Chapter 7 - The Secondary, February 3 - March 28, 2000 - Episode 2Listen to podcast
The doorman at the Harvard Club has been instructed to send Mr. Lazard to the main dining room where he is further directed to the table at which Joe Windaw of Windaw & Wallar and Joanne Ankers of Big Router are sitting. They are half way through their first cocktail. Larry orders a Coke and they settle in with small talk to wait for Franklin Adams of ad-Ventures who has called Joe to say he will be a few minutes late.
“How was Davos?” asks Joe.
“Overwhelming,” says Larry. “Never seen anything like it. Simon Peres, Yasser Arafat - people like that just sort of wandering around.”
“Didn’t Clinton speak there?” asks Joanne.
“Yeah, he did, but he wasn’t wandering around like the other guys. Spoke, but didn’t say anything, as far as I could hear. I guess if you can smoke pot without inhaling you can speak without saying anything. Joanne, you look offended, you’re not a Clinton supporter, are you?”
“As a matter of fact, yes,” says Joanne. “He’s smart, which is more than you can say about most politicians, and I think he understands the needs of the Valley.” She means Silicon Valley in California, of course. “I worked for him in the last campaign and helped manage a PAC for him at Big Router. I don’t know whether people hate him because he’s smart or because his wife is smart.”
“He wasn’t so smart about Monica Lewinsky. Made Hillary look pretty dumb, too.”
“See,” says Joanne, “people can’t discuss him rationally. What’s all that have to do with what kind of President he’s been?”
“Hey,” says Larry, “I didn’t mean to be offensive. By the way, saw a great t-shirt. It said ‘Viagra — a medicine to make blood leave a man’s head and go to his brain’ the quote is signed Hillary Clinton.”
Joanne’s smile looks forced.
“Fortunately,” interjects Joe, “here’s Franklin. He won’t want to talk politics.”
Franklin joins them. “Sorry to be late,” he apologizes. “One of our portfolio companies is having a little bit of a liquidity problem and I’m trying to help them think it through. Bunch of bright twenty-somethings, but I don’t think they’ve ever thought about the need for cash to pay the bills before. Mom and Dad probably paid for college.”
“What single malts do you have?” he asks the waiter. When Franklin gets his glass, they toast the secondary.
“Okay,” says Larry. “I’ve got all of your requests for the secondary, and I really don’t think there’s going to be much of a problem getting you close to what you want. There need to be more shares for management than you’ve left room for, but I think a little adjustment…”
“We have a change,” says Joanne.
“What’s to change?” asks Larry. “You told me Big Router doesn’t sell shares in secondaries as a matter of policy. Do you want to buy some more?”
“No,” says Joanne. “That’s what changed. We do want to sell the same percentage of our holdings as the other VCs.”
“Why the policy change?” asks Larry. “This is gonna put a monkey wrench in things.”
“I’m not sure there is an overall policy change,” says Joanne. “And we don’t think it is putting a monkey wrench in things if we just ask to be treated like the other VCs.”
“You mean your policy is still not to sell but you want to sell hackoff? What the hell’s all that about?” asks Larry. “And what IS putting a goddamn monkey wrench in things is you telling me one thing and then changing it at the last minute…”
“Calm down, Larry,” says Joe.
“Are you afraid I’m going to offend everyone in your goddamn club?” says Larry. “This is a big fu… BFD. We’re a day before announcing our secondary. We have everything just about set. And she—” Larry is partly out of his seat.
“Calm down,” says Joe. This time it sounds like an order.
Larry waits. Joe says nothing more but keeps looking at Larry. Larry sits back down and looks away from Joe. For at least thirty seconds, no one breaks the silence.
“So Big Router is having a bad quarter,” says Franklin.
“What? Are you asking me?” asks Joanne who has not been looking directly at anyone. “We haven’t said anything about the quarter. Who says it’s weak?”
“Not asking,” says Franklin. “I know you can’t say anything. But I heard from a couple of places that the order book is weak and that some of the flakier dotcoms haven’t been paying their bills, so it makes sense that you’d be trying to show some portfolio profits. You have a nice gain in hackoff and it makes sense that you’d want to get some of it into this quarter.”
“Are you selling other portfolio companies?” asks Larry.
“I can’t comment on any of that,” says Joanne.
“Okay,” says Joe. “Why don’t we get down to the numbers? Larry, you said you had an allocation in mind — obviously it’ll have to change with this new development — but why don’t we start there? What do you have?”
“This blows it all up,” says Larry. “Okay, just let me get my computer booted.” He takes his Dell laptop from his attaché case, pushes his table setting out of the way, and starts to open it on the table.
“I’m afraid you can’t do that,” says Joe.
“Do what? You haven’t even seen the numbers,” says Larry.
“I’m afraid you can’t open a PC on the table here. It’s a house rule. No working papers at dinner and certainly no computers on the table.”
“Jesus Christ,” says Larry. “Is that because everyone at this club has a daddy who’s so goddamn rich they don’t ever have to do business? Or is that what they want to pretend? Let’s get out of here and go to a real restaurant then. We’ve got work to do.”
“I think that’ll take more time than it’ll save,” says Joe calmly. “If we can’t finish over dinner, I can get us a private room after where we can work. Look, Larry, I know you’re upset. But I can’t believe you need a computer to remember a few numbers. Maybe I would, but you don’t, not even if your day is six hours longer than anyone else’s. Where did you get up this morning, anyway?”
“Davos,” says Larry. “Yeah, I remember the numbers, but it isn’t going to be easy for everyone to follow without seeing them. You okay with doing this blind, Franklin?”
“I’m fine,” says Franklin. “Go ahead.”
“I’m fine with this also,” says Joanne.
Larry takes a deep breath. “As you know, we’re planning to sell three million shares in the secondary. Barcourt says its okay if fifty percent of those come from selling stockholders, so that leaves us with 1.5 million shares to divide up between us. That’s the easy part.”
“I’ve got it,” says Joanne.
“I hope so,” says Larry, “because now it gets hard. Franklin, you said adâ€‘Ventures wants to sell twelve percent of its stake so long as no one else is selling a bigger piece. Joe, you said you guys want to sell 650 thousand which is thirteen percent. Of course, we were counting on Big Router holding…”
“But that’s changed,” says Joanne.
“I understand that. But Joe asked that I go over what I originally was proposing before you changed your mind, so that’s what I’m doing.”
Joanne starts to say something, but stops on a signal from Joe which only she can see.
“Okay?” asks Larry. When no one answers, he continues: “So if Windaw & Wallar gets to sell thirteen percent, then ad-Ventures would need to sell thirteen percent which is another 585 thousand making one million 235 thousand. Clearly that doesn’t leave enough for—”
“Can you repeat those numbers?” asks Joanne.
“Jesus Christ,” says Larry. “You said you were okay with doing this blind. These numbers don’t matter anyway, because they’re not going to work.”
Frankin says: “Larry said that if ad-Ventures and Windaw & Wallar sell thirteen percent of their holdings, that adds up to one million 235 thousand shares which leaves only 265 thousand for the management team, which he is about to tell us is too little.”
“Right,” says Larry. “That just isn’t gonna—”
“And I agree,” says Franklin. “Larry and his team deserve more than that. And what about the other VCs that came in for small amounts with us? Larry, what were you assuming for them?”
“Nothing ... I mean I assumed zero. You didn’t say anything about them and I assumed that they wanted to hold.”
“No,” says Franklin. “I’m sorry about that, but they will expect to get — they have to get — the same percentage that we get.”
“Great,” says Larry, “so we have an even worse problem. Anyway, just to finish what I started with, I was going to propose that you two both sell ten percent of what you’ve got. That’s just a little less than Franklin asked for. You’re in at an average price around a buck a share so, if you sell ten percent at 150 bucks that’s what, a 1500 percent return on your initial investment, plus you’ve still got ninety percent of your stock.”
He pauses, but no one says anything.
“Then,” he continues, “I was proposing that Aaron Smyth and Frank Folger each get to sell sixy-five thousand shares and Donna sells 100 thousand.”
“What about Dom and what about you?” asks Franklin. “We’re up to one million 180 thousand so far, I think.”
“Right,” says Larry. “I’m glad you’re following. Dom doesn’t want to sell any shares.”
“Why not?” asks Joe. “He should take some money off the table. He earned it.”
“Doesn’t want to,” says Larry. “Remember, he comes from Microsoft. That’s all he can talk about, for Christ’s sake. Anyone there who ever sold off any shares was sorry because almost every six months it doubles. He’s right about that. He says he doesn’t want to sell. He doesn’t need the money and he doesn’t want to sell. Anyway, that leaves Louise and me selling just five percent of what we have, half the percentage you guys are selling.”
“Okay,” says Franklin. “I understand that. Not sure I would have agreed to be cut back to ten percent but, like Larry says, those numbers aren’t going to work anyway. So where do we go from here? Joanne, how much is Big Router looking to take out?”
“We … uh … we’re just looking to be treated like the other VCs. Whatever percentage of your holdings you guys end up selling, we want to sell, too.”
“Let’s do the math,” says Franklin. “If we were to give Larry and the execs what they asked for that’s … uh … 550 thousand shares…”
“Can’t do that,” says Joanne. “Too much.”
“Let me just work it out,” says Franklin. “Then we’ll go from there. That would leave 950 thousand shares for everyone else. Altogether, venture investors have seventeen million shares. That means we’d be selling just over five percent of what we have. That doesn’t work for ad-Ventures. I don’t want to speak for Big Router or Windaw & Wallar but my guess is that isn’t going to work for you, either.”
“No way,” says Joanne.
“I thought you’d take whatever the other VCs take?” says Larry. “So how can you say ‘no way’ to five-and-a-half percent if they’re willing to take that?”
“Doesn’t matter,” says Joe. “We’re not. My partners really want to sell the 650 thousand shares we asked for.”
“I think we should call it off,” says Larry. “That means Louise and I will hold our position and so will you. Hopefully the stock goes up some more and we all sell in a careful way.”
There is another long silence. Joanne looks like she is going to say something, but Joe again signals silence to her. The silence is broken when the waiter takes their order.
After the waiter leaves, there is another silence. Finally Larry says: “I’ll call Barcourt in the morning and tell them we’re calling it off.”
“It won’t work,” says Franklin gently.
“What do you mean?” asks Larry in a higher-pitched voice than normal. “Barcourt isn’t going to do a secondary if the CEO doesn’t back it. They won’t do it if I don’t sign a lockup. You’re the Board; you can fire me and get another CEO to agree. But that won’t look good and you’d better be ready to explain why you ignored your fiduciary responsibility to the other shareholders because you couldn’t make an immediate 2000 percent profit for yourselves.”
“It won’t work because the company needs the money from the secondary,” says Franklin. “And it also won’t work because Joe and I will just be forced to distribute the shares we have to the Limited Partners in our funds. And they’ll sell as fast as they can, most of them. We book a gain for the fund at whatever price the stock is at when we distribute it. We’re not going to hold the stock and wait for it to go down.”
“You were willing to sign a lockup as part of the secondary,” says Larry.
“Sure, and we still are,” says Franklin. “But we need to lock in some fund performance and we do that either by selling a little in a secondary or distributing a lot.”
“Big Router Ventures can’t distribute,” says Larry. “It only books a profit if it sells. How do you handle that, Joanne? What happens when these guys distribute and their investors sell and the stock tanks before Big Router can get out? You can’t sell fast, you know. You’re subject to Rule 144.”
“I … uh … We…” Joanne is flushed.
“That doesn’t matter,” says Joe. “That’s not what’s going to happen. We’re going to do the secondary for the very good reason that hackoff needs the cash. And we’ll have no problem answering to public stockholders that we did exactly what needed to be done to keep the company solvent — perhaps despite irresponsible management. During the IPO you said, if I’m not mistaken, that the company would have sufficient cash based on the IPO alone to fund it until it’s cash flow positive. Now here we are at the end of ‘99 with only about forty-two million in cash. And, from what Donna tells me, we’ll easily burn through that in just three more quarters, one of which we’re already in. So the company needs a secondary.”
“Like hell we do,” says Larry. “The equities in our portfolio were worth 250 million at the end of ‘99 and they’re worth even more now. We’re already getting cash out of this without even trying to. Last quarter we cleared about ten mil when AOL bought one of our companies…”
“I’ve always thought we should’ve held the AOL stock,” says Joanne.
“Well, we didn’t,” says Larry. “We stuck to our strategy of selling things the market can easily absorb and that don’t have the upside of our startups. We did what we said we’d do.”
“But AOL is up,” says Joanne.
“Regardless,” Larry persists through clenched teeth, “we are getting cash from our portfolio now. CBS is gonna buy one of our companies for cash this quarter and I think another one may go, too. This is cash that’s coming in whether we want it or not. If we need more liquidity — and I’m not saying we do — we can just proactively sell some of the portfolio.”
“You don’t want to do that, Larry,” says Franklin. “It’s always been your strategy to hold the equity where we can and let it appreciate. Besides, a lot of the companies aren’t public yet. And you’ve signed lockups on some of the best stuff that IS public. There isn’t that much you can sell. You run the risk of tanking the ones you do sell and creating nervousness about the rest of your portfolio companies. I don’t doubt that you could raise some cash that way or that some cash’ll continue to come in over the transom from the portfolio. But it’s better to do the secondary you planned.”
“Are you the good cop, Franklin?” asks Larry. “When did you guys script this?”
“Just trying to do what’s best for the shareholders and for our investors,” says Franklin. “And for you, too, Larry. Look, I have an idea, do you want to listen?”
“You’re right — the company has a cushion in all that stock it holds in its portfolio, so it probably doesn’t need to sell as much company stock as it was planning to,” says Franklin. “The company could probably make do with the proceeds from a million rather than a million-and-a-half shares…”
“I don’t see how doing a smaller secondary is going to solve this problem,” says Joanne.
“Why don’t we let him finish?” says Joe. “Franklin is very smart. Did you see how fast he did all those numbers in his head?”
“Thanks,” says Franklin, “this is just an idea, though. I haven’t had time to think it all out, so it may be dumb. Suppose we go ahead and offer three million shares as planned but the company only sells one million. Then there are two million shares left for selling stockholders and we ought to have a much easier time divvying this up if no one gets greedy.”
“I don’t know,” Larry says. “I hear you, and I appreciate that you’re thinking out-of-the-box, but Barcourt was pretty firm that selling shareholders can’t be more than half the offering. Said the optics are bad beyond that or something.”
“I’m sure you can handle Harvey Maklin,” says Franklin. “You were making a convincing case that the company didn’t need any more cash. Surely you can show that the proceeds of a million shares are enough.”
“Yeah, I can,” says Larry. “But they’re liable to just come back and say we should do a two million share offer.”
“I’ve never known you to be naïve, Larry,” says Franklin. “Probably you have jet lag. Those Concordes are too damn fast. Remember: Barcourt’s commission is based on the total selling price. They won’t want to cut back the size of the offer.”
“So what’s the rest of your proposal?” Larry asks.
“Okay. If we put aside 400 thousand shares for management…”
“That’s not enough,” says Larry.
“Let me get it on the table,” says Franklin. “Then you can piss all over it.”
“Right here in the Harvard Club? On the table?” Larry smiles for the first time in the discussion.
“If we leave 400K for management, there’s 1.6 million shares for other selling shareholders. That means just over nine percent for us.”
“Nine-point-fourteen percent to be exact,” says Larry. “But that’s still not enough for management. We can’t do that.”
“We’re going in the right direction but it’s not enough for us either,” says Joe. “No way my partners will settle for selling less than ten percent of our position. Just isn’t gonna happen.”
“We need ten percent, too,” says Joanne.
“Do you want what everybody else gets or do you want ten percent?” asks Larry. “I’d really like to know what Big Router’s position is. Is there a certain amount of profit you’re trying to milk out of this position to cover your bad quarter?”
“I didn’t say we’re having a bad quarter,” says Joanne. “We need at least ten percent. So do the other VCs. I don’t see what’s so complicated about that.”
“This isn’t working,” says Larry. The food comes during the ensuing silence.