Many writers have documented the demise of venture capital dealflow in 2008 and have forecasted a dried up 2009. Startups are in for a world of hurt, similar to 2000 when you couldn’t get anything funded at all and all the developed e-commerce talent (including me) moved to higher paying corporate jobs. During those days, it seemed like the only salable operators sticking it out at earlier stage companies were the highest ranks or the earliest employees and those at companies that rounded in 1999 and had enough for this bad spell.

The giant volume of hires in those dot-coms between rounds B & C, whose 1% went to 30 bps in the matter of months because of step-down rounds or other bad deals were out of there faster than you could say “sign-on bonus”.

This put many young companies at a disadvantage in managing through their first difficult period. Unfortunately as VCs and other investors primarily buy into a management team and key employees, this put many venture backed startups in a bad position even when capital began to flow more easily.

In this version of the bust, startup founders and VCs should have the good sense and forethought to know that the when things go bad, through the layoffs and cost reduction, you have to keep your key resources properly incentivized. Protect your own investment through preferred equity structures and strong board participation. But always position the company to pay everyone in a large exit by retaining and fully aligning the management team and their relationship with key talent that will help the company grow in the hard times and drive it to scale and liquidity when things clear up.

A good startup should be able to grow in a downturn because the market opportunities that are being served are new. In order to give a startup a shot, the employees need to feel fully aligned with the investor. If the VC operates like a big company with heavy preference for itself and low percentage, common equity for the key operators, the newer, riskier opportunities are foresaken for safer returns to maintain survival, rather than growth.  The combination of preference overhangs and lower valuations result in low value common stock and therefore, the company operators will move to a lower risk threshold since the payout is smaller.  In this scenario, the opportunity is better served by a larger company that fully scaled cost structures and the startup is now at risk of competitive threat from more established players.

So founders, investors and board members: Re-up your key men before things get REALLY bad!