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WALL STREET'S CRUNCH is now spilling into the world of Silicon Valley start-ups.

Many of these closely held companies, already smarting from dwindling opportunities to go public and a souring economy, are stuck holding illiquid debt instruments called auction-rate securities. These obscure securities already have caused financial headaches for big publicly traded companies like JetBlue Airways Corp. and Bristol-Myers Squibb Co., the closed-end mutual-fund industry and even some hospitals and schools.

The instruments were marketed as extremely safe investments, nearly the equivalent of cash. But now, amid wider credit-market worries, the $330 billion market for the securities has seized up, making it hard for holders to convert them to cash. And the mess will hit many start-ups harder than other companies and institutions holding the instruments, lawyers and investors say.

"It's a huge problem," says Edward Wes, a partner with the law firm Perkins Coie, which represents start-ups and venture-capital firms out of its Menlo Park, Calif., office. "The private companies need liquidity more, because they're burning cash faster than public companies."

Start-ups often have little revenue and need ready access to their cash and short-term investments to fund operations and make payroll. That is unlike many public companies, which often have larger cash reserves.

So if the squeeze in the auction-rate market continues, start-ups that parked big chunks of their cash in these securities — thinking they were liquid — could be forced to dump them for big losses, if they can find buyers at all.

Ken Lawler, a partner at Battery Ventures in Menlo Park, says that 12 of the 65 start-ups in Battery's portfolio hold auction-rate securities, though only a few face near-term liquidity problems. On Feb. 29, eight venture-capital firms participated in a crisis conference call titled "Failed Auction Forum," sponsored by financial-analytics firm Clearwater Analytics LLC to discuss solutions to the auction-rate meltdown.

Several start-ups that recently filed for initial public stock offerings reported holding auction-rate securities at the time of their filings. They include medical-device company Cardiovascular Systems Inc. of St. Paul, Minn., and molecular-diagnostics firm XDx Inc. of Brisbane, Calif.

XDx reported holding nearly $8.8 million in auction-rate securities as of June 30 and is backed by Silicon Valley venture firm Kleiner Perkins Caufield & Byers. Cardiovascular Systems, which makes devices to treat vascular disease, said in its filing that as of Sept. 30, $17.4 million of its $18.5 million in short-term investments — which it classified as "available for sale" — was parked in auction-rate securities.

XDx declined to comment. Cardiovascular Systems didn't immediately comment.

These firms aren't alone. Venture-capital investors across Silicon Valley are scrambling to determine their exposure to the crisis and help start-ups they have funded work out temporary solutions, like taking out special lines of credit from banks or selling auction-rate securities at a discount on an emerging secondary market. The problem is believed to affect companies that include Internet firms, semiconductor makers and larger medical-related firms poised to go public.

"My sense is, it's all across the board," says Steve Spurlock, the operating partner at Benchmark Capital in Menlo Park.

Not everybody invested in the securities. Among Benchmark's investments, for example, Mr. Spurlock says that "a couple" of portfolio companies hold the debt investments, though they don't represent a significant percentage of their cash.

Many start-ups bought auction-rate securities at the urging of the cash-management departments of investment banks, which often hold money for start-ups that have raised cash from venture capitalists, according to investors and start-up executives.

Money raised by the young companies is supposed to be managed very conservatively, not for growth. But "start-ups sometimes get a little anxious and try to squeeze extra returns from their cash investments," says Spencer Rascoff, the chief financial officer of Seattle Web real-estate company Zillow.com.

Some small companies may have jumped at the chance to buy auction-rate securities and earn a slightly higher return compared with, say, a money-market fund. The firms may hope to use the extra money to hire employees or deploy new products, he notes.

Mr. Rascoff said Zillow has held auction-rate securities in the past but unloaded all of them more than a year ago. The company never had more than 2% of its cash tied up in the securities, he said.

Furthermore, not all start-ups holding auction-rate securities are in trouble. Companies with only a small portion of their cash in the securities may not need the money for months, or even years — by which time the troubles in the market may have cleared up.

One executive at a Silicon Valley technology company said his firm holds less than 10% of its cash in auction-rate securities, so the seized-up market "is not going to impact us from an operational standpoint for quite some time." But, he said, "if this persists into the summer or the fall, I'm going to be losing a lot more sleep."

Write to Rebecca Buckman at rebecca.buckman@wsj.com