Hard Drive: Bill Gates and the Making of the Microsoft Empire (34 page)

project. “They felt threatened by Apple’s BASIC, which was a considerably better implementation than theirs. And Bill Gates felt compelled to convince Apple not to ship the one Donn Denman had developed. And he succeeded.”

Denman had been working on MacBASIC for two years at Apple. When Sculley suddenly scuttled the project, it broke Denman’s heart. “I felt like my two-year-old child had been taken from me,” he recalled. Beside himself after two years of work, Denman climbed on his motorcycle and went racing wildly through the foothills above Cupertino. As he was rounding a sharp curve he lost control and crashed. Although he scraped several layers of skin oflF his arms and legs, he escaped serious injury. “I felt like I didn’t have too much to live for at that point,” he said. Denman would end up taking a six-month leave from Apple before coming back.

The decision to cancel MacBASIC came at a time of very low morale around Apple. The Mac was not doing particularly well, the industry was in a slump, employees had been laid oflF, and Steve Jobs had been kicked out of the company. But caving in to Microsoft hurt the most.

“Everyone was somewhat disgusted over it,” Denman said. “I know the issue came up several times in public meetings. People would ask John Sculley, ‘Whatever happened to BASIC? I’m working away on this project and how do I know it’s not going to get canceled like BASIC. .. ?’ Sculley’s answer was, ‘We did some horse trading there. It was the right decision for the company. It was a business decision.’ Ultimately, I came to accept that point of view. I wanted to create something for people to use, and it didn’t get used. To me that was a big tragedy. But it was an ace that Apple traded with Microsoft for something, and I’m not in a position to evaluate whether that was a good deal or not.”

There were others around Apple more outspoken about Microsoft’s hard-ball tactics. Bill Atkinson, one of the company’s top software developers, said of Gates: “‘He insisted that Apple withdraw what was an exceptional product. He held the gun to our head.”

Other companies would soon have similar things to say about the way Gates and Microsoft did business. What particularly frightened industry insiders was that Microsoft was still a fairly small, privately held company in 1985. But even as he was arm-twisting Apple, Microsoft’s boyish-looking leader had set in motion a series of events to take his company public. The Microsoft juggernaut was just starting to gather momentum.

CHAPTER 6

King of the Hill

_W

eaving in and out among the other skaters as he picked

up speed, Bill Gates was riding the fine edge between

being in and out of control, one misguided step from disaster, pushing himself, as usual, to the limit. On the hardwood floor of the roller skating rink, many of the more than 100 Microsoft employees who had turned out for Gates’ 30th birthday party marveled at his skating abilities. Rock ’n’ roll music from Paul Allen’s band blared in the background. The more intense the music, the faster Gates seemed to skate, gliding backwards and forwards with equal ease.

There had not been much time for roller skating in the last ten years since Gates and Allen had formed Microsoft, but Gates, who learned to skate at an early age, quickly found his childhood form.

Although Microsoft’s leader appeared to be in good spirits as he spun through lap after lap this October day in 1985, he had a lot on his mind. The company’s board of directors was due to meet in less than 24 hours to hear his decision about taking Microsoft public. Gates had avoided the unavoidable as long as possible, and he was not looking forward to the next few months. A legal prospectus would have to be prepared, and then he would have to tour the country selling investors on the company’s stock, which would consume much of his valuable time. And Gates knew that in the end, along with the fantastic personal riches, would come the inevitable distractions to his employees as programmers wrote code with one eye on the price of their stock.

In the last few years, several computer startup companies had gone public, the most celebrated of which was Apple. When its stock was traded publicly for the first time in December of 1980, Apple’s value was estimated at $1.8 billion, which was more than Ford Motor Company. The fortunes that had been made were mind boggling. On paper, Steve Jobs was suddenly worth more than $250 million. In 1983, two of Microsoft’s fiercest competitors, Lotus Development Corporation and AshtonTate, also went public, to enormous financial success. But Gates was in no hurry for Microsoft to take this same rite of passage. He did not want to open Microsoft’s corporate doors to the public. For one thing, the company did not need the instant infusion of cash that a public offering would provide. It was making a great deal of money. Pretax profits were running as high as thirty-four percent of revenues. And remaining private had definite advantages. There were no stockholders to please, no onerous filings with the Securities and Exchange Commission. The only disadvantage was that Microsoft’s key employees and managers who had been getting stock options over the years had no tradable security. Until Gates decided to take the company public, there was no liquid market for Microsoft stock.

Regardless of what Gates wanted, however, his hand was about to be forced. It was only a question of time until the day arrived when Microsoft would have to offer its stock to the public. The 1934 Securities Exchange Act required all companies to register and file public reports as soon as stock had been distributed to 500 or more employees. As far back as 1983, Gates had projected that Microsoft would reach that figure by 1986 or 1987. It now made a lot more sense for Microsoft to take charge of its own future.

“We decided to do it when we wanted to, not when we had to,” Jon Shirley, Microsoft’s president, told
Fortune
magazine.

In early 1985, Shirley, Gates, and David Marquardt, the sole venture capitalist in Microsoft, had started serious discussions about an initial public offering. But Gates wanted to wait until two major products, Excel and Windows, had been released. He told the board he would have a recommendation by the end of October.

The roller skating party was held on Sunday, October 27, the day before Gates’ birthday. When he met with the board the next day, he had made up his mind to go ahead with the selection of underwriters, even though he still had serious reservations about the entire process. With this decision finally out of the way, Gates hurried off to the elegant Four Seasons Hotel in downtown Seattle, where his mother was throwing him a much more private birthday party.

Microsoft’s point man in dealing with Wall Street would be 50-year-old Frank Gaudette, the company’s chief financial officer who had arrived the year before. He had previously managed the public offerings of three software companies. But those companies did not have Microsoft’s leverage, and Gaudette couldn’t wait to start negotiating with underwriters who had been tripping over themselves for years as they called on Microsoft, trying to get close to Gates for the day Gates decided to take the company public. This time, Gaudette and not the investment bankers would be setting the terms. Gaudette recommended that Microsoft select two underwriters to co-manage the public offering. One would be a leading Wall Street investment firm, which would act as lead underwriter, putting together a syndicate of underwriters and allocating stock among them. The second co-managing firm needed to be one that specialized in technology stocks. Choosing this specialty, or “boutique,” firm would be simpler, as only four firms with the kind of expertise Microsoft was looking for existed. Choosing the Wall Street firm, however, would be more difficult. Eventually, Gau- dette narrowed the field to eight firms, telling each of them they would have half a day to pitch their firm to him. In the end Gaudette was particularly impressed with Goldman Sachs. As a result of his recommendations to Gates and Shirley, Microsoft invited representatives of Goldman Sachs to meet with Microsoft officials over dinner at Seattle’s Rainier Club the night of December 11.

The conversation at dinner was awkward. Gates, who wasn’t thrilled at the notion of going public in the first place, had heard horror stories about investment bankers from Lotus leader Mitch Kapor. Gates was tired and prepared to be bored during dinner. Shirley was caustic, despite Goldman’s attempts to establish a rapport. At the end of the evening, Eff Martin, a vicepresident of Goldman Sachs, told Gates that Microsoft could have the “most visible initial public offering of 1986—or ever.” In the parking lot of the Rainier Club after dinner, Gates told Shirley, “Well, they didn’t spill their food and they seemed like nice guys. I guess we should go with them.”

A few days later, the firm of Alex. Brown & Sons of Baltimore, which had been courting Microsoft for years, was picked as the specialty investment banker.

There was one sticky problem left to resolve.

Gates had signed an agreement with the managing editor of
Fortune
magazine to allow one of its writers to tag along throughout the public offering process. Gates, in fact, was enthusiastic about the idea. He felt other entrepreneurs might learn from Microsoft’s experience. The publicity wouldn’t hurt, either. A year or so earlier, Fred Gibbons of Software Publishing Corporation had wanted
Fortune
to write a. similar article when his company went public, but the underwriters and lawyers balked. A public offering is a sensitive matter to investment bankers and lawyers; any information disclosed in such an article that is not contained in the company’s prospectus could be used by disgruntled shareholders as the basis for a suit should the stock not do well.

Negotiations between Microsoft and
Fortune
took more than a month. The agreement that was finally signed allowed lawyers for Microsoft and the underwriters to read the story and suggest—not approve—changes before publication. The story would not be published until well after the public offering, when the stock had a chance to stabilize.
Fortune
writer Bro Uttal, chief of the magazine’s West Coast bureau in Menlo Park, California, was handed the assignment.

When they found out about the
Fortune
deal, the two principal underwriters Microsoft had picked wanted nothing to do with the article. But Gates held his ground—if they wouldn’t agree, he told them, Microsoft would select other underwriters to manage its public offering. As Gates pointed out, firms were lined up at the door to underwrite the offering, smelling millions of dollars in fees. The two underwriters quickly backed down.

By the end of the year, the national press began writing stories of a possible public offering by Microsoft in the near future. Although the negotiations to select the underwriters had been done in secret, there were tell-tale signs of the company’s plans. Microsoft had recently announced that William Neukom, formerly a senior partner with Shidler McBroom Gates & Lucas, had become Microsoft’s vice-president of law and corporate affairs, a newly created position. Microsoft had also announced that Portia Isaacson, 43, founder of Future Computing and a respected industry forecaster, had been named to Microsoft’s board of directors. Fleshing out aboard of directors and bringing in legal counsel is usually a sure sign that a private company like Microsoft is preparing for a public stock offering.

Throughout January of 1986, Neukom worked on drafting the critical prospectus. By law, Microsoft’s stock could only be offered on the basis of information contained in the prospectus. If the company’s stock fell after it was publicly traded, angry investors could sue Microsoft if pertinent information about the company’s affairs was left out of the prospectus.

“Like all such documents, it had to be a discrete sales tool, soft-pedaling weaknesses and stressing strengths, all the while

concealing as much as possible from competitors,” wrote
Fortune’s
Bro Uttal in his article.

Ruthann Quindlen, a security analyst for underwriter Alex. Brown, said Gates was very concerned about some of the problems Microsoft was having at the time the prospectus was being prepared. The company had invested heavily in writing applications for Apple’s Macintosh computer, which had failed to do as well as expected. And Microsoft Windows was getting very bad reviews from the trade press. Quindlen was part of the “due diligence” examination that the lawyers and underwriters conducted with Gates and other Microsoft executives, looking for potential skeletons in the closet. While Alex. Brown & Sons was used to dealing with software companies and the unusual personalities of people who spent their lives in front of a computer screen, Goldman Sachs was not.

“Steve Ballmer was pretty wild during the due diligence,” recalled Quindlen. “He was his normal, ebullient self. Once, he was right behind one of the minions from Goldman Sachs and he clapped his hands together to make a point and the guy jumped about five feet out of his chair. They’d never seen anything like it. They just weren’t used to this kind of company.”

Ballmer, even more than the other Microsoft executives, came up with so many potential developments that could result in Microsoft’s demise during due diligence that one of the investment bankers quipped, “I’d hate to hear you on a bad day.”

The final step before filing with the SEC was to set the price range of the stock to be sold to investors. The underwriters suggested a range of $17 to $20 a share. At first Gates insisted on a range of $16 to $19. It was highly unusual for a CEO to argue for a
lower
price. But Gates felt uncomfortable. A price of $16 would give Microsoft’s stock a price-earnings multiple of more than ten times estimated earnings, which was comfortably between the multiples of personal computer software companies and mainframe companies. At $20 per share, Microsoft’s market value would shoot up to more than half a billion dollars.

“Bill had a sense of proportion,” said one of those involved in pricing the stock. “It seemed ridiculous that a company would have that kind of price earnings ratio. He just felt uncomfortable with that kind of prominence, and with the expectations that would be raised in the minds of people who bought the stock. He just didn’t have any way to predict how well the company would do.”

Microsoft was considering what amounted to about a $40 million deal. Of that, $30 million would come from the sale of roughly two million shares at an assumed price of about $16 a share. The remaining $10 million would be collected through the sale of stock by existing shareholders in the company, who had agreed beforehand not to sell more than ten percent of their holdings. If the underwriters exercised options for an additional

By the end of January the prospectus was ready. On February 3 Microsoft registered with the SEC, and the underwriters sent out 38,000 copies of the prospectus. For the first time, the media got an inside look at the internal operations of Microsoft. The prospectus was a journalistic gold mine, rich in detail, with nuggets scattered throughout its 50 pages.

Microsoft’s co-founders, Gates and Allen, were about to become millionaires many times over. Gates owned 11,222,000 shares of Microsoft stock, or slightly over forty-nine percent. He planned to sell 80,000 shares. Allen owned 6,390,000 shares, or twenty-eight percent. He planned to sell 200,000 shares.

Steve Ballmer, who owned 1,710,000 shares, would also do very well. Jon Shirley owned 400,000 shares. Other major stockholders included Charles Simonyi, with 305,667 shares; Gordon Letwin, with 293,850 shares; and Gates’ parents, who together owned 114,000 shares. After Gates, Allen, and Ballmer, the largest stockholder was Technology Venture Investors, with 1,378,901 shares.

The prospectus also revealed that Microsoft’s senior managers had been able to take out large company loans to purchase stock options in the company. Shirley had borrowed $810,751, of which he still owed more than $600,000. Steve Ballmer had borrowed $533,711 and had not paid back any of the loan. Scott Oki owed $56,211 on his loan of $198,711. And Frank Gau- dette, the chief financial officer in charge of Microsoft’s public offering, had borrowed $143,888 from Microsoft.

For the first time, Gates’ annual salary, as well as that of his top managers, was public record, Shirley was Microsoft’s highest paid manager, with a salary in 1985 of $228,000. Gates received only $133,000 in salary, far below what most CEOs of American corporations made. Ballmer received $88,000 in compensation in 1985.

The prospectus listed three board members in addition to Gates: Marquardt, Shirley and Portia Isaacson.

Allen was no longer on the board. Although he had not played an active role in the company since 1983, he had recently resigned from the board to start his own Bellevue software company, Asymetrix. Two of Microsoft’s first programmers, Steve Wood and Marc McDonald, had joined him in founding Asymetrix.

“.. . I had pushed him pretty hard,” Gates would later say of Allen. “He wanted to go out and prove he could do his own thing. I tried to convince him to do that within the context of Microsoft, but he decided to do it himself.”

The prospectus showed that Microsoft had been doing even better than most outsiders had thought. For the year that ended June 30,1985, Microsoft had revenues of $140 million. Its profits had totalled $31.2 million, or nineteen percent of revenue. That was better than its two chief public rivals, Ashton-Tate and Lotus. Of its total revenues, $75 million came from its operating systems division and $54 million from applications. The remaining revenue came from the sale of hardware, such as the Microsoft Mouse, and from the sale of computer-related books published by Microsoft Press, which the company had founded in 1983. Microsoft’s International Division accounted for a whopping thirty-four percent of total revenues as of June 30, 1985. Of that, fully twelve percent came from Japan. No single customer accounted for more than ten percent of Microsoft’s total business.

Once the prospectus was out, Gates and other Microsoft executives were besieged with calls from friends, relatives, and acquaintances wanting to buy shares of stock in the company. Gates even got a call from his doctor. According to
Fortune,
except for about a dozen people, including Gates’ grandmother and his former housekeeper, Gates turned down most of the requests.

“I won’t grant any of these goofy requests,” he said. “I hate the whole thing. All I’m thinking and dreaming about is selling software, not stock.”

But Gates still had one more obligation to fulfill before he could get back to managing his company. A road show had been organized to promote the company’s stock with institutional investors. It was set to kick off in Phoenix on February 18. At a February 7 rehearsal, Gates spoke in a flat monotone to the assembled investment bankers, going over the company’s vital statistics. When one banker criticized Gates’ delivery, Gates snapped, “You mean I’m supposed to say baring things in an exciting way?” Once the tour kicked off, Gates and company would make stops in eight cities, including London, over the next ten days.

There was a great deal of excitement and anticipation surrounding Microsoft’s public offering, and Gates and Gaudette spoke to packed audiences in each city. Institutional investors said they would take as much stock as they could get their hands on, and the show quickly took on a festive mood. Even Gates relaxed, when he found he could use the tour to push Microsoft products as well as Microsoft stock. In London, everyone celebrated by going to dinner at Annabel’s, a popular club that

British gentlemen supposedly took their mistresses to. After dinner, Gates and Ruthann Quindlen, the security analyst from Alex. Brown & Sons, danced long into the night.

“Bill loves to dance,” said Quindlen, who had known Gates since the early 1980s. “When he’s on the floor, he’s in his own world.”

During the road show, Quindlen discovered a side of Gates that few have seen. Microsoft’s youthful chairman was being publicly measured, and he was afraid to fail.

“He’s never failed at anything. He has picked things he will win at,” she said. “In every situation Bill gets into, private and public, he sets himself up not to fail. It’s what drives him so much. .. . I’m not sure he’s equipped to deal with failure.”

Because Gates has never known failure, according to Quindlen, he lacks a certain humaneness, and until he fails miserably at something that means a lot to him, he will never be a great man, despite all his accomplishments.

When Gates returned from the promotional trip, he suddenly had a change of heart regarding the offering price of the stock. He now felt driven to get the best price he could for Microsoft’s stock. These were heady days on Wall Street, where a bull market was raging. The underwriters thought the stock would trade publicly as high as $25 a share. Gates now wanted to set the price range for institutional investors at $21 to $22 a share. Why, he felt, should he give Goldman Sachs’ institutional clients millions of Microsoft’s dollars—the difference between the offering price and the price investors thought the stock would publicly trade at? After several days of intense negotiations with Goldman Sachs, with several major investors threatening to pull out of the deal if the price were too high, everyone agreed on a final price of $21 a share.

By March 12, the only remaining issue on the table was the management fee charged by the underwriters. Initially, Microsoft had said it would pay the underwriters no more than 6.5 percent of the selling price of the stock. But in the last few days, another computer company, Sun Microsystems, had managed to get a 6.13 percent fee on its $64 million public offering, far lower than usual. Gates had told Gaudette that Microsoft should be able to get at least as good a deal.

Goldman Sachs refused to go that low. At the stock price they were discussing, each penny a share was worth $31,000 in management fees. After a full day of haggling with Frank Gaudette in New York, Goldman Sachs’ best offer was $1.33 per share. The situation was tense. Gaudette was under orders from Gates—who, showing utter disdain for the excitement of the offering, had left the country for a few days of vacation— not to go above 6.13 percent, which amounted to about $1.29 a share. They were down to quibbling over pennies.

On the evening of March 12, a frantic Gaudette, unable to reach Gates, caught up with Shirley as he was about to leave a restaurant to buy his daughter a car for her 16th birthday. Gaudette had been able to get the underwriters down to $1.31. That was as low as they would go, he said. Shirley approved, and the deal was done.

The tight-fisted Gates later told Microsoft managers that he would have called off the public offering had he been around and the underwriters refused to meet his price. And he was dead serious.

At 9:35
a.m.,
March 13, 1986, Microsoft’s stock was traded publicly on the New York Stock Exchange for the first time. It opened at $25.75 a share. By the end of the first day, some 3.6 million shares had changed hands. It peaked at $29.25 before closing for the day at $27.75.

According to
Fortune
magazine, Gaudette called Shirley from the floor of the exchange during the morning free-for-all. “It’s wild!” he shouted into the phone. “I’ve never seen anything like it—every last person here is trading Microsoft and nothing else.”

The frenzied over-the-counter trading surprised even the underwriters. By noon, the stock was changing hands at the rate of thousands of shares a minute. Had they sold at the peak, investors who had grabbed up the stock at $21 a share could have made a forty percent return in one afternoon.

Analysts said they could not recall when a stock traded more volume in its first day.

“I’m pretty happy,” Paul Allen told the
Seattle Post-Intelligencer
newspaper as he watched the price of the stock climb throughout the morning. “Everybody involved in Microsoft since the beginning has been looking forward to this day.” Within weeks, the stock had hit $35.50 a share. Although Gates made only $1.6 million from the shares he sold, his remaining forty-five percent stake in the company was worth an estimated $350 million. A year after the public offering, in March of 1987, Microsoft’s stock hit $90.75 a share and was still climbing. At age 31, Bill Gates was officially a billionaire. No one in American history, from the great industrial barons and financiers of the nineteenth century to the modern day corporate raiders, had ever made so much money at such a young age. The computer whiz kid who had once seemed to define the term “nerd” was now the youngest billionaire in the country.

And he could have cared less.

On the day Microsoft went public and company employees were celebrating their riches, Bill Gates was off the coast of Australia on a 56-foot sailing vessel reading books and getting a closeup look at the Great Barrier Reef. He had chartered the boat and its crew for five days. This was to be one of his so- called reading vacations, in which he spent time alone plowing through as many books as possible.

“I was sort of pampering myself,” Gates said.

It would have been his longest vacation in years, except that Gates cut it short to meet with his old friend Kay Nishi the day after Microsoft’s public offering.