The E-files

It was a siren song that few ambitious men or women could long resist. Come, join us, beckoned the growing legions of dot- companies, promising challenge, adventure, new responsibilities, and the chance to get really, truly rich. And many left their stable bricks-and-mortar companies to answer the call. Each one who made the leap believed in his heart that maybe this company would be the one to make it big. Each left everything behind and, like pioneers, headed into uncharted territory, looking for buried treasure.

Most never found it. And few are willing to tell the tale of what they saw on the other side, especially if their voyage ended in failure. But some, mindful that those who ignore history are doomed to repeat it, are sharing lessons learned. The names and details may vary, but the lessons are similar, and, in the final analysis, very familiar.

Take, for instance, Ed Johnson, a self- described turnaround specialist. When Johnson got the call inviting him to join a dot-com, he had been unsuccessfully trying to convince investors that his waste- management roll-up was as interesting as … a dot-com. So he was intrigued when a friend told him that First Mortgage Network Inc., of Sunrise, Florida, was looking for a CFO who could help change the company from a traditional mortgage business to an Internet technology firm. “I wasn’t very interested until I talked to the executives,” says Johnson. “They were doing business with big names. They were becoming the technology platform for companies doing mortgages over the Internet.”

Johnson joined the firm in November 1998. In January 1999, the company changed its name to Mortgage.com. With more than $50 million in funding, the company had created a 200-person customer- support call center in Plantation, Florida. It was moving forward on its plan to build a Web-based, end-to-end electronic mortgage-fulfillment platform. It showed revenues of $61.2 million in 1999 (with $107 million in expenses, for a net loss of $46 million), and went public at $8 that August. “Mortgage.com was trying to change the way mortgages were done in the United States,” says Johnson.

Instead, the company will be lucky to have an impact on banking in Argentina. Johnson himself left in May 2000. In November, with its shares trading between 3 cents and 5 cents, the company sold its remaining technology assets to Banco Hipotecario, a Buenos Aires bank that held a part interest. Nasdaq halted trading on Mortgage.com stock in December.

Johnson attributes Mortgage.com’s collapse to bad timing. True, at a critical point, the mortgage refinancing market began to dry up, cutting into a big source of Mortgage.com’s revenues. But more was at play. For instance, profit margins were too slim to support the burgeoning infrastructure, most notably the call center, which contributed to a cash burn rate of $1 million a week by the first quarter of 2000.

Although Johnson claims that “these were all bricks-and-mortar issues, not Internet issues,” the bottom line is clear: the company had lofty dreams built on an unsustainable business model driven too fast by the unrealistic ROI expectations of its founders and investors.

Speed kills. So does greed. And that, say Johnson and other CFOs who have presided over failed or ailing dot-coms, is the point. A Web-based business is still a business, and all the investor expectations or cash infusions in the world can’t overcome an unrealistic business model or flawed market assumptions. Like rueful dot-com veterans everywhere, these CFOs admit that they let themselves think the old rules could be forgotten. Instead, they got a crash course in why they still count.

RULE #1:customers and suppliers, not technology, make or break an e-business.

The breathtaking early successes of Amazon, Yahoo Inc., and America Online Inc. spawned two pieces of dogma that have come to haunt other Internet businesses. One is the notion that the Internet rewrote the rules of customer and supplier relationships. It didn’t. If customers and suppliers don’t want to buy or sell a product online, even the best technology and the most streamlined, cost-efficient, Web-based, point-to-point transaction architecture won’t help.

Commodities like airline tickets, books, and CDs might move quickly on the Internet. But sales of higher-margin products like cars, pharmaceuticals, and mortgages remain complicated by law, customer habit, and long-standing supplier relationships.

Such complications hurt PlanetRx .com Inc. According to former CFO Steve Valenzuela, online drugstores planned to capture the 25 percent of the prescription drug market not already covered by prescription drug insurance plans, which generally have their own mail-in prescription component. One problem: “In the pharmaceuticals market,” says Valenzuela, who was CFO of PlanetRx from February 1999 to August 2000, “the insurance companies cover employees. They didn’t want to cooperate with the online pharmacies, because they viewed them as competition with their mail-order business.”

PlanetRx and other dot-com drugstores hadn’t anticipated the difficulty of getting insurance companies to cover their customers, and they learned to their dismay that most branded cosmetics companies will not sell through Web sites except their own.

“Pharmaceuticals and beauty supplies have been around for a very long time,” says Valenzuela. “The people in those companies know the products and the industry very well.” Unlike, he suggests, the people who started the online drugstores. “The logistics ended up being more complicated and expensive than people expected,” he says. “The complexities of taking prescriptions over the Internet or by phone…the importance of the relationship between a patient and pharmacist… you can’t escape the business basics.”

Mortgage.com faced similar problems. Johnson says about 97 percent of Mortgage.com’s customers ended up calling for support at some point in a process that was intended eventually to be completed entirely online. “This was, for most people, the biggest transaction of their lives,” he says, “and they felt uncomfortable doing it over the Internet.”

RULE #2: don’t bet your company on a market play.

The second “Amazon fallacy” is that the push to gain first-mover advantage justifies spending massively and rapidly, with the assumption that the market will fund further expansion. InfoUSA Inc. learned the flaw in this logic the hard way. Until about a year ago, the Omaha-based database firm was very profitable. That’s when, according to CFO Stormy Dean, the company decided to create a series of Internet-based divisions for the sole purpose of spinning them out. The divisions would leverage the firm’s business and residential information databases, many of which it already licensed to online search engines like Yahoo.

The company’s first project, InfoUSA.com, a site for small-business owners, was well received by the investment community and, by the end of second-quarter 2000, had raised $32.6 million in venture funding. InfoUSA.com generated YTD revenues of $12.1 million by the end of second- quarter 2000, with expenses of $21.3 million for the same period, for an EBITDA (earnings before interest, taxes, depreciation, and amortization) loss of $9.2 million.

At first, the company seemed to be on the right track. When InfoUSA.com secured venture backers, it sent the parent company’s stock to a 52-week high of $17 in March 2000. “Then the market turned, and everything that made sense for us suddenly made no sense,” says Dean. “Now we’re around $3.”

The three other properties– Businesscredit.com, an online credit-reporting service; Listbazaar.com, which sold databases; and Videoyellowpages.com–crashed with the market turn. The company has closed Videoyellowpages.com, and rolled Listbazaar.com and Businesscredit.com back into the core business. “We spent an enormous amount of money branding Businesscredit.com,” says Dean, “and we ended up finding out that our best source of traffic was a partnership with ourselves through InfoUSA.com.”

Dean is confident that the business ideas behind the Internet incubator projects were solid. But he admits the company erred in trying to grow Internet divisions using cash infusions from outside investors and a hot stock market. “We made those decisions based on the market conditions at the time,” he says. “Then we couldn’t spin them off. Our greatest fear came to fruition.”

At the end of third-quarter 2000, InfoUSA’s Internet properties reported a cumulative EBITDA loss of $23 million. The parent company reported EBITDA (adjusted to exclude acquisition and impairment of asset costs) at $40.1 million on sales of $235.8 million, compared with adjusted EBITDA during the same period a year ago of $49.7 million on sales of $188.2 million. Unfortunately, the Internet market downturn has also crippled InfoUSA .com’s customer base. As a result, says Dean, the company has “collapsed” InfoUSA.com back into the core company. In December, InfoUSA announced that it would lay off 325 people.

Dean says he’s learned his lesson. “I’m making new-business decisions now based on our ability to support development internally.”

RULE #3: don’t try to be everything to everybody.

Unfortunately, InfoUSA wasn’t alone in taking its cue from the “irrational exuberance” of the market for Internet plays. Many Web companies were created with the expectation that the market for Internet IPOs would never dry up, and this belief often resulted in overly broad business plans. Such dreams of grandeur were the eventual downfall of Mutualfunds.com, according to Elizabeth Hazell, its former director of finance.

Boston investment firm Nvest Cos. LP had owned the URL Mutualfunds.com since 1992, but it was not until summer 1999 that Bruce Speca, president and CEO of Nvest Funds (a division of Nvest Cos.), decided to build a company around the URL. He and his backers, including San Francisco financial services firm WR Hambrecht, Nvest, and TIS Worldwide, a software developer in New York, aimed to turn the site into a portal for mutual fund companies, advisers, and individual investors. Between then and April 2000, Speca “worked to develop a business plan that was just huge,” says Hazell, who joined the company in May 2000.

Mutualfunds.com finally launched a site that focused on training and education for dealer-brokers, but by then it was clear the firm would be unable to meet its lofty goals. “It was too much, too soon,” comments Hazell. Soon after she closed out the quarter, she went to the board. “At that point, we were almost bankrupt,” she recalls, “so I had to say to them, ‘Can you fund the launch?’ They responded that they weren’t going to fund us unless we could pull in some other investors from the outside.”

Hazell doesn’t blame the investors for their decision, which she felt was justified. And she doesn’t think that Web- based businesses are necessarily doomed. However, she believes that in order to avoid the “too much, too soon” trap, dot-coms must be scalable, must focus on a narrowly defined vertical market, and must be based on a business plan with specific milestones. In fact, it looks like Mutualfunds.com LLC finally got the picture. Although the company is in the process of liquidation, a subgroup of the firm’s employees has been financed by new investors to focus exclusively on providing online training and development for financial services professionals.

RULE #4:some things can’t be rushed.

In August 1998, David Farber and two partners, Katherine Legatos and Amy Ryberg, started a company that sold aromatherapy, bath, and body products on its Web site, Ingredients.com, which was launched in October 1999. The idea was to design the products internally and outsource the manufacturing, because if they relied on someone else’s product, they couldn’t make enough money. Farber was extremely skeptical about the dot-com retail world. “Even if [a branded-cosmetics dot-com] drove people to its site, it wouldn’t be able to turn the corner,” he says, “because of its business model.” He and his partners hoped to eventually build their brand to the point where they could sell product in stores. “We were a traditional company disguised as a dot-com,” he says. But Farber soon found out that even a sound business model takes more time to grow than the newly conservative crop of dot-com investors and the markets were willing to abide.

In the end, the company never got its second round of funding. It went through a major cutback in March 2000, and was shut down in October. “A year earlier,” says Farber, “people would have been throwing money at us. We could have gone public. I could have sold my stock. But at the end of the day, how do you measure success? You measure it by creating a company that has turned the corner and made it.”

Farber says the main lesson he took away from his experience is that even Web-based businesses can’t be grown overnight. “Building a small-to-midsize business is not a sprint, it’s still a marathon. No matter how much money you throw at it, you can’t speed up [the process] more than a little bit. Throwing money at it just allows you to make more mistakes.”

“We were all kidding ourselves that we could do things that normally take 5 to 10 years in 18 months,” he adds. “This experience was a reaffirmation about the old world and the way things work.”

RULE #5: beware your investors.

Why did these perfectly capable CFOs make business decisions that were risky at best? While all take responsibility for their actions, they also point to another factor driving those decisions–the pressure to deliver speedy, large returns to their venture backers.

Before joining Mutualfunds.com, Hazell had been the controller of a an Internet/CD hybrid subscription service for children called JuniorNet, based in Boston. When she joined, the company was in the middle of a Series C funding round based on a business plan written by lead underwriter Lehman Brothers and founder Alan Rothenberg. Hazell’s mandate was to work JuniorNet’s business plan into an operating budget. “It became clear that the underlying assumptions about the cost of customer acquisition were turning out to be very different from what was in the business plan,” she says. The backers had overestimated the site’s ability to convert page views into revenues, a fundamental error made by many dot-coms, says Hazell. “Clicks don’t mean money.”

“My thinking was that we’re dealing with Lehman Brothers and they’ve had all these hits,” says Hazell. “I figured they must know what they’re doing.” As a result, she says, “we really mismanaged the board and their expectations about what could and couldn’t be done. There was this mania about what could be accomplished, and the thinking was just ‘up the financing.'” (JuniorNet, which still has a live site, recently announced layoffs of one-third of its 120 employees, and is seeking a strategic partner.)

Johnson faced worse problems with his backers at Mortgage.com. In the spring of 1999, Intuit was negotiating to buy the company. Two days before the deal was to close, Intuit backed out, miffed by the aggressive negotiating tactics of Mortgage.com’s other backers, who, says Johnson, felt they might make more money on an IPO than on a sale. Then, shortly after Mortgage.com went public, Intuit cashed in $25 million in Mortgage.com subordinated convertible notes instead of converting it to stock. The move depleted Mortgage.com’s cash at a time when it sorely needed the assets. “Investment bankers will do anything to make a buck, and they aren’t your best advisers,” says Johnson. “When the company had an offer on the table, the board should not have been dreaming that the stock market was going to stay as hot as it was.” He adds, “These VCs have made a lot of money on their dot-com investments. How could I argue against them and tell them not to take that risk again, when they kept on succeeding? Looking back, I should have been more vocal. But you can’t be the stick in the mud that keeps people from making huge returns. A CFO would have a hard time surviving doing that.”

Sometimes it’s not the VCs who are to blame for shortsightedness, says Dean of InfoUSA. He learned first-hand that sometimes it’s the “VC within.” “Maybe we were a little overly exuberant spending money on our baby dot-coms,” admits Dean. “We thought we could sell a portion [of them] and pay down our debt. The idea had tremendous appeal. But you have to resist the temptation to micromanage your business on a day-to-day basis based on the whims of the stock market.”

“When you get into a market like 1999’s,” adds Johnson, “where the fundamentals don’t support the prices, any CFO knows in his heart that it won’t last forever, but I also didn’t know if I was right or not.”

Not one of the people profiled here was able to cash in the stock options that lured them in the first place. But all admit that despite the headaches, much good has come out of their decisions to join the dot-com world, however briefly. For some, it was a chance to move to the technology sector; for others, an opportunity to assume more responsibility. Not surprisingly, almost all (except for Dean, who remains at InfoUSA) have disavowed the pure-play Web world to rejoin infrastructure or bricks-and-mortar companies. They are all dubious about how many of the pure-play dot-coms can survive. And they all agree that it was one hell of a ride.

“In a demented sort of way,” says Dean, “all this craziness and uncertainty has been very exciting. I have been able to do stuff that I would never have been able to do in another company. We’ve had investment retrenchment, rapid expansion, integration, cutbacks–all of it.”

In May 2000, Johnson took the lessons he learned at Mortgage.com with him to his new position as president and CFO of Able Telecom Holding Corp., in Sunrise, Florida.

Hazell says that joining a dot-com was a way to get out of the computer hardware business (she had been a corporate controller at Digital Equipment Corp.) and test her mettle. She says she’s swearing off the dot-com world for good because it’s “too risky.” After leaving Mutualfunds.com in early December, she joined wwWhoosh Inc., a software firm in Watertown, Massachusetts. She says that her experiences with dot-coms allowed her, for the first time, to feel the full weight of what it means to be a CFO. “I learned so much from Mutualfunds.com,” she says. “That job was about me accepting the responsibility of my position. Previously, there had always been a CFO there to help deliver the message.”

For Valenzuela, the dot-com experience provided a new set of tools for evaluating future job opportunities. While at PlanetRx, he resolved that his next position would meet four criteria. It would have a high-quality management team with industry expertise, a high level of technology that creates barriers to entry from competitors, a financial model with gross margins in excess of 50 percent and operating margins of greater than 20 percent, and sizable market opportunities.

He believes he has found a place that meets those criteria. After leaving PlanetRx in August 2000, Valenzuela became CFO of Silicon Access Networks Inc., a San Jose, California, company that develops next-generation semiconductor chips for sale to large networking firms. “I learned that it’s difficult to differentiate your company from others on the Internet,” he says, “so going forward, I wanted to make sure I was with a company that had a way to differentiate itself.”

For a skeptic, Farber has walked away with the most positive feelings about his time on the other side. “I’m still proud of what we built at Ingredients.com,” he says. “Plus, it also gave me the opportunity to transition to a technology career.”

Last March, Farber became CFO of Urban Data Solutions Inc., a developer of a spatial information management platform that builds three-dimensional maps of urban areas. He says he’s traded in the “build it and they will come” mentality in favor of “the customer is here, we have to execute.”

“This company,” says Farber of his new gig, “is based on customer contracts, not a wing and a prayer.”

Kris Frieswick is a staff writer at CFO.

PLANET RX.COM