Reality Check--Virtual, of Course
A perplexing disconnect from reality haunts the American financial community. Despite the recent ups and downs--mostly downs--of technology issues on the stock market, venture capitalists and investment bankers are still pleading for entrepreneurs and engineers to step forward and qualify for millions of dollars to launch new high-tech enterprises. Dreams and visions are the currency of the hour. Ann Winblad of Hummer Winblad Venture Partners in San Francisco told CBS MarketWatch that "we are funding these companies when they are two people and a hand-puppet show." The "due diligence" that supposedly keeps second-rate startups from receiving substantial cash flows is sometimes ignored: Venture capitalists have been known to strike deals with new companies mainly to discomfit rival investors. Swathed in marketing hype, marginal technology gets passed off as a vital next step.
Investment banker J. Neil Weintraut of 21st Century Internet Venture Partners notes that "the number of ideas that translate into viable businesses has not kept pace with the amount of capital chasing them." The result is a clear oversupply of high-risk technology startups. Ambitious individuals are reacting to this situation with predictable impatience and greed. Business-school graduates are skipping opportunities at conventional companies to join technology startups--whether in computer software and hardware, Web-oriented marketing, telecommunications, advanced medical devices, financial services or virtual reality.
Never mind that such startups commonly fail: They still offer stock options that, in best-case scenarios, will mint new instant millionaires; and hope springs eternal in the entrepreneurial breast. Tom Eisenmann, a business professor at Harvard, tells of students who "don't want to be talking to their grandchildren about how the new economy took off and they were sitting on the sideline." Older companies are trying to attract the young and restless by mimicking the upstart startups: supplementing salaries with more generous stock options, creating work units with unusual freedom of action and shifting a larger share of their business activities to the Internet. But the billions of dollars that are sloshing around as venture capital make it hard for conventional types to compete. Though some recent initial public offerings of technology stocks have turned out to be duds, the signal success of Linux software packager Red Hat, which tripled in price during its first day of trading on August 11, seemed to reinvigorate the industry overnight.
In 1997-98 companies in the US technology sector absorbed $2.5 billion of the $2.7 billion annual growth in venture capital investments. Faith follows funding, and the mythology spreading across the country and around the world is that computer technology brings revolutionary improvements in business efficiencies, which means a richer world and a better life for all. The new bible of this movement is Bill Gates's Business @ the Speed of Thought, which teaches that "every bit of data in a company should be in digital form and easily retrieved. This data will include every file, every record, every piece of e-mail, every Web page." Gates advises businesses to stop using paper altogether, which is a scary concept in itself, given the tendency of computers to crash. His advice also underplays the plain fact that the hyper-use of computers cannot guarantee a smooth transition to a brighter tomorrow--or profits all around.
Even Red Herring magazine, a leading journal that habitually focuses on technology startups with a benign eye, has warned its readers of "weak, pubescent companies" with "untried management teams, thin balance sheets, toxic convertible financing, unknown auditors, whiffy promotion, and hokey products." According to J. Carlo Cannell, one of the magazine's more pessimistic columnists, investors who buy Internet equities are "chasing stocks like rabid lemmings on Viagra." Another Red Herring writer, Mark Williams, has commented on "those aspects of the Internet industry that still, alas, resemble a Ponzi scheme more than a coherent business."
Too many high-tech stocks are little packets afloat on an ocean of debt. The average startup stands little chance of turning a profit in the foreseeable future, a condition that makes it extremely vulnerable to sudden losses of investor faith. Even established equities like Yahoo! have been known to suffer losses of more than 40 percent on a given day, and the roaring volatility of tech stocks has become the stuff of instant legend. Panic selling follows maniacal buying, sending prices into fabulous slumps before "bargain hunters" return to the market and send valuations soaring again. To take a famous example, the value of a share of Amazon.com stock has fluctuated between 1412 and 22114 during the past sixty-two weeks. This cycle keeps on churning and churning.