Google's hard bargain

Wall Street's money machine gives the Web search mavericks rare power to cut their own deal, but business motives may win out in the end.

Stefanie Olsen Staff writer, CNET News
Stefanie Olsen covers technology and science.
Stefanie Olsen
6 min read
Money talks.

How else can you explain the antibusiness rhetoric of Google's quirky plan for an initial public offering, in which a pair of doctoral students both thumb their noses at Wall Street and convince some of its biggest powerbrokers to help make them billionaires?

The Internet search darling's filing Thursday revealed major breaks with the legacy of Silicon Valley IPOs and reflects rare concessions from venture capitalists well versed in the methods of breaking the will of company founders. Many have tried, but few have succeeded in fending off the calls of the money men.

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While it remains to be seen whether Google's iconoclastic leaders can adhere to their mission of running a public company, the sheer strength of their business has already proven to be the ultimate bargaining chip.

Case in point: Google's revenue grew 300 percent from 2001 to 2002 and another 176 percent from last year to 2004. Last year alone, the company had $105.6 million in net profit on $961.9 million in revenue. Excluding provisions for charges including stock-based compensation and taxes, Google last year had an operating profit margin of 62 percent, or $571.8 million.

"They're in an exceptionally strong position," said Hank Barry, a partner with venture capitalist Hummer Winblad, adding that Google's IPO plans are an anomaly in Silicon Valley, against the backdrop of tech giants like Yahoo, Oracle and Siebel.

A different path
Most technology companies and their founders have taken the path of least resistance in going public, bowing to intense pressure from venture capitalists and bankers and opting for the most obvious route to wealth. Not many tech company founders, for instance, write a seven-page letter outlining their belief system as did Google's, warning investors to proceed with caution.

Opting for a Dutch auction IPO, Google is attempting to give average investors a better chance to buy shares, shunning traditional methods. Typically, institutional investors run the show, setting the share price of an offered stock and allocating shares to parties of their choice. One company that fits the Silicon Valley mold is Salesforce.com, which recently filed to go public with the sale of 10 million shares--nearly 10 percent of the company, for an approximate market capitalization of $850 million.

In addition, Google co-founders Larry Page and Sergey Brin plan to maintain control of the voting rights of the company by introducing a dual-stock structure, granting more voting power in preferred share allocations. In the end, Page and Brin expect to maintain just over 50 percent control in the company.

Many media companies have opted for a dual voting structure, including The New York Times and Dow Jones. Google's choice of this method illustrates that Internet media is becoming more mainstream.

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This kind of structure gives company founders the ability to control their franchise through voting rights without being vulnerable to ousting by shareholders, when and if there are quarterly dips in performance. Eastman Kodak, by contrast, is facing intense pressure from shareholders over its intention to shift from an analog photography company to a primarily digital provider.

"It makes it difficult to remove them, so they can follow the investments they want to go after," said Mark Sherman, general partner at venture capitalist Battery Ventures. "In a system of checks of balances of financial markets, it creates a way of them of having more power relative to other companies."

It's not absolute power, however. If the founders were to go in a "wacky" direction, employees and ultimately, shareholders would defect, Sherman said. "Investors can vote with their feet every day."

Exercising their authority, Page and Brin added a "shareholders' owners manual" letter to Google's filing--an unorthodox approach to typically unreadable prospectuses--and indicated that they plan to run the company with a long-term outlook, rather than guiding investors quarterly.

Venture capitalists and securities experts agreed that no technology company has sought such control over the typical checks and balances of Wall Street.

"Every executive would love to say they're going to run their business on a long-term basis and not a quarter-to-quarter basis, but only Google can get away with it," said Peter Astiz, chair of the corporate securities group at national technology law firm Gray Cary.

Founders have often clashed with their financial backers. More than 100 years ago, New York financier J.P. Morgan forced Thomas Edison into a humiliating deal with a hated competitor in the electrical lighting business to create General Electric. Apple Computer's Steve Jobs was temporarily sent packing in the 1990s when powerful shareholders disagreed with his vision for the company. More recently, America Online founder Steve Case has found himself on the sidelines after his Time Warner takeover faltered.

Yahoo set a precedent for Google's colorful culture in the early days--but when its fortunes slid during the dot-com bust, its hand was called. Management stepped in to radically alter its largely care-free college campus style, bringing in former Warner Bros. executive Terry Semel and a more business-like, buttoned-down style.

Many techniques borrowed
Managed outside of convention, Google has borrowed as much as it has created in its path to domination in the search engine market, many industry watchers say.

Google followed in the footsteps of other Stanford University alumni Yahoo and Altavista. And its underlying search algorithm draws on the university's patented PageRank system, although it secured an exclusive license through 2011. The formula, which helped mint Google's success, makes it easy to determine a Web page's popularity by counting the number of other Web pages linking to it and their importance to the Web's structure.

Google also copied the successful formula of Overture Services, the pioneer of paid search, by auctioning sponsored text ads linked to keywords. While cribbing from Overture's system, it built a bigger and more profitable ad network. Ninety-five percent of Google's revenue comes from advertising, and then there's the company's operating profit margin of 62 percent.

What Google has perfected is standing by a singular credo: serving Web surfers with simple, fast search results. Its bare-bones site stands in stark contrast to cluttered portals such as Yahoo and MSN with the same features.

"The story of Google is not one of creation. The story of Google is one of doing it second and doing it better," said a former Internet search executive who asked to remain anonymous.

The company also has stuck to an unconventional management style. For example, Page and Brin ran the company for two years without electing a chief executive officer. Even after they hired Eric Schmidt, former chief executive of Novell, Google didn't adopt an orthodox management structure. Page and Brin kept their informal control over the company, continuing weekly status meetings with the entire staff against Schmidt's wishes.

It also created an unconventional product development strategy, in which teams of three or four engineers work together on new projects, or what's called Googlettes.

Despite the financial strength and the possibility of extreme wealth, Google's co-founders have long wanted to remain private. That way, they would ensure their control over the technology, maintain their privacy, and avoid being beholden to Wall Street. In essence, they bucked the common trajectory of technology companies toward going public.

However, in the end, Page and Brin acquiesced to the financial interests of employees and its investors, which pressed Google to go public in 2003, according to people familiar with the matter.

The resulting IPO prospectus reflects a compromise of the founders interests and those of Silicon Valley celebrity Kleiner Perkins and Sequoia Capital, industry watchers say.

"What they have done is stood up for what they believe in, despite intense pressure from investors and competitors--that's their biggest success over the technology," said Jim Pitkow, CEO of Moreover Technologies, whose former company, Outride Technologies, was bought by Google.

Still, Google's story as a public company has yet to be written. Decision making, leadership, management hierarchy and communication styles often change radically once a private company turns public. Any number of issues, including litigation from its biggest rival, Overture, over its paid search methods, could affect the company's management style and financial power.

"Whether Google has succeeded as a result of their management style or in spite of it remains to be seen," said an industry executive who asked to remain anonymous.