To Pixar and Beyond

by Lawrence Levy

  A stock option gives an employee the option to purchase stock in the company in the future. Its value derives from the fact that even though the employee doesn’t have to pay for the stock until later, the price the employee pays at that time is set at the value of the stock when the employee receives the option, usually when he or she joins the company. If the company is wildly successful after the employee joins, the value of that stock could grow astronomically, but the employee only pays the price set when he or she received the option. All the rest is profit. For example, if a company’s stock is worth $1 per share when a new employee joins, and if that employee receives an option to buy a thousand shares of stock, five years later if the stock is worth $100 per share, the employee still pays only $1. He or she makes $99 profit on each of those thousand shares, or $99,000 of profit. This is how Silicon Valley gives birth to new generations of millionaires and billionaires.

  If Pixar had failed in any one area, it was that its employees did not have stock options. Steve had long promised that he would fix this, but it had not happened. This shortcoming was the single biggest source of resentment and bitterness with employees at Pixar. In my early weeks at Pixar, barely a conversation started with me that didn’t quickly lead to the question “What about the stock options?” This wasn’t a gentle inquiry as much as the bubbling over of a seething cauldron of anger and frustration.

  Pixar’s employees, especially those who had been there the longest, felt trapped. They felt let down and misled by Steve for not giving them a right to share in Pixar’s success. But they had little choice other than to wait and see what happened because they had invested so much time in the company. It would make little sense to leave now, especially when Toy Story’s release was imminent.

  Making matters worse, Steve had made promises to a handful of Pixar’s senior team, giving them a share of Pixar’s film profits that might be converted into stock options. I was the most recent of those, having received a promise of stock options when I joined the company. Besides the top executives, everyone else was excluded. This was a disaster in the making. All it would take was one domino to fall, and an exodus of Pixar’s talent could happen overnight; if not now, later. That would spell the end of Pixar’s capacity to innovate.

  On this issue I was caught squarely in the middle. On the one side, Pixar’s longtime employees were angry and bitter. There were constant gripes as I made my rounds at Pixar:

  “Will Steve take care of us?”

  “We’ve waited a long time for this.”

  “I hope you make it right.”

  “I’ll believe it when I see it.”

  On the other side was Steve, who had all the power to decide how many stock options to give Pixar’s employees. A stock option plan requires a company to set aside a percentage of its stock for the benefit of its employees. In start-ups that percentage varies, from as low as perhaps 15 percent to as high as 40 percent. Because Steve owned 100 percent of Pixar, every option that went into the stock option plan would reduce his personal stake in the company as those options were exercised by Pixar’s employees.

  Steve wanted to reduce his share as little as possible. He had in mind the kind of percentage that a new start-up might use, as low as 15 or 20 percent. That might work for a company just starting out, one that might expect to hire 50 or so employees in its first couple of years. But Pixar was far bigger than this. It already had approaching 150 employees, and many of those were seasoned veterans who, by Silicon Valley standards, were entitled to significant stock option amounts.

  The problem was exacerbated by the possibility that we might try to take Pixar public soon; Steve was aiming for the end of the year. The price of a stock option is set at the value of the stock at the time the option is granted. Early in a company’s history that price will likely be very low because the company doesn’t have much value. It might be well under $1 per share. But as the company grows, its value goes up, and so does the option price, maybe to a few dollars per share. Obviously, it is much better for an employee to pay a lower price for stock in a company. As a company approaches its initial public offering, or IPO, its value is presumably growing and growing—which is the momentum that makes the IPO possible—with a corresponding increase in the option price.

  Because Pixar was ostensibly close to its IPO, the option price would have to be set much higher than if Pixar was a brand-new start-up. This meant that Pixar’s employees who had been there since the early days would be paying a much higher price for their stock options now than they would have had they received them years earlier, when theoretically they should have received those options. There was nothing we could do about that now, but this was going to be a very bitter pill to swallow. It put even more pressure on granting options generously.

  Steve did not want to take these factors into account. His position was that “the option price doesn’t matter because we’ll make the value of the stock so high.”

  He was also adamant about taking no risk that he would lose control of the company in the future, as Pixar’s stock options were exercised by employees, and as Pixar sold stock to other investors. I didn’t need to ask him why. He wanted to avoid any risk of being in a position like he had been in at Apple where the board had effectively ousted him from the company against his will.

  I understood that Steve wanted to retain control of Pixar, but I felt there was more to it than that. He could have authorized more options in the pool and still retained control. He just didn’t want to give up his own shares. When it came down to his own pocket or the pockets of Pixar’s employees, Steve wanted the stock in his pocket. On the one side, I couldn’t blame him. He was the owner of the company. He had taken all the financial risk.

  But on the other side, I grew frustrated with Steve over this. I felt we had a chance to fix an injustice in a way that would allow everyone to win. Giving up a little more stock would make little difference in the wealth Steve would enjoy if Pixar succeeded. In any other start-up, Pixar’s key employees would have had stock options years earlier, at very low exercise prices. It was virtually unheard of to put in place a stock option plan so close to a potential public offering. This did not have to be such a battle.

  The more I waded into this issue, the more I felt like a punching bag for everyone: Pixar’s employees thought I was protecting Steve. Steve thought I was asking for too much for Pixar’s employees. It didn’t matter that, inwardly, I sided with Pixar’s employees. My job was not to take sides but to broker a solution that would work for Steve and the rest of the company. It was the first time I felt myself pitted against Steve, though. He began to get irritated when I brought up the subject of stock options.

  “We’ve already discussed it,” he would add curtly. “Just show me the proposed plan.”

  But I couldn’t make a plan without enough stock to put in it.

  “When Steve digs in his heels, it’s very hard to move him,” I complained to Hillary one night. “Most of the time we’re on the same page, but we’re not on this one and there’s little I can do.”

  “Look, if you’ve tried everything,” Hillary said, “what else can you do? It’s his company. It’s not your fault.”

  But I felt I needed to fix it. I could feel the tension building on this issue. Everyone was itching for a stock option plan, but when they saw how much stock was in it, the bitterness would just grow. I had to wrestle more stock from Steve than he wanted to give.

  And so, on my long drives between the Berkeley Hills and the San Francisco Bay, I worried. I worried about how seriously we would be taken as an entertainment company. I worried about Disney claiming the space that Pixar was creating. I worried about the pressures a new strategic agenda would put on Pixar’s culture. And I worried about Hal Vogel’s observation that taking a film company public was a “long, torturous, and expensive obstacle course.”

  But it was the stock options that bothered me the most. Many of Pixar’s employees had staked their entire careers on
Pixar, had given it the best years of their professional lives. What kept them there? What kept them from jumping ship for more lucrative opportunities? I reasoned that it could only be because they were passionate about Pixar. Despite all the years of commercial failure, they believed in the potential of their own work, and they wanted to see it through. We could not rely on that for much longer, though. They now needed to be rewarded for it.

  Somewhere on those drives, in the quiet of my own car, I realized that no amount of deliberation was going to resolve my worries. Sometimes there comes a point when you jump not because you feel ready or are sure that you’ll make it across the chasm, but because the conditions are forcing you off the edge. That’s when you find out if you can fly. I felt this was the time to jump. We had to start moving, and resolving the options problem was the place to begin.

  As mundane an issue as it might seem, I believed that Pixar’s fate hung partially in the balance over how much stock we put in the stock option pool. Too little, and Pixar’s key employees might be forever disgruntled, ruining the culture on which Pixar was built. I wasn’t sure I had anything further I could squeeze out of Steve, but I needed to take one more final swing at it, even if it meant incurring Steve’s legendary wrath. I picked up the phone one night and called him.

  “We have to add more stock options,” I said flatly. “We can’t make it on the amount we have allocated right now. It’s not enough. A few percent more, and we can give it a shot and still have a good chance you’ll maintain control of the company even after we go public.”

  “I said I didn’t want to revisit this,” Steve griped. He was on the verge of dismissing it. I suggested a number. It was as far as I thought he might go.

  “Will this be it?” Steve asked, totally exasperated. “Will this be enough options to last for a long while?”

  I didn’t think it would be. It would barely get us by now.

  “Yes,” I declared with unfounded confidence. “We’ll make it work.”

  “Then I don’t want to hear about it again.” And with that, Steve ended the conversation.

  I breathed a deep sigh of relief. It could have gone much worse. I would still get a lot of grief over not having enough options to go around, but I had gained enough to now make a case that if Pixar became a big enough success, that would make up for it.

  I at last had my first real toehold. The option plan was pivotal to moving Pixar forward. But now the stakes were higher than ever. Those stock options needed to be worth a lot one day. A small win wouldn’t cut it for anyone. Pixar was aiming for the big time.

  PART II

  8

  Four Pillars

  By the end of the summer of 1995, the tide at Pixar had turned from the drive to finish Toy Story to the countdown toward its release. You could feel the pressure valve letting off steam within the company as the seemingly endless number of production tasks were whittled down. The film crew was visibly more at ease, and by 6:00 p.m. on any given day, the parking lot was emptier than it had been in a while. We had made some strides on the business side also, by winding down the RenderMan sales team and exiting the business of animated commercials.

  It was not nearly time to celebrate, though. Toy Story’s release date was November 22, 1995, the day before Thanksgiving, about three and a half months away. Between now and then it had to go through the phase of filmmaking called post-production, a slew of tasks that would transform Toy Story into a finished product. These included making final edits and last-minute dialogue changes; incorporating final color correction; adding film credits; finalizing the musical score and songs; adding the sound effects for balls bouncing, doors closing, and myriad other noises; duplicating the film for delivery to movie theaters; and more.

  Because Pixar did not have its own post-production facility, much of this work occurred at George Lucas’s Skywalker Ranch in Marin County, less than an hour’s drive away, where Lucas had built a world-class audio post-production facility. During this time period, we at Pixar had no real sense of how the film was coming together. It felt like waiting for the lunar module to emerge from orbiting the dark side of the moon. Pixar was mission control while John and a small crew were on radio silence as they navigated this part of Toy Story’s journey. It would be a couple of months before we would see the final product. We were collectively holding our breath.

  Besides finishing the film, there were other things about its release to worry about.

  “I’ve seen the latest Toy Story trailer,” Steve said one Saturday. “It plays too young.”

  By now, my leg had healed enough for Steve and me to reestablish our weekend walks. This time we stopped at Steve’s house afterward and were sitting in the courtyard, admiring his abundant fruit and berry trees.

  “We have to keep the pressure on Disney about the trailers,” I suggested.

  Since the spring, Disney had been showing what were called “teaser trailers,” short snippets that hinted at what was to come. The first teaser trailer had been attached to Disney’s animated feature film A Goofy Movie. I had taken my entire family to the film just to see the one-minute teaser trailer for Toy Story. Imagine our disappointment when it didn’t play! My first big moment in film dashed in an instant. We later discovered it was in 80 percent of the film theaters where A Goofy Movie played, but the Century Cinema 16 theater in Mountain View had not been one of them. My family had to make do with the snippet of Toy Story I had at home that they’d already seen a hundred times.

  Now Disney was preparing to ramp up the full marketing campaign for Toy Story’s release.

  “The way the studios market movies is so old-fashioned,” Steve griped. “Loud trailers and cheesy billboards. I think we could do better.”

  The marketing of Toy Story was pivotal. Pixar took the idea of family entertainment seriously; Toy Story was for all members of the family, not just young children. If Disney aimed the film’s marketing campaign only at families with young children, it could drastically limit who might come and see the film. We had learned how crucial the opening weekend box office was; it would set the tone for the film’s entire run. Therefore, it mattered how many different trailers there were; whether they appealed to children, teenagers, or adults; what films they were attached to; and the extent of the advertising campaign.

  Adding to our concern was our disappointment with how Disney had handled the making of toys and other merchandise for Toy Story. Due to a late start, many of their usual merchandise makers had passed on it. We wanted to make sure the marketing went off without a hitch. Steve decided to personally handle the marketing talks with Disney. He had called them about this latest trailer.

  “I’m not sure they’re listening,” he complained to me. “They agree that we need to appeal to different audiences, but I’m not sure what they’re doing about it.”

  In truth, there was not much more we could do besides complain to Disney. The film’s marketing was their responsibility, and ultimately we had to trust them. But I was sure it didn’t hurt to have Steve breathing down their necks.

  Meanwhile, my focus was on putting the finishing touches on Pixar’s business plan. By now, Sarah Staff and I had crunched the numbers every which way. But no matter how we looked at it, the fundamental challenge remained the same. The level of success Pixar needed to make a viable business was, by every measure, truly absurd.

  Domestic box office performance is the yardstick by which Hollywood measures the success of a film. It refers to the amount of ticket sales in movie theaters in North America. Our profit projections were based on various levels of box office success. For example, if we assumed $100 million in domestic box office revenues for each of Pixar’s films, the projections did not work at all. The costs of production and the infrequency of film releases made it nearly impossible to sustain the business. At $150 million in domestic box office revenues, the business began to work. But it didn’t really take off until box office revenues exceeded $180 million per film.

 
; But here was the reality: releasing films that consistently performed at the level of $150 million or more had never been done, by anyone. Of all the animated films released by Disney since Snow White and the Seven Dwarfs in 1937, only two had a domestic box office that exceeded $150 million: Aladdin in 1992, which had earned $217 million, and The Lion King in 1994, which had shattered all records with a domestic box office of $313 million. If you excluded The Lion King and Aladdin, the average domestic box office for Disney animated feature films was far less than $100 million.

  And that was Disney films, a brand trusted in every corner of the globe. If you included the animation efforts of other studios, the average was drastically lower. In fact, no studio besides Disney had ever released an animated film that had a domestic box office much above $50 million in its initial release.

  How was Pixar, in the new and untested medium of computer animation, possibly going to perform at the levels it needed to succeed? Any way you looked at it, building an independent animation studio required a level of box office success that was not only unprecedented; it was almost unimaginable.

  We still needed a business plan, however, a road map to give Pixar a shot at success no matter how improbable. After examining a seemingly endless number of permutations, the plan we finally developed had four pillars.

  First, we had to increase Pixar’s share of the profits from our films. There was no scenario in which Pixar could become a viable business under the profit-sharing arrangement in the existing agreement with Disney. We tested many possibilities and concluded that the minimum profit share that Pixar would need to achieve its goals was 50 percent. Therefore, the first pillar of our plan called for increasing Pixar’s share of the profits to at least 50 percent, which was a four- or fivefold increase over what we had now.