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How Venture Capital
is Ruining the Internet
By Eric
Janszen • Bankrate.com
Venture capital companies, investment banks and brokerage
firms are primarily responsible for the Internet mania. So-called
"Internet technology" companies -- the ones that iTulip.com
parodies -- were created by venture capitalists in cooperation with
investment banks for the purpose of issuing worthless stock to an
uneducated public
The uneducation was provided by media organizations
interested in selling advertising to the bogus bubble companies.
The purpose of advertisement, like the breathless stories around
them, was not to sell products or services to consumers but to market
the bubbles to investors, to add to the exuberance of an investing
public already whipped into a stock buying frenzy by journalism-free
editorial content.
The sweat of the speculator-entrepreneur was exploited
by VCs and investment banks to produce the bogus bubble "business."
The sucker "investor," who yearned for the Internet riches he'd
read so much about, supplied the cash by purchasing stock exactly
as worthless as an iTulip.com Stock Certificate. The investment
bank kept the float (number of shares sold to the public) small
relative to the demand and managed the distribution, and by pricing
the stock low, the investment banks virtually guaranteed a pop in
stock price after it hit the market.
The situation got so egregious that Japan -- the nation
criticized by the West as practitioners of corrupt "crony capitalism"
-- is considering barring premier U.S. investment bank Goldman Sachs
(NYSE: GS) from advising
it on privatizations. Japan's Ministry of Finance "has become increasingly
alarmed about Goldman's management of some recent international
share issues."
After these IPOs, venture capitalists realize millions
in capital gains from the sale of stock, while investment banks
earned millions in transaction fees. As a side effect, the entrepreneur
maybe earned a few million bucks, after VCs had diluted the founders'
interest to a tiny fraction of the company's total shares, or kicked
them out of the company altogether to install "marquee names" that
attract institutional investors.
By investing in startups, VCs created demand for
VC funding via a self-fulfilling system. The IPO of the zero profit
bogus Internet business, iconified by Amazon.com, fed more money
back into the VC system to be used to finance other bogus companies.
And so on. A company that attempted to grow by the arcane method
of building a business from profits was crushed by competitors that
were not profitable but had instead a pile of VC cash to use to
out-market any puny competitor, profitable or otherwise.
As recently as a few years ago, venture capital was
a source of capital for expansion of a business model proven by
profitability. With the bogus bubble companies, VC has become a
lethal competitive offense among unprofitable businesses to crush
potentially profitable competitors that tried to grow a business
without them. More than any other factor, venture capital is responsible
for producing the zero profit Internet company. Without venture
capital, the pricing mechanism of the market of consumers, rather
than the artificial pricing mechanism of cash-rich venture capitalists
and investment banks, will prove which Internet business models
do and do not work.
It's a sinister game, but not a new game. Tune in
Thursday for a look at venture-led debacles of years past.
-- Posted: July 18, 2000
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