Where are John and Todd?

The jazz band was playing. The sun was setting over Elliott Bay. And the lawyers, accountants, entrepreneurs and venture capitalists all appeared to be having a good time last night as Fenwick & West celebrated the opening of their spectacular new office in downtown Seattle.

But as I made the rounds at the party, two topics of conversation kept bubbling up. (And no one would characterize either as good news stories.)

The first was the Entellium debacle, a monumental blow up in which two top executives of the Seattle software startup were charged last week with wire fraud in what a federal prosecutor described as a classic case of “cooking the books.”

Seattle’s venture community is tight, which means many don’t want to talk on the record about mistakes of others. But the message last night from several sources was clear. Why weren’t audits completed? Where was the board? How did these executives pull this off?

One accounting professional told me that it has become customary for venture capital firms to waive audits of early-stage companies in part because of the added expense. But when that topic arises next time, he said there is one word he will now share: “Entellium.”

A venture capitalist, however, noted that they require audits of all companies that have started generating revenue. (We reported last week that Entellium’s accounting firm never completed an audit.) And many agreed that a $20,000 to $40,000 audit could have uncovered the fraud, an expense that would have been well worth it given the $50 million that federal prosecutors say was invested in the company.

One party guest noted how the Entellium story would have been much bigger had it not been for the economic meltdown, which was the second major topic of discussion last night.

In fact, the mindset appears to have changed in the past two weeks in the technology community. Earlier this month, many sources were putting a brave face on the situation thinking that the technology community — which was the cause of the last economic pinch — may escape this one.

That no longer appears to be the case, with many people citing the grim warnings coming out of top Silicon Valley venture capital firms like Sequoia and Benchmark Capital.

An angel investor last night cited two examples of how entrepreneurs who were thinking about leaving big companies to create startups have decided to stay put, while a third entrepreneur had a term sheet pulled by a venture capital firm.

The reason the offer was pulled? The venture firm said it was passing on new deals at the moment in order to “double down” on existing portfolio companies.

Both scenarios spell potential trouble for the startup community. After all, if entrepreneurs are afraid to make the leap and venture capital firms are unwilling to fund new startups, a vicious cycle may occur in which innovation stalls. (Heck, my wife just turned on NPR for me to hear this statement from the reporter: “Isn’t it a terrible time to start a business?”)

This follows news that Portland-base Jive Software chopped one third of its staff, or about 40 employees,, and Seattle-based Redfin cut about 20 percent of its staff. There’s also word that a Seattle venture firm plans to bring together CEOs from portfolio companies soon to discuss measures for weathering the storm.

It may not be that bad. A lawyer at the party told me that certain areas of the economy such as health care and biotechnology are holding up fairly well (that’s a sector accustomed to hard times) and a venture capitalist indicated that there are ways for new companies to capitalize on the market downturn.

But the overall feeling was one of major concern. The tech community is not immune from the problems on Wall Street. So everyone better buckle in for a wild ride.

– John Cook, johnharoldcook@gmail.com