What it means
In the late 1990s, the internet was new and exciting. Companies selling goods online, building websites or providing internet services attracted huge investor attention.
Many had little revenue and no profit, but investors believed that the web would change everything and that early leaders would become enormously valuable. Share prices of technology companies, particularly those listed on technology-heavy markets, rose sharply.
New companies went public quickly, often after only a few years in business. Some used measures such as website visitors or clicks rather than profit to argue that they were worth large sums.
Around 2000, sentiment changed. Investors began to ask when these companies would make money, funding became harder to find, and share prices fell steeply.
Many firms ran out of cash and closed, while a smaller number survived and went on to become major businesses. The episode left lasting lessons.
A new technology can be real and important while individual companies are still overvalued. Valuation should be anchored to cash flow, profit or a credible route to both, not only to excitement about growth.
The term is still used in everyday business language. A company can be described as a dot-com to mean an internet-based business, and people sometimes warn that a new craze looks like a dot-com bubble.
Investors, founders and finance teams often compare new booms with that period to test whether valuations make sense. For finance professionals, the period also changed practice.
Rules on accounting disclosure, analyst independence and the quality of information given to investors tightened afterwards. Lenders and investors now ask more detailed questions about unit economics, which means the profit or loss on each customer or order, before they commit capital.
In practice
Real-world examples.
Example
A founder in 1999 launches an online pet-supply store and raises $20,000,000 by listing on the stock market. Sales are low and costs are high, but investors reward her with a high valuation because she is promising to capture the whole market. Many investors follow her lead without checking whether the business can ever make a profit.
Example
An investment analyst compares today's technology start-up with a dot-com business of the late 1990s. She notes that the new company has real customers and a path to profit, so the comparison is only partly fair. She concludes that the lessons about valuation and cash burn still apply.
Example
A bank lending officer reviews a loan request from an online retailer. Remembering the dot-com crash, she asks for monthly cash flow forecasts and detail on customer acquisition costs before agreeing terms. Her careful questions help the company improve its plans, and the loan is approved on stricter terms.
Case study
Seen in the real world.
Webnest Online is a fictional internet retailer founded during the dot-com boom. It raised a large sum from investors and spent heavily on advertising and a lavish office.
In this illustrative case, sales grew quickly, but each order lost money after delivery and marketing costs. When investor enthusiasm cooled, the company could not raise more funds and was forced to close.
A rival, Greenlane Digital, spent more carefully, tracked profit per customer and focused on repeat orders. It grew more slowly but was still trading when the crash ended, and it later became profitable. The illustrative lesson is that growth without a path to profit is fragile. The founders of Greenlane said later that being forced to count every dollar in the early years was what saved the business.
Watch out
Common mistakes.
- Believing the whole internet industry failed. Many companies collapsed, but the technology and many surviving firms went on to thrive. Many surviving companies from the period are now household names.
- Using the term only for failures. Dot-com simply describes an internet-based business, though it is often linked to the bubble. Not every internet-based company was a failure, and the label does not itself imply poor performance.
- Assuming a high valuation proves a company is valuable. Prices can run far ahead of profit and cash flow in a speculative period. Always test valuation against earnings, cash flow and realistic growth.
Questions
People also ask.
What was the dot-com bubble?
It was a period of rapid growth and then a sharp fall in the share prices of internet-related companies around the end of the 1990s and the start of the 2000s. The bust that followed in the early 2000s wiped out many companies and a great deal of investor wealth.
Why did it matter for finance?
It showed the danger of valuing companies on excitement and growth alone, and it led to tighter disclosure and scrutiny. It also led to improved standards for analyst research and company reporting.
Is the term still used?
Yes, both as a description of internet businesses and as a warning when comparing new booms with the past. Analysts and investors often compare new booms with it to test whether prices make sense.
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