500,000 users total before charging. Now, PageOnce is planning to start charging Blackberry users on Dec. 1 when it extends service to the Research In Motion devices. Charging iPhone users will take more time for technical reasons, he said.

George Hoyem, general partner of Blueprint Ventures, said that some companies are going to come up short.

"Most companies will not be able to raise capital in this environment," and if they are successful, the terms may be unpalatable as valuations will be lower, Hoyem said.

"The safest place to be right now is cash flow break-even, so you can tread water and wait for the sun to come out," he said.

Hoyem said some investors are already positioning to take over where others fail.

"There are funds being formed to take advantage of the carnage,'' he said. "I know it to be a fact that funds are being formed to pick up these busted VC plays at pennies on the dollar."

Martin Pichinson, founding partner of Sherwood Partners LLC, a well-known Mountain View consulting firm that helps restructure distressed technology firms and liquidate those that fail, said calls for his services have recently gone from several a month to several a week.

Kenneth Sawyer, managing director of Saints Capital in San Francisco, said that limited partners are increasingly looking to sell their investments, or they are quietly approaching general partners and asking that capital calls be deferred for the rest of the year.

"It's a great market for us," he said. Saints Capital specializes in buying venture capital and private equity investments from entities seeking a quick exit.

The credit crisis has only worsened the already existing crisis in the venture capital market caused by the lack of IPO activity, according to the National Venture Capital Association. The issue is particularly acute for funds — which typically have 10 year life spans — that are maturing and are out of cash.

There were only six venture-backed IPOs in the first three quarters of 2008, the lowest volume since 1977, and if that situation continues, it could inhibit the rate of investments next year, said NCVA President Mark Heesen. Mergers and acquisition activity is also sluggish.

Two of the year's successful deals — Bill Me Later's $945 million sale this month to eBay, and World Wide Packets sale in March to Ciena for approximately $300 million — were backed by San Francisco-based Azure Capital Partners.

General Partner Mike Kwatinetz said the current slowdown in the venture market is positive in some ways because startups are being more realistically valued.

"The deals are less competitive,'' he said.

Sharon Wienbar, managing director of Scale Venture Partners of Foster City, said two companies in her firm's portfolio recently acquired smaller companies that did not have the cash they needed to expand.

"It's classic in a downturn, you see the strong get stronger and the weak get weaker and the strong take advantage of the weak,'' said Wienbar, whose firm focuses on early stage companies in broadband and wireless communications, software and biotechnology.

But Wienbar said the atmosphere so far is totally different than after the 2001 bust, when venture firms were swapping out CEOs of companies en masse, replacing company builders with cost cutters.

Timothy Draper, managing director of Sand Hill Road stalwart Draper Fisher Jurvetson, which in the third quarter was reportedly the most active venture capital investor in the nation with 26 deals, said there have been "quite a few layoffs" in his portfolio, but the results are likely to be stronger firms.

"I believe entrepreneurial people become much more creative and driven when faced with unusual and challenging situations," Draper said. "I think this dip will be the birthplace of some of the greatest companies in the world."