The Inside tory of Microsoft's Stock Issue ‘MNMONEY & MARKETS /COVER STORY INSIDE THE DEAL THAT MADE BILL GATES $350,000,000 m by Bro Uital Going public is one of capitalism’s major sacr ments, conferring instant superwealth ona few ented and lucky entre- preneurs, Of the more than 1,500 companies that have undergone this rite of passage in the past five years, few have enjoyed a more fren- zied welcome from in- vestors than Microsoft, the Seattle-based maker of software for personal Its shares, h 13, zoomed to § \ i | computers, offered at $21 on Mar on the over-the-counter market before set- tling back to a recent $31.25. Microsoft and its shareholders raised $61 million. The biggest winner was William H. Gates II], the compa- ny’s co-founder and chairman. He got only $1.6 million for the shares he sold, but going public put a market value of $350 million on the 45% stake he retains. A software prodigy who helped start Micro- soft wi still in his teens, Gates, at 30, is probably one of the 100 richest Americans. Gates thinks other en- trepreneurs might learn from Microsoft's experi- ence in crafting what some analysts called “the deal of the year,” so he invited FORTUNE along for a rare inside view of the arduous five- month process. Compa- nies hardly ever allow such a close look at an of- fering because they fear that the Securities and Exchange Commission might charge them with touting their stocl Answers emerged to a host of fascinating questions, from how a company picks inv: ment bankers to how the offering price is set. One surprising fact stands out from Micro- Soft’s revelations: Instead of deferring to the priesthood of Wall Street underwriters, it took charge of the process from the st PHOTOGRAPHS BY NUBAR ALEXANIAN ei 23MONEY & MARKETS nent, Micros DOS and N ing app! sheets and word:pracessing IBM, A nd other person: Ye ft stood p: floated stock wor al 1983, Nor did it budge in when three other microcompu feware companies managed ion of reasons were simple. Unlike its eit gains. Th 1655 New York Oi Bringing the road show i 24 FOR fie born child." 2 public offering wou! distr his employees. “The whe pro ced lke a pais and ‘once you're public, People 8 because the stock price doesn elect your financial performance. And to we a stock trader call up the chief exec sk him questions is earings shoulkn’ grease. fering was just a question he masters all sorts of knowledge & Gates had been sel tounding lelity- Oadly, Gate ns te slugsh Mereees dese ser withthe SEC, Once registred th etal hmocll. Gates elt Hi iin elect would bave a puble mate Bilen > enough investors ny dedicated to tects to make a publeofering says Jon A. Shirley, 48, M Microsoft ChairmasEmerging from a pow-wew 1 Michael Rome of Goldman Sachs ing officer. “We decided to do it when we wanted to, not when we had to, In April 1985 Gates, Shirley, and David F Marquardt, 37, the sole venture capitalist Microsoft (he and his firm had 6.2% of the ck), resolved to look into an offering. But Gates fretted. To forestall sticky questions from pote s, he first wanted to Jaunela two important one of them delayed over a year, pending agreement with IBM for developing pro- ‘grums, He also sound out key employees who owned stock or options and might leave once their holdings became sal- able on the public market, “I'm reserving the right tos warned. Don’t be surprised if I call rated Y THE board meeting of October 28, held the day skating, party for Gates's 30th birthday, the chairman Bad done his soundings re at ease, The board decided it was time to select underwriters and gave the taskcto Frank Gaudette, 50, the chief financial officer, who had come aboard a year before. Gaudette was just the man to shepherd Mi crosoft through Wall Sireet. He speaks in the pungent tones of New York City, where his ate fatter was a mailmai, an street smarts, He had already helped n offerings for three companies, all suppliers of computer software and services, sniffing millions in and felt ad prides himself Aspiring underwriters, a prospective investorin New York, Aies, Brown's Quindlen croft’ Gates, Shirley, and Gauedette. d been stroking Microsoft for ye: enticed the company's officers to so-called technology conferences—bazaars where entrepreneurs, investors, and bank ers look each other over. They had called regularly at Microsoft, trying to get close to Gates and Shirley. Gaudette had been sitting through an average of three sales pitehes of getacquainted dinners a month. Gaudettc proposed that since Microsoft was well established, it deserved to have a Wall Street name’ as the lead under- nt firm would put to- et the syndicate of underwriters, which eventually was to number 114. It would allocate the stock among underwriters and investors and pocket giant fees for its trou- ble, Gaudette suggested a “technology bow- fique” commanage the offering to enhance Microsoft's appeal to in who special ,e in technology stocks. ‘Narrowing the field of boutiques was ea: Only four firms were widely known as spe- i technology companies: Alex. Brown & Sons of Baltimore, LF. Roth: Schild Unterberg Towbin of New York, and two San Franciseo outfits, Hambrecht & Quist and Robertson Colman & Stephens. ‘Culling the list of Wall Street names took longer. Microsoft's managers concluded that ‘some big firms, including Merrill Lynch and Shearson Lehman, had not done enough homework in high tech, The board pared the ‘contenders to Goldman Sachs, Morgan Stan- ley, and Smith Barney. It also included Cable Howse & Ragen, a Seattle firm that could be a third co-manager if Gates and Shirley de- ‘cided that pleasing local investors w the bother ‘Get on the stick,” Shi Gaudette. "Keep Bill and me out can't spend the time. Give us a recommen: tion in two or three weeks. Early in November, Gaudette called the ight investment bankers who had survived he first cut. “I need half a day with you,” he said. “Take your best shot, then wait for me to call back. I'll have a decision before ‘Thanksgiving. But remember, it’s my deci sion—don't try going around me to Bill or Jon." Gauderte made up a list of questions, Tanging from the baldly general—“Why should your firm be on the front cover of a Microsoft prospectus?”—to the probingly particular, such as, “How would you distrib ute the stock, to whom, and why?” After a whirlwind tour of New York, Balti- recommendations to Gates and Shirley on November 21. Then he took off for a ten-day vacation in Hawaii, a belated celebration of his 50th birthday in the 50th state. No deci- sion would be announced until his return The investment bankers turned frantic. Theirs is a who-do-vou-know business, and they mobilized their clients, many of th Microsoft customers or suppliers, to besiege d Shirley dette bad methodically ranked the in- ent houses on a scale of 1 to § in 19 But he also stressedMONEY & MARKETS the chemistry between Microsoft and the the board quickly blessed the selection ther $10 million for 600,000 or so sha ns would finally determine the wi Goldman Sacks and Ale The underwriters, as is cust in initial Among the major houses, Gaudettehad been The off public oferings, would be granted the option ‘most imps tightly Links its un which writing group with its keeps close tabs 0 stitutional buyers. For those Ds ber 17 at e 0 sell more shares. If tion for 300,000 adalt Gaudette thought Goldman would underwriters and their attorney, Some confu create the liquid market the com: ecially good at maintainin iy _ sion rept inat first. Hes tle spe- as Mi ly cially, delayed the arrival of several key Gates had thought longest about the price n their eople until early afternoon. One of Miero- Guided by Goldman, he felt the market Soft’s high prios d accord a his gis ps ies was mi pe so carefully phrased that 0 Microsoft etowinalawsuitby puter software companies like Lotus and Ashton-Tate, which have na product lines. On the other hand, he figured the mar N DECEMBER rth Gates an phoned Ef W. Martin, 37, a vice esident in Goll tockholder co ning he had be slinsisted that the n misled. The comp s San Fr cisco office who had been calling on Micro- Sullivan & Cromvell,ahidebound WallStreet ket would give Microsoft a lower multiple soft for two years. "I lke you guys,” was miffed to see that the law than companies that create software for Gaudette said, “and Microsoft wants to give wnt only an associate, nota partner. mainframe computers because they gener: you dinner on December 11 in Seattle, Do The 27-point agenda covered every ly have longer track records and more pre you think you can find time come?’ the offering. 6 said the company was di ple revenues. A price of roughly $15, at the stuffy Rainier Club was awk: mplating a $40-million deal. Microsoft more than ten times estimated earnings for ward. The private room was large for the _ would raise $30 million by selling two million fiscal 1986, would put Microsoft's multiple party of eight, and one wall wa: hares at an assumed price of around $15, right between’ al software tition ideal for Existing shareholders, bound by Gate ‘comp party were me jrmal rule that nobody should unload mo A host © ame up at the all ne: how well they g ake or than 10% of his holdings, would collect the hands meeting. Both Shirley and Gates were break the deal. Microsoft's top dogs dida make things easy. Gates, who had heard seare stories about investment bankers fr friends like Mitchel Kapor, chairman 13 Development, was tired and preps bored. Shirley was ¢ know exactly what G ‘could do for Mi soft an hour everyone stood in & semicircle as Mart plained their efforts to be rechnology companies. An 9 - But it was not until talk mpany’s stock th ‘arms across his chest started rocking to and fo, a sure si terest. At the € er, M ablie offering of 1986—or ever. ‘Well, they didn’t spill their they s ood ane ed like nice gays,” Gates drawied jerward in. the we should go with the and Shirley drove back to Microsoft head uarters, is nanaging underwrit: ers. Gaudette leaned toward Robertson to his colleagues lot. “I gue: Colman & Stephens. But Alex. Brown had ting Microsoft longer than any other investment banking house. “Better the whore you know: than the wh f don’t,” Shisley concluded, Three days later When the SEC quibbled, she oferin 28 EE LUY 21,1986Around of pool passes the timeas ban aseyers wait forthe prospectus atthe printers mans Bin concerned that going public would interfere comb the text for the least hint of misrepre- managers exhaustively described their par With Microsoft's ability to conduct business, sent the prospee- of the business and fielded questions. Su Shirley wondered whether all three of Micro: tus « nive, Like all prisingly, the Microsoft crew tended to be soit’s top officers would be needed for the 5 discreet sales more conservative and pessimistic than the ad stiow,” meetings at which cor 00 esses anc interrogators, Steven A. Ballmer, 30, a vice representatives would explain the offering t0 strengths, all the while conc president sometimes describe i stockbrokers and institutional investors. as possible from competitors fer ego, came up with so many scenatios for Gates tried to escape the tour by saying, face osoit's one banker eracke tiously, “Hey, make the stock cheap enough VEN BEFORE Microsoft had picked “I'd hate to hear you on a bad day and you won't need us to sell it!” its underwriters, Robert A. Eshelman, By late January’ only one amgjor item re Miccosoft’s attorney, Willim Hl, Neukom, 32, an attorney at Shidler MeBroom, mained undecided—a price range for the 44, a partner at Shidler McBroom Gates & had started dra e prospectus. stock. The bull market that began in Septem. s in the ttle being Bil’s fa That task took all of Janwary, “As usualy’ bad kept 1 ead, pushing up P/E m H. Gates—raised another mat- says one of the investment bankers, “it was multiples for other software companies. The company would have to tone down Bataan death march.” Neukom, underwriters suggested a price range of $17 ‘cul id, lest it appear to st left Shidler MeBroom to join Mi share, Gates insisted on, and got, 1g," oF touting the stock. soft. sp ist week of 1986 with Eshel- $16 to $19. His argument was ultraconsery: ess releases could no longer refer to cer ske in bout the company’s tive; $16 would guarantee that the under: tain Microsoft programs as “industry stan- products and Twodays aweek for writers would not have to go even lower to dards,” no matter how true the phrase, the next three weeks, many of the people share price of $20 would Neukoms would review all y's of who had been at the all: hanes meetin rosoit’s market value above half ¢ nde even Microsoft's sleek he le suburb to edit the prospectus. ably high. the first sessions, on January 8 and9, Cliristopbe: the com the underwr he thought uncomfor head of Goldman sk rife with co soft’s stock could information in this a“ due d jon, griling the company's 0 skeletons. Gaudet lified that Sullivan & Cromwe for a lower range than the adictions. By sold only o On Febr rr rushed th proof of the prospectus to Los Angeles { furnished a pa Angeles of- Sullivan & Cromwell's approval and conti fice, Charles F 39. Gaudette had ued on to Washington, D.C., with 13 copies. met him years before in New York but was Two days later Microsoft registered w bowled over by how much he hid ch 1 objec fon, Microsoft would have to circu heavily amended one, inviting rumors the deal was fishy. However che wed. SEC, the unde riters sent out 38,000 gloomy the prospectus, many investors Rechlin was 4 pounds lighter and sported copies of the prospectu he lawyers be would fail to read it before buying. Then if shoulder-length hair and a fierce sunbun n waiting anxiously yents from the he market price promptly fell, they would For ten hours Gates, Shirley, and ¢ orMONEY & MARKETS A weary Gates ponders sort. Re Mics s managers —from Gates's doctor um of Gaudette's—called ack at the offering price eople, includ begging to buy Except for about a do Gates's grandmother and lis former house eeper, who wanted sal lots for sentimer al reasons, Gates turned most of them down, “T won't grant any of these gooty re quests," he said. “I hate the whole thing. Tm thinking and dreaming about is selling HEARSALS FOR the road chow ed and Gaudette apy crosoft’s inhouse attorney, had ad Gates to say nothing to anybo ed from the prospec int mation. At Goldman Sachs's New York offices for a February 7 rehearsil, Gates wondered to himself, “With my mouth taped, what's the point of giving a speech?” Ad ing about 30 investment bankers and unchara fobote monotone whe covering Nl tals ley stfengike He became annoyed snapped Gates: “You mean I'm s ‘ay boring things in an exciting delte, however, was in He praised arid repraised the company" rec his tak with clichés av jokes. "When it comes to earn claimed, showing a graph of qu changes, "the pavement is bumpy, but the experts roms Co hioned way: We: engagementsin privileged investors. E way through, the “It was a thorough review,” he says, “but it various ports tors called the SEC n, Eff Martin of Go ayal Observatory at stockholders to sell an ste al Les Mi to Annabels club. C the night away Quindlen, a se- curity analyst for Alex. Brown Festivity was many big_instit they would take tock as they could get. By the end of February the Dow Jones industrial average had passed 1700, In Lon don, Martin told G: marketing group con ry hot. The $16 to $19 would have to be market while euphoria fom the road show ran high. But the SEC held the starting flag. an. On March 4 and 5 an SEC reviewer phoned in the commission's comments oa the pre Describing liminary prospeetu The SEC older! equi- had picked all nits, from how Micro- lelte soft accounted for returned merchandise to competing in- whether Gates had an employment contract (he does not), Its major concer appeared to be that the underwriters allocate sh widely enoug pblie and not ike the offering truly wa for a handful of an was relieved. was nothing to make m ‘On March 6 Micros nach drop.” lawyers and avd negotiate changes, Meanwhile, the company persuaded two nal 295,000 schlin hones hore to Suny proof*a prospectus,MONEY & MARKETS ‘On Goldman's trading floor, far shares. The next day, as the lawyers pored ‘over proofs of a revised prospectus n Francisco office of Bowne & Co., the fi- nancial printers, Gaudette zestfully bi raise the price. Eff Ma had flown up to Seattle that m ‘good news. The “ list of buy tors—was among the best Goldmzn had ever seen. The underwriters expected the stock to trade at $25 a share, give or take a dollar, several weeks after opening. A sounding o big potential buyers showed that an offering price of $20 to $21 would get the deal done. Gates asked Martin to leave while he con: ferred with Shirley and Gaudette. This was a different Gates from the one who two months before thought $20 too high. “These guys whe happen to be in good with Gold- ‘man and get some stock will make an instant profit of $4,” he said. “Why are we handing millions of the company's money to Gold: man’s favorite clients?” Gaudlette stressed that unless Microsoft left some money on the table the institutional investors would stay away. The three decided on a range of $21 t0$224 share, and Gaudette put ina con: ference call to Goldman and Alex. Brown. Eric Dobkin, 48, the partner in charge of common stock offerings at Goldman Sachs, felt queasy about Microsoft's counterpro- posal. For an hour he tussled with Gaudette, using every argument he could muster. Com ing out $1 t00 high would drive of some high-quality investors. Just a few significant defections could lead other investors to think the offering was losing its luster. Dobkin raised the specter of Sun Microsystems, maker of high-powered microcomputers for ook” on Microsoft the orders from institutional inves- a2 RTUNE MAY 2), 1786 and Forester (in jackets) monitor the opening action. ‘engineers that had gone public three days ater ina deal co-managed by Afex. Brown Because of overpricing and bad Iuck—com petitors had recently announced new prod: ucts—Sun’s shares had dropped from $16 at the offering to $14.50 on the market. Dobl warned that the market for software stocks was turning if Gaudette loved it. “They're in pain!” he crowed to Shiley. “‘They"re used to dictat ing, but they're not running the show now and they can't stand it.” Getting back on the phone, Gaudelte crooned: “Eric, I don't mean to upset you, but I can't deny what's in my head, | keep thinking of all that pent-up demand from individual investors, which you haven't factored in. And I keep thinking we may never see you again, but you go back to INVESTOR'S SNAPSHOT J Microsorr | SALES (LATEST FOUR QUARTERS)$172.5 MILLION CHANGE IRON YEAR EAR NA | NET PROFIT. $33.3 MILLION CHa NA RETURN ON COMMON | STOCKHOLDERS’ EQUITY 30% ANE-YEAR AVERAGE NA | RECENT SHARE PRICE $31.28 ICE/EARNINGS MULTIPLE 23 TOTAL RETURN TO INVESTORS (OFFERING TO 6/20) Ta%" PRINCIPAL MARKET ache eng a7 sano notes: te Index ore the institutional investors all the time, ‘They're your customers. I don’t know whose interests you're trying to serve, but if you're playing both sides of the street, the \s dragged on, Shirley be- came impatient. Eshelman, the securities lawyer from Shidler McBroom, was waiting in San Francisco to get a price range so he ‘could send an amended prospectus off to the SEC. Finally Gaudette told Dobkin, “I've lis tened to your prayers. Now you're repeating yourself, and it’s bullshit.” The two compro: mised ona range of $20 to $22, with two pro- visos: Goldman would tell investors th target price was $21 and nothing less, and Dobkin would report Monday en which in- vestors had dropped out. big investors in Boston threatening to “uncircle” move their names from Gol Sachs's list. Chicago and Baltimore were fraying at the edges—T. Rowe Price, for ine stance, said it might drop out above $2 while the West Coast stood firm, The market had closed fat, worrying Goldma men. But their spirits revived the next day as the Dow surged 43 points. Gaudette, nowt confident that he and Dobkin eould agree on a final offering price, flew with Neukom to San Francisco to pick up Martin, and the three boarded a redLeye Aight fox New York. showered and aved, Gaudette reached Goldman Snchs’ Offices at 11 o'clock on Wednesday, March 12. Neukom walked over from Sullivan & Cromwell, where the other lawyers were preparing the last revision of the prospectus After lunch the two Microsoft oflicers went to Dobkin's office and patched Shirley and Marquardt into a speakerphone. The conferees had no trouble agreeing on a final price of $21. The market had risen an other 14 points by noon. The reception for a $15 offering that morning by Oracle Sys- tems, another software company, seemed a ‘The stock bid ‘opened About hal the potential dropouts, cluding T, Rowe Price, had decided to stay in, The only remaining issue was the under- writing discount, or “spread!"—the portion of the underwrit: ers to cover salesmen's commissions, under writing expenses, and management fees. Having agreed fairly easily over dollars, the two sides bogged down over pennie: Microsoft had always had a low spread ‘mind, no more than 6.5% of the selling price. ce that woefore negotiators at Sun Micro- achieved. Shirley approved, Neukom beck- stock nl at $27.75. The opportunity to systems, where Marquardt is a director, oned Dobkin back into the room, and Gau- take a quick profit was too great for many wangled 6.13% on a $64-n dette ultered one ened his institutional investors to. resist. Over the Gates wanted Microsoft to get assent to $1.31: “It's a go!” Dobkin hugged next fer ‘good a deal on its offering, But he had gone Gaudette. David Milles, a beefy ex to Australia, where he was dificult to reach. player who was Goldman’s syndicate es in Microsoft's offering has wound up In theory Gaudette lacked aut er for the offering, thundered down the in the hands of individuals, bove 6.13%, oF ju stairs to his office bellowing to his assistant, In the wake of Microsoft's tsiump Dobkin opened with an Doreen, we have a deal still fears that bed on e that weeks they sold off roughly half ier shares. An estimated one-third of the touched on what other Goldman clients had No longer able to offer stock tid, noting that Sun's spread was off the AUDETTE SAVED his cheers for prices, he finds it harder to lure talented pro- bottom of the e next morning. AtBAM.acouri- grammers and managers aboard. On the ath. managing nderwriten ved heal er had delivered Microsoft's “filing er hand, his greatly enriched executives have compensa marketing package” to the SEC—three copies kept cool heads. Shirley, who cleared over d raised Microsoft's offering price of the final prospectus and a bundle of exhib- $1 million o ares he sold, 20%. Goldman's best offer, Dobkin said, was its, including the underwriters’ agreement to most lavish. He bought a 45-foot cabin eruis- 65%, or $1.36 a share. But if pushed very buy # ich had been signed only er, traded in two cars for fancier models, and hard lternative, it might, justto hours earlier. ‘The commission declared at may givein to h aig for an ex: forts ¢ shares, wi keep things amicable, go as low as $1.34, 9:15 that Microsoft's registration was effec- otic horse. Gates used part of the $1.6 mil Having given away $62,000—each penny of tive. On the trading floor at Goldman Sachs, lion he got to pay off a $150,000 the spread was worth $31,000—Dobkin and Gaudette heard a trader say, “We're going to and may buy a $5,000 ski boat the room to let Micro- shoot the moon and open at 25! me. One vice president who raked in more At 9:35 Microsoft's stock traded publicly than $500,000 can think turned, Gaudette declared on the over-the-counter market for pt a $1,000 ev jven definite orders: no time at $25.75. Within minutes Goldman programmer who received nearly $200,000 more than $1.2 he argued, Micro- Sachs and Alex. Brown exercised their op- plans to use it to expand his warking hours soft was a much easier deal to handle than tion to take an extra 300,000 shares between by hiring a housekeeper Sun. As to the underwriters’ marketing ef- them. Gaudette cou That's just the kind of attitude Gates m prizes, Constantly urging people to the price of Microsoft's stock, he warns that it may bec A few wee ‘AL 3:90 the two sid after the offering, strolling through t Goldman Sachs now at ware developmi he noticed a chart of $1.30. They were arguing over $98,000 in a total fee of more th: nd pressure was building. TI 1@ Mat and would cl Members of the syndicate were: know whether the deal wi Microsc tock price posted on the door to er's office. Cates was bothered. sa distraction?” he asked a Dobkin Eric, you iterating h wasting my time,” Gaudette sighed wearily, his coat. “'m going to visit me saint ed mother in Astoria. When. y something to say, send a limo to pick me u With that, the Goldman team left the room. Dobkin retu door. “Sometimes these things go better with fewer people,” he observed, Gaud ited he lacked authority to go higher, “All Tean do is try to get another penny from Jon," he said. "But I'm calling him just one ‘more time, so don’t screw up.” “Make the call” Dobkin said, aude ned alone and closed the was leaving restaurant to bi 6th birthday git they could get, Gaud Zid, was $1.31. Thoush above Sun spread, it was way below what any other per sonal computer software company had #86 [0 33