How to Get Rich in America
A look at how companies like Palo Alto's Lunar Design are seeking the long-term payoff by taking equity instead of cash for their services.
True wealth doesn't come from working for a paycheck. A new generation of service companies, like Lunar Design, have figured out that it's all in the multiple
By most outward measures, Lunar Design would be considered a success. A Silicon Valley-based industrial-design firm, Lunar employs 40 people and last year generated more than $8 million in sales. The company's austere Palo Alto headquarters, with its starkly curved lobby walls, showcases its inspired labor for the likes of such techno-heavyweights as Xerox, Silicon Graphics, Hewlett-Packard, and Motorola. The firm played a key role in the design of Apple's Powerbook and recently gave shape to an ergonomically exquisite $5 toothbrush for Gillette's Oral B division.
But for all the firm's high-toned, West Coast cool, Lunar's success is, in part, more surface than substance. Industrial design is a competitive business, especially when you locate yourself in downtown Palo Alto, where office space goes for $4 a square foot per month (as opposed to half that in an industrial park three miles outside of town). "Margins are thin in this business," concedes Lunar's president, Jeff Smith. That has pushed Lunar into generally accepting whatever jobs walk through the door. "You're always doing someone else's work," adds Smith wistfully, rather than having the freedom to pursue independent projects.
When the firm opened its doors, in 1986, drafting tables were pretty much state-of-the-art. At the time, it cost Lunar about $2,000 to equip a single designer. Now, with the latest CAD software, the cost of setting up a designer can run as high as $50,000. The high cost of keeping current ensures that Lunar will have to continue to accept whatever work walks through the door—just to cover operating expenses. For all its apparent success and cachet, Lunar Designs seems to be running in place, albeit with plenty of style.
The Power Of The Multiple
The sense of running in place was the conundrum that bedeviled Smith, one of Lunar's three founding partners, back in the late 1980s, when he began talking up meaningful change with his two partners, Gerard Furbershaw and Bob Brunner. What would it take to change Lunar's business model to give the earning statement some upside pop and the design team a creative lift? Brunner, who left Lunar in 1989 to become Apple's chief designer, recalls having conversations with Smith about how they spent a fair amount of their time giving counsel and strategic advice to start-up clients, almost as if they were venture capitalists. If that was the case, then why not partake of the spoils?
So Smith and Furbershaw set out to liberate Lunar by hitching its fortunes to something more hopeful than the fee-for-service treadmill. Stock, not cash, would become the energizing and value-building force, the coin of their realm. The partners knew that $1 in cash taken as payment for design services would never amount to more than $1 in sales—and a lot less of that in profit. On the other hand, a dollar in equity taken in exchange for services rendered could someday multiply into $5, $10, or even $20. The value of a share of equity is limited only by the ultimate valuation of the company. By setting up deals in which Lunar would receive equity-based compensation from its clients, the founders could tap into "the power of the multiple"—the ability to turn what might have been simply a fee-for-service payment into an equity stake worth much more in the long run.
'We want talented people to participate with us simply to garner more passion and energy,' says Smith. Not only is the process more inspired; it's also less costly.
While Lunar Design is ahead of the curve in thinking about how to supplant cash with the exponential possibilities of holding equity, it is far from alone. It is simply at the advance of a powerful wave that represents a radical new way of thinking about how to transact business. Tapping into the power of the multiple is, in fact, becoming more apparent every day as an efficient way to operate. As the stock market approaches the once seemingly unreachable 10,000 level, as employee-stock-option grants explode, as mutual funds proliferate, and as Social Security begins its slow migration toward inevitable privatization, a broad understanding that equity is the path to enduring wealth has taken hold.
Leveraging an equity stake becomes a means to take better advantage of skills and to build wealth. It becomes a way for a company not just to control its destiny in a chaotic economy but to simply do a better job in a world where quality and timeliness count all the more. It amounts to more than just taking stock in lieu of cash. It's about integrating a company's fortunes with its customers'—and, ultimately, making work more creative and meaningful in the process.
Providers of all sorts of professional services, once happy to settle for fees, are now asking their clients for stock. Their clients, for the most part small, start-up companies, are responding, knowing that stock is a cheaper currency in the short run and a powerful motivator over the long haul. Consultants, lawyers, designers, public-relations specialists, and even bankers see not only more upside reward via equity but also a chance to make their work more varied and relationship-based. (See "The power of the Multiple: A Sampler," on page 52.) Jim Sweeney, a former consultant who was recruited to be the CEO of health-care start-up Bridge Medical, says, "This is a hot topic for all consultants right now." Sweeney, who is currently working with consultants from Parthenon Group, in Boston, believes that those who don't want to embrace it "will become competitively disadvantaged." Parthenon's CEO, Bill Achtmeyer, agrees: "Businesspeople make return-on-investment judgments every day, and CEOs are often incented by the rise and fall of the stock price. If we think we can provide good strategic advice, then we ought to take similar risks." In the case of Bridge Medical, Parthenon took all of its fee in stock.
The multiple is also a democratizing force. It unleashes the wealth-building potential for service providers—and their employees—that traditionally was held by the select "money" people: investment bankers, venture capitalists, angels, and high-growth companies dabbling in strategic partnering. Now a firm like Lunar, ostensibly tied to one narrow discipline, is assuming a far broader and more textured identity—a multiple personality of sorts. Lunar has become a de facto venture capitalists and is about to start developing its own products to entice others. It looks for good ideas wherever they may occur—in small start-ups and large corporations, and inside the heads of its own designers. It has built a virtual network of experts that it can tap to get an idea from concept to market as quickly as and as cost-effectively as possible. As it puts together projects Lunar retains as much of the equity as possible, keeping it in the hands of the people who have actually created the value. The sense of shared ownership and common reward is the unifying principle behind the power of the multiple.
Opportunities for companies like Lunar have been increased by a fertile investment niche opened by a mismatch between the high degree of entrepreneurial innovation in today's economy and the changed demands of venture capital. "There are a tremendous number of really good ideas out there that don't get done," says Gary Cantu, a high-tech entrepreneur who is currently working with Lunar Design. "Venture capitalists used to support seed-level deals, but that has changed drastically. Ideas in the $250,000-to-$1-million range are harder to fund because venture capitalists are looking for bigger chunks of stock and bigger returns."
That is where Lunar Design and its virtual network of partners fit in. Together they can pool their capital and invest smaller sums in the start-ups that are flying below the venture capitalists' radar. "We want to back anybody with a good idea and the right technology but who does not have the resources," says Smith. Lunar wants the ideas that would otherwise fall through the cracks.
