Daily Archives: March 14, 2010

The 10 Year Anniversary: Lessons from the Dot Com Crash by Gregory Hilton

It was 10 years ago yesterday that the spectacular five year growth of the NASDAQ composite index peaked at 5,132.52. It had surged by 50% during the preceding year, and few saw the storm clouds on the horizon.
President Bill Clinton repeatedly spoke of the “new economy created by the information superhighway”, and Vice President Al Gore promised “You ain’t seen nothin’ yet!” Silicon Valley was transforming the world, and few people thought it was headed for disaster.
The nation was mesmerized by stories about entrepreneurs such as Marc Andreessen of Netscape. He was on the cover of TIME magazine at the age of 24, and two years later his company was sold to AOL for $4 billion.
Companies were under pressure to go public quickly, which was far easier to do in those days. More than 1,300 technology companies went public between 1995 and 2000, and 534 venture-backed initial public offerings occurred just in1999 and 2000. (In 2008 and 2009, only 18 venture-backed companies went public).
Most of the dot coms were not based on real business models. People kept investing in this new economy, but they weren’t interested in long-term growth. They were looking for a fast profit. Back then the Fortune 500 companies were looked upon as poor investments. Instead of a 7% return, investors believed they would receive 30% returns from tech start-ups.
Common sense was abandoned and investors were backing business plans they did not understand. The senior employees of these firms were recruited with promises of stock options which later turned out to be worthless.
The dot com bubble burst in 2000 and during the next two years NASDAQ lost 80% of its value. Five trillion dollars of virtual wealth disappeared. The vast majority of high tech startups shut their doors after burning through their venture capital, and they had never turned a profit. We now refer to them as dot bombs.
NASDAQ never recovered and today it is 53% below its 2000 peak. Stocks such as Yahoo fell from $115 to $5. In its worst business decision, Yahoo purchased GeoCities for $3.57 billion in January 1999, and a decade later this subsidiary was closed completely. Nortel Networks went from $113 to $1, and InfoSpace went from $1,305 to $22. AOL was then valued at $161 billion, while today it is worth $4 billion.
Tech investing was not rational a decade ago. Market share is important but the crash taught investors that profits do matter. In the late 1990’s high tech and dot com firms were receiving huge infusions of cash from venture capitalists, but once again they did not know how to turn a profit. In fact, that often was not their stated goal. They were instead working to increase traffic to their web sites.
Many times there was no useful application for the technology behind some of these dot coms, and the growth expectations were not realistic. It took Amazon five years to turn their first profit at the end of 2001. Pets.com was losing money on every sale and they promised to turn around the loss with increased volume.
Several scholarly studies have now been done on the dot com failure. One interesting observation was that not a single entrepreneur received venture capital funding by submitting a business plan over the transom. Social networks were highly important and entrepreneurs who received funding either knew the venture capitalist or gained a personal introduction.
The companies that survived were the ones which ignored the “Get Big Fast” business model. The days of 30% to 40% annual growth rates are gone, and now stock prices are reasonable and they are not at highly inflated prices. Venture capital firms are far more patient today, and an idea requires far more vetting to get funding.