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(Part 2)

Taysom worried that his idea might be ahead of its time. It seemed that all of the major search services were still sorting out their content and business models (InfoSeek was still charging for access, and nobody was selling advertisements). But Yahoo! seemed like an inventive site, so Taysom tried his luck and called. "And the first thing Jerry said to me," he remembers, "was 'if you hadn't called me, I would have called you. ' " Jerry got the news feed vision. He had been thinking about it himself for months. He further surprised Taysom by informing him that as far as he was concerned, Yahoo! was "not just a directory, but a media property. " And so almost a year before it logged its first nickel of revenues, Jerry had already started to view and position Yahoo! much as he views and positions it today.

Yahoo! and Reuters remained friends, but not partners, for months after that. Reuters was willing to offer its content in exchange for a share of the ad revenues it generated. But Yahoo! had no revenues to share just yet. With this and other business matters starting to loom large, Jerry realized that it was time to solicit some business-savvy help, to perhaps even write a business plan. At the time, an old college friend of his, Tim Brady, was in his second year at Harvard Business School. Business school shared an awful lot of syllables with business plan, so Jerry put Brady to work over his Christmas break. Partly using HotWired's first media kit as a reference (see Chapter 7), Brady quickly produced a five-page snapshot of Yahoo!'s business prospects for Jerry and Dave to present to venture capitalists. Thus armed, Yahoo! began making the rounds on nearby Sand Hill Road, the epicenter of the American venture capital community.

Jerry and Dave met with dozens of VC funds during the first months of 1995. This required them to become instantly fluent in the ways of some of the world's most sophisticated financiers, even as they continued to keep up with a growing daily deluge of site categorizations. On top of this they were now managing more Web traffic than all but a few people in the world had ever faced. There were no ready rule books to follow in this, and Yahoo!'s servers required constant tending. Soon days, then entire weeks slipped by in which Jerry and Dave barely saw their homes. There in their trailer, "Dave and I would sleep in the same spot," Jerry recalls. "He would sleep for about four hours, and then I would work. And then he would get up and work and I would go to sleep. " They played music continually, but there never seemed to be more than one CD in there (for months it was Hootie and the Blowfish, then somebody mercifully brought in the Counting Crows). Draining as all of this was, they were having a blast. "It's just one of those things where when you were doing it, you just thought it was the coolest thing," Jerry recalls. "There was nothing else in the world like it. You were doing it, and there was such camaraderie, it was like driving off a cliff. Like Thelma and Louise. You just don't know what's going to be out there. There might be a net to catch us, and there might be nothing. But we didn't care. We had nothing to lose. "

Before they really sailed into the void, Jerry and Dave found their way to Sequoia Capital. One of the Valley's best-regarded venture funds, Sequoia counts among its investments Apple Computer, which launched the personal computing revolution; Atari, which created the video game industry; Oracle, which has pioneered and dominated the database industry for years; and network hardware giant Cisco Systems, which is said to have been the single most profitable investment in the history of the venture capital industry. These are just a few legendary companies that Sequoia can boast about having seeded and nurtured to success. But these days, it's a Yahoo! poster that hangs behind its receptionist's desk.

Mike Moritz, the partner who led Sequoia's eventual investment in Yahoo!, vividly remembers his first visit to Dave and Jerry's trailer. When he arrived, the Chief Yahoos were "sitting in this cube with the shades drawn tight, the Sun servers generating a ferocious amount of heat, the answering machine going on and off every couple of minutes, golf clubs stashed against the walls, pizza cartons on the floor, and unwashed clothes strewn around," he recalls. "It was every mother's idea of the bedroom that she wished her sons never had. "

Moritz wasn't planning to stand in for anybody's mother, so the mess didn't particularly worry him. Other aspects of Yahoo!'s chaos, however, did. For one thing, it was still "very unclear who really cared about this," he recalls, and "very unclear what the business was. " Yahoo! also had no seasoned management, and "one of the craziest names around. Why would anyone ever back anything called Yahoo!?" But more than anything, Moritz was troubled by the fact that he could think of no instance in which "the venture community [had] ever invested in anything that gave a service or a product away for free. And people talk[ed] about Netscape giving its product away for free . . . but that's a lot of hoo-ha!"

Moritz's concerns were of course quite legitimate. Yahoo! was a goofy name, Jerry and Dave were anything but a proven management team, and their business model could be best summed up as giving away service over the Web. The popular notion that Netscape had already proven that this model could work was also, indeed, hoo-ha. The Navigator had never been de jure free for most people. And while its price tag was a de facto fantasy for the majority of its users, Netscape was known to be generating most of its revenues from client software sales. Yahoo!'s model at the time, such as it was, was far closer to HotWired's. HotWired's "product" was entirely free, and was supported by a well-defined ad revenue model (see Chapter 7). But Yahoo! was never designed to be a vehicle for advertising. Jerry and Dave were only considering an ad model in reaction to an unexpected opportunity¬and they were still anything but committed to selling ad space at all (Moritz recalls that they were in fact "very apprehensive . . . and justifiably, about adding a commercial taint to the Yahoo! service" for fear of turning off their existing users).

None of this meant that Yahoo! lacked commercial potential. The giving away service over the Web model turns out to be a very powerful one, and Jerry and Dave were fast becoming masters of it. Fortunately for all parties, Moritz saw this quickly. A former journalist, he was already convinced of the Internet's communicative power. His first visit to the trailer also made it clear to him that "these guys were sitting at a very interesting position on the Net that could, if developed properly, be reasonably strategic. "

But while Moritz was quickly sold on Yahoo!, others soon were too. America Online was the first to make an interesting rival overture. AOL was then about to eclipse CompuServe as the world's largest commercial online service, and was in the midst of a major push into the Internet market. The company felt that it needed a search engine, and made Yahoo! an offer that, Dave recalls, would probably have made him and Jerry into millionaires fairly quickly. AOL's alluring carrot also had a fairly menacing stick lurking behind it, in that the online giant warned Jerry and Dave that if they didn't sell, they'd soon find themselves competing with a deep-pocketed AOL-sponsored rival. This was no idle threat, as AOL clearly had the resources to build its own Yahoo! It could also jump-start that process by buying one of Yahoo!'s competitors (as it eventually did).

Dave and Jerry considered AOL's offer closely. But in the end they chose to build rather than sell. AOL was mainly offering stock for one thing, and the structure of the deal would have tied them to working there for years. But a bigger issue than money or liquidity was that "we still wanted to do it ourselves," Dave recalls. Building Yahoo! was fun, particularly without adult supervision. He and Jerry were also worried that selling to AOL would have "most likely killed" Yahoo! in the end.

A procession of other corporate suitors soon followed. Dave and Jerry held at least exploratory talks with MCI, Microsoft, and even CNet (see Chapter 8). But the only other formal offer they received came from Netscape. Netscape first contacted them when Marc Andreessen learned that they were planning to move off the Stanford campus. He soon arranged for Netscape to host their site for a couple of months. Some weeks into this arrangement, Jerry and Dave were invited to "just come on board as Netscape employees and do this," Jerry recalls. This offer was in essence quite similar to AOL's. Like AOL, Netscape wanted to take their service in-house, and sign them on as employees. Like AOL, Netscape also mainly had stock to offer. But unlike AOL, Netscape had not yet gone public, and its stock was still valued at an almost sarcastically low price. Netscape also seemed like a far better cultural fit than AOL, and the threat of it creating a rival directory if they said no was much scarier. All of this made turning Netscape down "a harder decision than anything else,' Jerry recalls. But in the end, he and Dave decided to go it alone. Sequoia financed their company in April of 1995 at an assessed valuation of $4 million.

Luckily, Netscape never did introduce its own directory service. It instead gave Yahoo! a tremendous boost by linking the "Internet Directory" button on its Navigator's toolbar directly to the Yahoo! site throughout most of 1995. This link amounted to a ringing endorsement from the world's most powerful Internet software company. It also made turning to Yahoo! a natural, easy, and preprogrammed action for everyone in the Navigator's vast user base. The timing of this could not have been better, as millions of people were then discovering the Internet (and the notion of Internet directories) through the Navigator. In this, Yahoo! became the default entry point for countless maiden explorations of the Web.

For its part, AOL eventually purchased WebCrawler, one of the better early index search services. WebCrawler went on to draw tremendous traffic, as subscribers to both AOL and GNN (an Internet service provider that AOL bought during its acquisitions binge) were given browsers that pointed directly to it (much as Netscape pointed to Yahoo!). But compared to Yahoo!, whose form and features subsequently evolved dramatically, WebCrawler remained very much of a no-frills service. In this, Dave was probably right to worry that Yahoo! would have suffocated as an AOL property.

Yahoo! did anything but stagnate in its makers' hands, however, as Dave and Jerry threw their company into high gear as soon as Sequoia's money was in the till. The first people they hired were Tim Brady, who had helped with the business plan, and an engineer name Donald Lobo. Srinija Srinivasan, whom they had met in Japan, then became Yahoo!'s first "surfer," or site categorizer. She went on to "single-handedly build the surfer and editorial department that Yahoo! has today," Jerry says. Her arrival (and that of the other early surfers) finally freed Dave and Jerry from the frenetic and at times tiresome job of site categorization.

With so many new people to train, deploy, and motivate, a new CEO quickly rose to the top of Yahoo!'s shopping list. This wasn't because Jerry and Dave planned to reduce their own involvement in Yahoo! They rather knew that their company had the potential to get big fast, and neither of them felt fully equipped to run a giant Yahoo!¬a sentiment that was no doubt shared by their backers at Sequoia. They hired an interim CEO to fill in while they looked for a full-timer. Within a few months, they met Tim Koogle, and their search was over.

Like Jerry and Dave, Koogle was a product of Stanford's engineering department. Also like them, he began dabbling in entrepreneurship while still a graduate student. His company "rebuil[t] engines for wealthy Stanford undergraduate students whose cars were always breaking," he recalls, and was not quiiite as successful as Yahoo! So after completing his studies, Koogle established a more substantive enterprise, a contract engineering firm that Motorola later acquired. Koogle remained with Motorola for several years after that. He worked in its Japanese operation, ran one of its Canadian divisions, then did some corporate venture capital work. Eventually he left to run a large division of Litton (later Western Atlas) called Intermec.

Jerry and Dave liked Koogle because they sensed that he "was willing to put up with a lot of change," Jerry recalls, and there was certainly going to be plenty of that at Yahoo! It also seemed that Koogle's background had prepared him well to see the company through many stages of growth, which meant that they could get "a great CEO for a long time to come" in him, Jerry remembers. Once Koogle started, Jerry and Dave were both happy to hand over the managerial reins to focus more deeply on other matters. Dave remained on the engineering team, while Jerry started working more on business strategy and outside relations.

Koogle recalls that his first order of business was to "put meat on the bones in terms of our vision. " Yahoo! needed to start producing revenues. It also needed to prepare for battle, as competition in the directory space would no longer be of the mellow, everybody-wins, EINet Galaxy sort. It was in fact likely to become quite hotly contested and lavishly funded, as Netscape's August IPO had made it clear that winning on the Internet meant winning very, very big. A number of serious competitors were by then on Yahoo!'s horizon. InfoSeek had stopped charging admission at its site, and was already selling ads. Lycos had split off from Carnegie-Mellon University, and was looking very commercial, hungry, and tough. So was McKinley, a company that had recently published a successful Internet Yellow Pages book. The jilted AOL was meanwhile starting to promote WebCrawler, Microsoft was almost by definition a potential competitor, and there was a pending dark-horse entrant to the race in a company called Architext. Dave and Jerry had had one close brush with Architext already during their swing through Sand Hill Road, when Netscape's backer Kleiner Perkins tried to talk them into merging with the company. They refused. Now they knew it was only a matter of time before Architext came after them (Architext is now called Excite, and its search service debuted in the fall of 1995).

Yahoo! met its competition with an entirely new look in August of 1995. A number of major additions were introduced to the site that month, the most obvious being advertising. Tim Brady recalls that the company "went out meekly" with that change. Just as feared, it was greeted with "a lot of E-mail saying, 'You sold out. I can't believe you're doing this,' " Brady recalls. This criticism stopped after just a few days, however. And if anybody actually abandoned the service for having the nerve to make a living, their boycott never dented its traffic. Along with advertising, Yahoo! rolled out a major overhaul of its hierarchy in which the original 19 top-level categories were pared back to today's 14. At the same time, the news service that Yahoo! first discussed with Reuters in late 1994 finally debuted. Accessed through a "Headlines" button on Yahoo!'s front page, this featured news stories in several topical categories (e. g. , Business, Entertainment, Politics, Top Stories).

Although it had been almost a year in the making, the Reuters debut was the first public indication of a new and deeper level in Yahoo!'s functional strategy. Yahoo! had traditionally delivered service to its visitors by literally sending them elsewhere. In offering news, it was now becoming a destination as well as a hub. This shift might have been viewed as simply an extension of the site's new revenue model, since now that Yahoo! was affixing its pages with banner advertisements, every page it served represented advertising real estate. Destination services like news that generated more traffic would therefore also generate more salable ad space.

But there was more to the Reuters' launch than this, as adding news was just the first of several major bids that Yahoo! has made to not only become a greater generator of traffic, but to also become a broadly useful tool. News was followed by weather information in December. Weather was followed by stock quotes in the spring of 1996. Stock was followed by a blizzard of new sites and services in the summer and fall of 1996. Through all of these additions, Yahoo! has been bidding to integrate itself with its users daily media habits, and more generally, to aggrandize its role in their lives. And within a year of the Reuters' launch, the site had succeeded in redefining itself and much of its market (as all of its major competitors followed its lead). No longer just a gateway to the Web, Yahoo! had become a nexus of information of all types. If it continues on its trajectory, it could well grow into a service that millions turn to daily as they now turn to their newspapers, phone books, and more.

The revenue implications that this could have are for now unclear. But the value in out-executing EINet Galaxy and the World Wide Web Virtual Library was no clearer back in the days of "Jerry's Guide," and if Jerry and Dave had stopped then to ponder their revenue model, they never would have started again. But they didn't stop, because they have always understood intuitively that more traffic and attention is better than less. The market value that Yahoo! attained scarcely a year after its first round of venture financing indicates that their early instincts were good. Not ones to fix unbroken things, Jerry and Dave are still essentially following the same strategy that they have been following since Yahoo!'s inception¬that of continually bidding for more traffic and attention by continually providing more and better service for free. They are now among the best people in the world at doing this. And they will almost certainly continue to be, because it turns out that giving away service over the Web has a real first-mover advantage to it. This is because success in this model is measured in traffic, and traffic on the Web begets more traffic.

As an early and successful player in this game, Yahoo! has always had a tremendous traffic base compared to almost anybody else. This makes it easy for it to stay ahead by continually parlaying its traffic into still more traffic. Yahoo! traffic begets more Yahoo! traffic because first-time Yahoo! users almost invariably find the site to be accessible, friendly, and useful. The service works for them, so they come back. Regular users become traffic annuities, and Yahoo! now has millions of them. Heavy traffic also makes for an ideal platform for launching new destination services, which can themselves generate still more traffic. For instance, Yahoo! became one of the Web's leading news providers the day it switched on its Reuters service. Many other sites had been providing news on the Web since long before that. But Yahoo!'s enormous daily audience provided its new service a vast ready constituency which soon eclipsed the readership of many longer-established news sites. Today, Yahoo!'s news service draws plenty of its own distinct and loyal traffic. This traffic can itself now help to launch still more services.

Once the August, 1995, makeover was complete, management turned its attention to the more mundane, and suddenly more pressing matter of funding the company. Yahoo! actually turned a profit shortly after it started selling ads. But profitability does not always translate into positive cash flow, and even if it did, Yahoo!'s market opportunity warranted far more aggressive growth than its meager income could sustain. For this reason the company lined up a second round of investment in the fall of 1995. Management asked for a $40 million valuation. This seemed adequately audacious, given that Yahoo! had only been making money for a few weeks, and had been assessed at $4 million just seven months before. But when the investors heard the figure, "nobody even blinked," Jerry recalls, which left him and his slack-jawed team thinking, "Shit, it should have been higher!" Still, everyone was happy just to have the money in the till, particularly in light of its sources. The financing's strategic investors were Reuters, which had long been an important friend, and a fast-growing Japanese conglomerate called Softbank.

Softbank was founded in 1981 by Masayoshi Son, a Japanese entrepreneur with an American education and Korean family roots. By the early 1990s it had become Japan's dominant computer software distributor (it now claims a 50 percent market share). Softbank first attracted considerable American attention when it acquired Ziff-Davis's trade show operations in 1994, gaining title to such properties as the enormous COMDEX computer conventions. It gained even more notice the following year when it acquired Ziff-Davis's publishing properties for $2. 1 billion, a transaction that closed just a few weeks before the Yahoo! investment.

Masayoshi Son learned of Yahoo! through Sequoia¬he sat on the board of Cisco Systems with Don Valentine, a Sequoia partner¬and became intrigued with Yahoo!'s business. His Ziff-Davis link immediately made him an attractive potential investor, as Yahoo! was already talking to ZD about partnering on a magazine at that point, and it seemed that this project could only go more smoothly if the publisher's new owner acquired a stake in Yahoo! as well. Jerry was also excited about Softbank's potential to help Yahoo! establish a presence in Japan. Japanese Web traffic was just starting to rocket at that point, which made it look like a great time to start a Japanese Yahoo! And since Jerry considered Yahoo! to be a media property, and therefore a cultural product, he believed that a Japanese Yahoo! would have to be locally grown in order to succeed. Softbank ultimately acquired 5 percent of Yahoo!'s equity in its second round of financing, which closed in November of 1995. The two companies quickly established a joint venture to develop Yahoo! Japan, and not long afterward, the first issue of Ziff-Davis's Yahoo! Internet Life hit the newsstands.

Yahoo!'s second round of investment funded the development of several second-generation Yahoo! services, as well as the hiring of several seasoned managers. This new team was put to its first real test in December, when Netscape made it clear that the Internet Directory button on its Navigator would soon point to rival directory service Excite (formally Architext). This button had been pointing to Yahoo! for almost a year by then, and had brought the service considerable cachet. It had also at times fed it up to 20 percent of its traffic directly¬a significant proportion which if anything understated the button's significance, as many (perhaps even most¬there was no way to tell) of the people who came directly to Yahoo! had originally discovered it through the button. Jerry recalls that there had been talk about reallocating both of the Navigator's buttons (a second button, "Internet Search," had long pointed to InfoSeek) since the summer. Nobody had a problem with this, as the buttons had turned out to be very valuable real estate and it was quite reasonable for Netscape to want to start charging rent for them. But the process, Jerry recalls, had been "a long and tortuous road. ' At one point, Yahoo! had been asked to submit a bid for its button. At another, there had been talk of connecting the buttons to an alphabetic listing of links to several search services (which sucks if your name starts with "Y"). But all had been quiet for some time when Netscape suddenly called with the news about Excite in mid-December. "We were like, shit, merry Christmas to you guys too," Jerry remembers.

The change was implemented almost immediately, and everybody held their breath over the holidays. Then in January, Yahoo! was still one of the Web's biggest draws, having lost less than 10 percent of its traffic. Tim Brady now looks back on the button calamity as "a turning point for us as a company, mentally," because "it was like the floor was pulled out in a matter of two days, and we were still standing. We were looking around, waiting for things to collapse in a lot of ways. And we were just like, I guess we're on our own now. It was that kind of feeling. And bad as it was at the time, it was a good feeling like. . . . OK, we're our own business, you know, love to be there but we're not there, so let's deal. And it really gave us this feeling of independence, and made us think about how we're going to do things and approach markets outside the confines of Netscape. "

Bigger, older, better funded, and still standing, Yahoo! entered 1996 ready for the mantle of autonomy and stability that an initial public offering could give it. The timing for this seemed perfect. Netscape's August IPO had shown how hungry, nay, ravenous the investing public was for exposure to the new medium, and few business seemed to offer more direct exposure to the Web's growth than the search services. After all, the more people use the Web, the more they needed to search. So as Web usage went, so should go the directories (or at least their traffic). Yahoo!'s own traffic history certainly supported this notion. By February of 1996, the company was serving over six million pages to its visitors every day. This was double September's traffic, several times the previous February's traffic, and growth wasn't slowing. Yahoo! had also already signed up more than 80 paying sponsors in less than six months, indicating that it was highly capable of converting its traffic into revenue.

Long before finalizing its IPO plans, Yahoo! got another call from Softbank. It turned out that Masayoshi Son wanted to up his stake in the company. And this time, he wanted to acquire enough of the companys equity to make his holding one that he could deem "strategic. " Yahoo! CFO Gary Valenzuela recalls that Son "made a very specific point of saying, the way I look at investments, there's a line [at] 30 percent" ownership, which to him meant the difference between being a financial investor and "a real partner. " Being above that line was very important to him.

Jerry and Dave agonized over Softbank's offer. They knew that Son was the gateway to Japan. Between that, his Ziff-Davis properties, and his expanding interests throughout the Internet, he could clearly become an outstanding partner to their company. But Yahoo! would have float at least 10 percent of its equity in the IPO to make its stock adequately liquid in the market. Selling Son enough of the company to leave him with 30 percent of it afterward would therefore require that both Jerry and Dave sell off large pieces of their own holdings. Jerry recalls that neither he, nor Dave, nor Sequoia particularly wanted to sell anything. So in the end, they all sold in equal parts and made the deal work. Jerry, who like Dave was left with just over 15 percent of the company after the IPO (to Sequoia's 17 percent and Softbank's 37 percent) knew it was the right thing to do, but it still upset him to sell off such a big piece of Yahoo! "It's like giving part of your kid away," he now says. "It really feels like that. Nobody believes me, but that's basically what it feels like. " Still, the kid did all right from the deal, as Softbank's investment put over $60 million into Yahoo!'s coffers.

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