One of my favorite high-tech variations of this is to create a subsidiary company to develop a new technology. The investors in this company get a minority interest in the stock, entitling them to a fixed percentage of the licensing fees. The parent company pays the subsidiary for use of this technology. The amount of this payment is a fixed percentage of the sales from service that incorporates the new technology.

This winds up being a good deal for the business because you’ve got the money to develop the technology without diluting your ownership interest or taking on crushing debt. It’s also not a bad deal for the investors because they know exactly what they’re investing in, and if it works, their return is guaranteed, not plowed back into corporate expansion.

To get back to the story, though, David did tell me one other little thing: His partner had to do his due diligence. At the time, I had no idea what this meant. I thought perhaps it meant he had to diligently go to the bank and present a check to me, to whom it was due. What I learned is that “due diligence” means that prospective investors have the right to come in and thoroughly examine your books and all aspects of your operations. With some investors, due diligence is just a formality; with others, it is a virtual inquest. With Peter Sudler, it was definitely the latter.

Peter Sudler was at the time David’s younger partner. He had once served as one of the lead U.S. attorneys to the Justice Department’s Organized Crime Strike Force, and he approached due diligence with the zeal of the prosecuting attorney he once was. If there was excess waste or corporate expense account padding that his and David’s money were really going to finance, Peter Sudler would find it out. But from the moment he pulled into the parking lot of our ramshackle headquarters building in the Bronx, he knew that this definitely wasn’t the land of padded expense accounts.

Our books were so simple it took less than an hour for Peter to review them. We bought our phone time for X and sold for Y. Each client required one box, which served as their callback connection. They’d call in, the box would recognize their signal, and immediately call them back with an American dial tone. The average profit per client was quite high, and the list of companies waiting to sign up was quite long. In short, it didn’t take much to see that this was a good deal.