Preselling The Company
Amid the celebrity of last year's megabucks mergers, nobody paid much attention when one of the country's bestknown microcomputer-software publishers acquired one of the country's most obscure microcomputer-software developers. The snub was understandable, since the payment of 500,000 shares of Ashton-Tate common for all of Forefront Corp. appeared on paper to be the conventional outcome of a typical high-technology venture. But in fiscal fact, the clever folk at Forefront added a Lewis Carroll twist to the annals of start-up financing. And, for their part, the people at Ashton-Tate added a touch of patience to the annals of acquisition -- and product development. You have to admire the Through the Looking-Glass sequence. First, Forefront's founders sold the company to Ashton-Tate for a nifty profit. Then, they started it up.
In mid-1983, when this unusual saga began, Robert Carr and Martin Mazner had recently left positions elsewhere and were designing the elements of a sophisticated software package they called Fred. Carr possessed programming skills and Mazner marketing smarts, but infant Fred demanded pure capital -- a minimum of $5 million, they figured -- to form a business strong enough to enter the software market. To be sure, they could have tapped a venture pool, since in those days a person needed only a key to a garage to whet investor appetites. But the pair decided that they didn't want to go that route.
One concern was that to part with that kind of money, venture capitalists would seek a huge payback, achievable only through building the proposed company into a massive vertical entity. And anyone who aspired to such fast growth, Carr fretted, would hold that the goal of business was return on investment. "We had the same end in mind," he admits, not entirely berserk, "but we wanted to create a special place for software development along the way, attracting top talent, removing them from money worries, and creating a nest." Of course, that would be a different culture from the one venture capital would spawn. "We can do it better," Carr urged Mazner with enthusiasm, "and let's have fun while we do it better."
More to the point, before you design ambitious five-year business plans, they reasoned, you ought to get the product at least partly working. Even then, you're going to have to go out and sell the damn thing, and that means spending venture capital on management and salespeople -- excess baggage in the nest they envisioned. Since their program was well enough along to suggest its finished state, Carr and Mazner decided to get Fred a hearing at an extant software publisher whose treasury might accelerate the development process. They had nothing in particular in mind, except that the goal would be toward symbiotic benefit: like a shark and a pilot fish, if one fared well, the other would, too.
The pair studied the list of corporate associations they felt might appreciate Fred's mutual potential -- among them, VisiCorp, Digital Research, MicroPro International, Lotus Development, Ashton-Tate, Software Publishing, and Microsoft. Not wanting word to spread, they contacted only two of the companies for starters. By the luck of the draw, one was Ashton-Tate, a quick trip down the coast in Culver City, Calif. The other was Lotus Development Corp., in Cambridge, Mass., whose head, Mitchell Kapor, was scheduled to be in California the same week. At first Ashton-Tate's then-chief executive officer, David Cole, in the process of bringing his company public, turned them down. Ironically, Lotus almost got a peek at Fred first -- with who knows what consequences, since it was but a few months before Lotus's own competing Symphony came out.
But the fates of free enterprise decreed that integrated software should have two prime contenders. Cole consented to a one-hour audience, and the rest is history. Ashton-Take kept Fred -- soon to be called Framework -- and its two guardians for 47 additional hours. In that interval, a letter of intent was drafted, capitalizing Forefront as a going concern, and a formula was devised to determine the amount of the cash-out three years down the line, in August 1986.
Ashton-Tate had proposed buying everything outright then and there, as any normal company would do when faced with the opportunity to add immediate substance to its product line. "We said no," Carr relates. "Their eyebrows raised, and they looked baffled. We said we want to do something different: start a company around the product, and then have you buy the company in a few years. We believe in Framework so much that we're willing to bet on the come."
In this case, the come was no vague roll of the dice, but a strict formula that at merger time would factor the profitability of the start-up times an earn-out ratio (relating to how well Framework performed within the Ashton-Tate line) times Ashton-Tate's average price/earnings ratio. Pitting it measurably in open contest against Ashton-Tate's stalwart dBase II and dBase III in the end-user arena would demonstrate Framework's profit potential, Carr calculated. Deferring to the company's P/E ratio would be a short-cut to appraising Forefront: how Wall Street assessed Ashton Tate's market value in relation to its earnings should apply to Forefront as well. And, even more brazenly, Forefront's profitability (essentially, net profit over sales) would give the savviness of the to-be-acquired talent its proper due. Hastening to seal the deal, Ashton-Tate presented Carr and Mazner with $25,000 in earnest money -- enough, surely, to phone the luckless Kapor person-to-person and tell him next Sunday's dinner was off.
Ashton-Tate agreed to invest $975,000 toward the completion of Framework by plowing $750,000 into development and buying 15% of Forefront for $225,000 -- sufficient for the tiny company to gear up and plunge ahead. But when Framework was done, Forefront would need a revenue stream. So Ashton-Tate became Framework's publisher, being granted marketing rights in return for which it would pay Forefront royalties. With the tail now wagging a salivating dog, the public company was held to minimum performance standards by which it was obligated to roll out Framework as soon as development was complete, and to spend a stipulated minimum on advertising in the first year. There was also a floor price of acquisition below which the deal would not be consummated, even if Framework fizzled but Ashton-Tate still wanted to own the development company.
For its troubles, Ashton-Tate received an option to buy the remaining 85% of the formative company in August 1986. At that those three years were a concession by Forefront's principals, who hoped for longer exposure before the final price was calculated. "But considering that they wanted to buy us that same day," Carr generously cedes, "we were willing to let the chips fall where they may."
The bones of that setup are not unfamiliar to commerce: a big company buys a small fraction of a small company, accompanied by rights to purchase a larger interest in the future. Ashton-Tate, for one, has since made similar arrangements with private enterprises, but the rights provisions are based on the latters' projected revenues, not on arcane calculations relating profitability to the whims of Wall Street. Even rarer, neither are the target companies apt to consist of a "handful of recruits," as Carr affectionately saw his yet-to-be-gathered cadre, but are solid businesses such as East Hartford's MultiMate International Corp., which Ashton-Tate recently bought -- for straight cash. "[The Forefront formula] remains unique," acknowledges Norman Block, Ashton-Tate executive vice-president for finance and administration. "I know of no other. They don't even have seed capital. Nonetheless, they had the kernel of an idea and had some development work done already. And they were supremely competent people."
The chips fell a year ahead of schedule, and resoundingly at that. By the turn of 1985, after Framework was finished and had been shipping for only six months, it was clear that the five-function program was a smash hit. Framework was chipping in a healthy 18% of Ashton-Tate's annual revenues.
But the resultant royalty income to Forefront muddied the buy-out waters in ways the drafting attorneys had not anticipated. Since Forefront's sales consisted of Framework royalties alone, how much should fairly be expensed for more development, favoring the buyer? How much should be brought directly to the bottom line as profit, favoring the seller? "There was a lot of uncertainty around the one-time shot that looked simple," Carr says on reflection, "but actually left a lot of things unclear. To be frank, that would be the one thing I'd change if I were doing it again."
Partly in light of such complications and partly to cement ongoing development of additional products, Ashton-Tate offered to throw the formula to the winds and merge early. Why not, replied Forefront, all 18 of whose employees held uncashed-in equity in the on-paper-rich company. But considering that TATE (as it's publicly listed on NASDAQ) common had fallen to around $10 a share, at what reward? "It was an excellent piece of timing," Carr admits with relish. "Both parties felt the stock was a good buy, but we argued that we can't take the risk on counting on it going up, so we need to get a number of shares that at $10 would constitute a fair price. Ashton-Tate said, 'My God, you guys want 500,000 shares? If it goes to $20, that's an incredible amount." And so it was: by the end of January, TATE was trading at over 20.
Among the assets Ashton-Tate had received in return for its 1983 commitment to the unorthodox contract were intangible dividends paid back instantly from Forefront's spanking new offices in Sunnyvale, Calif. "We were more highly motivated because our price had not yet been determined than if we already had the money at a fixed price," Carr recalls. "We wanted to work motivation into the structure, and the logic seems to have been successful. It helped bind us together. We knew we were going to be rewarded in three years."
American Dreamy as that sentiment is, in retrospect Forefront stockholders undoubtedly could have gotten more if they had cast their lot with venture capitalists and had built a vertical company. But, Carr believes, the morning-line odds were stacked against them without Ashton-Tate's entry. "There are a number of things that you really can't put a price on: the name, the expertise and experience they have in the microcomputer marketplace, established goodwill, established public reputation, the ability to get people to listen to them. These are things we would have been foolhardy to feel we could build from scratch. It's hard to go out there and say, yes, there are another 500 start-ups but, listen to me, I'm different. It seemed to us there was less promise for added risk."
Devoted exclusively to software development, the idealistic founders understood that their creation was not an organism that could survive on its own in the open market. Instead, like some creature with an inescapable place in the food chain, Forefront's charter was ultimately to merge. A corporate guardian was needed, since no self-respecting venture capitalist would have funded a start-up if the only payoff was going to be the price of merging the little company into a big one. Now a designated Ashton-Tate "development center," Forefront yet lives on in the Valley, its nest intact. The blending was so seamless that nary an employee, including the founders, has departed. "The only thing that has changed," says Carr, "is that our business cards and paychecks now say 'Ashton-Tate."