SEASON 2 - EPISODE 0106 - APRIL 24, 2024

A Spin-Off Story

In the podcast, REWORK host Kimberly Rhodes talks with 37signals co-founders, Jason Fried and David Heinemeier Hansson, about their journey spinning off products. They stress the value of keeping contracts simple and how once the handover is done, it’s best to take a hands-off approach and let the new team run things. They share their experiences with boards and underline the need for trust and flexibility.

Watch the full video episode on YouTube

Key Takeaways

00:43 - The steps they took to transition “Know Your Company” into its own independent entity.
04:49 - Contracts don’t offer as much protection as people believe.
10:58 - The differences in spinning off a startup vs. a long-established company.
14:53 - Letting capable partners take the reins and run the show independently.
18:51 - The challenge in finding the right partner for a spin-off business.
20:12 - In any transaction, things may not turn out as expected, but it may be worth taking calculated risks.
23:19 - Contracts don’t necessarily prevent disputes and can sometimes escalate them unnecessarily.

Transcript

Kimberly (00:00): Welcome to REWORK, a podcast by 37signals about the better way to work and run your business. I’m your host, Kimberly Rhodes and with me are the co-founders of 37signals, Jason Fried and David Heinemeier Hansson. Well, a lot of people think when you close a business or wrap up a business, you have two options. You sell it or you just shut it down completely. But there are other choices. In fact, I want Jason and David to talk to us today about another option they’ve done with spinning off a company. So Jason, let’s start. I think a lot of people might know the company for Basecamp, HEY, ONCE, maybe even Highrise, but you guys have actually had other companies and have taken them in different directions. So kind of tell us the story of Know Your Company.

Jason (00:42): Well. Yeah, so these all start off as products. So Know Your Company was an internal product. We also had something called the We Work Remotely job board, which was also a product which we spun off and sold. So we’ve sold things, we’ve spun things down, we’ve absorbed things, and then in this case, in Know Your Company’s case, we sort of spun something off. We also did this with Highrise as well. We spun it off. That ended up differently. So we can talk about a wide variety of things, but in the case of Know Your Company, we built this thing, I think it’d been about a year or so since it had been out, something like that. And then we decided to sort of simplify our entire product range and have fewer products. So it made sense to spin that one out. And we happened to know someone named Claire Lew who we’d worked with previously as a consultant who we thought would be perfect to run this thing.

(01:27): And the business had only done about a quarter million bucks in revenue at that time. So it wasn’t like a huge deal for us, but it was something that was happening, was growing, was interesting, it was new, it was exciting, and Claire was kind of perfect. So we kind of, in effect kind of got lucky that we happened to know somebody who we thought could run with it and was really kind of aligned with it, and we wanted to make it really simple. The thing I hate most about pretty much everything in the world is paperwork. I just don’t like paperwork. I don’t like legal things. I don’t like contracts. I’ve signed a thousand contracts in my life, never had to deal with any of them. You put all this effort and energy into writing contracts and all these protections and all these clauses and all this stuff, and they’re five pages and you go back and forth and back and forth and you sign 'em and you never refer to 'em again.

(02:13): I know some people are going to go, well, I got in a lawsuit once and whatever. I haven’t, it’s not an issue for me. I don’t like all the work that goes into basically nothing. So we wanted to make sure there was a very, very simple structure for this. So we came up with this idea that, hey, we’ll give you half, we’ll keep half. And if you get to a million dollars in revenue after, I think it was actually after we spun it off, or maybe it was in its history, I forget how that was worded, but when you hit a million bucks, we’ll give you 25% more and we’ll keep 25%. So you get 75, we get to 25, and that’s how it works in perpetuity. It was a one page agreement, which I posted on the internet for people to see, and it is like five things like this, that, the other, this and that done, sign it. We had to make some amendments to an LLC agreement as well, but fundamentally it was that simple and we’ve never had to deal with anything since. I mean, she eventually passed the million dollar mark, so she has 75, we have 25, and everyone’s living happily ever after.

Kimberly (03:15): What year is this? Are we talking about, by the way?

Jason (03:18): I don’t remember. David, do you remember what year it was?

David (03:21): 14? 2014 maybe? Is that right? They just celebrated. Yeah, it’s got to be 2014 because…

Jason (03:27): Oh yeah, 10 years,

David (03:28): Right? 10 years.

Jason (03:29): 10 years, yeah. And the idea again was like, how simple can this be? I mean, literally it could have been a handshake. I mean it wouldn’t have changed anything, but we made it one page. And I think part of this too is just our own daring ourselves to just do that. What if we just made it one page? Why is this have to be more complicated? Certainly we can give it to lawyers and certainly they’ll make it more complicated and certainly they’ll add more pages and they’ll bill everybody on both sides and nothing’s going to matter at the end of the day anyway. So let’s just keep it real simple. And we did that and it worked. And it’s not to say every time anyone ever does something like this, it’s going to work. But I do think it’s a very, very viable option in many situations.

(04:09): I think things are vastly over complicated, primarily by lawyers, but also by everyone’s own concerns and fears and expectations about all the things that could possibly go wrong. And what’s interesting about contract law is that lawyers on both sides spend a lot of time making these bulletproof contracts, and yet people are always in litigation about contracts. So it’s like you can make these things as waterproof and airtight and whatever buttoned up as you want. It doesn’t seem to matter. You can still get yourself in a lawsuit and arguing and spending and going to court and all the things. So we just prefer to keep it simple.

David (04:44): I think it’s a basic notion of risk management where a lot of people have insurance for various things that they consider both to be a remote possibility, but a likelihood that’s realistic and that if the damage does occur, it would be seriously damaging to them or their financial state. That’s why you take out a piece of insurance. If you look at this case, here’s a business that by the time we spin it off has done a quarter of a million. That’s something, not nothing, but it’s also not that much. If Claire had actually been a completely devious person and not the extremely likable, honest individual that she is, and she had somehow sort of cheated us because this contract didn’t have all the provisions that a million lawyers would put into it, what was the risk? What would we have let go of? First of all, if Claire hadn’t been there, if Claire hadn’t been able to take this over, we quite possibly just would’ve shut it down or at least put it into legacy mode until the end of the internet set up.

(05:51): It wouldn’t have evolved further. So what was the risk we were trying to mitigate or could have mitigated by making a more ironclad airtight contract? There just really wasn’t a lot, and this is the part that gets me with a lot of contract negotiation is that the initial risk assessment is just poor. Doesn’t matter. If it’s one thing or the other thing doesn’t matter. Are we able to absorb the worst case scenario that comes out of this? If so, what’s the point? As Jason says, the contract doesn’t do very much in terms of ultimate protection. What it might do is by the time you’ve been through years of legal wrangling, there’s an advantage on your side if you have something. But first of all, when are you ever going to go through that? Is that worth this object? And a lot of times the answer will be no.

(06:46): As Jason said, I’ve signed a ton of contract in my time too, and one of the areas where I see this the most is in racing. So in racing, you’re signing contracts across jurisdictions. Racing teams usually deal with people from all over the world. So you have a team in the UK trying to sign a contract with a driver in the US and everyone sort of pretends that it’s a real contract even though there’s absolutely no enforceability in it. If a company from the UK wants to sue an American driver for breach of contract, good luck. It’s never going to fucking happen. And you also tend to see it occasionally drivers and teams and other individuals, they do break their contracts and people go like, yeah, okay, that kind of sucks. So you have this kind of pretend world. We’re pretending that the contract really covers all the bases.

(07:35): We’re pretending that it’s enforceable and actually maybe one in a million contracts actually A will be enforceable, B will be about something that matters and C will eventually create some sense of justice or restitution. Most of the time that’s a really bad bet. It’s a really bad use of your time and your money, especially on the legal side of this. If you had gone through that with a couple of investments too, where you look at the legal bill afterwards for making that investment, you’re like, Jesus, that’s fucking 10% of the proceeds that went into the business just went to the legal operation of it. Again, not proportionate at all. So yeah, contracts are essentially an illusion most of the time where we sort of agree to pretend that the truth it, it’s governing it, but it’s a very thin line and I would not pay that much in most cases for that piece of fiction.

Kimberly (08:33): Okay, so let’s go back to the beginning because I think it’s an interesting choice to spin off this brand where you guys have had many other products that you haven’t spun off and have kept until the end of the internet. So I mean quarter of a million dollars, a lot of people listening are probably like, that’s a lot of money to start off after a year. Why did you decide to spin off that one in particular? And then you also mentioned Highrise, so maybe we can talk about that as well.

Jason (08:57): I’ll give you a few different reasons and I can’t tell you which one was actually the one. It’s usually never the decision or the reason. It’s like a handful of things that sort of come together. This was relatively new first of all, so it was easier in a sense to spin it off. It just was a new thing versus something we’ve been running for four or five years. Your tentacles get into something, things get tangled up with other systems. We actually had built this in a way where it was actually pretty clear cut or pretty clean, easy to cut off I would say. The business model was entirely different. You would pay per employee once, so it wasn’t a one-time fee for the product, but for every new employee it was a hundred bucks once. So the whole thing just felt like a different thing and we were really gung ho to focus just on Basecamp and we had these other things. Some of them got put into Basecamp, for example, Campfire at the time got moved into Basecamp. Highrise, I don’t know if we’d spun it off yet at this point or we spun it off later. I’m not sure. I don’t quite remember when we spun that one off maybe before that. I don’t remember actually when that happened. David, do you remember?

David (10:08): It was after.

Jason (10:09): It was after? That hadn’t happened yet, right? It was like a perforated piece of paper. It was like a clean cut, very easy to hand over. And because it was new, it felt like we were in a sense giving away less, especially if we’re going to give away half of this thing. And then ultimately up to 75%. Had we been running on this for 12 years, I don’t think we would’ve given away half, just no big deal. So for a bunch of different reasons, it just made sense and we had this operator, Claire, who we thought would be just absolutely perfect and would run with it and was totally responsible and had done some product development and was a designer and just loved the subject matter. It just all made enough sense that it was just the right thing to do, I think.

David (10:54): A key part there is it wasn’t quite at the idea stage. Something was built, it had real revenues, it had real customers, but as Jason said, for us it wasn’t material. The other more likely alternative was exactly, we’re going to put it into heritage mode and we’re going to run until the end of internet, but we’re not really going to make any more money off it. So it felt like almost like a startup idea. When founders get together and do a startup, it’s easy to talk or easier to talk about equity than it is 10 years into an existing business that has tons of customers and real value. It actually becomes really sticky and that was perhaps part of the problem we had with Highrise. Highrise was a huge business. By the time we spun that off, it was doing millions and millions of dollars a year in revenue.

(11:47): It had tens of thousands of customers. If it had been a standalone startup, it would already have been in the top one percentile of startups in the SaaS world of how well it was doing. So you couldn’t just do the same thing. You couldn’t just find an operator and say like, here, it’s a gift for literally tens of millions of dollars. And that’s why with Highrise, we tried something else first we tried to sell it, but what we found at the time was it’s quite difficult to sell a business where the team doesn’t come with and we weren’t willing to sell part of the team with Highrise. We wanted to find someone else to run it and do it like that. So that ended up being a different situation where we retained a hundred percent of the equity in Highrise and we brought in a new team to operate it but not own it.

(12:34): That did turn out quite differently. Was it because of the structure? I think probably not, but it was easier to see how clean the cut could be with Know Your Company and just what a great fit Claire was for that business and we could all just smile and do virtually a handshake. And I think that’s the other reason why the contract for handing it over could be just one pager. I don’t know. I’d like to, maybe we would’ve been as bold, but it’s harder to do a one page contract for something worth literally tens of millions.

Kimberly (13:05): Yeah. Okay. So tell me this because I’m curious about your involvement. I know you mentioned there’s just a one page contract and I’ll link to that in our show notes, but from that point forward, were you two hands-off and someone else is just completely running this and you’re taking a little bit of the profit, or are you still involved in the day-to-day?

Jason (13:26): There was some technical transition work that we had to do to help her get her stuff running on her own stuff. I had trained her a bit on because at the time I was doing, there’s actually me and another guy here at the company were doing all the sales, so this was actually a sales heavy product before anyone could sign up, I had to sell them and that was a requirement. No one could sign up self-service at the time. It was like, here, let me walk you through this thing. Let me show you how we use it. Because it was a big ask. It was like for most companies, if we had 30 employees, it was three grand upfront once, so it was just a different kind of thing. So I’d walked through these sort of sales with Claire for, I don’t really know how long it was, but it was enough for her to get a sense for how I was selling and how I was talking about it and the questions that had been coming up with customers and how to address some of those things. And again, then some of the technical assistance. And then she eventually hired another programmer, and I think it was after that it was hands off once the transition technical transition happened, and she is a quick learner, she knew the material. It wasn’t hard for her to get the sales process, but it would be unfair just to literally give someone a box and be like, here, it doesn’t really work that way. It needs to be some transition.

David (14:44): What I thought was interesting with the transition was that we instituted a board. It was Claire, Jason and I, and we operated that board for I think maybe five years. I want to say maybe it was slightly shorter than that, maybe three or four years. And we would meet, I think once a quarter or at least once every six months and go over the challenges and whatever. And after we had done that, maybe 10, 20 times, Jason and I looked at each other and went like, you know what? We can’t teach Claire anything. Claire knows all the material better than we do. She knows her business better than we do. She knows the technical challenges better than we do. Why are we making Claire show up to these board meetings and just tell us everything she already knows? It feels very loop sided. It feels like this is just for the surface of us, for Jason and I to get an update on the business that we have a stake in and we don’t really need that.

(15:40): We trust Claire to run this well. Let’s just disband the board. And that’s exactly what we did. After I think about whatever 15, 20 board meetings, Jason and I said to Claire, do you know what? You don’t need to do this anymore. You don’t need to put time into the presentation. You don’t need to put time into the update. We not only trust you, but you have exceeded whatever we put into it in terms of knowledge and direction and so forth. You should just run it how you see fit, and that is such an interesting contrast to the other boards I’ve had. I was about to say fortune, but I actually mean misfortune to have been on ever since. I fucking hate boards. I actually have a board meeting tomorrow and I’m not looking forward to it because boards in most cases, again, there’s a million exceptions…

Jason (16:29): Are boring.

David (16:31): They’re boring. My eyes pop out kind of boring because they’re an update that’s rehearsed, prepared by an operating team who’s trying to keep a number of stakeholders happy and cheery about the sense of the business. Again, I’m sure there are excellent board members in situations where that’s not the case. I’ve never been on a board meeting that felt like that. I’d never literally been on a single board meeting and I’ve been on a lot that felt consequential. That was like in this room, with these people, during the one hour we have, we cracked a hard nut. We saw the light, there was this interaction and we were arguing back and forth and ta-da, here’s the solution. Never fucking happened. Never happened. It doesn’t mean there’s not the occasional pleasant conversation, but I just felt like this is a waste of time. And I remember talking to Jason about it at the time and it was a little bit the same thing of, okay, so why couldn’t a handover agreement just be one page?

(17:34): Why couldn’t you just disband a board if it’s no longer serving a helpful purpose neither to the business or the owners or the operators? I’d never heard of it before, never heard of a voluntary disbanded board. Usually that’s not how it goes, and I think that was part of the appeal. Let’s try that and what a success. I can’t even imagine asking or having asked Claire to have done this a hundred more times or however long it’s been in the 10 years since we spun it over or handed her over to her, that would just have been complete waste of her time. Doesn’t mean we’re not still there. It doesn’t mean you can’t still tap either Jason or I to ask, and I’ve talked to her technical partner a number of times, Daniel who does things on the Rails side, all that can happen doesn’t have to happen inside the stodgy formality of a board.

Kimberly (18:25): I think this is an interesting story because you knew Claire, you had a Claire, someone who’s listening who’s like, yeah, I have this business and it’s doing great, but I don’t want to be in it. How did they find a Claire? How did you find a Claire that was a perfect fit for this business I’m going to hand off and still make a profit from?

Jason (18:44): I think it’s incredibly difficult. I think we got lucky. When we met Claire. We didn’t meet Claire because we were trying to sell her a business or give her a business. We met Claire because other reasons, Claire was actually a consultant doing similar work. We met her through a guy named Neil Sáles-Griffin who we’d been working with on something else and they’d gone to school together and it just kind of like happened. We’re like, you know what, Claire, would it be great to run this? I think going out and searching for a partner, which is essentially what that is, is a really hard search, but they exist. Operators exist. People are out there who had started business before and are looking for something new right now, or they’re an entrepreneur in residence somewhere. Frankly, I don’t have good advice for this because I think we’ve had a couple experiences.

(19:23): One is we did the Claire thing, which I think worked out in that situation. We also sold, We Work Remotely to another company. They got a better deal out of it than we did certainly, and the Highrise spinoff wasn’t really a full spinoff. It was bringing in a new team that didn’t end up working out. Three years later, we brought it back in house and we’ve been dealing with that ever since. So I don’t know what our track record really is here. It’s a hard thing to do. I think there’s some people who buy and sell businesses all the time. I think you’re better off asking them. I don’t really have great advice on this.

Kimberly (19:59): That’s fair. David, anything else to add before we wrap it up?

David (20:03): Yeah, I’m trying to think if there was a heuristic I could pin and go like, that would be great. I don’t think so, and I think that’s just, you should go into every kind of transaction like that thinking, all right, what if I don’t like where they take it? What if I don’t like where it goes? Do I still want to do it? You know what? There’s pretty good odds. Even in the Claire situation, we had very strong indicators from having worked with Claire that she was absolutely the right fit for this, but could also have turned out differently. Would I have made a different decision in that moment because of it? No, I probably wouldn’t. Nor would’ve made a different decision probably in the moment about Highrise. As Jason mentioned, Highrise didn’t pan out for a variety of reasons, and the team ran it for three years and that wasn’t a success on the metrics that we had set up, but I think it was still very much worth trying and I think we actually did have good indicators at the time that the people we put in place to run it, were going to be good at doing that.

(21:04): It’s so hard to try to deduce all of this down to how can we be sure? Well you can’t. That’s the stakes. That’s the game. If you want to be sure, then you have to have no expectations. So we sold another business called Sortfolio, which was a place to find a web designer, and we sold that to an operator team, and that was about as clean of a cut as we’ve done with anything that kind of was almost like an app. For the best of my knowledge, it’s still running. Haven’t followed up on it at all, haven’t even thought about it at all. It only just popped into my head now and that’s probably the first time it four years I’ve thought about Sortfolio that can be a successful way of doing it where you just completely sever ties. But in the case of something like Highrise where we didn’t or Know Your Company, which by the way is now called Canopy.

(22:03): Is harder and you take more of a gamble because you feel more involved. And this was ultimately one of the reasons why the Highrise experiment ended up ending was because it was not a clean cut. Jason and I were still on the hook reputationally for this customer base. This was a large operation, large number of customers, a lot of overlapping customers, people who had bought Highrise who had also bought Basecamp, and you couldn’t just make the cut there. We had to take a leap of faith and we didn’t make it to the other side on that one. We did it on the Know Your Company thing and anyone who had signed up originally to use Know Your Company when Jason was selling it, and if they’re still there, I’m sure perfectly happy and thrilled with it and we are happy with how the translation went. So I think in all of this you have to realize you’re not going to be able to know. You have to take some degree of leap and faith that is going to be based on a gut assessment of what the person and the situation is and then you do an inventory upfront of whether you can live with all the outcomes and base it on that.

Jason (23:16): I think you’re probably best off after you do the handoff, closing your eyes and looking the other way. I remember with the Highrise, we were actually, another board. We were sort of on those board meetings were hard because David and I had a whole bunch of ideas for where to take the product and the team that was running it had different points of view and we’d have these combative meetings and they would go their direction, which is fine. They were running it, that’s what they’re, but why are we then having these meetings where we’re butting heads all the time? No one’s listening to us, which is fine, you don’t have to, but then we shouldn’t be there. There’s no reason for us to be there in the first place. And I think because we had so much skin in the game with that product and we were still sort of involved and it was a complex product, it would’ve been better for us.

(24:06): We couldn’t, as David mentioned, we tried to sell, we couldn’t, but that probably would’ve been the better outcome. Sell it and don’t look back because when you kind of keep one foot in, it’s pretty messy. I think actually and with Know Your Company, even though we own 25%, we don’t, this is going to sound crude. We don’t pay attention to it. I don’t mean it, we don’t care, but it’s not something… Claire’s running it. She’s got her team doing it great. All hers. Highrise was a bit different. It was also quite complicated to disentangle. I don’t even know if it was ever fully disentangled from our setup. Was it David?

David (24:42): It wasn’t. No, it it wasn’t.

Kimberly (24:43): Was that one a one-page contract?

Jason (24:47): No, that was a little bit longer. It wasn’t that long, but it was a little bit longer because there was some more incentives tied to compensation that we had to detail. It wasn’t as clear as you get 25% or 50% or 75%. It was like if you hit this target, you get this percentage of profits or however it was worded. I forget all the wording, but it was a little bit more complicated than that. And also as David mentioned, it just was a deeper product. It had more revenue, had more customers. There was a little bit more to pay attention to. At the same time, I’m going to go back to my point about contracts. It probably didn’t matter anyway what was in that contract. What was going to happen? Are we going to sue them? They’re going to sue us? I suppose that could happen. Contracts don’t prevent lawsuits. They just get you in deeper in a sense. In fact, it’s almost like you’re pre-paying for the lawsuit that’s never going to happen. So anyway, it’s like insurance essentially, as David mentioned. So anyway, now I’m ramblin

Kimberly (25:42): No, that’s great. Well, thank you for sharing that. Know Your Company is still thriving and has recently rebranded to Canopy. You can find them at www.Canopy.is. I’ll link to all of this in the show notes. REWORK is a production of 37signals. You can find show notes and transcripts on our website at 37signals.com/podcast. Full video episodes are on YouTube and Twitter and if you have a question for Jason or David about a better way to work and run your business, leave us a voicemail at 708-628-7850. You can also text that number and we just might answer your question on an upcoming episode.

A Spin-Off Story

Key Takeaways

Links & Resources

Transcript