(FORTUNE Small Business) – When you meet Kate and Andy Spade in their whitewashed product gallery, it's easy to forget that they're budding corporate titans. Looking like Audrey Hepburn's best friend, Kate, 40, wears clunky vintage costume jewelry with a boxy fuchsia jacket and exudes pink-cheeked wholesomeness. Andy, 41, cracks jokes, while Henry, the Spades' white Maltese, yips imperiously when he feels he's being left out of the conversation. First entrepreneurial venture? "We stole things and sold them to other people," Andy says, deadpan. (Note to white-faced publicist: It's a joke. See, we're pointing that out.)

Kate was Kate Brosnahan in 1992 when, as a former fashion editor, she designed and made her first square bag out of construction paper. With money tight, Andy didn't leave his job at an ad agency to join Kate at the company until 1996. Three years later the Spades sold 56% of their handbag business to Neiman Marcus for $33.6 million. Defying the odds in the fickle fashion industry, the little square $155 purse has become an icon in less than a decade. As almost any American woman can tell you, a KATE SPADE label on a handbag signifies sophistication, freshness, and impeccable good taste, all rolled into one. And it is now the foundation of a $70 million company that makes stationery, shoes, men's handbags, glasses, fragrance and bath products, and soon home accessories. --ELLYN SPRAGINS

"KATE: Growing up in Kansas City in the 1970s, I liked fashion, but I don't think I ever thought I'd start a handbag business. Before I had my driver's license, though, I'd ask my mother to take me to a vintage shop in the city called Past Times to get things like a little coat and gloves. My mother thought it was great because a lot of what I was buying were like things she used to wear in the 1950s and 1960s.

ANDY: As a kid in Arizona, I was a skateboarder and outside the mainstream. At school I wasn't involved in all the stuff that the other kids were. I always wanted to do something else. My parents encouraged it: Don't think about being a doctor or a lawyer. Just use your creative skills to build something. And in college at Arizona State University, I started an advertising agency with a friend of mine. In 1986 we were named one of the top 50 new businesses in Arizona by Phoenix Magazine. It was kind of funny. Kate and I were dating at the time.

KATE: Andy and Elyce Arons, who later became our business partner, and I were supposed to go to Europe after graduation. But Andy stayed in Arizona because of his business, and Elyce moved to New York to get going on her résumé. I was visiting Elyce on the way back from Europe, and I applied to a temp agency to make some money. The next morning they offered me a job at Condé Nast. After the temp job I stayed on as an assistant to the senior fashion editor.

ANDY: Meanwhile, my partner in the advertising agency decided to go back to Los Angeles. Kate had just landed this great job, and I was stuck in Arizona. So I sold the agency to someone I was working with and got on a plane and came to New York without a job. But I found one at an agency fairly quickly, and moved on to another in six months.

KATE: The reason I started making handbags was because of Andy's suggestion. After moving through a number of positions, I had been promoted to senior fashion editor after six years at Mademoiselle magazine. I wasn't sure the next step was one I wanted to make.

Andy just said, "you know, i think we should start something." He really thought it should be advertising, and I agreed. Everything Andy was doing creatively was amazing, and I thought, "I'll just sell it; he'll create it." And then we realized he was making much more money than I was, so for him to quit his job wasn't going to work out. Andy said, "What about handbags? You love them."

ANDY: She never bought the typical brands. She would find her own things from different places. I thought, "How hard can it be?"

KATE: I quit my job in 1992. I was in my one-bedroom apartment on the Upper West Side. I sat down with some tracing paper, and I knew immediately what the shape should be--a very simple square. At the time no one was doing anything that clean. The shape gave me a real flexible canvas for applying all the ideas I had for a lot of colors, patterns, and fabrics. I made a model out of tape and construction paper. Then I looked in the back of Women's Wear Daily for handbag-pattern makers. They make a technical pattern, and then they make a sample.

ANDY: There's a big problem with fabric if you're small, because you can't buy small runs of fabric. But when you show buyers a bag in a particular fabric, you need to know stock is available. So Kate went to the Yellow Pages and located a company that made potato sacks. She called up and found out that they had no minimum order size. So we bought burlap from the potato sack company and sewed bags out of it. But we did have to buy the webbing for the handles in bulk, which was a decision that paralyzed Kate.

KATE: It was going to cost us $1,500. Andy was taking a shower, and I was in the bathroom. I was thinking, Let's back out before we get in over our heads. And he said, "Okay, we'll do it." I said, "Andy, let me think." He said, "What are the handles made with on all your bags?" I said, "Webbing." And he goes, "Where's the problem? You'd better order it."

ANDY: She had left her job. She wasn't bringing in money--she was spending it. But it was for both of us. I think she was thinking that she was a burden. But look at what she built.

KATE: What we built.

ANDY: What we built. At our first trade show they gave us terrible space, way in the back of the building. We moved in furniture from our apartment because we didn't like commercial displays and because it was cheaper. We didn't get enough orders to cover the cost of the show, but we came out with orders from Barneys and Charivari, two influential stores in Manhattan.

KATE: They sold quickly. We got some reorders, and it was time to show another collection. Then we were showing five markets a year, which means doing designs five times a year. I kept showing the same square shapes. I remember Barneys saying, "Yup, you showed us those shapes last time. It's just new fabric." And I said, "Well, that's the idea. That's the concept."

ANDY: We wanted to create the next Levi's 501 jeans, L.L. Bean shoes--one of those items that continue forever. I love that one shoe that Converse makes--the Jack Purcell. They're just great icons. That's why we continued with the shape. The collection was very tight, very edited, for the first two years. I think if we had changed the shape, our bags would have gotten lost. But we had to insist. Then fortunately the consumer started responding, and the stores kept reordering. So it worked. And that made us identifiable.

I decided to quit my job to join Kate in 1996 because we were turning into a real business, which was challenging. When you start your own company, you get to be creative, but at the same time you're responsible for running a company. Nobody tells you that. It's not just doing bags, it's getting paid for them. In advertising I was working only with creative people. In this company you're dealing with payroll, accounting, and shipping and warehouses, which I'd never dealt with and which I'd never wanted to deal with. We started to think, "How do we do this thing well without putting ourselves under, because we don't have any backing?"

KATE: One thing we did right was taking it slowly. It may not look like that, but in terms of how the retailers were looking at it, we were slow. The pressure and encouragement to keep going into different categories was big.

It was only when we felt comfortable that we had a group of designs we loved that we started to do shoes. We both thought it was better to kind of tippy-toe in, get our feet wet, find out where the successes and the failures are. Even though we started small, we set it up the way we did the handbags. You build it strong enough that, if you were to take the handbag and other product lines away, you would still have a healthy shoe business--

ANDY:--without leaning on the other categories. If you had never heard of Kate Spade and came across her paper line, would you love it?

A new category is like going into a completely new business. Distribution is different. The product and process and manufacturing are different.

The business experienced this huge growth we didn't expect. When the CEOs from the big stores told us how much they'd sold that week, it would scare both of us. We would say, "Can you honestly slow down? You have to make sure the presentation is right." The CEOs were shocked.

In both 1996 and 1997 sales were doubling. Everyone was excited, but we knew things in this industry go up and down. We didn't want that. We wanted a steady long road. We wanted to do it correctly.

In 1997 we hit a low point. We were running our business out of our home, a loft in Tribeca. Workers would show up at six in morning. We had so many boxes in our 1,800-square-foot loft during shipping time that we had a path from the bedroom to the bathroom. It was hot. We had no air conditioning, and it was August. We had put everything into this. I put in my 401(k) money. Our friends were buying their first homes. They had money in the stock market. We didn't know for sure that the business was going to work.

I thought, "This is exhausting. We can't manage all this." We talked about paying off all our debt and closing the business down. But I had to believe in it. I couldn't blink. If I blinked, she'd fall. I had to keep her hopes up. We got to a point where we couldn't do it alone.

KATE: We already had partners: Pam Bell, who joined the company in 1993, and Elyce, who joined in 1994. Figuring out what the four of us would do was easy. We needed to hire a second tier of managers, and that was harder. We tended to think, "Whatever needs to be done is the job." But when you hire people who've been at other companies, they expect more formal direction and management. So one of the smartest things we did was hire a president, Robin Marino, in 1999. Robin had been a senior vice president at Burberry Ltd.

At the same time we had to learn how to turn off the business at home. Andy was better than me. I talked about it 24 hours a day. I would pop out of bed and blah, blah, blah, and go to bed, blah, blah. We started straightening that out a couple of years ago. We just said, "This is insane. I think it's all we talk about."

ANDY: You start something, and pretty soon it controls you. But now we're going into Act II. Our core competency is creativity and design. So we'll pursue a lot of personal interests, including possibly TV programming, film, and publishing. We want to continue to innovate. We never had the idea of being a big company, but we do want to keep it interesting."