The New Deal
Forging partnerships with other companies may be the smartest way to acquire or upgrade your technology. Just ask Jeremy Davey
The elevator opens directly into the seventh-floor suite, penthouse-style. The office walls are an eye-popping shade of neon chartreuse, and San Francisco's picturesque Nob Hill stretches for blocks outside a large window in the reception area. Workers sit before six state-of-the-art computers-cum-design-stations, busily adjusting the palettes and design elements that flash on their 15- and 20-inch screens.
Welcome to the nerve center of Pabulum Internet Advertising Agency Inc., an up-and-coming Web-site-design and Internet-ad company that lives up to the image of what a bold young high-tech business should be, and then some.
It's hard to imagine that only a short time ago this well-appointed brick building was largely vacant and in various stages of disrepair--and that the lean, energetic Englishman who runs the business, Jeremy Davey, was working out of an eight-by-four-foot converted closet with practically no capital to help him realize his ambition of breaking into the competitive domain of electronic commerce. The story of how Davey got from there to here--weaving together a series of partnerships that landed him posh office digs at well below the market rate and a costly high-speed telephone line free from a giant telecommunications company--is a compelling tale of the good things that can happen when a flair for seizing opportunity meshes neatly with the forces of serendipity. But it also provides a lesson for growing companies of all kinds: the smartest way to acquire or upgrade technology may be not by handing over cash or relying on credit and interest-accruing rental agreements but by forging partnerships with companies that have what you need.
Indeed, partnering to leverage technology investments may be the wave of the future. A 1997 survey conducted by Arthur Andersen's Enterprise Group and National Small Business United found that CEOs of small and midsize companies plan to invest 3.3% of their total 1998 revenues in technology. And the outlay will likely only get larger: ever-more-sophisticated (read: expensive) technologies, such as electronic data interchange and high-speed T1 telephone lines, are becoming the norm, and small-company owners are realizing they will have to provide for them in their operating budgets--somehow--to stay competitive.
Trading goods and services for technology is not as far-fetched as it might sound. According to John Harbison, a partner in charge of the Strategic Alliances Practice unit of the management-consulting firm Booz, Allen & Hamilton Inc., such arrangements are becoming increasingly attractive to technology companies as well. In exchange for providing small businesses with technology at reduced rates, says Harbison, those companies improve their chances of getting something that money can't necessarily buy: immediate access to a wider customer base and the opportunity to achieve greater market penetration in desirable business sectors. Bartering for technology, Harbison cautions, does require a good deal of stamina and resourcefulness on the part of a small-business owner (Davey's story is a case in point), and the bigger the company you're trying to court, the more layers of resistance you're likely to meet. But the payoff can be well worth the time spent wheeling and dealing, particularly if you're a cash-strapped start-up and getting wired is key to your survival.
Just ask Jeremy Davey. He founded Pabulum in March 1997, convinced that the brave new world of the Web was going to be the next big thing in marketing and advertising. Initially, the business was a one-man show: Davey would work with customers on developing promotional Web sites with his Pentium 133 notebook and then farm out the graphics-intensive components of the design, such as photo manipulation and streaming video, to subcontractors that had the equipment to do the job. It didn't take him long to realize, however, that the field of on-line marketing was crowded with entrepreneurs. If Davey wanted Pabulum to grow, he was going to have to be something more than just another digital-ad guy with bright ideas and a trusty laptop.
So he began to hatch a vision for a new kind of electronic-advertising venture: rather than simply designing Web sites by contract, he would develop whole blocks of cyberspace into centers of electronic commerce, the equivalent of selling virtual real estate. Here's how the five-step plan would work: First, Davey would register for a broad domain name in a popular business sector (say, www.webwines.com or www.bookshops.com). Next, he'd construct a Web site with that domain name. Then he would set up commerce on the site, contracting out space to suppliers of those goods or services, much like a developer of a strip mall leasing out units to individual merchants. As the site gained traffic he would solicit advertising to bring in additional revenues. Finally, he'd sell the site to an actual purveyor or manufacturer of the goods or services mentioned in the name (a wine wholesaler, for instance), retain a percentage interest in the business, and move on to another registered domain name (say, www.workouts.com) to begin the process anew. According to Davey's projections, the new and improved Pabulum could expect to generate $1.6 million in annual revenues in two years.
Big plans, but how could a tiny company with no cash flow possibly transform itself into a Web dynamo? To make his virtual-real-estate plan work, Davey knew, he was going to have to move heaven and earth. He would need a slew of computers equipped with top-of-the-line scanners and the latest design software. He would have to abandon that cramped cubicle and set up shop in a bona fide office. Most important, he would need a high-speed, full-time telephone connection to the Internet--a hookup requiring costly installation and servicing fees. Yet only a year after forming Pabulum, Davey was well on his way to making his vision a reality, not by hammering out financing deals with banks but by orchestrating partnerships with business interests that stood to gain from Pabulum's success.
"Everything I've done, I've done because I've had no money," Davey says with typical disarming candor. "People seem to recognize and admire determination. If they believe in you, I guess they believe you'll pay--eventually! When I look back I often wonder how I got to where I am. A lot of people helped along the way, and I was able to leverage every little thing."
Jeremy Davey's career as a virtual-real-estate-empire builder began, ironically enough, with a piece of real real estate: that seven-story building, at 701 Sutter Street, in San Francisco's fashionable Nob Hill district. It was September 1997, and Davey was pounding the pavement in search of office space that could serve as Pabulum's new base of operations. As soon as he laid eyes on the Sutter Street site, he was smitten--so much so that he not only began to formulate a plan for leasing all five floors of its available commercial space but also vowed to base the design of Pabulum's new logo on the wrought-iron grating around the balcony. "The building was pretty much vacant," he says, "and the whole idea of bringing in companies that could assist Pabulum [in realizing its new business model] formed in my head."
Davey's plan was at once simple and bold. If he could land a master lease on the whole building, he figured, he could then sublet space to other Internet-related companies--they would be both his tenants and his business partners. And he reckoned that the perfect lure to attract those companies would be to wire the entire building with a high-speed T1 telephone line. Since he was going to need one himself, why not make it available to all the tenants and boost the value of his investment? Buildings wired with a T1 line are in heavy demand in areas like San Francisco, where high-tech companies abound: T1 lines are much faster than plain old telephone service (POTS), and they allow for a continuous connection to the Internet instead of requiring users to dial and log in to an account whenever they need to go on-line. Wired buildings also command premium rents. If Davey could secure a master lease at a bargain price and manage to get a T1 line up and running, he could charge his tenants enough to cover his own rent and create positive cash flow to foot the bill for the rest of the technology Pabulum would need.
But could Davey score that crucial lease at a price that would make his numbers work? His inquiries turned up a mix of good news and bad news. The building, he learned, had been foreclosed upon and only recently purchased by its current owner, Albion Pacific Properties LLC, a San Francisco real-estate-development and -management company. Albion Pacific was renovating the building's shared areas, including the lobby and the elevator, but not the floors, some of which were in terrible condition. Ever the pragmatist, Davey pared down his aspirations from all vacant floors to two, the sixth and the seventh. Then he arranged a meeting with Albion Pacific's leasing agent, Art Wiener, and geared up for some serious negotiating.
The offer that Davey put together was unconventional, to say the least, but it was also too tantalizing for Albion Pacific's president, Andrew Meieran, to pass up. For starters, Davey agreed to pay a $12,000 security deposit (which included rent for January, the first month he'd take ownership) on a five-year lease up front, so if he defaulted on the lease, Albion Pacific wouldn't be left holding the bag. The real deal clincher, though, was Davey's proposal to "Internet-enable" 701 Sutter Street at no cost to the real estate company, a move that would significantly increase the building's commercial value--from $1 to about $2 a square foot. Davey also agreed to help lease out the rest of the building's available space to other Internet-related businesses.
In exchange for those concessions, Meieran agreed to lease Davey the two floors at well below the market rate--80¢ a square foot--for the first year. (After that, Davey's rent would increase each year, and in the fifth year he would be paying the 1997 market value for the two floors.) Meieran also granted Davey's request for a grace period from mid-November to the end of December, before Davey's rent payments kicked in on January 1, so that he could renovate the floors and complete the wiring installation.
For all that to happen, however, much remained to be done. Although Davey had laid the groundwork for getting 701 Sutter Street wired, he had yet to work out the details. Little did he know that his negotiating had just begun.
Shortly before Albion offered Davey an intent to lease, Davey had made an oral agreement with a telephone and computer-network dealer to have the T1 line installed at a wholesale price. The dealer, in turn, would profit by selling wiring services to the building's future tenants at the going rate. Then, on November 3, the same day Davey signed a renegotiated intent to lease with Albion Pacific, the dealer got cold feet and backed out. Now the pressure was really on: unless Davey could broker another agreement along similar lines, the building of his dreams was going to turn into a house of cards.
The setback, it turned out, was a blessing in disguise. On the same day that Davey learned that the wiring deal had gone sour, he met for lunch with a potential customer to discuss a Web-site project that would provide on-line tours of wedding locations. When Davey chanced to mention his predicament, his lunch partner recommended that he get in touch with WinStar, a young fixed wireless telecommunications company in Falls Church, Va., that bills itself as "an alternative to the Bell operating companies." WinStar, he informed Davey, was aggressively building its wireless network in San Francisco by acquiring the rights to place the dishes necessary for its wireless services--everything from local and long-distance calling to wide area networks--on the roofs of commercial buildings. In exchange for the "roof rights" to a building, WinStar would install a dish, free of charge, that could provide enough bandwidth for that all-important T1 line.
Davey wasted no time following up on the lead. Right after lunch he phoned the WinStar engineers, who were then in town investigating prospective sites for dishes, and explained his plan. Could they meet him at 701 Sutter Street that afternoon to see if the location was appropriate for their network? The WinStar reps agreed, and a few hours later Davey was whisking them up to the roof of the building (with leasing agent Art Wiener in tow) to get their take on the site.
The upshot of the meeting was another good news/bad news scenario. On the positive side, 701 Sutter was in "line of sight" of not one but two WinStar transmitters, which meant that the building had two separate access points into WinStar's network. On the downside, Davey's building was far too small for WinStar to consider wiring on its own dime, since the way the company recoups the cost of its free equipment installation is through acquiring new on-site customers for its services. "Typically, WinStar targets buildings that have at least 60,000 to 100,000 square feet," says Davey. "Mine is only 20,000 total."
Rather than giving up, however, Davey decided to find a way to meet WinStar's requirements. Albion Pacific, he knew, also owned a 100,000-square-foot building at 995 Market Street, in downtown San Francisco. So he went back to WinStar with a new pitch. "I asked them, 'What if I could get you roof rights to 995 Market, too?' That was a complete gamble. I didn't even know Andrew [Meieran] at the time. I had only worked through his broker [Wiener]. But I said, 'What if?' "
That what-if became Davey's ticket to technological plenty. WinStar agreed to place a dish on the roof of 701 Sutter Street at no cost, contingent on the company's obtaining roof rights to 995 Market Street. As for Meieran, he needed little convincing: outfitting the larger building with high-speed wireless telecommunications fell right in line with his own development plans. "I envisioned building a futuristic multimedia community there," he says.
In fact, Meieran was so gung ho about the idea that he teamed up with Davey to negotiate the specifics of the deal with WinStar. Meieran knew that installing a dish on the roof to provide the T1 line was only the first step in Internet-enabling a site. For the connection to be functional, every phone and every computer in the system would have to be hooked up to the T1 line, a process known as "wiring to the desktop." And he knew that a landlord could rent spaces already wired to the desktop much faster--and at a much higher rate--than spaces that required tenants to contract for their own connections.
Sensing they had a formidable bargaining chip with 995 Market Street, Meieran and Davey decided to ask WinStar to absorb the expense of the desktop wiring as part of the deal for the roof rights. Together they drew up a business plan to show WinStar how wiring to the desktop could bring the telecommunications company much higher returns than just placing networking equipment on the roofs of the two sites. With WinStar's own wiring and jacks in place for the dozens of employees who would soon be occupying the offices at each location, their pitch ran, the company would essentially acquire a built-in customer base. "We showed them that 'you will benefit by X number of dollars if you were to wire to the desktop,' " Meieran says. Davey further sweetened the pot by offering to use his local contacts in the Internet industry to provide the telecommunications newcomer with vital leads to other potential customers in the area.
The proposal was submitted to WinStar's West Coast managers in charge of San Francisco operations. The projected figures won them over, and they agreed to the ambitious wiring-to-the-desktop plan. Davey was ecstatic. "The estimated valuation of the wiring and equipment [for 701 Sutter alone] was in excess of $45,000," he says. "It is important to understand that for us it was free."
With the wiring agreement seemingly in place, Davey turned his attention to the remaining hurdle--his $12,000 security deposit. There wasn't a moment to lose: it was already mid-November 1997, and his intent-to-lease agreement was about to expire. With his checking account down to the double digits, Davey once again decided to up the roof-rights ante: he proposed that WinStar pay $4,000 for the roof rights to each of the two sites and credit the payment to his own deposit. That would leave him with $4,000 to raise.
This time, however, Davey's creative maneuvering failed to do the trick. There are as yet no hard-and-fast industry standards that govern how payments for roof rights actually change hands; the field is too new, and each deal is still negotiated ad hoc. Although Davey believed he had struck an agreement with WinStar, his security deposit never got credited, and he had to resort to some feverish last-minute hustling to meet his deadline. He wound up having to borrow half the 12 grand from a customer in exchange for help with some upcoming projects. Davey's wife was able to lend him the remaining $6,000, thanks to an insurance-claim payment she received on the very day that Davey needed to hand over his security deposit to Albion Pacific.
By November 20, after weeks of nip-and-tuck negotiations, Davey finally had his deal. His first rent payment wouldn't be due until February 1, which would give him the running start he needed to set up Pabulum's operations at 701 Sutter Street and find a subtenant. "I was the proud owner of two floors," he recalls. "It's a great space in San Francisco, and the cheapest deal in the city. I didn't have any equipment yet; I just believed it was a good idea."
The ensuing months, however, brought their share of new trials. No sooner had the lease been formalized, Davey says, than WinStar began waffling on its obligations. The top brass at corporate headquarters were now claiming that the required "wiring to the desktop" would be satisfied if they "wired to the router," the device that splits the T1 line from the backbone equipment to the tenants' PCs. The problem is, a wired router still doesn't establish a link to the actual workstations that a business would be using to perform on-line communications. "They were supposed to have the wiring done by January 1," says Meieran. "But they got to fighting among themselves: the tech guys, who said one thing; the midrange guys, who know part of the business and part of the technology; and the top guys, who don't know the technology at all and just see the capital investment as this huge amount."
Just like that, Davey's lease was again in limbo. His agreement with Albion Pacific called for him to "Internet-enable" the building, and the vagueness of that language was coming back to haunt him. (Once WinStar had agreed to "wire to the desktop," that became Meieran's definition of the term Internet-enable, and it was Davey's responsibility to sort out the technical details.)
The dispute led to a delay, and with it, Davey's honeymoon ended. He had planned to have until the beginning of January to get the wiring done and the rest of that month to secure a sublessee, but without the wiring completed, he couldn't sublet his other floor at the rate he'd counted on to be able to cover February's rent. And he had even lined up a terrific prospect--a well-known network-security company called MCR that was in the market for a wired office and eager to ink a deal. All the company needed was the assurance that the T1 wiring would be up and running, but now that WinStar was stalling, Davey couldn't guarantee a date when the service would actually be in place.
MCR eventually moved in anyway, but rather than leasing out the sixth floor from Davey, the company leased the fourth floor from Albion Pacific at a rate lower than Davey could afford to give. Not only that, but when MCR CEO Matthew Harrigan hired his own contractors to complete the connection to WinStar's T1 line and subtracted the charges from its rent payment to Albion, Meieran turned around and submitted the bills to Davey. After all, under the terms of Davey and Albion's agreement, the building should have been fully Internet-enabled already, and Davey was contractually accountable for any associated expenses.
MCR's wiring bills weren't Davey's only financial headache. Because he was spending virtually all his time haggling with WinStar, his business plan for Pabulum was languishing, and the billable hours he was able to devote to his Web customers had all but evaporated. By now it was March, and Davey was having to borrow more money to make his rent and--as he had no line yet for his own telephone service--to pay for his pricey cell-phone calls. Moreover, he still had an unoccupied floor to rent out.
So Davey did what Davey always did when he found himself in a tight spot: he forged yet another strategic alliance--this time one that would ultimately lead to Pabulum's salvation. He and MCR's Harrigan agreed to form an exclusive joint venture called the IDEAS Group. (IDEAS stands for Internet Design, Engineering and Security.) Together, the two companies would market themselves as a one-stop shop for Internet services, with Pabulum designing the Web interfaces and MCR providing the engineering and security arrangements.
Davey's partnership with MCR was a risky one, since at the outset he had no way of knowing how the wrangle with WinStar was going to play out. What finally broke the impasse, Davey says, was his being able to give WinStar executives hard evidence that they were losing the valuable customer leads he'd originally promised them in exchange for the T1 wiring. "We basically held them for ransom," Davey says, smiling.
WinStar officials would not comment specifically about the delay, saying only in a written statement: "There was a misinterpretation. However, it was resolved to our customer's satisfaction." True, but it took a four-month tussle that tested all of Davey's pluck and mettle as a negotiator.
The turning point had come at the end of March. One of the Internet domain names Davey had registered for in launching his virtual-real-estate plan was www.svb.com, an abbreviation for sauvignon blanc. Davey quickly noticed that confidential E-mail was mysteriously showing up at that address. The correspondence was intended for Silicon Valley Bank, based in Santa Clara, Calif., which was operating a Web site under the name svbank.com. Because the E-mail contained sensitive information on financial transactions, Davey was able to sell the domain name www.svb.com to the bank, so that any customers who inadvertently dialed in the abbreviation would be routed directly to the bank's home page. In the process Davey also acquired another key ally: the senior vice-president of Silicon Valley Bank's Emerging Technologies Division, Mark Horn, who took a shine to Davey's entrepreneurial gumption and suggested that the IDEAS Group join the bank's soon-to-be-launched eSource program.
The eSource program, which will enable the bank's business customers to network and team up with one another for crucial business services, is a perfect fit for Davey and Harrigan. It will give the IDEAS Group access to a select pool of businesses that are hot prospects for Web-site design and on-line security services. As for Davey, the deal proved to be a crucial stroke of good fortune: not only did he get a much-needed infusion of cash from the sale of the domain name, but he now had a rich source of customer leads that he could dangle in front of WinStar to show the telecommunications company what it stood to gain by holding up its end of the wiring bargain.
Dangle he did, and WinStar at last saw the light. By May 1998, 701 Sutter Street had a fully functioning T1 connection wired to the desktop, at no cost to the tenants or the owners. And in confirmation of Davey's initial vision the previous fall, everyone involved has come out ahead. WinStar has won several contracts from Davey's leads. Albion Pacific sold 701 Sutter Street at a profit, with the provision that all existing lease agreements remain intact. And Andrew Meieran is using the 995 Market Street site as the showpiece of what he hopes will be a lucrative chain of "smart" wired properties in both the Bay Area and Southern California.
And Jeremy Davey? To judge by the bustling offices on his seventh-floor aerie--chartreuse walls and all--Pabulum's virtual-real-estate realm has a bright future. The money he has saved on rent has enabled him to hire three employees and acquire the key pieces of technology he needed, including three Macintosh PowerPCs used as design stations, two Pentium 166s used as administrative PCs and design stations, and a battery of servers and server hardware. In addition, he has rented his sixth floor at the $2.10-a-square-foot rate he wanted.
"The great thing about leveraging is that everyone wins," says Davey. "If you make the deal attractive enough, people move very quickly to make it happen."
Julie Bort is a freelance writer based in Silverthorne, Colo., and coauthor of Building an Extranet (John Wiley & Sons, 1997).
Let's Make A Deal
Jeremy Davey's wired-to-the-desktop T1 line is a best-case example of what strategic alliances can get you. Yet most every business can benefit from such partnerships in some fashion, says John Harbison of the management-consulting firm Booz, Allen & Hamilton. "Alliances are a powerful option for all kinds of companies," Harbison claims. "But the need is even greater in high tech, where companies are growing so rapidly that they don't have time to do things for themselves. There are lots of opportunities for companies to come in and help in exchange for technology."
Some tips, from those who've been there, on how to leverage your technology investments through partnerships:
John Harbison: Consider alliances with large companies, especially those with a track record in them. Over a recent five-year period AT&T, for example, has formed more than 300 partnership agreements with companies of all sizes. But allow extra time for negotiations: decision making at large companies usually takes a while, and you're likely to run into some red tape.
Matthew Harrigan, CEO of MCR: Know exactly what you want out of a deal from the outset. Make sure your proposal states clearly who is going to do what and by when, and have options available on how to get each task accomplished.
Jeremy Davey, CEO of Pabulum: Tailor your deal for your prospective partner, specifying how a partnership will tangibly benefit that company's business. The more incentive you can provide, the more likely it is that you'll cut a deal quickly.
Mark Horn, senior vice-president of Silicon Valley Bank's Emerging Technologies Division: Always be on the lookout for potential alliances. Be creative in envisioning how you might team up with companies all across the business spectrum.
Andrew Meieran, president of Albion Pacific Properties: Choose potential partners both by the technology they offer and by their financials. Make sure they have the capital to do their part. Then, ask the right questions of the people who have the authority to respond, and get all aspects of the deal in writing.