Just a few months ago, there were questions about whether or not Silicon Valley (and internet companies in general) would be impacted by a recession.

Now that most economists predict recession, the credit crunch has turned into a crisis and 2007’s Web 2.0 funding numbers don’t look too bullish, the question has shifted from “will the internet economy be affected?” to “how bad will the internet economy be affected?

Jim Breyer, who sits on the board of Wal-Mart and was the first venture capitalist to invest in Facebook, thinks the impact will be “huge“:

“Silicon Valley is often very delusional. So one of the challenges is to step back and say, ‘If there is a recession, why won’t advertising spending be cut dramatically? And if advertising spending is cut dramatically, why doesn’t that deeply affect our consumer Internet companies?’

“It’s always my view that it does. We don’t expect there to be as much of an impact, perhaps, on great companies in the Valley such as Google. But we expect there to be a significant effect.”

It’s my opinion that this downturn will be deadly for a considerable number of internet startups.

Some of the victims will not be killed by the recession itself; many would have inevitably failed because they had not established any means of generating enough cashflow to sustain themselves without further investment.

A recession that makes it harder to generate revenue and to raise additional capital will simply speed up the dying process.

But catastrophic events such as major economic downturns are interesting phenomena because they also typically provide compelling business opportunities to entrepreneurs who are smart, prepared and know where to look.

Startups that did not raise significant amounts of capital and that have not scaled up at a rate significantly disproportionate to cashflow and revenue growth, for instance, are more likely to be capable of surviving recession and emerging as stronger players as many of their funded counterparts who scaled excessively fail.

Startups with a solid financial footing may be able to take advantage of the situation to buy out struggling competitors or synergistic properties on the cheap, again enabling them to emerge from the downturn in a much stronger position.

Additionally, as businesses cut costs to deal with the realities of recession, there are always opportunities for companies that can help businesses save money.

Unfortunately, of course, many of the most hyped internet investments in recent years are consumer internet startups that have proven little ability to save anybody money.

Those that aren’t in a strong position have good reason to be concerned.

Silicon Valley entrepreneurs and investors have created and funded startups that were based more on hype than on sensible business models and they’ve made foolish assumptions about how insulated they would be from the larger economy.

The naivety and arrogance that is often found in Silicon Valley is epitomised by Facebook founder Mark Zuckerberg’s recent comment:

“I don’t spend that much time studying the overall economic climate, even though people seem to think that there’s this general slowdown going on. It may slow down slightly, or it may not be affected, but in general, our growth is so rapid that I would be pretty surprised if it got affected in a meaningful way.”

This naivety and arrogance can sharpen the axe of recession, but for savvy internet entrepreneurs, there’s good reason to be excited.

The downturn will help separate the wheat from the chaff and establish who is a contender and who is a pretender.

When this process is occurring, there is often no better time to make a move. If you’re a startup on solid footing, exploit the situation to strengthen your business at the expense of vulnerable competitors.

If you’re an entrepreneur who doesn’t need a venture capital subsidy, put your own resources to work to build a company while those who can’t do the same sit on the sidelines and go back to their day jobs.

In the internet startup world, the old adage “when there’s blood in the streets, buy property” is aptly rephrased as “when there’s blood on Sand Hill Road, build a company.