The Fall of a Dot-Com
Blinded by Net fever, big-name investors poured millions into Craig Winn's chaotic Value America

On a balmy day last April, Craig A. Winn, a onetime housewares salesman, momentarily became a dot-com billionaire. As the stock in his e-tailing startup, Value America Inc. (VUSA), ascended from its initial public offering price of $23 a share to a giddy high of $74.25 on Apr. 8, 1999, it became clear that the charismatic entrepreneur had tapped into the mind-set of the New Economy. Investors flocked to his idea of a ''Wal-Mart of the Internet'' where shoppers could order jars of caviar along with their gas barbecues or desktop computers. And why not? Winn had already signed up some big-time investors, including Microsoft co-founder Paul Allen, financier Sam Belzberg, and FedEx Chairman Fred Smith, whose names added cachet to the venture.

When the stock settled down that day at $55 a share, the three-year-old, profitless company was valued at $2.4 billion. Yet the 45-year-old Winn maintains that he was overcome with melancholy as he watched shares trade that first day. ''I felt fear and anguish,'' he said recently. ''I believe the company was genuinely worth the IPO value. When the stock shot up to three times the IPO price, I recognized that this was not reasonable. You are never closer to your greatest failure than when you are at the moment of your greatest success. I was very humbled by it.''

Winn's unease was prescient. In the 12 months since the IPO, Value America has gone from euphoria-inducing heights to a struggle for survival. In late March, auditors expressed doubt that the company could survive as a going concern. Nearly half of Value America's 600 employees have been fired. With the stock now trading at $2 a share, investors have lost millions. The obligatory shareholder class action has been filed. And Winn, founding CEO and entrepreneur extraordinaire, has been ousted by an all-star board that includes Fred Smith, former Newell Rubbermaid CEO Wolfgang Schmitt, and celebrated headhunter Gerard R. Roche. ''A year ago,'' bemoans one insider, ''we were infallible. Now, it's a complete crash and burn.''

''NOT OVER YET.'' The company says it is in ''advanced discussions'' with potential investors and expects to gain sorely needed cash within a few months. ''Rumors of its demise might be a little premature,'' says William D. Savoy, a Value America director who manages Paul Allen's personal finances. ''It's not over yet.''

Value America's rise and fall is emblematic of an era of unbridled optimism and outright greed. Possibly only during a period of unprecedented valuations and a seeming suspension of the rules of finance could someone of Winn's background amass the following and the finances to get a company off the ground as quickly as Value America took flight. For most of his stint at the company, Winn, who collected a salary of $295,000 a year, had little of his own money at risk. His business experience consisted mainly of leading another public company into bankruptcy. His technology experience: nil. Winn and his company practiced New Economy values with a vengeance. A massive ad budget was spent well in advance of any profits. Yawning losses were excused as a necessary evil in the pursuit of market share. There was a rush to take an untried company public at the height of the investor frenzy for new dot-com stocks.

But the Value America saga goes beyond the excesses of the Internet era. Serious questions are also being raised about alleged gross mismanagement, abuse of corporate funds, and the sometimes erratic and bizarre behavior of Winn, who asked that the money-losing company finance his personal jet and who dreamed out loud of running for President. ''There have been a fair amount of decisions and expenditure of funds that were questionable,'' says director Schmitt. (Winn counters that the plane was needed because of the company's location in Charlottesville and that the board approved of it.) ''Everyone figured he was more a genius than crazy,'' says a former senior executive at Value America. ''As time went on, everybody got more concerned.''

One thing Craig Winn, a salesman at heart, could do is spin a good tale. His story of a ''frictionless'' business model was perfectly attuned to the times. Winn's cyberstore was supposed to harness every efficiency promised by the Web to create a new paradigm in retailing. His breakthrough idea? The store would carry no inventory and ship no products. Instead, it would pick up orders from consumers and immediately transmit them to manufacturers who would ship IBM computers and Knorr soups, Panasonic televisions and Vicks Vapo Rub, direct to customers. It featured more than 1,000 brand names, many in multimedia presentations online.

The story was mesmerizing, the execution somewhat less so. Insiders say Winn tried to do too much, too soon. Computers crashed. Customers waited and waited to get orders filled. Discounting and advertising drained cash and wiped out any chance of profitability. Returned merchandise piled up in the halls of the company's offices. ''They got going too fast,'' says Smith. ''They got unfocused.'' Winn disagrees. ''In the Internet world, no one is willing to invest in a company that grows slowly,'' he argues. ''Go find an Internet company that said it was going to be methodical.'' In retrospect, the story's most surprising aspect is how long the public--and the board members--continued to believe in Winn.

POLISHED PITCH. For the boyish-looking entrepreneur, with his sandy hair and perpetual smile, the world of the Net seemed a natural fit. He was always a man, say friends and colleagues, who looked to the future, and he certainly had a way with words. Associates say that Winn would drive to work with the radio off, practicing the slogans that would give his sales pitches a New Economy resonance, even if the precise meaning was unclear. He grandly called his e-tailing venture ''the marketplace of the millennium.'' He described his concept as ''alliances of consumption with alliances of production.'' Above all, he intoned, Value America permitted ''friction-free capitalism.'' A colleague said Winn called his practiced pitches ''the Art of Emphasis.''

Winn quickly embraced the worst excesses of the New Economy, particularly the notion of building a business empire where sales--not profits--came first. He spent money lavishly, running through the company's cash as if it were unlimited. In an era when not-yet-profitable dot-coms burned through giant ad budgets, Value America spent even more, second only to E*Trade Group in the size of its marketing budget in the first nine months of 1999. For the year, its ad spending hit $69.6 million. Taking a page from the Lee Iacocca playbook, Winn filmed a series of commercials last June starring himself--at a time when Value America could hardly afford the cost of TV airtime. Winn says the idea to do the spots came from outside public-relations experts.

Other expenditures were even harder to understand. Winn agreed to purchase a 34.4-acre expanse of land for $5 million where he planned to build a multimillion dollar headquarters. The property was later appraised at less than $2 million. It cost the company $400,000 to get out of the contract. Winn disputes that valuation and says the building was needed. After a newly recruited CEO discouraged Winn's purchase of a corporate plane, Winn and co-founder Rex Scatena spent $650,000 for a down-payment on a Hawker 800 anyway. With board approval, they began expensing their trips to the company and put two pilots on the payroll at a cost of $250,000 a year. In 1999 alone, the cost of the plane to Value America was $800,000. Winn now claims the company still owes him and Scatena the $650,000 down-payment, which he says the board agreed to cover. Scatena could not be reached for comment.

Meanwhile, as investors anted up more cash to keep Value America going, Winn began taking money out. During one investment round, in the summer of 1998, when Microsoft founder Paul Allen put in $15 million, Winn sold some of his own holdings, pocketing some $5.7 million. Allen, who declined comment, knew of the sales at the time. ''There were extenuating circumstances,'' says Savoy, declining to go into further detail.

The splashy expenditures hid some fundamental problems with Winn's business model. In signing up as many vendors as possible, there was little regard to whether their products were suited for sale via the Web. Many manufacturers simply weren't capable of shipping a single box of Tide or a bottle of Advil. They had no experience in dealing directly with consumers. Glenda M. Dorchak, a 24-year veteran of IBM who is now CEO of Value America, says she tried ordering a pair of toothbrushes. It took weeks for the package to arrive, and when it did, it was one toothbrush short. Indeed, Winn's basic premise of eliminating the middleman never happened. Most orders were handled by the ultimate middlemen: old-fashioned distributors.

Still, at the height of the company's success last April, Winn seemed neither humbled nor melancholy. He started voicing political ambitions, even a desire to become President of the U.S. Winn told colleagues he planned to withdraw from the company in order to run for lieutenant governor of Virginia. That, he said, would give him a platform for a Presidential bid in 2008. Winn dismisses those stories and says he had given up his Presidential aspirations ''a long time ago.'' He also began cultivating relationships with politically connected conservatives, including former Education Secretary William S. Bennett, who joined his board last summer, and Reverend Jerry Falwell, who was invited to buy shares in the Value America IPO under the friends-of-the-company provision. While other dot-coms might have a ''chief evangelist,'' Winn had a ''chief of staff,'' Mick Kicklighter, a retired three-star general who traveled everywhere with his boss, taking notes.

WINNERS AND LOSERS. Although Value America is just months from running out of cash, Winn is set for life. He lives just three minutes from the company's Charlottesville headquarters on a 150-acre estate, where he has built a Greek Revival mansion modeled on George Washington's Mount Vernon. Both Winn and Scatena, who served as outside counsel to Winn's earlier bankrupt venture, have been feverishly dumping their stock since being forced out of the company in November. Winn has personally realized cash gains of about $53.7 million and still has an additional $15.5 million worth of stock. Winn's backers have not fared so well. Allen has lost roughly $50 million, according to public filings. The personal and company losses of FedEx founder Smith approach $8 million.

So where were the directors during this debacle? Many of them were still being recruited in the months following last April's IPO. Savoy and Smith came on soon after the offering, but Schmitt, Roche, and Bennett joined during the summer. When an executive-suite coup erupted in November, they had barely settled into their roles. Directors contacted by Business Week say they acted appropriately and still express confidence in the company.

Winn shows little regret about the fate of Value America or of the well-heeled backers who believed in him. He cheerfully meets with a reporter in his ''carriage house'' to recount his role in this New Economy cautionary tale. Seated in a brown leather club chair before a massive stone fireplace and a crackling early-morning fire, with his yellow lab, Crystal, at his side, he looks the picture of country aristocracy.

Life wasn't always so comfortable. Winn says that in his first year as a manufacturer's rep, in 1978, after graduating from the University of Southern California, he was painfully shy and worked 90-hour weeks to earn just $12,000 for the year. He had joined his gregarious father in a housewares venture. The younger Winn was raised on the business, which his father ran from a home office next to the kitchen, in Sierra Madre, Calif. From the age of five, Winn says, he knew he wanted to sell. He proved a quick study. Within a few years, he had bought out his father and was pulling down a six-figure salary. His success brought him a house perched on the edge of the Pacific Ocean, a sailboat, and a big bank account.

It also brought him greater ambition. In 1986, Winn founded Dynasty Classics Corp., a maker of lighting products. Four years later, with annual sales of nearly $100 million, he brought the company public. Within eight months, however, after revealing a fourth-quarter loss, the stock fell from a high of $18.50, to under $4. In October, 1993, Dynasty filed for Chapter 11 bankruptcy. Russell Schreck, a turnaround consultant who became president of Dynasty after the filing, blamed the problems on ''a lack of structure and discipline. You had an entrepreneur who grew the company very quickly, but he hit a brick wall. There was a lack of accounting.''

UNTRIED PRODUCT. Winn has a different view. He says the company was forced to file for bankruptcy only after Wal-Mart Stores Inc. (WMT) reneged on a deal to help fund the production of $25 million worth of lamps and other products. Wal-Mart says it doesn't comment on vendor relations. ''I was not without blame,'' recalls Winn, who grows misty-eyed as he tells the story. ''I was at the helm of the company and there were any one of a hundred things that I could have done better.'' Remarkably, though, given Dynasty's fate, Winn feels he was underappreciated. ''When things go south, there is an element in society today that is very vile. You get to see the underbelly of people.'' Winn says he met the payroll out of his own pocket for a time, but never received any thanks.

Over the next couple of years, as interest in the Internet began to heat up, Winn dreamed of the ultimate sales company, one that would advertise, market, and take orders but never handle the merchandise. Eventually, he cranked out a 250-page business plan for Value America, and on July 4, 1996, he and a few friends and partners moved their families to Charlottesville to launch it.

Winn and Scatena anted up about $150,000 each in the startup and began to furiously hire the talent necessary to make a go of it. A big break occurred in December, 1997, when Winn persuaded the Union Labor Life Insurance Co. in Washington, to invest $10 million in Value America. Winn quickly paid himself $150,000 from the proceeds, saying that his initial cash outlay had been a loan. Six months later, an even bigger break occurred. Through the insurer's contacts, Winn gained a meeting with Paul Allen and William Savoy in Seattle and persuaded Allen to put $15 million into the company, giving Winn's fledgling business a $300 million valuation--and instant credibility.

The IPO of last April took place well before Value America had begun to prove its mettle. But Winn had tried to take it public even earlier. In September, 1998, only three months after Allen's investment, Winn tried to cash in on the connection with a $75 million offering. But the IPO market had temporarily dried up. When his bankers told him he'd have to accept a lower price for the stock, Winn cancelled the offering.

It was a crushing blow, but Winn says he gained encouragement from Intel Corp. (INTC) founder Andrew S. Grove, whom he had met through a mutual friend. At a dinner shortly after the failure, Winn says that he told Grove of his troubles. ''He put his arm around me and said 'I believe in you. You're going to do well, and you're going to live to see far brighter days.''' Grove says he was supportive but doesn't recall the details of the dinner.

Few outside the company knew how badly things were going. Value America was struggling to meet its growing payroll. It began delaying its payments to manufacturers. ''We played vendor bingo,'' says one former executive. ''Whenever they complained, we paid.'' Dorchak confirms that, strapped for cash, the company was forced to delay payments. Winn and Scatena loaned the company $550,000 in late September, 1998. Then Winn led what insiders termed a ''pass the hat'' round that raised $7 million more. Winn didn't invest more money himself because, he says, SEC rules prevented him from doing so. Winn says that what he did was far more selfless. ''We got no stock or anything for our loan,'' he says. ''That was genuine charity there.'' Both he and Scatena took repayment of their loans before the end of the year.

Despite the scare, Winn and Value America won lots of publicity, partly a payoff from the millions spent on ads in The New York Times and other newspapers. In February, 1999, CEO magazine dubbed him ''the prince of e-commerce,'' just months after his company nearly went belly-up. ''Princes rise and fall,'' says J.P. Donlon, editor in chief. ''If this was bullshit, I thought, it was platinum.'' The buzz attracted more money and big names.

Fred Smith was one. Smith had often expressed skepticism about e-commerce, but he believed that Winn had the ideal business model. ''I thought this was one of the best things I've seen,'' recalls Smith. In January, 1999, Smith committed $5 million of his own money and $5 million of FedEx's money to the venture. Allen, meantime, put in $50 million more.

As the new money and the support of other big backers, like Gary Winnick of Global Crossing Ltd. (GBLX) and financier Sam Belzberg, rolled in, Value America began to operate less like a business and more like a cult. ''When you're around him, you get caught in the swirl,'' says one former manager. ''It's like drinking Kool-Aid.'' Winn would gather his employees and speak for a full hour at a time, promising that everyone standing before him would someday be a millionaire. At one session, recalls employees, he stood on top of railroad ties on a chilly May morning in the parking lot and spoke for an hour about his life and career. ''As he talked, the sun rose higher in the sky and the air became warm and comfortable,'' remembers Tom Matthew, who wrote product descriptions for the company's Web site. ''I wondered if Craig had planned it that way.''

It was an exciting place to work, even if the hours were horrendous and the inconveniences many. ''People were stacked on people,'' recalled Melissa M. Monk, vice-president for sales. ''It looked like an anthill.'' Sales soared from $134,000 in 1997, and to $42.3 million in 1998. But the losses rose just as fast. After losing $425,000 in its startup year of 1996, the company lost $2 million in 1997, $64.8 million in 1998. Few investors worried about the red ink: Net companies were supposed to lose money to gain scale and clout in a frenzied marketplace.

''A HIGH.'' Winn decided he needed help in managing the torrid growth. Before going public on Apr. 8 last year, he recruited the head of U.S. Office Products Co., Thomas Morgan, to become chief executive. Morgan, 46, a mild-mannered man, had met Winn on a golf course and was hoping to sell him his line of office products. Instead, Winn persuaded him to leave his job as CEO of a $4 billion company and take a flyer with a Net startup. Winn remained chairman, but Morgan was supposed to be the professional manager who would run Value America's day-to-day operations.

The IPO was a huge success, creating dozens of paper multimillionaires, including Morgan. ''It was phenomenal,'' he remembers. ''It was a high for everyone in the organization.'' That evening, Winn celebrated by arriving in a limo with his wife, Katherine, for a celebratory dinner at the local country club.

The celebration proved short-lived. Winn, say insiders, had trouble giving up control to his new CEO. Although Winn denies it, several present and former executives say he frequently undermined Morgan and continued to micromanage nearly everything. ''There was never a major decision he was not involved with,'' says Morgan. ''Craig would just do what he wanted to do and informed me after the fact.'' Winn disputes this, maintaining that he largely focused on developing outside alliances. Winn promised to give more authority to Morgan over the next three months, but the shift never materialized.

Meantime, in its zeal to meet the unrealistic expectations of Wall Street, the company was making ever more desperate and wasteful marketing deals. The company paid Yahoo! Inc. (YHOO) $4.5 million for a year's worth of Web site ads that several insiders say brought in less than $100,000 of revenue. The company spent $1 million for a booth at Comdex, the computer show, hoping to sign up 100,000 potential Value America customers. Instead, the event brought in only 16,000. Winn argues that most of the decisions were made by Morgan and Dorchak, who as president was responsible for marketing and sales. He said he was against another deal to pay $750,000 to sponsor Dennis Conner's America's Cup yacht. ''We kept spending money like it was going out of style,'' says one former top executive.

Investments in more fundamental areas were more scarce. ''The Web site was perpetually slow, outdated, and uncommonly difficult to navigate,'' recalls ex-employee Matthew. Instead of fixing the problem, Matthew said, the company focused on meeting its financial numbers. ''We needed to do X amount of business this quarter and add X number of products to the site so the stock price would stay high and we would all be millionaires. Who cared that the store ran like molasses or that order tracking was virtually unmanageable.'' Through the end of last year, Value America still got over half its revenues from customers dialing in by phone. Winn maintains that the computer systems worked well and that appropriate investments were made in them. Adds CEO Dorchak: ''It's like icing a cake that hasn't been baked. We had someone here who was just icing an unbaked cake.''

To drive revenue and keep the stock inflated, the company introduced ValueDollars, which consumers could use for 50% off the cost of purchases. The discounts virtually assured that the company would lose money on every sale it made. By last summer, Value America was handing out 1,000 ValueDollars with the purchase of a $1,000 color TV. ''It was uncontrollable,'' says Nick Hoffer, senior vice-president for marketing. ''It was crazy.''

Inside the company, chaos was rampant. Winn, insiders say, ran the place on daily whims. He spent $1.8 million on a Christmas catalog that didn't get into the mail until late November. ''That was one of the projects of the day,'' says Hoffer. Winn says the delay resulted because the marketing department failed to follow his May directive to work on the catalog, which he says, was largely paid for by the brands. Toward the Christmas holiday season, the company advertised a Sega Genesis game at $199. At that price, with ValueDollars added, every sale was below cost. Even more troublesome, Value America secured only 1,200 units. Orders the first day reached 1,500 units and eventually topped out at 6,000. To meet demand, the company sent employees to Toys 'R' Us (TOY) and other stores to buy the product off the shelf. ''We fulfilled every order, at a huge cost,'' recalls Dorchak.

SOAP OPERA. Although Winn spoke grandly of his inventoryless model, in the third quarter of 1999 alone Value America recorded an inventory writedown of $350,000. How was that possible? To secure the supply of some goods, Winn had to agree to purchase such products as Compaq and Toshiba computers that later were sold below cost, resulting in a writedown. Meanwhile, many orders, insiders say, were transmitted to vendors by fax or e-mail, a far cry from the instantaneous computer-to-computer model Value America had promised.

Meanwhile, Morgan was growing ever more frustrated waiting for Winn to resign as promised. Winn still occupied his corner office, triple the size of Morgan's. On Nov. 1, Morgan walked into Winn's office and resigned, but the entrepreneur persuaded him to stay by promising to come up with a plan to leave. Just 10 days later, after a four-hour meeting in which Morgan aired a list of grievances, the founder finally agreed to give up the chairman's job immediately. At least that's how Morgan remembers it. Winn says he only agreed to think about the issues. That Sunday, Nov. 14, Winn asked a colleague at Value America to go to his log cabin on his estate and get a two-page, handwritten document he had drafted. The memo, left on a table in the cabin, stated that Winn was stepping back into the CEO's job.

When Morgan saw the document that night, he was dumbfounded. He confronted Winn the next morning, then contacted a director before taking a holiday to give the board time to act. Finally, Smith, Roche, and other directors began interviewing senior managers in the company. On Nov. 23, the Tuesday before Thanksgiving, the board voted to fire Winn. Schmitt was named chairman, while Dorchak, 45, was named CEO when Morgan quit for good.

Dorchak now finds herself trying to pick up the pieces. The promotions helped to increase revenues last year fourfold, to $182.6 million. But losses of $175.5 million nearly equaled its sales and have led to a liquidity crisis. The market capitalization of the company is now less than $100 million--below its valuation during the first round of venture financing, in 1997. Meanwhile a shareholder lawsuit alleging that the company made misrepresentations to inflate the stock is pending in U.S. District Court. The company says the claims are without merit.

Since taking over in November, Dorchak has restructured to focus on electronics, technology, and home-office supplies and has laid off nearly half of the payroll. But Dorchak has her own critics who point out that the day after announcing the layoffs, she chartered a private plane at a cost to Value America of $25,000 to spend New Year's in Arizona. She says she did so after working 26 hours straight and missing the last flight out of Charlottesville.

Dorchak's hopes for survival hinge on her ability to sell investors a new game plan. She plans to market Value America's technology to other companies eager to sell products over the Net. ''The business model the company has today is the model it should have had all along,'' says director Savoy. ''Attempting to deal directly with consumers probably wasn't the smartest idea on their part.''

At a time when lots of Net bubbles are bursting, the humbling of Value America is a fitting postscript to an age fast fading. While such failures may be a price the market must pay to break new ground, the lesson here is simpler: In a period of near mania, almost anyone can find buyers for a house of cards if he has a good enough pitch.

Sitting in his very sturdy mansion, which he calls Windom Hall, with majestic views of the Blue Ridge Mountains, Winn wants his millions and the last word. ''Not only is the company nearly bankrupt,'' he says, ''it's current management is morally bankrupt. They have chosen to recreate history.''

Some history.

By JOHN A. BYRNE