Entrepreneurship and Wealth Creation
Session Two: Growth Strategies
Friday, November 12, 1999
3:30-5p.m.

Ted Snyder: Welcome everybody, and welcome to the Darden School and to the University of Virginia. I'm Ted Snyder, Dean of the School. I also wanted to say welcome to the people elsewhere in the School. I understand that we've got multiple classroom that are all filled up right now. I also wanted to welcome our audience on the web. Not to beat a dead horse, but I can't wait until we get that new auditorium . We've had a great day already and many of you know that I think about wins for the school and for the University and we've already had two. It may be a little bit confusing to the web audience because the session that we just finished will be shown after this one, but this next session will make it a trifecta for today, and the session itself is on entrepreneurship and wealth creation in the digital age.

We've got another great group of people. I wanted to thank again our students. Darden and the University of Virginia pride itself on being student-centered which means the students do a lot of the work, and I wanted to thank in particular the Technology Club and the Entrepreneurship Club and turn it over to the president of the Entrepreneur's Club, Chris Duffus.

Christian Duffus: Thank you. Thanks again for coming out today. I think this is a phenomenal opportunity. If UVA were going to be going public today, I think we'd have a valuation of a couple billion dollars. This panel, again, is "Entrepreneurship and Wealth Creation"-- entrepreneurship in the digital age, the opportunities and the challenges. We're going to take on a similar format to the previous panel and without further ado, I guess I would like to introduce our panelists here. We have Doug Lebda of the LendingTree. Allen Morgan of the Mayfield Fund. Dean Johnson of ValueAmerica and Frank Batten, Jr., of Landmark Communications and Marco Protano of the CoolAudio. Again, each of the panelists will be going into a little bit about themselves and their companies and then we're going to open it up to questions with Patty Sellers. Thank you, and Doug--

Douglas M. Lebda: It really is a pleasure -- I actually left Darden midway through the two years. I left after my first year to start Lending Tree, so instead of the hot seat, we'll call this the hat seat. The dean promised me a degree in exchange for wearing this hat during this session [laughter/applause]. Just to go into a little bit about what Lending Tree is and how we started. Lending Tree is a loan marketplace that connects consumers to a network of lenders who compete for their business. The company was founded after my own frustration about 3_ years ago trying to get a mortgage loan for a $60,000 condominium that I was buying in Pittsburgh, Pennsylvania. Basically I went through what most people go through. You have to open the newspaper, shop for interest rates, pick a lender and then apply for one loan with one lender. It's a process that leaves you feeling out of control, feeling disempowered, disillusioned, and extremely frustrated, so the question I asked was why can't I just put my information some place and then have lenders access that who want to approve borrowers like me and then make me competitive offers and I can compare offers and pick the offer that works the best.

I did what most people do. I started writing checks for the venture and went out and for a marketplace business, I had to go sign up banks which was a tortuous 3_ years ago. They were not at all ready for this. None of them had web sites. If they did, it was basically a one-page brochure and for us to say we're going to transmit loan applications directly into your underwriting systems, get back approvals, and this is all going to happen on line, that was quite a tough sell.

I spent a year at Darden and during that time, I wrote a business plan. It was really the best year of my life. I would go to class from 8:00 in the morning until 1:00 in the afternoon, spend from 1:00 to about 6:00 p.m. working on Lending Tree trying to write a business plan, trying to put together some of our first investors, doing things that literally had three phone lines in our apartment. Would answer the phone. My wife was helping out. She'd answer the phone, Doug Lebda's office and they'd say, "is Mr. Lebda in?" She's say, "one moment, please," and she'd hand me the phone working at the desk. We used to have a photocopy delivery, photocopy sales people. We learned very early that they'll actually lend you a copier for two weeks at a time to try out, so every two weeks we'd get a new photocopier , and we did that. We'd have four burley

guys bringing in one while four burley guys took one away. Our neighbors didn't know what was going on here . It was a lot of fun.

Today, Lending Tree is a 100 people. We just passed the 100-person mark this week. Actually, we hired several of my classmates who're working with us, a few of whom are here today and it's company with a 100 people really focused on the mission which is to give consumers choice and empower them in their loan transactions. We get over 3,000 loan applications every day across all consumer credit categories. We have over 95 lenders operating on our network. We are the only loan marketplace. We have other competitors out there, but they all lend money. There's nobody just making a match and so we'll talk a little bit about marketplace companies and that's something that I think is great on the Internet.

Last month, the month of October, we closed over $110 million worth of loans on the site, closed over 4,000 loans all credit types. We used to close-- At the beginning of the year, if we did 100 loans a month, it was a great month and used to have to try to tell stories to make ourselves sound bigger and hopefully by the end of the year, we're going to be largest loan originator on the Internet compared to anyone else out there.

A little advice-- I was asked to give a little advice to MBA students and I would just say for people who are considering whether or not to start a venture, try to see, try to get into a different mindset and this really goes for anybody starting a venture, whether you're in school or whether you're working some place else, whether you've been out of a school for a number of years. Really, start examining upsides and downsides differently. For me, I was going through the interview process during the first year and was doing very well, and once I realized that my downside of starting my own venture was that I'm not going to make $7,000 a month working for Bank of America and my down side is $15,000 that I'm going to make in the summer and my upside is unlimited because I can actually change the world, create a new company, do something amazing. That really changed my mindset, and then once I was sitting after that summer and said, okay, do I go back to school and try to get a job with a big consulting firm or do I do this. I had a similar type of analysis to make. I said, gosh, you can make a $100,000 a year out of Darden.

Well, okay, so you're going to give up a little of that, but at the same time, the upside is unlimited and then you realize that people who fail are actually better suited in the marketplace anyway than people, if you had to come back and get another job, so there really is no downside to somebody who wants to start a venture, especially in today's marketplace, so I would just challenge people to think about that because it really really is fun and we just have an incredible time doing what we're doing.

To talk about my view of the Internet and where things are going--the Internet is really friction-free capitalism and for somebody like myself who is not a big fan of government, is not a big fan of large corporations, really likes the aspect of having lenders competing for the consumers' business and really what that means to them and how excited they get when they're getting offers and banks are begging for their business instead of the other way around. We love friction-free capitalism.

Everything on the Internet becomes commoditized very quickly. If you're selling a good or a service, it is going to become a commodity and we are seeing it now with the loan process. We have big banks that tell us that brand matters. Brand doesn't matter. The consumers especially with something like a bank where the banks view their brands as very important, in actuality consumers views the bank's brand as somewhat intrusive and not necessarily a place that they put of lot trust in, so everything gets commoditized very quickly. It's very very difficult to make money on the Internet selling a good.

My view of the Internet is that what's going to win, the companies that are going to create long-term sustainable competitive advantage are marketplace companies or exchanges, but over the long term, that's what really wins, and to succeed on the Internet, I really think you need three things. You need paranoia which you heard a lot about today. You need an incredible amount of focus because there are constantly things that you can do to take you off of your course, and the last thing you need is tenacity. There'll be hundreds of people that tell you it'll never work, that tell you it's going to take too long, there's too many competitors.

We launched our site. Microsoft Home Advisor came out. I mean, gosh, Microsoft and Intuit are in our space. I can remember, I did the business plan competition here at Darden, left and a guy in the room said, oh yeah, I worked at Intuit last year. They're working on this. And you think you can't compete against people like that when in actuality you can if you do it differently.

I'd like to talk just a little bit about marketplaces and what we see as the competitive advantage. A lot of talk about business to business and business to consumer. I think that's a bad way to look at it. I think it's better to look at it--do I sell a product or do I make a match or make an exchange. For example, any marketplace, be it a business to business, be it a business to consumer marketplace like we are, or even a consumer to consumer marketplace, like eBay, those are very high margin businesses and people refer to them as a vortex business because each side you get buyers and sellers and they come together and they start to feed on itself, and we think those are really the ways to have companies that are really going to have long-term, sustainable advantage.

You see something similar with community sites where the last panel had a lot of those, where you get people coming on and then you can attract more advertisers which attracts more people which attracts more advertisers, and you basically are making a match instead of selling a good and I think it's going to be difficult long term on the Internet to make money by selling something to anybody, and if you are making a product and selling it to a business, they're going to have the same thing because the barriers to entry are fundamentally low, and we really like companies and we think that we have a long-term view of this, that companies that make markets are really what are going to be the long-term winners on the Internet.

Allen Morgan: I'm Allen Morgan. I'm a partner at a Menlo Park-based venture capital firm called the Mayfield Fund, and when I was planning for this, I felt kind of conflicted because the sort of fashion advice I got was business casual. But where I come from, business causal means a polo shirt and long pants, if there're going to be clients there and short pants if they're not, so I've been slowing taking things off all day and I was told to wear a coat and tie but I promise I'll stop here .

Mayfield is a 30-year-old which makes it the oldest continuously operating fund along the infamous stretch of Menlo Park called Sandhill Road and Mayfield today invests in 3_ areas--health care technology. There's still a couple of partners barely sort of trudging on in that area. Most of us are focused on Internet companies of one kind or another, and four of the partners, either all or some of their time, focus on communications technologies.

I thought what I might do is briefly go into how the Internet has changed the way we look at and interact with companies once we've invested with them. In the good old days, it was typical for companies that succeeded to go public and four or five years after they were founded and the typical trajectory they were on would be to start with a technology, spend a couple of years developing the technology. Towards the end of that period, start thinking about hiring some marketing people and when the technology was finished, you'd actually hire sales people, and that usually took two to three years.

Today's market is probably exemplified by, or as well as I can exemplify it, by a company that I'm an investor in and on the board of called Varsity Books which is not too far from here, and the company was founded just about 14 months ago and just about three or four weeks ago, filed to go public and in that time they went from being represented on five campuses to over 250 seriously represented. They raised in that time about $50 million and the company's got 120 employees. I'm an active board member, you can tell , Varsity Books is typical for an Internet business that we look at these days.

The second thing I would point out is I do think that selling things on the Internet is a tricky business. Varsity Books people think of it as an on-line college textbook store, but what it really is is information and marketing channel to the college demographic and books, simply because the traditional way you buy textbooks in college is such an awful experience, was, if you will, the grappling hook that the company shot up to hook onto the wall that they were going to scale, but the long-term pressures on margins in selling things is very tough, so those of you considering your own Internet businesses, if you're going to sell things, make sure that you have a strategy beyond things.

Dean Johnson: I've had the opportunity to be instrumental in the founding of two businesses here in Charlottesville which I consider myself quite lucky. One, in 1991 and another in the last 1997 to just recently time period. The first is there's a case in first year marketing called Charlottesville Quality Cable. I don't know whether they still teach it or not. It's a skimming versus penetration case and I'll probably look like an idiot at the end , but at the risk of that, I'll give you my two-minute dissertation on that, but I want to compare that with the most recent company that I've helped rise out of the primordial soup and that's a company called Value America which sells stuff on the Internet.

Charlottesville Quality Cable, for those of you who didn't read the case, was about a company that was going to provide cable television service where cable television service doesn't exist and to compete with existing cable television providers using radio frequency technologies, but between the two I think is kind of instructive. It illustrates a little bit about the power of the Internet. It illustrates a little bit about the maturity of the capital markets. It illustrates a lot about the bravery in my judgment about the capital markets.

The market that I was shooting for in Charlottesville Quality Cable was Charlottesville and any place I go could get licenses from the FCC. At Value America, an Internet company virtually, the United States if not the world is your oyster in that. The margins, the gross margins, in the cable company are pretty healthy--around 60% after you've paid the programmers.

At Value America, we crowed to Wall Street last quarter because we had achieved a 6% gross margin and 4% of that 6% came off of product sales, so we managed to sell something for a dollar that we bought for 96 cents.

There were significant constraints at Charlottesville Quality Cable. One of the most important was capital. This is 1991--the capital markets weren't as mature back then. We had also had the difficulty of obtaining licenses from the FCC and you talk about governmental regulation in the Internet, well, the whole RF area is rife with government regulation and that's something we had to face and we also had entrenched interests. There was a monopoly out there called Cable Television and this was flying right in the face of their monopolistic operation.

At Value America, the challenge was to build a brand and to enter that competition for eyeballs. How do you bring people to your site and there are some entrenched interests. That is to say brands don't want to turn their backs on existing brick and mortar distribution to go to virtual distribution, but not anywhere nearly as great.

The ownership that I was able to obtain in the first company was around 50%. I had a partner. The problem is if you have a partner, you go from 100% to 50% and at Value America, if you don't found the company, it's much more difficult to get a meaningful participation there, so you pray that the pie gets very large because your little sliver isn't going to increase dramatically if it doesn't.

The capital that we tried to raise in 1991 for this idea was extremely hard to acquire, but we did spend on things that had tangible value--on capital assets, on PP&E, and we raised the princely sum of $3 million and felt that we were pretty doggone smart for having done so. The capital for Value America was not easy to acquire. I had to open checks that were coming to me in the mail, literally. We raised $276 million in a period of 18 months. In November and December of last year, we were closing $5 million deals every three days. People had recognized that the Internet was something and that they wanted to get in early and this was a pre-IPO company.

Having said that, it was cheap but what did we do? Did we spend it on assets? Absolutely not. We spent it on real estate in the Wall Street Journal and in New York Times and ads and so it was an entirely different characteristic. You can't compare night and day, but I think you can see from what I'm saying there're some themes you'd want. You want to have high margins. You'd want to own it all. You'd want to have as few constraints as possible, be in an easy capital market and have the United States, if not the world, as your ability and really, if you have to fall down on one side or the other, you really fall down on the Internet, but what do these have in common. What I've always found and I don't want to sound trite, but if you don't have a strong people in either area, you're not going to succeed but you've got to create a culture, at the risk of sounding like B.F. Skinner, you have to create a culture or an environment for these people to succeed.

You've got to create an environment that either you're going to do the job or die trying, that people have a sense of urgency, and you, at the leader, as the potential leader, have to have a fanatic dedication to this because it provides an important leadership factor. There will be some dark times, whether it's when you get sued by a rival cable company or when Amazon triples their ad spending in the fourth quarter, but people, employees, are going to look to you for your leadership as well as your ability to pull on your own or lead by example.

And, lastly, risk taking. One of the things I've constantly emphasized to people when they've come and interviewed and they say, well, Value America or CQC or whatever, isn't fully baked yet. I'd really like to go with a company that has all the systems in place and has everything ready to go. The problem is that when you're competing with a sense of urgency in a dynamic market, you have to be ready to take that ship out to sea even while you're still constructing it, with the hope that you're going to break ropes in the storm and not a mast, so I think there're some little lessons to draw on there, but I feel a little humble being on a panel of wealth creation sitting next to Frank Batten , so I'll stop and we'll see what he has to say. One of my great regrets is not being in his study group. We were at Darden together.

Frank Batten, Jr.: I'm the chairman of Landmark Communications. Landmark is a privately-held diversified media company based in Norfolk. The most well-known thing that we own is the Weather Channel. We also own some other traditional media businesses, some TV stations and newspapers and that sort of thing. On the Internet, we own Weather.com which is the leading weather-related site. It's in the top sort of 25 or 30 sites on the Internet in terms of traffic. We also have some other investments. We own 25% of Autotrader.com which is the leading used car site on the Internet and we also own about a fourth of Bitters Edge which is an auction portal and auction aggregator, and we have some other Internet investments that are in the works.

I thought I'd talk a little bit today about Red Hat, which I get more questions actually about Red Hat than I do about Landmark. As an individual I was one of the first significant outside investors in Red Hat. Two years ago I had the privilege and really sort of undeserved privilege, I think, of being able to buy shares in Red Hat when the company was valued at $4_ million and since then, since the IPO and all that, the value's gone up a little bit since then.

______________: Where are you taking us to dinner?

Batten: Well, the lock up hasn't expired so , so a raincheck. I thought I'd talk about sort-- A lot of people hade said, well, why is it that you invested in Red Hat? What did you see in that? I talk about my Darden experience was relevant to making that decision. When I was at Darden, one of my favorite courses, and this doesn't seem like what you'd think about talking about at this conference, was operations, the whole factory management and that sort of thing, and I'd gotten really interested in that and I was a liberal arts major in undergraduate, but had sort of really loved the manufacturing and the industrial engineering side of things and I really enjoyed that.

Then after Darden, based on sort of some seeds planted here, got really interested in the Japanese manufacturing techniques and the Toyota production system and all those sort of things, and of course, Japan was really a big thing to think about back in the '80s, and I concluded from that what the Japanese had or what Toyota had and other Japanese companies had, was not so much better products but better processes. They had better processes. Toyota, for example, better processes for designing cars and then better processes for manufacturing cars, and so when I saw the Red Hat opportunity and first met the Red Hat folks back in January of '96 and ended up investing the summer of '97, when I first saw and the open source of software development model, which is that software can be freely shared and redistributed and developed by people, software programmers all over the world, sharing their work over the Internet, it really struck me that even though Linux at the time was a much less powerful operations system than Solaris and even the Windows antique, it really struck me that that was fundamentally a better process for developing software for designing and manufacturing software, if you think of it in those terms, and so it really struck me that even though Linux was not the greatest now, and I think that was why a number of venture capital firms--

Evidently, the Red Hat had called on a number of the leading venture capital firms and had been turned down and I think the reason was that Linux was really not seen as a great product at the time, as a great operating system. But it struck me that it's sort of gone from zero to 30 miles an hour in just a couple of years, and that the process was going to lead to a rate of improvement that was much faster than the other operating systems and was soon going to surpass that and plus, the price--free--is kind of hard to complete. It's hard to get a better price than that. So, that's how open source, as a software development model, would be a better process.

Then, how does Red Hat sort of in an environment where pretty much anybody can copy its products and put them out over their own name, how does Red Hat distinguish itself from the other distributors of Linux? And there was where my Darden marketing training came in and really, the consumer marketing because Red Hat is really a branded product and the power of the Red Hat brand was such that people really wanted that sort of-- You could download Linux from anywhere or you could buy very inexpensively from all sorts of people who put out CD-ROMs saying this was a version of Linux, but it was something about that Red Hat brand that made people say I want the trusted brand and so my Darden marketing background that really sort of struck me that the brand would work, and I still get lots of questions, well, how do you make money selling free software? There's lot of people who'd pay $1.00 for a bottle of Evian and the water inside doesn't cost very much.

Red Hat has since expanded beyond purely selling software to selling a lot of services, support and engineering services and that sort of thing, which is really fundamental business, but it's been a good investment opportunity for me and I hope that each of you all who are students will listen carefully and participate well and try to think about how all the different courses at Darden can apply to your new business ventures and I hope you're even more successful than Red Hat, but not in software, of course .

Marco M. Protano: Hello, everyone. Our business is probably the baby of the group. We actually just launched about a month ago and actually we're in U.S.A. Today today which is great and Entertainment Weekly and what we are is CoolAudio is a great opportunity that actually was started earlier this year, and it basically had grown out of frustration and not only myself, but a lot of people around me, and then through some research that we found out that there a lot of consumers out there who actually were quite frustrated and had abandoned the home electronics categories, consumer electronics, and yet it was a time when the digital technology is actually increasing at its most furious rate and there's actually technology that can bring better than live entertainment almost, in your home, and so with a partner actually who's an audiophile and I myself am not an audiophile. I can barely change the time on my VCR, and decided that we would actually go into the marketplace and create basically a retailer on line that would go around the world and actually find the best of products that we could get exclusivity on as well as selectivity distribution agreements on, put them on line, and actually offer the best of customer service that was unparalleled.

This is sort of the Saturn approach, so if Saturn automobiles was ever going into consumer electronics, they would be doing what we were doing, because we patterned our business after them, and to bring a little bit of excitement and magic back to the entertainment category in consumer electronics which has been missing over the years, and to do that all in a forum that was not only on line on the web but also out in the community because what we heard through all of our focus groups and interviews that we did around the country, was that consumers were frightened. Frightened about going into a consumer electronics store, even more frightened about getting a box into their home and having to put it together by themselves, and what we were going to do is actually set up and we have so far set up an installation and set-up network nationwide as well as dealers, so it's basically a clicks and bricks strategy that we just launched.

It's called CoolAudio.com and we're very happy to launch this and actually it's a great business opportunity where we focus in about four things. The first is content. Really, we have a mission of educating our consumers and really providing them with content, branded content, that we have the best audiovideo writers who are writing in very much easy-to-understand format. We also have the best of selection. We're not going to have a wall of TVs. We actually had the best TVs that are out there or the best of audio products. Service is also unparalleled, both, before, during, after and beyond. We actually located our operation here in Virginia because we could be guaranteed that we could have a great service component as well being out in the community around the country in 25 major metro markets, but the most important attribute is simplicity. This is one category that unlike the computer market where it's getting more technical, it's actually getting simpler to buy a computer. In audiovideo consumer electronics, it's getting more complex and it's getting more difficult to buy and so we bring simplicity to the category and that's one of our more important attributes.

We're out there right now going out and raising capital and actually we have raised $3 million to date and we're actually in a fourth stage right now with some VC firms and so we are raising our second round and actually we are-- I guess a couple of lessons that I wanted to point out is one is to move fast. We thought we were moving incredibly fast and competitors are coming out of the woodwork on a daily basis and I think that's very very important and always try to stay one step ahead. I think it was mentioned in this morning's session about literally having on the shoes to outrun the person who's in the tent with you from the bear, but I think it's very important to actually to, one, not only move fast, but also to join up with competition. We actually just entered into a few agreements with competition as well as entered some agreements with people who would partner with us and open up market opportunities for us, and so right now, we actually have a business that we're projecting to grow quite rapidly and we're ramping up. We're New York City-based as well as Charlottesville-based and we have a great opportunity.

But I guess in terms of where the Internet is going--this is the question that was asked--I think I quote an MIT study from MIT Media Labs is you ain't seen nothing yet and we're gearing up for that and in terms of one, not only selling low end to mid end high tech but also merging technology convergence and literally trying to create a retailing operation where, as our other panelists have noted, it is quite difficult and there is that whole threat of commodiziation to fight that threat with building, as Warren Buffet would say, the moat around the castle as best as you can and we do that on a daily basis. That's what worries us and keeps us going.

Petty much in terms of whether the Internet in terms of retailing, I think it's going to be much more interactive and we're embracing a whole bunch of that. We have a whole bunch of technology that we've invested in to make it one-on-one as well as to make it a more of a group building situation , so that's CoolAudio. Thank you.

Duffus: I would like to open up Q&A with Patty Sellers, our discussion leader.

Patricia Sellers: Thank you. I'm going to ask the same question that I did in the first group because it yielded some terrific answers and insights and the question is in trying to attract investors and Allen and Frank, in your cases, I'd love to know what-- You can put this in the context of what attracted you to the companies that you decided to invest in, but what's the smartest thing that you did in positioning your company to investors and what's the dumbest thing that you did, the mistake that you made. Doug, Dean, Marco, for your companies, and Allen and Frank, companies that you decided to invest in.

Lebda: I think the probably the dumbest thing I did as I financed the company was not going to venture capitalists early enough. I think earlier on in my-- We had a very circuitous route of financing which I won't go into, but I did not go to value-added venture investors early enough which I think we have a great lead now. If we had signed up some of our investors now two years ago I don't even know where we'd be, but it would be probably much further along, and I think venture capitalist can add a lot of value if you find the right partner.

The smartest thing I think we did was in our last round of financing where we raised more money that I could've ever thought I would ever need, The story there is we went to raise a $10 to $15 million round of financing. Another smart thing we did is we hired an investment bank to go help us raise which generates a lot more interest and I would encourage people to do that, but we went out and ended up with six lead investor term sheets and one of them, a group called Capital Z Partners that invests only in financial service companies and really focuses on Internet financial services, basically said to us, what would it really take you-- Instead of $10 to $15 million, what would it take for you to own the market and we sat down and ran some numbers and we said $50 million bucks, and so we took down $50 million from Capital Z, GE Capital, Goldman Sachs, Priceline, and Marsh McClennan companies, got a tremendous amount of strategic value and the best thing is out of the three years that I started this company, this is the first time that we're not actually out there constantly trying to raise more money, and I would encourage anybody who's thinking about a venture, take the amount of money you think you need, multiply it times 5 or 10, and you're probably still a little light .

What's happening is the cost of entry continues to go up, and what I think is going to happen over time and I think it's already there, is that Internet companies, the Internet is basically becoming the medium and it's not necessarily becoming the industry but it's really just a medium to transact business which means that companies using the Internet are going to need to be financed like traditional businesses and to be dominant, you're going to need a tremendous amount of money to get you there.

Morgan: I'd say the venture capitalist version of the dumbest thing-- I guess the dumbest thing that we as an industry did was be slow to recognize the following shift in what makes a great company and the shift is caused by the Internet. Back to my introductory remarks, the standard sort of lore of venture capital industry used to be the three important things when you look at a company--are they addressing a huge market? Do they have a dynamite team? And do they have killer defensible technology? That shifts when you talk about an Internet company, particularly and most noteworthy, when it's a business to consumer Internet company where the three most important things to picking the winners are, number one, are they addressing a huge market? Two, do they have a great team, but third, do they have an innovative business model that properly leverages the web, and we and all of our brethren, even on Sandhill Road where the Internet really started first, certainly in a start-up company anyway, missed a lot of companies because we had not switched our filters from huge market, great team, wonderful technology to huge market, great team, innovative business model.

A final word on that--today, in general although it's a little bit different if the company you're backing is an Internet infrastructure company or a business to business Internet company, but in general, I urge my companies not to develop any technology internally because so much technology is now available from third parties and speed-- When I was in college, which was years and years and years ago, you were told not to do drugs because speed kills. I don't tell my kids this, but the 1990s version of that is speed thrills, and if you're developing your own technology, it slows you down and speed is the ultimate weapon on the Internet.

I suppose I'm having trouble coming up with the smartest thing we've done. The smartest thing we've done is probably invest in a number of great companies that now that we've figured it out, that do address big markets and have great teams and have innovative business models.

Johnson: The smartest and dumbest thing I've ever done are sides of the same coin and that is the staging of investments. At Value America, had I the opportunity to do it all over again, we would not have tried to go public quite as quickly as we did. We may have done a C round of investments which we ended up having to do, because we tried to go public not this past September but the prior September. We were out in the public market when there'd been two serious brakes. The Dow had fallen from 9,000 to about 7,8000. A lot of the wind was out of the Internet company sails, and really, if we had failed to go public, we didn't know what was next and we were running out of money at the same time, but that's another story, so we raised enough money just to get to the public offering and it wasn't a luxury of going public. It was a necessity of going public and we were going public with about a half a billion dollar valuation.

At the time we went out, the brakes in the market had to pull back and really nearly went out of business there, but keep in mind that the other side of it was, it's really smart because we were going to get a half a million dollar valuation. We were projecting billions in sales. We had a trailing 12-month sales total of a princely $7.3 million and we were going to get a $500 million market cap out there. That's a huge carrot, but the problem is that once you are public, you on a treadmill of Street expectations and also in a rapidly growing company, our infrastructure was not up to the task. We came within a hair's breadth of getting a reportable condition from our auditors and that was a risk that would have cratered the company, so on the one hand, you've got this huge carrot out there, but you're walking a very fine line between going fast and going way too fast in a very tangible way.

Batten: I guess I'll answer that maybe as I would guess that the founders of Red Hat would answer if they were here based on the things I've talked about. I think one thing that they were smart to do has been to get investors who really understood their business model and believed in their business model, especially since open source is-- Most people just don't understand it, and it's just hard to understand unless you really sort of think about it a while. It's not sort of on the surface understandable and I many of the people who've come in, either as managers or investors and other open source companies are always sort of trying to push these companies toward the proprietary software model. Do open source plus proprietary and that sort of thing, and my role in the company was to-- Fortunately the founders never wanted to do this, but my role in the company was to sort of lay down in front of that train if anyone ever tried to let the company deviate at all from the open source model, and I remember the founders saying they'd go back after meetings with me sort of amazed that not only was I not trying to push them proprietary. The only reason I was even interested in that was because it's open source.

Same when Benchmark came in an investor. Benchmark and Gray Lot, two venture firms, came in summer of '98 as investors, and Red Hat didn't go to them. Actually, they came knocking on Red Hat's doors because Kevin Harvey at Benchmark really believed in the open source model and understood it and that sort of thing, so I guess I would say-- And, at the time, incidentally, Red Hat weighed as an alternative to the venture people was sort of doing one of these-- Wanted the investment banks to get private equity from a bunch of basically passive investors, and I think it's been really helpful to the company to have people who not only understood the business model but were really committed it and didn't sort of try to take the company off course. Fortunately Red Hat, everything's gone well, so I don't know. There haven't been any sort of serious mistakes or problems.

Protano: I guess one of the smartest thing that we did early on was to really latch onto strategic investors who were friendly, who were well connected, who were from both within the industry and outside, who could really open a lot of doors, who could also be great mentors, who could really help us grow the business and get it from a concept stage to first and second phase, but I also think that one of the things that we probably should've done earlier on was to really approach the venture capital community much sooner and to do that quite rapidly. Not that we're running out of money and one of the things that I've learned is that financing is a never-ending process and that you go from one phase to another and I think that was probably the other thing that I learned.

Audience question: My question to you guys is if you could give us your view of the advantages and disadvantages of starting financing and building a company in a town like Charlottesville that's off the beaten path versus in a major area such as New York or San Francisco where surrounded by potential strategic partners as well as you're in the backyards of most of the venture capital funds.

Morgan: I'm happy to lead off because we face that question all the time. It's a tension and there's no right answer. In my neck of the woods, the pluses are you have access to an incredibly deep and rich infrastructure from hundreds of venture capital firms to experienced law firms, experienced accounting firms, banks that are used to dealing with companies that aren't going to earn money for a long time, banks that are willing to give you better terms if you'll give them equity, where every place you go you have to be careful about discussing your business plan because the people at the next table are probably planning a competing business, but that provides a richness and sort of an ecosystem in which it's very easy to start a business, very easy to hook up with people who understand how to help you grow your business.

The minuses are it's expensive because it's become an attractive place to live. That is most relevant for those of you who've started your companies because it costs a lot of money to hire and/or relocate people to the Bay area. The best thing about the Bay area and then I'll flip over and talk about other areas, however, is not cost of living, not having experienced people around you, but really the ethos of the place where failure is only failure if you didn't try. It's not failure just because you didn't succeed. Scott McNeely who has one of the best speech writers-- He's the chairman and CEO of Sun Microsystems, has, I think the best speech writer I know of a technology CEO, and he has a saying that the great thing about Silicon Valley is it's not whether you go off the cliff or not. It's how close to the edge your skid marks start . The upside of a place like Charlottesville or for us, we've made, unusually for us, five investments in Northern Virginia in the last 10 months, is just really the flip side of all of that. It's easier to be a big fish in a small pond. Cost of living and acquiring and retaining employees tends to be lower.

Another sort of atmospheric kind of factor--employee loyalty tends to be higher. Where I live, people switch jobs twice, three times in a year if they get a better job offer or they think a company's hotter and you don't find that so much here. The downside side you don't have the infrastructure as well developed and you don't have the (it's our view anyway) you don't yet have the view of people in the sort of environment that it's okay to fail. The only failure is not to try at all or not to try hard enough.

Johnson: From the bank's perspective, it's a negative. People around here, it's small town banking and they want asset-based loans. From angels, I think there're a lot of money folks here who would be interested in participating in the Internet just in a small way. Maybe through you and the venture capitals, I think there's a certain snobbishness with all due respect, that you're outside of an urban area.

______________: Don't say that to me.

Johnson: Yeah, what can you-- You're outside of an urban area. What can you know? What kind of cross-pollination can you really have on your business plan and your contacts? I know, I just flipping through my business cards here and I didn't see anybody from Charlottesville and I'm thinking to myself, wow, this is a great opportunity to do some networking and would've have the opportunity to if I just stayed in Charlottesville, although in Charlottesville I think you do have the patience. You can develop a little bit a more patience. You have time to kind of work through your things. I've worked in the Silicon Valley and everything proceeded at a frenetic pace, not just a quick pace, and sometimes it seems a bit scattered and for people resources, I think it's a plus and a minus. It depends on what you need. If you need programmers, you can get them as long as you can pay them to keep them, but if you need English majors, we've got them in abundance and they're quite happy for the wages.

Lebda: Lending Tree is actually headquartered in Charlotte, North Carolina, so I know this very well, and when I was deciding where to go to locate the company, I really looked at a number of factors and Charlotte actually popped out as number one. What we were looking for were things like a low cost of living, highly educated work force, good climate, good business climates. Banking and finance was important to us and B of A and then First Union being there were key, but really, the advantages as I've come to realize since we've been there are the fact that we can really hire top talent because we are a big fish in a small pond, so if you are in the southeast and you want to work at an Internet company and you're in the city of Charlotte, there's only a couple options so we can hire literally the best people out of each of the companies around there and they want to come work for us. You can also do it at a lower cost which I think is key.

The biggest advantage though is I think outside of some of the other major Internet areas, you can build a more unique and I think a more sustainable culture. You can actually do something different. You can have employees coalesce because you have turnover that's less than 3% a year, and you can create something that I think is a little more unique and a little more sustainable over the long term.

The downside is it takes longer to get it going. You can't find people who necessarily get it right away, whereas if you were in San Francisco, everybody knows what stock options are and they know if you're in your second round of financing and your valuation is this, you deserve a quarter point in options and they know exactly what to ask for, and they know more about option investing periods than you do, and we've actually had to educate our people about what stock options mean and the reasons that they're important, so the downside is it's a little harder to get it going but once it does, I think it's a plus.

Batten: Red Hat is in Durham, North Carolina and I would say it's cut both ways. Fortunately, unlike Charlottesville, North Carolina State is a land grant university. It turns out a lot of UNIX developers, so there're a lot of sort of people to do the development work that just naturally come out of N.C. State or one of the other universities there. Interestingly though, when Red Hat was sort of trying to get its portal strategy cranked up, it could not find enough HTML programmers and people really good web site builders so it actually went to San Francisco, bought a web site design firm. The design firm basically fired all their customers and that was a way to sort of overnight get 30 employees, so I guess it's a way to-- I think you can base a company outside of Silicon Valley or Boston but probably have to be flexible if there're certain skills you need. You may actually have to go to those sort of areas.

Protano: In terms of CoolAudio, we looked at both Charlottesville and urban areas and actually we settled on both, settled on both Charlottesville and urban and it really provides to us the urban landscape and New York City, for example, provides great success and Silicon Alley to the resources, financial marketing and retailing as well as to the audio video world. In terms of Charlottesville, it gives us incredible operating efficiencies and effectiveness for our call center as well as warehousing and fulfillment. A little bit more in terms of where to locate a company and just being in a venture capital financing mode right now, is the inherent somewhat bias of being an east coast-based company versus a west coast, in that we've heard from some venture capital firms that there is that bias of just looking at west coast deals versus east coast deals, and so that's a very interesting paradigm in terms of which coast would you locate your business.

Audience question: Another question. Dean actually brought up the topic earlier and that is the timing of when to go public. How do you make that decision? What are some of the things going on because everybody's very anxious [to go Internet] and they're anxious to go public right away, but you've also got the strategic decision to try to make--do I expand the product or do I expand the target market to give you that best __________.

Johnson: In our case, and you're talking to the CFO now of a company, and I'll take it from there, you need to ask yourself the central question--can I sustain what it takes to be a highly valued public company after I go public. Do I have the systems? Do I have products coming to market in the right order? The last thing you do is want a swoon in revenues or in some way have your system crash. You can log on Yahoo! and find out how long Toys 'R Us was down or the outage at Amazon or goodness knows what happens at eBay and so the question for us was were we sufficiently developed as a company organizationally and the ability to deliver our market expectations to do that. My humble estimation was that no, we weren't, and luckily, in a perverse way, the market crapped out on us and prevented us from going out again, allowing us to regroup and then go out, but I'll tell you, if you drew a graph of Value America's value over time, it spikes up at every IPO attempt and when we went out in April, it was a billion dollars, and we'd just done a round of financing prior to that at a valuation of (I'll pick a number) $340 million-- Astronomical numbers but still 3x what you're prepared to get in the public, so you're kind of-- The carrot as I said earlier is so big and it is such cheap money you almost feel derelict tin your duties if you don't go after that.

Batten: I would say I think there's a real power, especially if you're the leader or have reasonable hopes of being the leader in your category, however you define your category. I think there's real power in being first out, just because the IPO is a branding and marketing event. I think eBay would've been successful even as a private company, but certainly they got a lot of leverage from just all the free marketing that they got from the IPO, not even anything to do with the actual cash they got, and really sort of defined them as their type of auction company.

Lebda: I think the key is to really prepare the-- Go as soon as you can after your company's infrastructure is really prepared for an IPO and by preparations, really you need a different level of sort of legal support, different level of accounting and finance and a lot of start-ups just aren't ready for that and you really most importantly need to have an infrastructure where you actually know you have such control and knowledge over your numbers that you know exactly what's going to happen based on where the market goes so you can meet expectations. Fortunately, at our company, we have some just very very good finance people and some financial modeling folks that are wonderful at knowing based on whatever happens how short or over we are going to be with our projections three months out and then we can always be adjusting so we're never looking back. We're always looking forward and then as soon you can have the infrastructure prepared, and I think it's good to do that early and I would encourage anybody who's starting a company to do all your corporate clean up ahead of time so that you don't need to do that so you're actually ready to go.

Then it's market timing and first mover and the key is you want to be able to go at a moment's notice. It is truly like the Minute Men. When the window's open, it's open and when it's shut, it is truly shut and you need to be able to jump at an opportunity and also make sure that you're out first.

Sellers: Very much related to this, Fortune has a story in the November 8th issue. It's called "Born to be Bought," and it's about this sort of increase in what we call designer start-ups and I'm curious about Allen's opinion of this, whether he sees an increase in this, but it's basically these sort of swaggering entrepreneurs who may deny that that is their purpose in life, to be bought. Sort of the more impressive thing to do is do a multi-billion dollar IPO or an IPO that gets the company valued at a billion dollars plus, but more and more entrepreneurs are deciding that's really a major long-term bet and the safer way, the better short-term play, is to just sort of design a product or an Internet feature, pose it as a company, and sell it to Yahoo! or sell it to Amazon in a year. I'm curious--are you seeing more of that and does that involve a different kind of strategy and business building strategy in order to do that?

Morgan: I guess my answer to that is a little bit round about. In the good old days I referred to my introductory remarks, it was easier for venture capitalists to have a sense that somebody's business plan was what we would call a product and not a company, because technologies didn't change, technologies changed more slowly but markets really changed more slowly. What's happened in the Internet is if you think about the beginning of the Internet for purposes of this discussion as being Netscape's IPO, there's been sort of a compressed evolution of a global marketplace in a time frame that none of us could have imagined, and so that you have companies like AOL which they think about 30 or 40% of the Internet goes through AOL.

I was at a meeting at one of the big co-hosting sites Exodus. It shows how many different ways you can measure traffic but they have about 40% of the world's web traffic run through their data centers. You get players that have gone from start-ups to market domination in that short a period of time, it's very hard as those of you in the audience who are business schools students and trying to pass your strategy course, to figure out where the market is going to be or figure what place your idea will have on a market that changes daily, and so, again, as investors, we look at companies that we think are addressing big markets, have great teams, and have innovative business models.

Some of those companies that we think could be large, independent, free-standing companies, it turns out that Yahoo! buys your major competitor and you don't have the choice any more of sort of meandering along on Internet time building an independent company, you've got now a much more limited sort of menu to choose from and a lot of the choices on that menu are hooking up with Lycos or Excite@Home or AOL. We don't fund companies that are designer start-ups because it tends to make the wrong mindset. What we find in our practices that the market just moves so rapidly because there are already a number of just very large players in it that can totally alter the marketplace and yesterday you would have had an independent strategy and today you just don't.

Batten: I think for the companies that are actual creators of technology rather than just users of technology, in many cases it's more logical for them to create a great technology and sell it to Sysco, someone who already has a wonderful brand name and sales engine and that sort of thing rather than developing all that themselves. I think for the companies that are more user of technologies, there's more of a choice there.

Duffus: We're going to have to break for questions from the McIntire School. We're going to utilize our technology.

McIntire School audience question: A recurring theme that we've been hearing from a lot of different speakers and panelists is that in order for a company to be successful, you need to find and retain good employees. I believe Allen said that one of the three criteria that you look at is a great team. My question is from a start-up company, where do you go and what method do you use to find and put together the teams for your companies.

Morgan: It's the hardest thing we do, and it depends on where the company is located and it depends on whether you're hiring the CEO or a VP in charge of an important business function, or you're hiring people farther down in the organization. At the senior levels, the job is still by and large done in two ways. You either hire a head hunter to do it or you use your own network, referring to your firm's network of candidates. In our practice, it's probably 60/40; in 60% of the cases where we're the lead investor, a CEO or very senior person will be found through a headhunter and in 40%, it's somebody we knew who because of our part of our job is networking, is either ready to leave their company or their company got sold or they had had a successful company and they've taken their six months off to travel to Italy and they're back ready to re-enter the fray.

Farther down in the organization, it's a big problem in Silicon Valley. True to Silicon Valley form, we're now seeing a number of business plans by .com companies that are trying to outsource the entire hiring function for companies, but the labor shortage in the Bay area and the traffic, are the two biggest impediments to growth right now.

Lebda: I would add that-- I would just say if you're starting up, probably the best source of talent are people that you know, really smart people generally know other really smart people and hopefully people who are smarter than yourselves that can actually make your business better, so I would encourage the first thing you do is you look around and you see who is, for example, for me it was Reddin Bouser who was a great marketer who was actually in my study group here at Darden who we convinced to come onboard very early. We needed a great numbers guy. We hired another Darden guy who was also in our class, so your friends and people that you know in your internal network, I think, are the best place to go.

Once you get a little further down the line, I would just echo the tremendous value of the retained search firms. We've just started using them recently and I'll tell you, it is, again, as far as the service they provide and the ability for them to go out and really find top talent out of industry. It costs you a lot of money. They get paid very well for what they do, but they can really find great people and they also undertake the whole process, so you don't need to screen 300 people to find the three top candidates.

Johnson: I don't want to repeat anything that's said here. What I would add is in addition to getting them, you've got to keep them, and people come and go for money, for stock options, and all that stuff. What they stay for is a tremendous work environment and you need to create that, and for interesting and rewarding work. At Value America in the last six months we put in SAP which is the big enterprise resource planning program and [CEBOL] which is a customer manager system in six months which is a Herculean achievement by our technology team and one guy registered 17 all nighters in the month of July and we're not paying these guys more than they could earn anywhere else at any other technology company in Charlottesville, but they had the opportunity to do something truly, in their view, monumental with all the best hardware and they had the best software and that, for them, is an example of terrifically interesting work.

Morgan: Could I get their names? There's a great article and I apologize to Fortune because I think it was in the Wall Street Journal a week or so ago in the marketing section about hiring and start-ups and the piece was mainly on, and I don't remember the name of the company, about how the CEO of the company was basically spending all of his time recruiting. On the interactive edition, and there must be archives that you can go search, but it was about a week ago and I think it was on page B-1.

Duffus: We have time for one more question at the McIntire School.

McIntire School audience question: Thank you for speaking today. My question is we hear a lot about the successes of the Internet business. I'd like to hear from the venture capitalists on the panel, could you speak a little bit about the failures that you've invested in and the core reasons for their failures, internal reasons. Thank you.

______________: How long do you have?

Audience: As long it takes.

Morgan: Let me try to answer the question like this. What are the leading causes of death for start-ups? I would say that the leading cause of death today is the inability of companies to manage growth and it is a sort of a bargain with the devil that a couple of my co-panelists have mentioned here because you can't afford not to grow at hyper speed but you also can't afford not to manage your growth, and most of the car crashes that you see in Internet start-up world are that somebody forgot because they were up all night 17 nights in row in July to tighten the lug nuts on the wheels, and so when the car started and got back up to 100 miles all four wheels came off and the car spins out of control. It is a long discussion but I would say the inability-- I mean, when God created the Internet, unfortunately she didn't create a thousand times more experienced senior management teams who could manage hyper growth and having witnessed people do it well and people do it poorly, it's one of the harder things to do in the world.

Batten: I'd cite one example of a company where we poured $20 million down a hole and nothing to show for it, and it was really-- I just made a bad judgment about the abilities of the manager, of the president, of that company. He had, it turned out poor business judgement. He sort of liked every opportunity he saw and had very little focus. Just could not focus on doing one thing well, and so that sort of certainly made an impression on me that. Since I lost $20 million on him, I've seen lots of people like him and I haven't lost any money on them, so I haven't given them any.

Duffus: Before we close today, I'd like to do a few things. First, I'd like to thank all of our sponsors at the e-Summit--Fortune Magazine and PricewaterhouseCoopers as well as every one else that was very instrumental in making this happen. I would like everybody to lead in a round of applause and then finally, I think that we should give our panelists a warm round of applause as well for their generously donating their time to us today to inform us on the opportunities that lay ahead.

Then, as a small token of Darden's appreciation for your time, I think Thomas Jefferson may have written with these things. These are official Thomas Jefferson pen and inkwell sets with goosefeather pens--kind of ironic for all you folks in the digital age , and then, finally, I guess, please everyone attend the cyber cafe upstairs where you'll be able to talk to a number of distinguished guests from the Darden School that will be available to talk as well as some of our panelists, and then thank you very much for coming out today and I hope this is only the beginning.