Transatlantic Cable: The sound of dot-com failure

If you stand in Silicon Valley for any length of time, you'll hear a distant crashing sound. It's the sound of dot-com companies failing as they run out of cash and collapse in an unholy mess. And it's a sound that's being heard more and more often in the Valley and throughout the US.

Of course, the biggest crashing we've heard recently was from London, where boo.com expired after managing to burn up an impressive £120m in cash in under a year creating an online store without actually managing to sell very much. And while boo.com may have been one of the biggest, it was by no means the first or the last - there have been plenty of similar failures in the US recently.

For instance, in the past few weeks, we've had the failure of the Digital Entertainment Network (DEN) and Toysmart.com. Meanwhile, numerous other companies are teetering on the edge: the health site DrKoop.com is (if you'll excuse the pun) on the critical list, CDNow could end up in the bargain bin and online grocer peapod.com is currently hawking its own wares by openly pleading for someone to buy the company.

It's got so bad that one analyst has started a weekly mailing list of companies that have failed, and another has claimed that of the 32 online retailers he examined, 10 were unlikely to survive the year.

Show me the money

The reason for all of these failures is the way these companies are funded. The theory is that you start the company with some venture capital (VC), make some noise (by spending loads on marketing), raise some more VC, make more noise in the market and then go public, raising an even bigger pile of cash.

If you're one of the founders, you then sit on this pile of cash and laugh maniacally as you retire to the Caribbean. But the only laughs at the moment are hollow ones as VC companies and investors watch their cash go down the drain.

The problem is that it's getting increasingly difficult to raise extra VC, and these companies are running out of cash, having spent it all on things like marketing in order to try and get their next round.

VC companies and investors are becoming more and more discerning in whom they fund, and many companies simply don't have the appeal they once had. Because there is no longer the guarantee of a huge IPO in the future, investors are insisting on things like profits and good market share, and these companies simply can't provide them.

Even the deep pockets of big initial investors aren't any guarantee. So instead, they're cutting costs, shedding staff and selling the family silver in order to stay alive.

Take, for instance, failed toy retailer ToySmart.com. Founded in 1997, the company started to get serious when it attracted a big investment from Disney, who handed over around $50m for a controlling interest.

The company proceeded to expand quickly, and spent a lot on marketing and expanding their site during the critical Christmas 1999 period. And they seemed to be doing well: the venture trumpeted figures from Media Metrix in December 1999 that showed a 102 per cent increase in traffic in a single week.

And yet a few short months later they were dead, with a rather plaintive note on their Web site that offered the assets of the company for sale: "If you are interested in purchasing ToySmart.com's assets, please e-mail the information to bids@toysmart.com."

Diagnosis : death by (cash) starvation

Another example is the health site DrKoop.com. Named after (and founded by) a former US Surgeon General, the site managed a very successful IPO in 1998, rising to a high of $45.75. Now the stock is languishing significantly lower - at the time of writing, it is at $1.81.

In fact, the shares fell a scary 41 per cent on one day following a report from the auditors that they had ''substantial doubt'' over whether the company could survive. The company is still going, but only thanks to a severe restructuring and some big layoffs.

Of course, there are still plenty of dot-com companies in the US that are not only surviving, but thriving. There are still plenty of new companies being founded and attracting VC. In fact, there have been several recent IPOs of companies that produce infrastructure products that have done very well, such as ONI systems, whose share value tripled on the first day's trading.

However, lots of other dot-com companies have postponed or cancelled IPOs (such as AltaVista and deja.com), preferring to wait for friendlier stock market conditions. The boom times aren't over, but the people with the money are certainly being far more cautious about where they put it these days.