Chapter 2. Destroyed by the Bubble

The room was full of people, some of whom controlled large amounts of investors' money. David Perry stood nervously as he prepared to step to the front and address the group during the Harvard Business School new business competition. It was for this that he had come to the Harvard Business School, but he could not escape misgivings. What if he bombed? Still, he'd prepared well, and as the final seconds sped by before it was his turn to present, excitement at the prospect before him pushed aside other emotions.

Perry stepped to the front of the room, wiped a bead of sweat from his forehead, and began, “I'd like to introduce a new concept to you. I call the company Chemdex.” He went on to discuss a new forum for B2B exchange in the life-science and medical equipment industries. B2B had never been done before, but it was quite impressive to the professors. In fact, it won second place in the contest. And this was good enough for Kleiner Perkins Caufield and Byers, who became the lead investor in Chemdex, and the first VC firm to fund a company of this nature.

With two million dollars of seed money in his pocket, a lot of courage in his heart, and a few weeks of life in the “real world” post-Harvard Business School, in June 1997, Perry hopped into his car, sped out to the West coast, and started Chemdex. Perry began the company in September 1997, with co-founder Jeff Leane (who left the company in late 1999), and launched the Web site in 1998. Perry was thrilled to secure about $13 million in VC funding from Kleiner Perkins Caufield and Byers, along with CMGI and Bay City Capital, by May 1998, and an additional $30 million by April 1999.^[2]

At this point, Perry was encouraged to build the business quickly and to proceed to the IPO, whether or not he was ready. Perry was again nervous, and remembered the day of his presentation. But all had gone well so far, and thus, nine months after the launch, in July 1999, Perry turned over the financial reports of the company to Morgan Stanley, BankBoston, Robertson Stephens, and Volpe Brown Whelan & Company, LLC to execute the IPO with a suggested per share price of $15.

It turned out he had no need to worry. Less than one year later, in June 2000, his stock was up 1,620 percent, to $243.50 per share. This was a bit overwhelming for Perry. He was out of business school for three years, and, at age 32, found himself almost a billionaire. But Perry wasn't worried about saving for a rainy day. He had a lot of faith in his idea, and was going to push it until it burst. He reinvested all that he received into the company.

In February 2000, when the company changed its name to Ventro, Perry held an enormous party for his employees, featuring himself lip-syncing in a rock video. He also bought a jet. He was a bit concerned that stock analysts at the Wall Street firms might look askance at a young CEO with a company that as yet had virtually no sales, not to mention any profits, spending this way, but he needn't have worried. The analysts had no problem with his actions. Mary Meeker, Morgan Stanley's Internet stock wizard, predicted that Ventro would have revenues of $129 million in 2000. So Perry saw no reason to sell any of his stock. To top it all off, in June 2000, he was named northern California's—and thereby Silicon Valley's—entrepreneur of the year.

Perry continued to grow his company, purchasing and building four new online marketplaces. He used his company's soaring stock to buy Promedix, an online marketplace for specialty medical supplies. He hired a staff of highly regarded executives, including Robin Abrams, president of Palm Inc., as his COO.

Though Perry was delighted with the growth of his stock and his business, he had a few misgivings. Building marketplaces was expensive, about $45 million for the first one, and about $7 million for the second, and for some reason, the revenue numbers just were not coming in as he, and Wall Street's analysts, had predicted. With the company's continued expansion, encouraged by the high stock prices, Perry began to realize that things may not be as rosy as he had expected. By the second quarter of 2000, Chemdex only had 144 corporate customers, and was generating considerably less revenue than Wall Street was forecasting. Perry tried to figure why the revenue numbers were so low. Potential customers simply were not buying. Later reporters would write that “Analysts said Perry's B2B dreams have collapsed largely because of a flaw in his business plan. Ventro 'attempted to get between the suppliers and buyers of mainstream products,' said John Bermudez, analyst with AMR Research, which studies online business markets. 'Suppliers don't really want anyone between them and their customers.'”^[3]

Further, though Perry knew his company's costs were enormous, he had not paid much attention because none of his venture capital backers, upon whom he relied for business direction, had expressed concern about costs. But with his firm's rapid expansion and high costs, losses started to get so out of control that Ventro's board of directors, against Perry's wishes, ordered a search for a buyer for Ventro. To Perry's dismay, by the end of 2000, Ventro closed down the original Chemdex chemical marketplace. By now the company had lost almost $618 million, and soon after, it lost most of its top executives. Then he had to do what to him was almost unthinkable—cut his staff in half. Perry saw his dreams dissolve. In June 2001, matters got worse when Ventro faced a shareholder lawsuit filed in federal court in San Francisco alleging securities fraud by Ventro executives. It had been two years since he'd taken the company public, and three years since he had founded it. The collapse of Ventro's stock price can be seen in Figure 2-1.

How did this happen? How was Ventro allowed to raise all this money, only to see it disappear? Did Perry lack experienced advisors? It wouldn't seem so. Brook Byers, who is the managing director at Kleiner Perkins Caufield and Byers, one of our nation's most experienced and successful venture capital firms, served as a director on Ventro's board, and as its chairman. Jon Callaghan has served on the board for years while a general partner at CMGI Ventures.

Today Ventro is holding on despite the fact that its stock is now listed at about $.30 per share. Perry himself, however, has been left in a most serious situation. Near the height of the company's share price he had exercised some options, buying shares of his company's stock at a price much lower than the price in the public market. Expecting the stock to go higher, Perry did not sell the shares but put them in his personal portfolio. When the stock price started to fall, he held on to his shares to demonstrate his confidence in its ultimate rebound to his investors. But by a quirk of American tax law, the Internal Revenue Service assessed him a tax on the difference between what he'd paid for the shares and their price in the public market on the day he'd purchased them (a so-called phantom gain). The amount of his tax liability was some $50 million—although he had never received a penny by selling any of the shares he'd purchased. Nor was there any escape for him via personal bankruptcy—bankruptcy does not discharge a debt to IRS.

Ventro struggles along today, still losing money and abandoned by its erstwhile supporters on Wall Street. A company that had in February 2000 been valued by investors at some $8 billion, was worth only a few million little more than a year later. A young entrepreneur who had been in February 2000 a very wealthy man was, a year later, so far in debt to Uncle Sam that never again could he reasonably hope to have any financial security.

Young entrepreneurs are not unique to America, nor is it only in America that they were able in recent years to obtain financing for their business ideas. Peter Kabel was 22 years old, a student at Hamburg University and a ticket seller at a motion picture theatre when he started his first venture, a graphic design company. Several years later, when he was 29 and had finished his studies, Kabel founded Kabel New Media, describing it as a full service e-business enabler. In March, 1998 KNM began operating a professional tennis tour Web site, taking responsibility for obtaining advertising revenues, and thus becoming a multimedia advertising agency. This became the basis of a story about potential sales and profits which strongly stimulated the imagination of the financial markets and future investors. A handsome, dark-haired young man, Kabel quickly became a favorite of brokers and investors in Germany.

On June 15, 1999, shares in KNM were sold (“floated”) to the public on the new market segment of the Frankfurt Stock Exchange, underwritten by two major banks: BNP Paribas and DG Bank. The share price peaked within six months at more than 13 times the IPO price. The company attracted several significant corporate clients. At its peak, more than 800 people were employed by KNM. Meanwhile, Kabel decided that the title “Professor” would enhance his reputation, and became a part-time professor at the College of Media Design in Hamburg.

Soon, however, financial results were disappointing, especially compared to the high valuation of the company. Beginning in March 2000, the company's share price entered a precipitous decline. Shortly, KNM announced a cessation of payments, essentially insolvency, and by August 2001, Peter Kabel left his position as CEO. On that same day prosecutors began an investigation of Kabel, because up to two weeks before the company declared insolvency he had been assuring investors that it would reach break-even at the end of 2001. Soon thereafter, Paribas ceased to sponsor the stock of the company. (See Table 2-1).

Table 2-1. Timeline for Kabel New Media.

Year	Events
1986	Founding of Peter Kabel's first company: Buero fuer grafische Gestaltung.
1991	Founding of two additional companies: Kabel Hamburg and Buero Hamburg.
1993	End of Kabel's studies and founding of Kabel New Media.
June 15, 1999	KNM goes public on the Frankfurt stock exchange (price: 6.15 Euro).
July 1999	First takeover of competitor “Cutup codes.”
March 2000	KNM reaches share price peak: over 80 Euro (worth: 1.3 billion Euro).
March 1, 2000	Acquisition of the Team4 (CRM specialist).
May 11, 2000	Acquisition of the Austrian IT consultant Scope.
May 16, 2000	Acquisition of the Swedish IT consultant Lexor.
May 24, 2000	Peter Kabel voted entrepreneur of the year 2000.
June 28, 2001	Temporary cessation of payment.
August 1, 2001	KNM's CFO and deputy chairman steps back.
August 28, 2001	KNM sells subsidiary in Vienna.
August 31, 2001	Peter Kabel announces his resignation.
August 31, 2001	Prosecutors start their investigations.
September 1, 2001	Insolvency proceedings for KNM formally commenced.
September 4, 2001	BNP Paribas announces its withdrawal from its position as designated sponsor of KNM.
November 2, 2001	The German stock exchange excludes KNM from the market (last price: 0.08 Euro).

Over the short period from June 1999 to September 2001, some $1.2 billion (the March 2000 value of the company on the Frankfurt exchange) of value had been created and had then disappeared.

It had taken about 18 months from its inception for KNM to become a publicly listed company. It had taken nine months for the company to reach a billion dollar valuation, and then it had taken 15 months for the company to become valueless. A promising entrepreneurial venture which, given a decade, might have become a major company, had instead been caught up in a financial bubble. The bubble first wildly exaggerated the company's value, inducing the firm's leaders to expand far too rapidly, and then, like a balloon when the nozzle was suddenly released, quickly deflated, causing employees at the company to lose their jobs and the investors their money.