I
At the beginning of startup.com, an entertaining documentary that tracks the rise and fall of Govworks.com, Khalil Isaz Tuzman, a handsome young investment banker, packs up his desk at Goldman Sachs and walks into the New York night, his arms full of boxes. It is May 1999. “I’m going to start an Internet company,”1 Tuzman says, his sheepish grin betraying his disbelief. A few weeks later Tuzman finds himself on Sand Hill Road trying to raise money for a business with no assets, no experience, and no financial plan. All he has to pitch is the premise that people would prefer to go online to pay their parking tickets, update their driver’s licenses, and otherwise deal with the government. Such services represent a “vertical market of $586 billion,” he assures a group of VCs. “Parking tickets alone come to $500 million.” A Kleiner Perkins representative tells Tuzman that Govworks.com is two years too late and located on the wrong coast, but he doesn’t get disheartened. After more than a dozen meetings, in California and on the eastern seaboard, he and his childhood friend, Tom Herman, extract pledges for close to $20 million, enough to get them started. Another Web dream is under way.
What had started out as a novelty for computer science majors and Silicon Valley mavericks was now a staple of the MBA curriculum. The University of Michigan Business School started a course, “From Idea to IPO in 14 Weeks,” in which students developed their own start-up proposals, and a venture capital firm paid $12,000 to sit in on the class. At Harvard Business School, a student poll indicated that of 880 students who would be graduating in the summer 1999, 343 were planning to join high-tech start-ups or venture capital firms, while only 308 were going into management consulting or finance. “I didn’t want to miss the Big One,” Patrick Mullane, a Harvard student who turned down a job at Arthur Andersen to join SupplierMarket.com, a B2B venture, told Fortune. “I didn’t want to miss the next Industrial Revolution.”2 The students’ role models were recent Harvard MBAs like Hope and Will Chen, who had sold their Internet billing company to eBay for $125 million, Stig Leschly, who had sold his start-up, Exchange.com, to Amazon.com for $200 million, and Anthony Tjan, who had raised $100 million for his Internet firm, Zefer. “There’s never been a time in contemporary history when there’s been a chance like this to leave your mark on the world,” Tjan said to The Boston Globe.3
Ivy League MBAs weren’t the only ones who saw the Internet as an escape from the routine and the bureaucratic. A survey carried out in the spring of 1999 suggested that one in twelve Americans was at that moment trying to found a new business. Many more were thinking about it. The exploits of Internet entrepreneurs like Jerry Yang and Jeff Bezos had turned them into icons. The media was full of stories about the demise of the corporation and the rise of small businesses. In a cover story celebrating the rise of a “Free Agent Nation,” Fast Company calculated that there were now about 25 million people who worked for themselves in the United States.4
While the Internet was undoubtedly spawning a lot of start-ups, much of what was being written about them didn’t make economic sense. The wave of individual enterprise, while commendable on some levels, was really an artifact of the speculative bubble, which was directing unprecedented sums of capital toward the venture capital industry. Enterprise without capital is like a Cadillac without gas. It may look impressive, but it isn’t going anywhere. In 1996, there were 458 venture capital firms in the United States, with $52 billion under management. By international standards, these were impressive figures; no other country in the world had a venture capital industry on anything like the U.S. scale. But in just three years the industry more than doubled in size. By 1999, there were 779 venture capital firms, with $164 billion to spend. Everything about the industry was getting bigger. At the start of the 1990s, a $100 million venture capital fund was considered large. Now, Kleiner Perkins and other Silicon Valley firms were raising billion-dollar funds. Much of the money that went into these funds was hardly speculative capital in the classic sense. The investors included university endowments, such as those at Harvard and Stanford, and charitable trusts, such as the Ford, Hewlett, and Wellcome foundations. Many of these institutions saw investing in venture capital funds as a less risky way to participate in the Internet boom than picking individual stocks.
With their coffers bulging, the VCs had the capacity and the incentive to fund a lot more start-ups. In 1996, they gave $11.2 billion to 2,123 new ventures. In 1999, 3,957 companies received a total of $59.4 billion. The average investment in 1999 was $15 million, but some of them were much larger. In one round of financing, Datek Online Holdings, the online trading firm, raised $195 million. In another, Planet Rx, an online drugstore, raised $59.3 million. The range of companies that received funding was startling. E-Stamp, a business that planned to sell stamps over the Internet, raised $31.5 million.
Each of these companies was heading for an early IPO, which is why they were able to raise so much money. The days when VCs nurtured investments for five or ten years before selling them to the public were over. These days, twelve months was a long-term investment horizon. Many VCs had reservations about what was happening, but they were just as trapped in follow-the-leader logic as the investment bankers and the mutual fund managers were. Before the advent of the Internet, VCs had often demanded that entrepreneurs put a third of their own net worth into their companies. By the middle of 1999, the VCs were competing with one another for the privilege of financing the next Internet business plan that came through the door, and all prior rules had been suspended. “It was absurdly easy,” a young Harvard Business School graduate who helped raise several million dollars for an Internet start-up in the fall of 1999, recalled. “You would walk into offices in New York and people would immediately offer money to you if they thought you looked smart. We didn’t have any data on the market; we didn’t have a product demo; we didn’t have anything. We had a business plan, but that was it.”5
Even the old-line venture capital firms, which were more conservative than their Silicon Valley and Silicon Alley brethren, were lured into the Internet industry. For the partners at the Mayfield Fund, an East Coast firm that had been going since the 1960s, it was Amazon.com’s $30 billion stock market valuation that proved the turning point. In the spring of 1999, they made more than a dozen investments in e-commerce companies, including an online invitation company, an online retailer of college textbooks, and a gay and lesbian portal. The Mayfield Fund also invested in Govworks.com.
II
The biggest venture capital deal of the year was for $275 million, and it closed in July, shortly after the Atlanta day-trading massacre. The company that received this massive cash infusion was Webvan, an Oakland-based start-up that was planning to build a nationwide chain of online grocery stores. Of all the follies of the Internet boom, Webvan was arguably (but not indisputably) the grandest. Louis Borders, the founder of the Borders bookstore chain, which Kmart bought from him in 1992, was the man behind Webvan. In his Internet venture, Borders originally wanted to target the entire American retail market—more than $2 trillion a year—selling everything from fresh fish to designer clothes over the World Wide Web. In 1997, when Borders went to see the partners at Benchmark Capital, they were skeptical about this plan, but his intelligence and ambition impressed them. After persuading him to start out with groceries, they agreed to invest $3.5 million in seed money. Sequoia Capital, which had financed Yahoo!, invested the same amount. One of Benchmark’s partners told Borders that he was setting up a billion-dollar company. “Naw,” Borders replied. “It’s going to be ten billion. Or zero.”6
By early 1999, Borders had raised another $150 million from a varied group of investors that included Yahoo!; CBS; Knight-Ridder, the newspaper chain; and LVMH, the French luxury goods conglomerate. (Bernard Arnault, LVMH’s suave chairman, was the latest old-economy bigwig to fall for the Internet.) Webvan used some of this money to build a 330,000-square-foot warehouse in Oakland, which would serve as a laboratory for testing Borders’s theory that he could undercut bricks-and-mortar competitors like Safeway and Kroger. As the existing online grocers, such as Peapod and Streamline, had discovered, selling groceries over the Internet was challenging. Grocery items are bulky, heavy, and, in many cases, perishable—all of which makes them expensive to store and transport.
Borders, a math major in college, believed the key to success was clever technology. When he set up his first bookstore, he wrote his own software to manage its inventory. The Oakland warehouse, which opened for business in June 1999, looked like something out of a Fritz Lang movie. A vast array of computerized conveyor belts delivered grocery items to specially designed “pods,” or assembly areas, where an employee packed them into bags. Webvan offered more than 300 varieties of vegetables, 350 types of cheese, and 700 wine labels. Once an order had been assembled, it was loaded onto a truck and taken to one of twelve docking stations in the Bay Area. There it was transferred to one of Webvan’s sixty small vans, which delivered it to the customer’s home in a predesignated thirty-minute time slot.
Despite its modern machinery, Webvan quickly ran into some old-fashioned logistical problems. The cold temperatures necessary to preserve fresh produce made the conveyor belts malfunction; the celery didn’t fit into the produce bags; the soft cheeses got crushed; and the delivery vans got stuck in the San Francisco traffic. Webvan also discovered what Peapod and other competitors had learned long ago. Most people prefer to drive to their local grocery store and pick out their own tomatoes. It had taken Peapod ten years to build a customer base of 100,000. Webvan needed a lot more customers than that to justify its heavy investment, and the early signs weren’t encouraging. On any given day, the Oakland facility, which was designed to handle eight thousand orders, was getting just three hundred or four hundred. And more than half of the customers who bought groceries from Webvan never returned.
By any objective standards Webvan’s launch was a failure, but that wasn’t reflected in most of the press coverage that the company received. A month or so after it started making deliveries, a report in Business Week said Webvan “may be the most innovative E-commerce venture to date.”7 The article quoted Kevin Czinger, a former investment banker at Goldman Sachs who served as Webvan’s chief financial officer, saying: “This is the first back-end re-engineering of an entire industry.”8 Also in July, Webvan signed a billion-dollar deal with Bechtel, the company that built the Hoover Dam, to construct twenty-six more warehouses across the country, starting with Atlanta. To pay for this expansion, it closed the $275 million financing round, with investors that included Sequoia Capital, Softbank (the Japanese investment company headed by Masayoshi Son), and Goldman Sachs, Webvan’s financial adviser. In return for the $275 million, the participants received just 6.5 percent of Webvan, which was already valuing itself at more than $4 billion. The presence of Goldman Sachs on the list of investors was particularly notable. No longer content to earn tens of millions of dollars in investment banking fees, the eminent Wall Street firm had decided to join the real action: acquiring Internet equity.
In early August, just two months after it started selling groceries, Webvan filed for an IPO. This was a new record, beating Drugstore.com, which had just gone public after five months in business. Webvan’s prospectus revealed that in the first six months of 1999 it had lost $35 million on sales of $395,000. Borders and his backers realized that they needed a reassuring front man to interpret these figures for Wall Street. They found him in George T. Shaheen, the fifty-five-year-old chief executive of Andersen Consulting, a leading technology consulting firm, with 65,000 employees in nearly fifty countries. Shaheen gave up a retirement package worth tens of millions of dollars to join Webvan. In return, he got 1.25 million Webvan shares, which weren’t yet trading, and options to buy another fifteen million at $8 each. Assuming that the IPO went off as planned, this signing-on package would be worth at least $100 million. Shaheen’s move demonstrated that just about anybody would join an Internet company if they received enough stock and options.
After a Labor Day lull, the IPO market picked up again in mid-September, with stock issues by, among others, Gardens.com, Ashford.com, and Perfumania.com. Webvan, meanwhile, released its prospectus. Shaheen told Forbes that Webvan would “set the rules for the largest consumer sector in the economy.”9 This was an innocuous enough comment, but it came during the pre-IPO “quiet period” when companies are supposed to remain silent. At around the same time, Adam Lashinsky, a columnist for TheStreet.com, published details from Webvan’s investor road show, which are usually off-limits to journalists. According to Lashinsky, the firm’s senior executives had said it would boast profit margins of 12 percent, compared to 4 percent for normal supermarkets, and that each of its warehouses could generate annual revenues of $300 million. This was wishful thinking—the Oakland warehouse was still operating way below capacity—but it should have been disclosed in the prospectus, which it wasn’t.
The SEC forced Webvan to postpone the IPO and file an amended prospectus. In the new document, which appeared in October, the firm revealed that Goldman Sachs, its own financial adviser, expected it to lose $78.3 million in 1999, $154.3 million in 2000, and $302 million in 2001. Even in the fall of 1999, selling a company that was expected to lose half a billion dollars in its first three years was no trifling matter. Fortunately for Webvan, the forced delay worked in its favor. During October, technology stocks continued to rally strongly, and the IPO market roared along. PlanetRx.com, Women.com, and E-Stamp were among the many Internet companies that went public. On November 2, the Nasdaq closed above 3,000 for the first time, a milestone that received a lot of media attention. Goldman Sachs seized the moment. Three days later, it issued 25 million Webvan shares at $15 each. The stock opened at $26 and closed at $24.875, for a first-day gain of 66 percent. This valued Webvan at almost $8 billion, the biggest first-day valuation for an Internet company since Priceline.com. Goldman Sachs and the other investors that had put up $275 million in July had doubled their money in less than four months. Shaheen, seven weeks into the job, had seen his recruitment package rise to almost $300 million. And Borders was now worth more than $2 billion.
III
Webvan’s IPO offered encouragement to other Internet companies that were spending money like Imelda Marcos on a shoe-shopping spree. Clearly, no online business was too dubious to be packaged and sold to investors as long as it had some prestigious names behind it. In the weeks following Webvan’s stock offering, TheKnot.com, a wedding site, went public, and so did many other e-commerce start-ups, including eGreetings.com, MotherNature.com, SmarterKids.com, and eCollege.com. Several big Internet companies filed to do IPOs early in 2000, including Homegrocer.com, Webvan’s rival, and Pets.com, a San Francisco–based start-up that was targeting the $20 billion a year market for pet food and pet accessories.
The battle of the pet sites represented the reductio ad absurdum of the Internet bubble, but it was no laughing matter to those involved. In the spring of 1999, more than half a dozen online pet stores were looking for outside financing, and more than two dozen venture capital firms were vying to fund them. The pet market was one of the few big chunks of consumer spending that remained untapped by Internet retailers. Nearly two-thirds of American families owned pets, and many of them would rather have gone hungry than deprive their canine and feline loved ones.
Greg McLemore, a Pasadena entrepreneur who had registered hundreds of Internet addresses, including Toys.com and Pets.com, founded Pets.com in November 1998 and moved it to San Francisco. In early 1999, he persuaded Hummer Winblad Venture Partners, a well-known Silicon Valley venture capital firm, to back the company, and he also sold a 50 percent stake to Amazon.com. Jeff Bezos, the devoted owner of a golden Labrador, had once offered a job to Julie Wainwright, Pets.com’s chief executive, and she negotiated the deal with Amazon.com. “We invest only in companies that share our passion for customers,” Bezos said. “Pets.com has a leading market position, and its proven management team is dedicated to a great customer experience, whether it’s making a product like a ferret hammock easy to find, or help in locating a pet-friendly hotel.”10
Amazon.com’s involvement with Pets.com came as a blow to the other online pet store entrepreneurs who were busy making presentations up and down Sand Hill Road. It didn’t stop them, though. In May, Paw.net, another San Francisco–based start-up, changed its name to Petopia.com and raised $9 million from Technology Crossover Ventures, of Palo Alto. “There is a huge potential for growth in the pet category as an e-commerce play,” Jay Hoag, a partner at Technology Crossover Ventures, said. “Currently, the pet food and supply market is highly fragmented. As more customers turn to the Internet to make purchases, Petopia.com will leverage its distribution and manufacturer relationships and its brand to create a nationally recognized virtual store and community for consumers.”11 This was a hopeful statement. PetsMart and Petco, each with hundreds of stores, dominated pet food retailing across the country, and neither had any intention of allowing its market to be taken away. PetsMart teamed up with an online firm called Petjungle.com to create PetsMart.com. Petco, after hiring Morgan Stanley to advise it how to go online, decided to invest in Petopia.com. When Petstore.com, yet another online venture, raised almost $100 million from a group of investors including Discover Communications, the owner of the Animal Planet cable network, the stage was set for a costly four-sided battle.
Pets.com fired the first shots. In the summer of 1999 it raised another $50 million from Hummer Winblad, Amazon.com, and Bowman Capital, a hedge fund. With money in the bank, it slashed its prices by almost 50 percent and hired TBWA/Chiat Day, an advertising agency, to create an expensive marketing campaign. This dual offensive was premised on the now-familiar argument that the only way to succeed on the Internet was to gain market leadership and establish a strong brand. By the end of 1999, Pets.com had racked up losses of $61.8 million on revenues of just $5.8 million. Most of this money went on advertising. TBWA/Chiat Day, which numbered Apple Computer and Levi-Strauss among its clients, created the Pets.com Sock Puppet, a chatty “spokesdog” that quoted Joseph Conrad, asked housecats out on dates, and objected to the use of socks as Christmas stockings. The Pets.com sock puppet quickly became a popular symbol of e-commerce, but it didn’t generate much business. At the start of 2000, Pets.com was attracting fewer than a million visitors a month to its Web site, and its revenues were lower than both Petsmart.com and Petopia.com.
The other pet sites, which had been forced to compete with Pets.com’s price cuts, weren’t faring any better. Most of them were selling goods at a loss. Pets.com even introduced free shipping, a big expense for twenty- and forty-pound bags of dog food. Insofar as there was any business logic at work, it was that the pet sites, after attracting customers with cheap dog chow, would then be able to sell them higher-margin products, such as ornate leather collars and down-filled cushions. Each site promoted itself as the one true community of pet lovers. Pets.com sponsored “Canine Couture” fashion shows and offered free veterinary advice. Petopia.com built an aviary and doggy pound at its headquarters and also entered an alliance with the American Society for the Prevention of Cruelty to Animals. Petstore joined forces with the American Animal Hospital Association. PetsMart bought AcmePet.com, a popular online community of pet owners.
At the core of all this activity was the race to do on IPO. The online pet stores provide a classic example of how the Internet boom had inverted the traditional order of business. Instead of using the stock market to build companies, VCs and entrepreneurs were now using companies to create stocks. Costly marketing campaigns were launched not only to attract customers but, more important, to grab the attention of potential shareholders. The task of building the company was secondary—a chore that had to be performed before the IPO, but not the real reason why Harvard MBAs like Andrea Reisman, Petopia’s chief executive, were giving up promising careers elsewhere. Pet food is only pet food, even to a Harvard MBA.
IV
The American public was the main beneficiary of the venture capital glut. In cities like New York, Boston, and Seattle, couch potatoes could now log on to their computers and order beer, videos, and ice cream—all of which would arrive within the hour free of delivery charges. Joseph Park, a twenty-seven-year-old Korean American, was one of the philanthropists providing this service. In 1997, Park quit his job at Goldman Sachs. (With so many of its employees leaving to become Internet entrepreneurs it is hardly surprising that the investment bank turned itself into an Internet investor.) Park and a friend, Yong Kang, set up Kozmo.com, an online convenience store that they named after the character on Seinfeld. After convincing Flatiron Partners, a New York venture capital firm that had financed many Silicon Alley companies, to provide initial financing, they rented a warehouse in the East Village and recruited dozens of bicycle messengers to deliver orders as small as a packet of gum. Taking a page from Priceline.com’s book, they hired Lee Majors, from the show The Six Million Dollar Man, to tout Kozmo.com in a series of commercials.
Kozmo.com proved popular, particularly with teenagers, college students and other nocturnal creatures. Park boasted that he was feeding “half the potheads in New York,”12 but marijuana users weren’t his only customers. Videos and computer games were the most popular items, and Kozmo.com also did a brisk trade in AA batteries and condoms. Henry Kravis and David Rockefeller, two of the richest men in the country, agreed to put some money behind Park’s vision, and so did Jeff Bezos. At the end of 1999, Amazon.com, which was buying stakes in a number of Internet companies, invested $60 million in Kozmo.com. A month later, Kozmo.com signed a cross-promotion agreement with Starbucks. Park and Yong were now making plans to expand to thirty cities by the end of 2000. There was even talk of launching in Tokyo. Such plans were posited on the successful completion of an IPO. In preparation for a stock issue, Kozmo.com recruited a chief financial officer from Federal Express, a marketing director from Ethan Allen, a chief technology officer from Coca-Cola, a logistics expert from United Parcel Service, a specialist in supply chain management from Ernst & Young, and a vice president of corporate development from Blockbuster.
What these veterans of the old economy really thought about Kozmo.com is an interesting question. The options they received, while it may have salved their doubts, surely didn’t vanquish them. If Kozmo.com hadn’t had “.com” attached to its name, it would have had trouble raising any money from outside investors, let alone $100 million. According to a subsequent study done by the consulting firm of Booz, Allen & Hamilton, each delivery that Kozmo.com made cost $10 in labor and overhead. This sum didn’t include Kozmo.com’s marketing expenditures or the cost of the goods it delivered. Since the average customer order was for about $12, it was mathematically impossible for the company to turn a profit. Changing the business model wasn’t really an option, either. Park had promised from the outset that delivery wouldn’t cost anything, and several competitors—notably Urbanfetch.com—were also offering free delivery. Park’s best hope was to take Kozmo.com public before its shortcomings became glaringly apparent, then try to find a deep-pocketed buyer, like Amazon.com or Webvan. As long as Internet stocks continued to defy economic fundamentals, a successful completion of this strategy was not out of the question.
Internet start-ups now constituted a major industry, with a broad range of ancillary businesses to support it, including venture capital firms, investment banks, management consultants, publicists, marketers, and lawyers. There were even “Internet incubators,” firms that brought all of these functions under one roof. CMGI, the Boston-based firm that had invested in Lycos and several other early Internet companies, had now turned itself into an Internet incubator, and its founder, David Wetherell, was now being hailed as an investing genius. Internet Capital Group, which went public in August 1999, was another Internet incubator. Idealab, a California-based firm that helped to create eToys, an online toy store that went public in May 1999, was a third. By now, the Internet start-up craze had spread to every conceivable sector of the economy—and a few inconceivable ones too. In The Monk and the Riddle, the veteran Silicon Valley investor Randy Komisar described meeting a young entrepreneur who was trying to raise money for an online venture called Funerals.com.
“We’re going to put the fun back into funerals.”
With that declaration, the meeting began. It was a curious elevator pitch.
”The fun back into funerals?” I asked.
”Absolutely. We’re going to make it easy to make choices when someone dies. You know, the casket, the liner, flowers, that kind of thing.”13
Journalists were particularly prone to the start-up bug. Michael Elliot, the editor of Newsweek’s international edition, quit his job and set out to raise money for e-Countries, a Web site devoted to geopolitics. Peter Gumbel, the Wall Street Journal’s Los Angeles bureau chief, became the editor in chief of Business.com, a new financial information site. The entrepreneurial spirit also spread to the staff of fashion magazines like Vogue and Elle, a group not previously noted for their devotion to the bottom line. Several prominent editors gave up their chauffeured town cars for fashion sites with names like Eve.com, Beautyscene.com, and Beautyjungle.com.
The two best-known journalists-turned-Internet-entrepreneurs were Kurt Andersen and Michael Hirschorn, former colleagues from Spy, the satirical magazine that had skewered the money culture of the 1980s. Andersen, a former editor of New York magazine and columnist at The New Yorker, had just finished his first novel, Turn of the Century, which bravely, if not entirely successfully, tried to capture the uneasy convergence of money, media, and ambition that contemporary New York represented. Hirschorn, a popular and rumpled figure, had recently been fired as editor of Spin magazine. Together, the two Harvard graduates decided to set up what their business plan described as “a must read online site for the cultural elite.” The name they landed on was Insidedope.com, which was eventually shortened to Inside.com. “It wasn’t just about the money—not for me anyway,” Hirschorn would later recall. “It was about creating something new, something not trapped in the dead-end culture of print magazines, something where the staff owned part of the company.”14 There is no reason to doubt Hirschorn’s motives, but he and Andersen were hardly oblivious to the immediate financial possibilities. At one point in The Turn of the Century, Lizzie Zimbalist, the main female character, consults an investment banker, Nancy McNabb, about floating her software company on the stock market. McNabb tells her:
“I think we can end up north, nicely north [of $75 million]. The KillerWare offering Thursday and the Be-My-Friend.com IPO tomorrow will tell us a lot about the weather we’re facing out there, microcap-valuation-wise.” She pauses. “You have earnings, yes?” The question is an afterthought.”15
Andersen no doubt appreciated the irony of fictionalizing the Internet boom at the same time he was becoming a player in it. “No one feels guilty about being rich anymore and not caring about anything except money,” he told the London Times. “Unemployment is at a historic low. The kids come pre–sold out. A twenty-one-year-old today knows only the post-liberal Reagan philosophy, the free market won. They come into a landscape where their college friends make $5 million overnight. They see the rewards of capitalism directly—and they look good.”16
College graduates weren’t the only ones with a benign view of what was happening. In the media circles where Andersen and Hirschorn circulated, most people no longer thought of capitalism as an oppressive system crying out for critique, or as a comic farrago ripe for satire; rather, they looked upon it as something akin to a Las Vegas slot machine with the barrels stuck on jackpot. Until the management got wise to it and did some repairs, they’d continue feeding quarters in the slot.