In September 2003, JJ came to me with a deal. He had been working for six months for a Korean company called C&C Enterprise Co., Ltd., a typical Korean-English name for a “computer and communications” company specializing in public transit fare collection. They had an idea that was so simple, it had eluded the world for decades. Instead of transit agencies issuing their own pass cards to the subways and buses of Seoul, C&C’s hardware accepted credit cards at the transit gates just like any normal credit card transaction. The charge would appear on your statement at the end of the month automatically. The system had been running in Seoul for eight years successfully but no other city in the world had adopted it yet.
My immediate reaction was, “Brilliant! Why doesn’t everybody do it this way?”
John Joo-seong Lee, or JJ as I called him, had been my employee and protégé for a few years in the nineties. He quickly had learned most of what I knew about real estate and just as quickly proved himself a better negotiator than I. Since I grew up as well-fed as he did hungry, he had sharper edges and greater self-assertion. But being a young whippersnapper, he decided real estate was too slow for him and left my employ to start a new venture deal concerning comic book characters in Korea. Unfortunately, at the tender age of 22, John couldn’t hold the pieces of it all together, and he ran through all the capital. In the meanwhile, I had become a virtual company, outsourcing everything and even firing my assistant. There was me and my data and then everyone else. I was lonely at times but I was hyper-efficient.
John came back to the New York area and went to work for Samsung, selling millions of units of read-write CDs to U.S. chain stores. He worked peacefully there until they fired him for going to see his wife in the hospital when she delivered their first child rather than coming to work. Getting fired from a big company was fine for John—he hated their imperious style and hierarchical structure. Due perhaps to his experience with my company, he was used to sharing ideas and information freely and getting to the next step, rather than worrying about how to let his superior take the credit for his ideas.
His father-in-law in Korea suggested he go to work for C&C. Their President was his friend from way back. C&C was supposed to be buying a U.S. company and John’s job would be to monitor their performance on location. John went to Korea and worked at their Korean office for several months as a foreign hire on a salary bigger than the locals, which was supposedly unknown to the other employees there. The company assigned him to the task of developing the American market for their system. They had lost millions trying to market around the world using non-native employees and they viewed John, who was raised in Chicago, as the native they needed for the U.S. But the acquisition of the U.S. company fell through and they couldn’t afford to give him a budget for his regular marketing activities.
He came to me. One of the most interesting aspects of his story was that a transit consultant to the Port Authority, a fellow named Bob Hamilton, was convinced that C&C could be a serious competitor in the New York market. It was one thing that John Lee thought this and quite another that an industry pro thought it.
After listening for a while, we arrived at an idea. He should find a U.S. distributor who would market their system for them. The structure could be a marketing contract or a joint venture.
“Why don’t you do it?” JJ asked me.
I spluttered, “Me?!! I don’t know anything about transit or fare collection. No, you need an industry pro or a company who can handle the research.”
Finally, he talked me into it. After a few months, I agreed to try to be the U.S. joint venture partner. John sold this idea to C&C and on January 4, 2004, I went to Korea to sign a letter of intent. Then I made my first mistake. I assumed that with John’s support, C&C would be easy to sign.
C&C President Young-Sam Jun was an affable fellow of 50 who seemed very reasonable. He had trained at Korea’s top university as a lawyer and had accomplished the original system design and installation in the early nineties, raising the capital, finding a partner bank, and working out the details with the numerous bureaucrats from the city and state agencies. Their patented contribution was that each gate and farebox computer would keep a “negative list” of bad cards and reject them. It’s equivalent to the list of bad checks near the register in a candy store and it works really well. Seoul is the third largest transit system in the world. Of the 7 million transactions a day using credit cards, only 420 turned out bad. I admired Jun’s perseverance and good fortune. The company had a modest building in an unglamorous commercial part of town. They had gotten rich off the Seoul installation but had been largely unsuccessful overseas.
I was cautiously optimistic that they would trust me with the U.S. situation and not try to micromanage me. This is exactly what Jun claimed he wanted. He said he liked the idea of a U.S. deal arranged in U.S. ways and would leave the management to us. He then left his subordinates to work out the terms. I was sitting across the table from JJ, “negotiating” with him for terms. It was peachy.
John and I presented a joint venture in which they would get 30% of the company in exchange for a small amount of cash, their technologies, and U.S. patents but would get the lucrative work of manufacturing the machinery. Using my laptop, I typed up a term sheet in the form of a letter of intent. Meanwhile I was frantically emailing my advisors in New York, trying to ascertain that the document wouldn’t commit me to any idiocies. I didn’t trust myself to make such a major deal and not incur a later disadvantage.
In retrospect, the letter of intent we signed on January 7 should have been binding. We left Korea with a signed non-binding letter of intent, promising to forward contracts to C&C shortly. C&C announced the letter and their stock went up 7%.
This proved to be the high point of our relations with C&C. It didn’t help that John hated them. He hated Jun’s imperious style, their employees’ lassitude, the chaotic way the office was run, the COO’s attempts to control him, and in general, hated working for them. He wanted to quit as soon as possible.
To see if the patents were good, we met with Steven Pokotilow of the well-known law firm Stroock. He mentioned that they had had quite a number of clients with convincing stories about deals in Korea but the deals always fell apart because there was no way to get the CEO to sign. I replied confidently that since John Lee’s father-in-law was an old friend of the CEO there, we were sure he would sign. We hired Stroock and they pretty soon gave us the whole treatment of a Wall Street law firm, assigning a team of junior lawyers to do the actual work, conferring in the most expensive way about corporate structure and deal terms, involving as many people as possible to drive up the bill. To be fair, the service was great. But at what expense?
Meanwhile, John and I dropped by a Go match. John was playing in the top-ranked tables and stood a good chance of winning, even though a professional was playing, too. We ran into an old friend there who had worked on the Amex and retired with a few million. John told him about our deal and he immediately offered to invest capital. We told him we’d send him the information and left feeling buoyed. What a vote of confidence that was!
I started researching the characteristics of the computer system that drove the card acceptance. There was a long, dull document, a Regional Interoperability Standard, which pretty much described how the card part worked. C&C had given us propaganda materials which described the rest of the system. It was arranged in tiers, with the gates at the bottom, station computers collecting gate data, agency computers collecting all the stations’ data, and a clearinghouse for the entire region. It seemed logical and normal for a distributed system. If instead of gates, you put terminals on the desks of insurance agents, you would have a standard server with outlying clients, hub-and-spoke arrangement. No big problem even in those early days.
We estimated what installation would cost and I started working up a business plan. The first thing I realized was that compared to the one-off installation of equipment, running the computer system would be much more profitable. The installation was complicated, union labor, capital intensive, fraught with regulation and made money exactly once. Running the system meant millions of dollars in fees each year, a relatively large amount of control, a great probability of future fees for upgrades, and all for simply running a database.
I conferred with Morris Silver, my accountant. Morris had been CFO of many companies and was a solid practical businessman, although fanatically stubborn. He had terrific stories. Once in a meeting he let the other side see a document and they tried to keep it. Morris dialed 911 on the conference-room phone. The guy gave the paper back.
Another deal involved Apple. He represented a company that made clutches, the devices that keep a laptop screen up. It was two months before the huge Christmas season. Apple was about $2 million behind on their payments. Morris flew to Taiwan and told Apple’s representative that if they didn’t pay up, he would hold up deliveries and short Apple’s stock. The Apple rep was astonished, “You’re serious, aren’t you!” They paid.
Morris suggested a corporate structure which was rather complex but extremely flexible for the future. Both C&C and our group would have holding companies. We would then start two “downstairs” companies: one for operations and one for licensing. Both holding companies would then own pieces of the downstairs companies. So far so good.
Next Morris conferred with Stroock, and here I probably made my second mistake, again from lack of self-confidence. I was rather swept away by all these high-powered people thinking about my business and assumed that they would suggest the best practices, give the best guidance. The corporate structure was complex, and I started charting out all of the items to be covered in the LLC operating agreements for each company—tag-along and drag-along rights, voting, tax provisions. By the time we got to the patent deal, I was too exhausted to notice that the technology transfer and patent license agreements varied from the original letter of intent with C&C.
Almost two months after the letter of intent signing in Korea, we finally forwarded them documents. At this point, we still assumed that they would sign, they would have to sign, they’d be crazy not to sign. With supreme confidence, we formed the companies so the closing could happen sooner. We started marketing ourselves.
The American Public Transportation Association, APTA, holds a meeting on fare collection every year in March. We wanted to go, to go public there, to attract our first business. We got business cards printed with our new company name, Smart Systems, and tentatively named our product MetroCharge, after the MetroCard, the current magnetic stripe transit pass card. We sent a letter to C&C asking for their approval to use C&C’s name at the conference, to which they agreed. We bought seats, made brochures, and created a web page.
We met with Bob Hamilton, a transit consultant, and he suggested how we should comport ourselves at the conference. In the course of the conversation, we discussed various aspects of the system. John was firmly fixed on the idea of our becoming a credit acquirer to handle the bank transactions but at that time, we had little idea of what that might involve. Hamilton agreed to prepare a paper for us about how to do this.
The advanced seminars at the APTA conference all described our system perfectly. Financial companies like Amex and Citibank made presentations practically begging the transit agencies to let them participate in fare collection. They all needed our solution. We also ran into a fellow named Mike DeVitto from the MTA, who seemed like a fine fellow. I briefly shook hands with a senior manager named Steve Frazzini but was so frazzled from meeting MasterCard’s incredibly rude representative that I wasn’t as articulate as I might have been.
The main players in the game were transit agencies, their vendors, and credit card issuers such as banks and card associations. It was a mistake to bother with the banks and associations. I wasted a lot of time presenting to them, with the sole result that they tried to patent our systems, stealing the ideas in advance. We were too small for them to deal with. If they hired us and anything at all went wrong, the VP in charge would get fired, whereas if they hired IBM, everyone would just shrug and move on.
Finally, I was sitting in the office one Friday, all alone, writing or playing a computer game or something, when I got a call from Mike DeVitto of the MTA. I remembered him from the APTA conference and asked him what his job really was. Head of the existing card system MetroCard. He invited Smart Systems to present to the MTA at their offices. I said, “Gladly.” We hung up and I did a little jig around the office.
On April 22 I pitched the MTA. They loved us. The next day, April 23, we had a similar terrific meeting with Citibank. The net result of that is that we all got a little silly. John Lee and my then wife started pondering how they would spend their millions. I claimed to John that I wouldn’t sell the company for $20 million. We were dizzy.
Also on April 22, we finally got comments on the documents we sent C&C. Although difficult to understand due to the limited English of the writer, they seemed to want us to separate the patent licenses from the technology transfer. This seemed quite reasonable so I agreed to do this. But they also wanted a two-year term to the licenses, making the fees periodically renegotiable. Although normal in Korea, this didn’t work for my American point of view, in which a contract, like a lease, was fixed at the outset of the contract. I didn’t want to spend four months every two years renegotiating terms. By April 27, I had formulated a detailed reply in the form of a term sheet. It tried to answer every question they asked.
On May 10, we got further comments from C&C which were even more outrageous. They basically demanded a vote on any significant decision made by our companies. This would have been completely unworkable. We sent a letter withdrawing the offer of a joint venture and asking instead for straight licenses. We suggested that we would exchange some documents but since a license was a relatively simple agreement, John and I would travel to Korea again to negotiate and sign.
Meanwhile the marketing side was developing quickly. It was complicated because there is a plethora of morons in the transit space. Populated mainly by military people familiar with large governmental organizations, entrepreneurial spirit and actual thought about the tasks’ problems were rare. For example, in a half-baked report, one consultant had suggested charging banks a license fee of $20 per card to enter the system. This was such wishful thinking that it was simply ludicrous. The same fools said they’d work with us if we gave them 51% of our company. We thanked them for their time.
Bob Hamilton was by then the main fare collection consultant for the Port Authority of New York, which used cards for their PATH trains to New Jersey. We had become very friendly, not least because both our wives at the time were Japanese, and we spoke the language well. According to Bob, since 9/11, the Port Authority had fallen on hard times. Income from the Trade Center was much reduced. All their major assets had become terrorist targets and they were spending millions on security. They wanted a cash flow and Bob suggested a joint venture format.
Morris Silver dryly suggested we ask Bob for five successful historical models of private companies doing joint ventures with government agencies. I thought this was hilarious, as we couldn’t think of a single one. Morris suggested that some kind of profit sharing or at worst, revenue sharing scheme might be possible but it was impossible to give equity. Our goals were too different.
We discussed capitalization of the company. Morris had another good idea: go to the investment banks who frequently placed bonds for New York State. Their venture capital wings could provide capital, they understood financing of long-term infrastructure, and their bosses could call Governor Pataki and deal directly.
He knew a VC expert who had worked for Lehman so we went to see the fellow in Frankfurt. The high point of that excursion for me was meeting our future CTO Martin Silbernagl in Berlin. A nerd of about 30 with tech glasses and a mop of blonde hair, he instantly understood what we were doing and had very good suggestions. One was to use a software requirements management system called Rational Unified Process. In a large system with many stakeholders, the RUP was a good way of keeping everyone on the same page, ensuring traceability of requirements, organizing change requests, etc. He was a big fan of iterative development, in which the system is built in stages with each stage producing a fully operational system and each change adding to the basic system in an organized way. Each stage would be achievable, terminable, and not endless. I came back with lots of reading to do but very excited about working with Martin.
On June 11, 2004, John and I went to Korea again. The short answer is: we failed to sign C&C. However, in late June Ron Snyder came to dinner and gave us a check for $100,000 as promised. We had told him that we failed to get the licenses but he trusted us anyway. It was very reassuring. I remember emotionally promising to do my best for him. C&C finally signed in September.
In the autumn of 2005, we got our first revenue by licensing MasterCard the right to run the pilot that we should have run. They further extended the license and we made about half a million from them.
By September, I had established good relations with Paul Korczak, an affable fellow who was in charge of new fare collection ideas. He had me write a self-introduction to Katherine Lapp, the Executive Director of the MTA. We persevered and in March 2005, I pitched executive members of the MTA. Katherine responded by inviting us to install a pilot in several stations.
I immediately had John call C&C and tell them that we had won the lottery. Astonishingly, they said only that they’d get back to us. Get back to us? We needed their full cooperation immediately! John called his father-in-law, who told us that Jun had been arrested for embezzlement of company funds and was in jail. The company would be paralyzed. It was a dark moment.
I’m trained in kung fu. When I take a hit, I keep breathing and dance. But this was like a scene in the movies where the guy takes a hit and starts spitting blood. He’s finished and so was I.
Without C&C, we had the enormous task of finding an equipment maker, designing our own system, and performing the installation before the MTA tired of waiting for us. Martin bravely went ahead with development and came up with some terrific ideas but finally it was impossible. I called Korczak and apologized, explaining that we were busted and couldn’t perform.
Sure, we had licensed the patents and that was a start but because we were unsuccessful in pushing out a system, the venture as a whole was a total failure. John Lee wisely left the company. I decided that I didn’t need to be in New York anymore and moved to Japan in 2007. This proved to be a very unlucky move, but that’s another story. In 2009, my key advisor Morris Silver died, compounding my isolation in Japan.
Although I was crushed by the whole experience, I dug in and tried to maximize the residual value for my shareholders. Over the next ten years, Martin and I developed patents that finally were defeated in court when we tried to sue to enforce them. That was an outrage—two of the three Appeals judges were clearly not following Supreme Court guidance. I returned as much money as I could and closed up shop in 2017. It was the end of a dream. I should have left when John Lee did and moved on. I took my responsibility to the investors too seriously and threw good money after bad.
A good venture capitalist knows that business is risky. My kung fu training tells me that when I get hit, I’m supposed to keep breathing and dance. But this was like one of those scenes in the Chinese films where the guy who gets hit starts spitting blood. He’s finished, and so was I. It took years to recover. It wrecked my already dying marriage and I started drinking. Fortunately, I managed to stop. Sure, I learned from the experience. These days when I mentor startups, I make them lean and mean and avoid any risks that I can. I want them to survive without getting too ambitious.