It’s an astounding reality. Exodus went from the success story of the second half of the 1990s into bankruptcy in a year. How could things have possibly turned so sour?

Hint: The answer isn’t the economic downturn.

“Exodus, to put it in a very blunt way, is a very unfortunate story,” Jagadeesh begins. “Exodus’ failure is not because of lack of customers, or market trend, it is because of lack of financial management. That’s the saddest part.”

The company benefited as much from the superiority of its services as it did from good market timing, and it had a genuine competitive edge. Marquee customers (American Airlines, Merrill Lynch etc.) repeatedly signed on. All of the elements pointed to success.

The Mistakes

The basic problem that the company was up against is a familiar one. Cisco experienced it, as did many others. As Internet growth exploded in the late 1990s the demand was so huge that companies were suddenly forced to build aggressively.

When the market turned in 2000, all of that aggressive growth was thrown back in their faces. For Cisco it took the form of a $2.9 billion write-off, mostly for excess inventory. For Exodus it meant $3.5 billion in debt incurred building new infrastructure. The difference is that a company like Cisco, with billions in cash, could take the hit and endure without incident. Exodus couldn’t stomach the interest on the debt and Wall Street’s sudden demand for profitability.

Welcome to Chapter 11.

Jagadeesh views the $250 million in cash Exodus sunk into Mirror Image as a “very risky proposition” and the first major mistake the new management made. But the real killer, in his eyes, was buying Global Crossing subsidiary GlobalCenter.

“From a strategic point of view the GlobalCenter acquisition was the right one, but the valuation was unbelievable,” says Jagadeesh. Then, from the time the deal was announced to the time the deal was closed this year there was already a downturn in the market. Jagadeesh suggests, “perhaps Exodus could have backed out of the deal.”

With the acquisition, 25 percent of Exodus was diluted, and the company inherited a lot of dot-com customers. According to Jagadeesh, top GlobalCenter employees had already left, and Exodus inherited a lot of people that they eventually had to lay off. There was severance to give out and the dot-com customers folded. The financial impact was huge. Jagadeesh hints that management should have seen it coming. Had the company backed out, it might have been able to get back on track for profitability (which according to the initial plan was slated for the first quarter of 2001), at which point the debt would have become a non-issue.

But perhaps the most obvious error was the incursion of the debt itself, especially at a time when Exodus was riding so high on Wall Street. Jagadeesh quickly does some math in his head and submits the following fact: Exodus stock was offered at an IPO price of $15, but after a series of stock splits was worth $1,280. Instead of going into debt the company could have made a lucrative secondary offering. Jagadeesh suggests, “Somewhere along the line instead of borrowing the money as debt they could have basically gotten the money for free by diluting, which would have been very cheap.” Exodus didn’t do a secondary offering until the stock had fallen back to $18.

Handing Over the Keys

Jagadeesh suggests, “When you’re steering that boat, you have to make some calls. You have to look at the market trends, you have to look at the demand you have, how you’re going to expand and based on that you have to make some decisions.”

Though he is careful to qualify his criticism by pointing out that hindsight is 20/20, he obviously feels that Exodus management didn’t make the right calls. He advises other entrepreneurs, “If there is a way to continue to be on the board if you still hold a chunk of the company in terms of the equity, if you can continue to be an influential voice on the board, then you can bring the founders’ perspective back and keep the management team in check to an extent.”

A New Reality

Exodus is really one of the few large-scale angel funding successes. Will its bankruptcy cause people to question that entrepreneurial model?

Jagadeesh answers, “the overall strategy of angel investment and entrepreneurship shouldn’t change. The whole process has been proven to be successful. This is not a company where the angel investors or the entrepreneurs failed to execute the original vision. From that angle, I still consider this to be a success.”

But he adds, “Most of the time an angel investor puts money into a company, an entrepreneur builds the company, and it gets sold. Then it becomes somebody else’s headache. There are very few companies that have gone all the way from angel investment to a successful public company and market leader.”

The late 1990s was a time of frenzy but, under the surface, also one of undeniable greed. Building a company for the long haul was not the most attractive proposition for many entrepreneurs, investors and even executives. The concept of “serial entrepreneurship,” highly praised by many in the industry, had entrepreneurs building companies in a matter of months and then handing off control just in time to get rich on a liquidity event. Given the furious pace of entrepreneurship at the time, many angel investors and VCs were on so many boards that they couldn’t offer sound advice.

That was fine when Cisco, Broadcom and others were announcing acquisitions every week, but in a down market, the fundamental thinking of that entrepreneurial model has been called into question. As Jagadeesh explains, things at Exodus might have been better if he or co-founder K.B. Chandrasekhar could have maintained an active role. Instead they were relegated to a “founder” role as others stepped in to capitalize on their success.

Jagadeesh points out that during its financial blunders, Exodus management had marquee advisors like Goldman Sachs. For Goldman Sachs, Exodus was a dream client, but the mentality of the day was to chase quicker payoffs. The important risk management that would be Exodus’ downfall was clearly not implemented.

Ironically, the reckless strategy paid off financially for those who implemented it, including Goldman Sachs, and executives (CEO Ellen Hancock recently resigned, but she cashed out handsomely over her tenure).

Those who ultimately lost out were common shareholders, advised to invest in Exodus because the company was a clear market leader. Exodus now trades off the Nasdaq as a penny stock.

Jagadeesh views this as an entrepreneurial learning experience. He reflects, “I see this as a positive thing, although from a financial standpoint it was a major blow to most of the people who did not cash out. A lot of people didn’t cash out at the right time.”

Despite its mistakes, the company is still a market leader with over 4,000 customers and the potential to rise from the ashes. In this new environment things will have to be run very differently. Jagadeesh tentatively predicts that Exodus will rise again.