Canada's Housing Bubble

Mar 10, 2010 David Gelles theglobeandmail.com

Ten years to the day after the Nasdaq hit its peak of 5,048.62 on March 10, 2000, the technology industry is learning to do more with much less

The excesses of the late 1990s technology boom created paper millionaires based on unlikely ideas.

There was Pets.com, which raised $100-million (U.S.) while trying to convince people to buy cat litter online and whose sock puppet mascot featured in an advertisement during the 1999 Super Bowl. There was Webvan, which spent $1-billion trying to cultivate a market for grocery deliveries. Both shut up shop in 2000.

Dim lights

Ten years to the day after the Nasdaq hit its peak of 5,048.62 on March 10, 2000, the technology industry is learning to do more with much less.

With the Nasdaq (COMP-I2,355.8715.190.65%) only recently having fought its way back above 2,000 to sit at 2,349 on Tuesday, Silicon Valley is a decidedly more sober place than it was a decade ago.

Gone are the days when dotcom start-ups spent millions of dollars for a Super Bowl advertising slot and threw lavish parties to celebrate their initial public offering.

Dim lights

After a glimmer of optimism in the Web 2.0 era a few years ago, the recession put on hold any wholesale return to glory.

A dearth of capital, a sense of frugality and a frozen IPO market are forcing entrepreneurs to make funding go further and wait longer for an exit.

The technology bubble was created by investors who believed that anything to do with the the Net would turn to gold. Nearly any dotcom business was able to gain funding and go public.

In the most poignant sign of overreach, AOL, the internet service provider, bought Time Warner in 2000 in what is regarded as the worst deal in history.

“Ten years ago, the bigger and bolder the idea, the more dollars would chase the idea,” says Geoff Yang, founding partner for Redpoint Ventures, a venture capital group that has backed the likes of Ask.com and Netflix.

“What you found were a lot of ideas that were big and bold but that hadn’t been proven.”

The rising tide lifted many ships, making thousands of entrepreneurs and investors fabulously wealthy. But when the bubble burst, the majority of those groups were wiped out. Silicon Valley has never fully recovered.

Investment by venture capitalists – the grease that keeps the innovation engine running – has shrunk from $100-billion in 2000 to $18-billion last year, according to the National Venture Capital Association. That figure is unlikely to rise significantly in coming years.

Fewer people are handing out money. The number of venture capital groups has fallen from about 1,200 to 900 over the same period, and the survivors are unable to replicate once stellar returns.

Yet while innovation continues and entrepreneurs cannot help but be optimistic, the chances for an astronomical payday are few and far between these days.

“This industry is much smaller today because of what happened 10 years ago,” Mark Heesen, president of the NVCA, says.

“There’s no question that this industry is contracting and will continue to contract.”

Technology entrepreneurs today are a scrappy bunch, working on shoestring budgets, fighting hard in a crowded market and decidedly more modest in their expectations.

Take David Lieb, who 18 months ago was a business school student growing frustrated by the task of entering the contact information of each of his classmates into his iPhone.

He wondered if there was a way to tap two phones together and exchange contact information. Bump Technologies was born.

Mr Lieb, a former engineer with Texas Instruments, spent $2,000 developing an application that let users swap contact details by “bumping” two iPhones together.

Once available on Apple’s App Store, Bump was an instant hit. Mr Lieb left school and moved to Silicon Valley.

He was able to scrape together $45,000 to keep his company going.

With several million downloads from the App Store, Bump attracted $3m from Sequoia Capital, a venture capital group.

But 10 years ago, Mr Lieb might have been a millionaire on paper by now.

Where the dotcom bubble made the simplest tech start-up a candidate for massive capital outlays, today’s investors are more selective.

“VCs are much more aggressive in making sure there aren’t 10 other companies doing the same thing,” says Mr Heesen.

“And you have much more realistic and better entrepreneurs today. There are better expectations on both sides of the aisle.”

Bump’s story shows that, for skilled engineers with a good product, success is still attainable.

“Great companies are still being born today,” says Ron Conway, an investor and early backer of Bump. “But it takes very little capital for a company to gain consumer traction.”

With less money flowing, it is a good thing that companies like Bump are able to work on a shoestring.

At the same time, “the cost of building a business has gone down”, Mr Yang says. “The drive down of commodity hardware, open source software and infrastructure on demand has really driven down the cost of starting companies.”

Though entrepreneurs may be scraping by, venture capitalists are praying they make it big. It was IPOs by the likes of Pets.com and Webvan that delivered those big returns.

But VC-backed IPOs, which numbered 270 in 1999 and 264 in 2000, are an endangered species. There were six in 2008 and 12 last year.

“It’s all about exits,” says Mr Heesen. “Until you see a vibrant exit market, it’s going to be difficult [for venture capitalists].”

Last year saw a handful of technology companies, including OpenTable, successfully offer shares on the public markets. Google is gobbling up companies, and purchased AdMob for $750m last year.

A vibrant exit market still seems a dream, although the rare company will be acquired for a princely sum.

Facebook, Twitter and Yelp, which seemed poised to go public last year, have stated that they are not eyeing an IPO any time soon.

What caused the tech bubble?

Long before the housing bubble, sustained low interest rates and global financial imbalances had already created the conditions for excess, writes Richard Waters. The promise of the internet provided the perfect excuse, drawing in tech visionaries and financial opportunists alike. The 1994 launch of the Netscape browser opened the online medium to a mass audience and triggered a gold rush.

Add in the boom in corporate technology spending later in the decade to deal with the Y2K computing problem – also known as the “Millennium bug” – and the full forces of fear and greed were unleashed.

Where did all the money go?

The wayward spending of the dotcoms – start-up internet companies – got most of the attention but it was the telecoms sector that proved the biggest sinkhole. An estimated $1,000bn was poured into long-haul fibre optic systems and the local networks to carry internet traffic far and wide.

Much was written off in the rash of bankruptcies that followed, though the wave of cash at least created the global communications backbone for the current generation of more successful internet services.

Copyright The Financial Times Limited 2010.

How did it all go wrong?

Multiple tech bubbles popped together. The dotcoms wasted their money on expensive advertising and lavish parties without coming anywhere near to generating the revenues to cover it. The boom in telecoms spending led to a collapse in prices.

Big companies slashed their spending on new servers and software as the twin fears of Y2K and disruptive competition from the dotcoms receded. By the end of 2000 the industry was in retreat on all fronts.

Who were the biggest victims?

Stock market investors bore most of the losses but the bust also left a trail of devastation across Silicon Valley as companies collapsed and employment fell. Some heavyweight corporate reputations were trashed: in what was billed as a merger of equals, Time Warner allowed itself to be bought by a start-up called America Online. The winners were the internet companies that sold at the peak of the boom or – like AOL – used their inflated currency to buy more enduring assets.