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The New, New, New Thing: Business Models and Employee Ownership After the Dot-Com Crash

Martin Staubus

February 2001

Throughout the late 1990s, I lived in Palo Alto, California, "ground zero" of Silicon Valley. Despite the location, I didn't work in the technology field during that time (I practiced law as an employee ownership attorney and did a stint as VP of Human Resources for a food service company). Living in Palo Alto, however, you can't spill a cup of coffee without staining the Hush Puppies of a techie. Indeed, I sometimes thought I was just about the only person between San Francisco and San Jose who didn't have a double-E degree from MIT.

I met a lot of people at that time who worked in the technology field. And I had some interesting conversations with them. One theme that came up from time to time was a frustration, or disappointment, with the dominant style of operating a business in Silicon Valley -- especially at the technology start-ups that populated the area.

The dominant business model for start-ups was to maintain a high-pressure pace of very long work hours, pushing as hard as possible to hit it big and hit it quick, with the possible payoff being a very large amount of money and, for the top leadership, a great sense of accomplishment (or big ego boost, depending on how you choose to put it). It became the accepted standard that a good start-up should be doing an IPO -- or receiving an acquisition offer from Cisco or Microsoft -- within three years of its founding, five years tops.

To be sure, lots of people thought this environment was exciting and liked being involved in it. People are different and one size doesn't fit all. But others I spoke with felt differently about it. Their take on it was that they liked being involved in the technology field -- it was fascinating to be involved in pushing the envelope, developing things that had never been done. But they didn't like that dominant model of doing business that wears them down, burns them out, and usually ends up being temporary. They wished there was an alternative. The technology whiz-kids who were recent college graduates in the 1980s were getting married and having children in the 1990s, and the idea of keeping a sleeping bag in their work area for all-nighters just didn't hold much appeal any more.

What my Palo Alto friends told me was this: "I want to be part of a start-up that is made up of good colleagues that I enjoy working with and that offers some sense of stability and control for those of us in the company. I'd like to be financially successful as much as the next person, but I'd be happy to give up the 'lottery ticket' shot at the super-bucks to be part of a business that isn't trying to dramatically transform itself, that will provide an opportunity to do interesting work without giving up the rest of life."

In 1994, a guy named Jim Collins, who was then a professor at Stanford, wrote a book called Built to Last. Jim researched and then described the key principals that America's classically successful business-builders -- like Bill Hewlett and David Packard -- had followed to create real economic powerhouses that produced great value over an extended period. The book quickly drew a large following, at least for about a year.

Then, in 1995, Netscape went public, doubled its share price within 24 hours, and a new business model was on the scene. "Built to last" was out, and "built to flip" was now the business model that everyone was following. The focus of the "built to flip" model was on generating rapid escalation of the share price through the appearance of big and bold prospects. Start-up founders sought to flip their stock to IPO underwriters, who would flip the stock to individual buyers on the market, with everyone motivated by the desire for quick, and very large, financial gain. The perception among those in -- or interested in -- the commercial technology field was that, if you pursued it flat out, giving it everything you had, you would have a good shot a getting incredibly rich, incredibly quickly.

This "built to flip" model was fueled by an unprecedented increase in the availability of venture capital. While venture capital funding had been running at about $6 billion per year before the Netscape IPO, it rapidly took off thereafter, nearly tripling from 1995 to 1998. Additional money was poured on the pile of funding by angel investors trying to get in on the next big flip.

Many who were young and intoxicated by the heady fumes of this go-go period claimed that this was going to be the way of doing business in the new era and the new economy. And with the evidence that was emerging daily, it was hard to argue a different point of view, although many certainly harbored questions and doubts about the sustainability of the model.

In the wake of the big drop in the tech stock market in 2000, however, many who dived into high-tech entrepreneurship in pursuit of the big hit are stunned and floundering. Some are still clinging to their original plan, trying to ply the built-to-flip model and waiting impatiently for the stock market to bounce back. There are people who moved to Silicon Valley in the last few years from Pennsylvania or Iowa or Connecticut or wherever, just to get a piece of that action, and it can't be easy to give up those dreams.

In truth, the evidence suggests that the built-to-flip model as the standard operating platform for high tech start-ups is already history. In the sport of bicycle racing, the riders spend much of the race riding in a single big mass of riders known as the Peleton. Eventually, one or a few riders will launch a surprise "breakaway," going out a good way ahead of the Peleton into the lead. Over the remainder of the race, the Peleton (which benefits from reduced wind resistance by riding as a group) gradually reels in the breakaway riders -- usually overtaking them before the finish line.

While the realization that the days of "built to flip" may be over has arrived suddenly, the ascendancy of that model was actually being eroded by forces that were building up even as the model was being hailed as the way of the new economy. The "Peleton" of the old economy was reeling in the breakaway industry.

The resistance of my Palo Alto friends, who found that the built-to-flip model wasn't producing the kind of life they really wanted, was by itself grounds for at least a few to look at alternative ways to organize work in the technology field. And even where start-up founders still wanted to push pedal-to-the-metal for big riches, they found themselves struggling in the recruiting wars for the scarce and essential technical talent they needed. With virtually every company in Silicon Valley offering generous stock option packages, a shot at some big bucks was a standard benefit. And while an entrepreneur who was hot on the built-to-flip track might still be able to lure talent by selling recruits on the chance to hit it big financially, these start-ups were having an increasingly hard time retaining the people who initially joined them. Other companies were beginning to realize that they would enjoy more success in holding on to their people (without whom they couldn't achieve anything) by providing something more than a lottery ticket. Companies that offered a life with some balance between the pursuit of wealth and the pursuit of other interests -- a life that was satisfying even if the pot of gold didn't materialize -- were holding onto the people they needed to build a successful enterprise.

To this point, however, those pursuing an alternative to the built-to-flip approach were still doing something fairly characterized as just that -- a search for an "alternative" to the dominant model, something that only a distinct minority would adopt. Then came the market drop of March 2000.

With the drop in the stock market, the development of a different business model may have moved from the sidelines to the mainstream. One obvious reason for this is the dramatic reduction in the availability of the venture capital that fueled the system. So long as the venture capitalists saw a ready and attractive exit opportunity in the form of the NASDAQ, with its seemingly insatiable appetite for IPO stock, the funding flowed and flowed. But early in 2000, the investors behind the NASDAQ collectively decided, seemingly overnight, that they weren't going to invest any more money in IPOs of start-ups without a proven profit record. Without that market as an exit, the venture capital funds quickly turned off the supply of capital. As of this writing, recently published figures indicate that venture capital funding has fallen by a third since the market drop. But that figure understates the reality, because venture capital funds are continuing to provide additional rounds of financial support to the start-ups that they have already put money into, but have cut much farther back in identifying new ventures that they are prepared to bring into their portfolios.

Without the insatiable stock market, underwriters cannot flip their stock, so they will not agree to underwrite IPOs. And without demand from underwriters, entrepreneurs and their venture capitalist backers have no one to flip their stock to. How, then, is a technology start-up to do business?

As people who don't know the answers are wont to say, "only time will tell." But I can offer at least a few hints. One thing I'm pretty confident about is that there is more than one alternative model. The goal for some people, harking back to the people I knew in Palo Alto, is to be a part of a small enterprise that wants to stay small, or at least grow in a very controlled way. These people prize the collegiality of working in a company in which everyone knows the others personally and benefits from the sustaining ties of close human connection. They want a sense of control over their future that comes with having a say in the path taken by the organization -- and they want to keep the enterprise relatively small to assure these benefits. Others aspire to build a great enterprise that will in time be a meaningful player on the public scene. They believe that venture capital can play a key contributing role in pursuit of those goals and they are prepared to tap into it in appropriate ways.

I also think employee ownership will emerge as an important factor as we go forward into this new world of the technology business, perhaps in some surprising ways. One thing we can say emphatically is that employee stock ownership -- primarily through stock option plans -- played a major role in the "built to flip" approach to enterprise. It was the critical mechanism by which company founders delivered their promise to their employees of a shot at real wealth.

Stock ownership has always been defined as a set of rights featuring two core elements. One, certainly, is a claim on the income of the company. If you own stock in a company that is projected to make a lot of income, you own something with a lot of financial value. But there has always been a second element to stock ownership, which consists of a role in the control of the company and a particular status in the enterprise, almost like a kind of citizenship. Traditionally, those two elements received more or less equal attention. But in the go-go days of the technology boom, the financial element of ownership was so large that it completely overwhelmed and submerged the other element. The understood stance of employee shareholders was, "I'll get in for a while, hopefully hit it big with the stock options, and cash out when the time is right."

In the post-"flip" world, the wealth won't come quite so suddenly. It will have to be built over a more extended period of time, as businesses have always done. And with the subsiding of the big wealth aspect of stock ownership, the other part of ownership will resurface and become significant once again. It will begin to matter more than it used to what kind of organizational culture you have, what kind of roles and status employees are assigned. An employee's status as a shareholder will matter in more ways than simply as an incentive in the form of a shot at a large pot of money.

While there will be multiple operating models for technology start-ups, I think a common thread will run through them that involves operating in a way that works successfully for the people in the company -- financially, as always, but in other ways, too. Whether a group's aspiration is to remain a small entity with a family atmosphere or whether they aspire to produce a great organization that will be a major economic and social contributor along the lines of Jim Collins' "Built to Last" concept, they will share a recognition that the pursuit of those goals should provide satisfying lives along the way for the people who populate the enterprise. The journey, as they say, may be more important than arriving at the destination.

Martin Staubus (mstaubus@fed.org) is a senior consultant at the Foundation for Enterprise Development. He has 20 years of experience in employee ownership, human resources, law, and organizational development. Trained as an attorney, Mr. Staubus has experience as a practicing lawyer, consultant, and corporate vice president of human resources. His work includes service as an employee ownership attorney, policy advisor and speechwriter for Labor Secretary Robert Reich, legal advisor to the California State Labor Relations Board, and deputy director of the ESOP Association. He is a member of the NCEO's Board of Directors.

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