Credit Crisis Spreads a Pall Over Silicon Valley

Since the credit crisis began gripping the financial world, Silicon Valley has watched from the sidelines, secure in the faith that it was insulated from the coming storm.

That faith is now being seriously undermined. High-tech entrepreneurs, investors and executives now believe the question is when, not if, the financial chaos will hurt the country’s cradle of innovation.

From San Francisco to San Jose, the effects are already palpable. This week, Apple , one of the Valley’s highfliers, lost 16.3 percent of its value as investors reasonably concluded that consumers would shun expensive gadgets over the holidays in favor of lower-ticket items — or paying down their credit cards. Shares in Yahoo and eBay are at their lowest levels in years.

Traveling in Europe on Monday, Steven A. Ballmer, Microsoft’s chief executive, conceded that financial problems would drag down business and consumer spending in the United States — and that many technology companies, including Microsoft, were vulnerable.

Other ominous signs abound. Semiconductor makers, many of which finance their capital-intensive operations with debt, have been hit hard. Advanced Micro Devices , a dimming rival to Intel , was expected to spin off its chip manufacturing operations this year to focus on processor design. Analysts say they believe the company has had trouble raising the hundreds of millions of dollars needed to make the move.

An A.M.D. spokesman, Drew Prairie, declined to comment on the status of the spinoff, saying that the company was in a mandatory quiet period ahead of an earnings release later this month.

The main drivers of Silicon Valley’s growth are start-up companies and the venture capitalists who back them. Many say that these engines of innovation are still chugging along, thanks in part to lessons learned and wisdom gained in the dot-com crash.

Nevertheless, a pall of anxiety seems to be spreading over the land.

“Funding will tighten up. We are certainly going to see some ripple effects,” said Ron Conway, a prominent venture capitalist who has invested in hundreds of Web start-ups over the last decade.

Start-ups that have less than six months of cash in the bank “better reduce costs,” Mr. Conway said. “I will certainly be advising my companies to do that.”

Silicon Valley has recited several calming mantras to itself during the prolonged economic turbulence. People are spending more and more time on the Internet — and advertising will inevitably follow. Blue-chip tech firms like Google , eBay and Cisco have balance sheets loaded with cash, not debt.

Yet nonstop economic gloom in other parts of the economy seems to have frayed the nerves of even the Valley’s most sublimely confident. Discussions of the economic crisis dominate conversations. Technology blogs offer prescriptions for riding out the crisis and intense debates over what percentage of start-ups are destined to fail.

According to a quarterly survey by Mark V. Cannice, director of the University of San Francisco Entrepreneurship Program, the confidence of venture capitalists has plummeted to the lowest level since the survey began in 2004.

“Everyone is worried about their budgets and everyone is worried about the economy,” said Jayant Kadambi, founder of Yume, a three-year-old online video advertising firm. “These are the conversations we have these days.”

Though companies like Yume claim that their business is not slowing, Internet advertising — the revenue model for an entire generation of Web start-ups — is perhaps one of the industry’s greatest vulnerabilities. In August, eMarketer, a digital marketing research firm, cited economic turbulence when it cut its projection for Internet ad dollars this year for a second time, to $24.9 billion, a 9 percent drop from its original projection.

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In the hardest-hit sectors of the overall economy, companies appear to be putting the brakes on their Internet spending. General Motors said last month that it was cutting its digital ad spending, after saying earlier this year that it would dedicate $1.5 billion, half its annual budget, to online advertising.

Jeff Lanctot, chief strategy officer at Avenue A Razorfish, an interactive advertising agency, said financial services and auto firms in particular were pulling back. He worries that if the economic woes continue, online advertising will be severely hurt in 2009. “The digital ad industry is clearly not immune from macroeconomic conditions,” he said.

One lingering problem in the Valley is a dearth of successful public offerings. Only six venture-backed technology and health care start-ups have gone public this year; only two are trading above their offering price. Last year, 86 such companies went public, according to the National Venture Capital Association.

That has plenty of people in the Valley worrying that venture capital — the fuel for new start-ups — might disappear as investors find themselves without a way to cash out.

CONTINUED : Financing: A rapidly closing door

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