Startup: A Silicon Valley Adventure

by S. Jerrold Kaplan

  Peter was like a walking New York Times crossword puzzle—an elaborate tessellation of obscure facts fitted together into a pleasing pattern. His pot belly and halo of gray hair made him look like a latter-day Friar Tuck. In contrast, Steve had a clinical, focused style. He dressed in various shades of plain, like a Norman Rockwell painting of a practicing engineer. His nondescript chinos precisely fitted his lean frame; all pocket flaps were neatly pressed flat and buttoned. Mitchell opened the meeting by unrolling several architect’s drawings on the conference table.

  “As you know, I’ve taken a lease on half a floor of office space in the tower next door. Here’s my thinking about how we could lay out the offices . . .”

  For anyone else, this would have been a classic “presumptive close”—proceeding as though an agreement had already been struck among the participants. In Mitchell’s case it was raw enthusiasm harnessed for a special purpose: it allowed the team to practice collaborating on a non-threatening subject. We studied the documents. To my surprise, a spirited discussion ensued.

  When Mitchell had achieved an acceptable level of give and take between the participants, he steered the discussion to the core issues: equity, financing, and the nature of the project itself. It slowly emerged that each of us had a different agenda. He was interested in building a new company that would recapture the teamwork and momentum of the old Lotus without repeating the same mistakes. Peter was interested in designing an “object-oriented” computer interface that would knit together diverse documents, spreadsheets, and databases in a coherent, organic whole. Steve wanted to build the leanest, flattest computer possible. I wanted to deliver a practical pen computer for working professionals. In each case, our goals for the project reflected our respective personalities and visions of a better world.

  The meeting stretched on until late in the afternoon, by which time Mitchell had deftly built a strong sense of unity, despite the fact that the project was still far too vague and broad to be practical. Each of us took our action items: Mitchell would line up financing, legal counsel, and facilities; I would investigate handwriting recognition; Peter would think about object-oriented interfaces; and Steve would notify his superiors at Apple that he would be leaving to join our venture.

  We finished up with an easy topic: naming the new company. We wanted something short and striking that would project a sense of mobility. Mitchell thought we should consider a two-letter word as a name, and proposed GO. I suggested ON. Peter observed that “On Technology” contained the word “ontology,” the study of being. So we went with ON.

  Forming a new company is like starting a romantic relationship. The early phase is emotionally volatile. You have to build confidence, establish a sense of fairness and balance. If one person feels he is investing more of his feelings, without reciprocation, the situation can quickly get out of hand, resulting in stormy mood swings ultimately leading to disaster. Continual contact and reassurance are essential. That’s why the three-week gap until our second meeting was a dangerous interval.

  The meeting was to last for two days, over a weekend. I was staying at Mitchell’s house, and Steve stayed at a hotel. At the outset Mitchell worked hard to recapture the enthusiasm of the earlier meeting. However, I noticed that Steve seemed distracted and less involved. That evening, after our first session, I mentioned my concern to Mitchell, who hadn’t openly acknowledged Steve’s change of mood. Mitchell restrained his natural exuberance and sat quietly for a moment.

  “What do you think is happening?” he said.

  “Maybe he’s having second thoughts. He’s being asked to give up a lot—a high salary, great benefits, a secure senior position at Apple, moving his family to Boston—”

  “Or maybe he went in to quit, told them what we were going to do, and they made him a counteroffer,” Mitchell suggested.

  I was a bit startled by his sudden paranoia, but then realized that this was distinctly possible. Steve was a free agent, and at this stage no one really owned the ideas we had been batting around. He was well within his rights to pursue the project at Apple if he could get the required internal support for it.

  The mere thought that Steve might defect caused Mitchell to feel betrayed. It undermined the sense of teamwork, of Musketeer-like commitment, that he was seeking to create. Even worse, Steve was in a position to walk off with the project and put the power and resources of Apple behind him.

  Throughout the night, Mitchell’s mood grew darker. Unable to check his suspicions out with Steve until the following morning, he became increasingly fearful of losing the fragile flame he had worked so hard to spark. By morning he was quite agitated. At his first opportunity, he confronted Steve.

  “Steve, I’m a little concerned that you may have some doubts about proceeding with the project.”

  Always honest but tempered, Steve came clean. “Well, I talked to Jean-Louis, and he escalated the matter to Sculley.” Jean-Louis Gassée, an opinionated and astute Frenchman, was president of Apple products, and he held John Sculley—the non-technical CEO who succeeded Steve Jobs—under a Svengali-like influence. Apple had a long-standing tendency to canonize its technical gurus, which was probably exacerbated by Sculley’s personal doubts about his suitability to lead a technology company.

  “I met with Sculley, and he asked me what it would take to stay and do the project at Apple,” Steve said. “I gave him a straight answer—complete freedom, protected resources, a separate staff and site. He agreed to my terms. I have to give him a final answer this week.”

  Mitchell’s worst nightmare had just come alive. But he had had an entire night to prepare an emotional defense. He spoke to the team. “You know, guys, I love this idea, but I think maybe we’re moving too fast. Maybe I’m not ready to jump back into startup-land right after Lotus. I’d like to take some time to consider what’s really going to work for me and what’s not.” Under the circumstances, this was a measured response, but I believe it was driven as much by personal disappointment as self-analysis.

  That was it. Just as easily as the idea had started, the project was dead. “Easy come, easy go,” I whispered to Peter as Mitchell and Steve attempted to make polite conversation.

  But after the meeting broke up, Mitchell took me aside. “Jerry, I’ve been thinking. Why don’t you try to do this project yourself? You’re a smart guy . . .”

  I was shocked. I thought of myself as an engineer, not a CEO. Mitchell had a reputation as a deft manager and business strategist. “But I’ve never managed squat.”

  “You think I had any more experience when I founded Lotus? Just remember, political history is written by whoever wins the war, and corporate history is written by successful entrepreneurs. All you have to do is make a pile of money and everyone will think you’re a genius.” He chuckled and shrugged. “C’mon, I’ll introduce you to some VCs.”

  2

  The Deal

  THE MODERN CORPORATION is quite possibly the highest form of human cooperation. Specialized resources in the form of labor, raw and finished materials, capital, and knowledge come together in a marvelous process that transforms these components into goods and services of greater value. This miraculous conversion is similar to the process by which dirt, water, sunlight, and a packet of information in the form of a seed are reorganized into a living plant. Like plants, corporations are born, grow, and die, reach out for resources, fend off predators, and compete with others. Businesses evolve over time, as less efficient corporations are replaced by more effective ones, whose successful practices are then emulated by others.

  It is against this backdrop that the “startup game” developed. The startup game is an elaborate contest created to accelerate the pace at which corporations evolve, played continuously by an endless parade of hopeful entrepreneurs. It is a carnival game of life, testing the strength, aim, and skill of contestants willing to expose themselves, for glory or ridicule, to public scrutiny. The challenge is to find a new or better way to do business; the r
ewards are increased wealth, enhanced personal reputation, and control over one’s own destiny. The startup game is designed to motivate our brightest, most creative, and hardest-working individuals to improve the use of society’s resources, increase employment, and provide a broader range of quality goods and services. Here’s how the game is played.

  It begins with an aspiring entrepreneur who is willing to step right up and be tested. As in many other games, the player starts with an artificial currency—in this case, the stock of the new venture. The goal is simple: increase the value of the entrepreneur’s shares, because when the game is over, these can be cashed in for real money. The trick is to swap some of the stock for three resources—ideas, money, and people—then use these resources to increase the value of the remaining stock.

  The ideas are called intellectual property, which includes the business concept itself and any unique designs, processes, or plans for how to pursue the business. The intellectual property is safeguarded by trade-secret protection programs and by patents and copyrights.

  The money comes from investors, usually a venture capital partnership. The venture capitalists, or VCs, get a special form of equity called preferred stock. This stock confers certain rights, known as preferences, such as the right to appoint someone to the board of directors.

  People are usually assembled by recruiting friends and associates and by hiring headhunters to find them. These people become the employees, who are paid with a mixture of cash and stock. The cash is enough to cover reasonable living expenses, but is often less than the employees would earn at a stable, going concern. The stock is what they are really working for. It is a part ownership in the venture, a chance to participate in the game and pay for it with their own labor—which is why it is often called sweat equity.

  The entrepreneur doesn’t raise all the required money up front because that would mean selling too much of the stock. Usually, the initial investment is just enough to reach some identifiable milestone. This milestone is chosen to demonstrate to potential future investors that the company’s prospects have improved, justifying a higher price for the stock, so that less of it has to be sold. If the money runs out before the milestone is reached, the game is over. In the meantime, other companies may try to steal the ideas, the people, and may even try to run the venture out of money.

  Venture capitalists typically look for a reasonable possibility of making five to ten times their original investment within five years. This corresponds to borrowing money at 50 percent per year or more (until recently, such an interest rate would have been considered criminally usurious). This high cost of capital makes the startup game a race against the clock.

  The final step in the game is a financing event called an initial public offering, or IPO. The IPO—when the company is first listed on a public stock exchange—usually marks the transition of the enterprise from a risky venture to a profitable company. Up until this time, it is virtually impossible to dispose of stock and get cash. Soon after the IPO, the entrepreneur is free to sell stock on the open market, as are the investors and employees. This marks the successful end of the startup game and the creation of a viable company. The entrepreneur can now cash in his stock and go home, take on the less risky job of managing a going concern, or step up and play the game again.

  Soon after the disastrous meeting in Boston, Mitchell arranged an introduction to the legendary venture capitalist John Doerr, whose firm of Kleiner Perkins Caufield & Byers had backed such prominent technology companies as Tandem, Compaq, Sun, and Lotus. John asked me to drop by his office the following Monday to chat with some of his partners. I mistook this for an informal bull session, but any experienced entrepreneur would have known better. To VCs, Monday is as sacred as Sunday is to the Vatican. This is the day when venture capital partnerships around the world have their official meetings to review potential investments. All the partners participate, come hell or high water—by video conference call from a branch office if possible, or by speaker phone from their deathbed if necessary. An invitation to address the partners at a top-tier firm like Kleiner Perkins—or KP, as it is known in the trade—is an unusual opportunity. I was unprepared.

  At the appointed hour, I showed up wearing a sport jacket with my shirt open at the collar. I carried little else but a maroon leather portfolio holding a tablet of paper and a pen which I had received as a Christmas gift. No business plan, no 35-millimeter slides, no charts, no financial projections, no prototypes.

  The Kleiner Perkins offices were on the thirty-fifth floor of a posh office tower in the heart of San Francisco’s financial district.

  The floor-to-ceiling windows framed a spectacular panoramic view of the bay on one side and the city on the other. The partners’ offices were extravagant by most standards, set apart from each other and from a large common area by smoked-glass partitions.

  The previous presenter was just finishing up. Dressed in a dark blue pinstripe suit, his red power tie thrust forward with a gold tie pin, he was nervously fielding rapid-fire questions from a brigade of partners and associates inexplicably packed into a small corner conference room. A bare prototype circuit board sat on the conference table. A crisp color graph projected on a whiteboard; the man’s perspiration gleamed in the reflected blue light.

  “Thank you, we’ll let you know our decision in about a week,” said one of the partners. The presenter collected his belongings and left quietly.

  After a short break, John Doerr reassembled the group and invited me in. He made a short introduction, covering my background and explaining Mitchell Kapor’s interest in the project, then turned the meeting over to me. I was nearing a state of panic. I paused to size things up, knowing that the brief silence before diving in would create a momentary impression of authority. In reality, I was searching for a strategy.

  I had a flash of déjà-vu. I remembered facing this same kind of “show me” crowd at my Ph.D. dissertation defense. The key to success there was in recognizing that although the examination committee had the power, I had the knowledge. The same was true here. I had done a lot more thinking about this topic than anyone else in the room, and to win their respect, I merely had to demonstrate this fact by keeping the discussion focused on the areas I had already investigated. I decided to lead with the business issues.

  “Gentlemen, you probably think that there is no longer any way to make money by starting a new personal computer company. The competition is brutal, and the barriers to entry are high. However, I’m here to suggest to you the possibility that the PC as we know and love it may not be the best and final form that computers will take. I believe that a new type of computer, more like a notebook than a typewriter, and operated by a pen rather than a keyboard, will serve the needs of professionals like ourselves when we are away from our desks. We will use them to take notes; send and receive messages through cellular telephone links; look up addresses, phone numbers, price lists, and inventories; do spreadsheet calculations; and fill out order forms. All of this can be done unobtrusively while sitting in meetings, conferring with clients, commuting to work on the train, or even when standing up and walking around. Like the fax machine, the pen computer can dramatically accelerate the pace and increase the efficiency at which business can be conducted.

  “I can’t say for sure when this will occur. But I do know that it will happen, and someone is going to make a big pile of money on it. With a little luck and some hard work, I think we could be the ones. Like the PC, I think this concept could come out of nowhere and take the industry by storm. I want to be the one to do it.”

  Having covered the business angle, and thrown in a gratuitous pledge of personal commitment, I proceeded to talk about the required technologies and the state of the art. The plain fact was that the project was technically very risky, and there was no point in hiding it. The greatest risk was whether a machine could reliably recognize handwriting and convert it into its equivalent in computer text, known by the strange acronym ASCII.
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  My audience seemed tense. I couldn’t tell whether they were annoyed by my lack of preparation or merely concentrating on what I was saying. Several people narrowed their eyes disapprovingly—or perhaps they were just deep in thought. I had been talking nonstop for about ten minutes, and figured I’d better close. Thinking I had already blown it, and therefore had little to lose, I decided to risk some theatrics.

  “If I were carrying a portable PC right now, you would sure as hell know it. You probably didn’t realize that I am holding a model of the future of computing right here in my hand.”

  I tossed my maroon leather case in the air. It sailed to the center of the table, where it landed with a loud clap.

  “Gentlemen, here is a model of the next step in the computer revolution.”

  For a moment, I thought this final act of drama might get me thrown out of the room. They were sitting in stunned silence, staring at my plain leather folder—which lay motionless on the table—as though it were suddenly going to come to life. Brook Byers, the youthful-looking but long-time partner in the firm, slowly reached out and touched the portfolio as if it were some sort of talisman. He asked the first question.

  “Just how much information could you store in something like this?”

  John Doerr answered before I could respond. “It doesn’t matter. Memory chips are getting smaller and cheaper each year, and the capacity will probably double for the same size and price annually.”

  Someone else chimed in. “But bear in mind, John, that unless you translate the handwriting into ASCII, it’s likely to take up a lot more room.” The speaker was Vinod Khosla, a young man born in India and educated at the Stanford Business School, who was the founding CEO of Sun Microsystems. He acted as a consultant, helping the partnership evaluate technology deals. His cool manner masked a fierce analytical mind and the competitive instincts of a gladiator.