Keith says in this article and elsewhere on his website that the Microsoft/RealNames debacle was "not because of money, but because of fear of losing control." As shown on the previous page, I actually agree somewhat with that statement. Where my view diverges from Keith's, however, is whether or not that is inherently wrong. Without going into too much detail and straying from the financial topic of this page, let me just say that Microsoft wanted to control what went through its browser and search engine because it believed it had a responsibility and good business reasons for doing so. For example, anytime someone types "New York Kindergarten Classes" into a search engine and it links to a child porn site, there's going to be hell to pay. If it happens in the MSN search engine or through the IE browser, Microsoft is going to bear the brunt of those complaints. RealNames' revised model of first-come, first-served natural language keywords would have permitted just these types of poor navigation experiences. Now obviously the DNS system permits that type of result too, but there's a big and very obvious difference between DNS and Keywords -- for better or for worse, DNS is a standard. Everyone knows they are typing in a domain name when they append a TLD such as ".com" to a text string. Thus, if the user types "www.kindergartenclasses.com" and nevertheless arrives at a porn site, the user understands that this is not the fault of Microsoft, Netscape, Opera or whoever else supplied the browser software. They understand perfectly well that some pervert registered that domain name and put his vile content at that address. This, however, is clearly not the case with RealNames. With a Keyword, the user has no idea how or why they started searching for kindergarten classes in New York and ended up instead on Interpol's most wanted kiddie porn list. If RealNames' Keywords were a recognized and adopted standard, perhaps Microsoft wouldn't have cared as much (or at all) about the RealNames data. The fact is, however, Keywords are not a standard. And if Microsoft didn't exactly trip over itself in rushing to lend its support to a Keyword standard, that's probably because it thought -- like most other rational business observers -- that Keywords were a crappy idea. Let's not forget that when Microsoft first "embraced" Keywords, it was embracing high quality branded terms to supplement its MSN search engine.
So it was definitely about Microsoft wanting control, but at least in this context, there was absolutely nothing sinister about it. But that's not important right now. Let's focus instead on all that money that apparently wasn't that important.
Keith wanted Microsoft to invest in RealNames so badly it hurt. Keith also wanted AOL to invest in the company. He hoped that these investments could be done side-by-side with RealNames' IPO, and he wanted Microsoft and/or AOL to be "on the cover" of RealNames' IPO prospectus. Keith had heard that Broadcom did this when Cisco bought shares concurrent with Broadcom's IPO, and he believed that doing so in RealNames case would lend marketing "buzz" to the offering. This strategy was perfectly consistent with Keith's unbounded love for PR over substance (Keith once lectured us that building a successful business is "all about theater").
Let me provide some context: In the world of private company investing, there are generally two categories of investors: "financial investors" (e.g., venture capitalists, hedge funds and the like) and the so-called "strategic investors" (e.g., companies that will invest in a start-up because it has strategic value to their business). A general rule is that strategic investors pay more than financial investors for their equity because, unlike a financial investor that is only concerned with return on capital, a strategic investor is deriving some independent business benefit from the transaction. Based on this rationale, Keith once said that "Microsoft would not be price sensitive" regarding their investment in RealNames. He believed that he could get in the neighborhood of $10-15 per share from Microsoft for shares of RealNames Common Stock.
It didn't exactly turn out that way.
Up in Redmond, bravado quickly turned to ankle-grabbing. Microsoft's lead negotiator from Corporate Development, Sanjay Chheda, looked at Keith and Ted like a lion looks at a lame gazelle on the Serengeti. Not only was Sanjay "price sensitive", he didn't want to pay any price for the stock. He also didn't want that crappy common stock, he wanted preferred stock with all of its accoutrements -- like a liquidation preference, voting rights, and all those other things venture capitalists usually pay a premium for. He also wanted a lot of the stock, like 20% of the company. Finally, Sanjay also wanted some revenues for the MSN unit, so for good measure he asked for a $40 million payment guarantee over the two year term of the agreement.
The team came back to Redwood City dejected. A battleplan was quicky devised. RealNames would offer Microsoft the 20% in equity for no cost, but they could not have the $40 million in cash. Keith would also insist on full product implementation, including the redirect and search placement (Microsoft had also suggested that the deal would only include MSN search and not the browser). The team flew back up to Redmond for another meeting. Keith outlined the RealNames proposal. The conversation went something like this:
Keith: So, we've considered your proposal and we agree with much of it. But we must insist on the full product implementation. We must have the browser redirect or there is no deal. However, we are prepared to give you the full 20% equity stake at no cost.
Microsoft: [silence...]
Keith: [noticeably anxious at Microsoft's silence] "And the $40 million, of course."
We will never know if Microsoft would've agreed to the deal without the $40 million guarantee. Maybe they would have, and maybe they wouldn't. We'll never know because Keith was so desperate to get the deal and get his IPO back on track that he offered up the kitchen sink. However, here is an interesting story that provides some clue as to what might have happened had Keith not jumped in. John Krass once joked with some RealNames people about the original negotiation of the RealNames/Microsoft agreement. When it was noted that Microsoft repeatedly used the tactics you learn in Negotiating 101 -- the "higher authority" trick and especially the "stay silent and let your opponent fill the void" trick. John laughed and said, "Yeah, I honestly thought that if we had kept quiet and not said anything else, he would have offered us a pony."
Go Back to Part I of the RealStory
