Heartily agree. So much communication occurs with body-language and facial expression. Even video conferencing doesn't cut it (and it's generally such a PITA that people fall back on IM/Skype anyways).

Regarding the office space, I agree here too. My 1st business we ended up moving office spaces and had an absolute BLAST decking out the new space. It felt like our geeky clubhouse and we'd often hang out in the evenings playing games or just chatting.

All that being said-- different things work for different folks. 37s is a fine example of a distributed company that seems to work just fine.