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Why-PO? Mark Zuckerberg’s Strange Plan to Finance Facebook

Facebook's public offering was widely anticipated. That doesn’t mean it makes sense.

Facebook’s decision to sell stock to the public for the first time dominated business news last week. The announcement came after a year of internet companies going public with massive fanfare—the professional network LinkedIn, social gaming company Zynga, and Groupon with the largest public launch since Google’s in 2004.

After years of speculation about a public offering, Facebook is the only one of its major rivals—Google, Amazon and Apple—to remain privately owned. The company’s impending arrival at the public auction block seemed preordained.

That doesn’t mean it makes sense.

The idea behind an initial public offering—that’s what IPO stands for, by the way—is that it’s a way to finance your business. Companies are initially owned privately, by just a few founders and initial investors, often called venture capitalists or VCs, whose start-up capital gets the business off the ground and earning money. As the company grows, however, more capital is needed to expand—open new locations, hire new engineers and buy more raw material, or whatever the company needs.

At that point, many companies want a lot more investors to come give them money to do those things. Luckily, there are plenty of people in the United States who want to invest in companies through the stock market, but to ensure that people don’t get ripped off, companies that want to sell stock widely need to disclose a lot more information to the public about their business—their earnings, revenues, expenses, how much executives get paid, risk factors, that sort of thing.

Companies tend to complain about all that disclosure—it’s a hassle, and it might reveal information that helps their competitors—but the potential to raise billions of dollars, not to mention the company’s profile, usually weighs over those considerations. A big IPO has become the bar mitzvah of American business: Little company, today you became a man.

Facebook has grown enormously in its six years of existence, funded by friends and relatives of founder Mark Zuckerberg, to the point where some people estimate the company is worth as much as $100 billion—though this is probably a very optimistic figure. Nonetheless, in last week’s public disclosure, Facebook said it had plenty of money to meet its business needs, and it plans to simply save the $5 billion it plans to raise from investors.

So why IPO? Because all of those investors, among the biggest names in Silicon Valley, not to mention Zuckerberg or the other founders, would like some money back from their investment. You may own a certain percentage of Facebook that's worth hundreds of millions, but unless you can sell someone some of your Facebook stock for real money, it doesn’t do that much for you. At the end of the day, this IPO will create a market for everyone who got in on the ground floor to walk away with some serious dollars—pretty much every news outlet did a wealth-porn story detailing all the new multi-millionaires coming out of Facebook’s IPO.

That’s not a bad thing. We want entrepreneurs who come up with world-changing ideas to get rich, and investors to keep funding their harebrained schemes—that’s the way we create incentives for world-changing ideas. But what if an IPO isn’t in the best interest of the company?

One of the biggest worries that comes with going public is market pressure—once your company is traded every day on the stock market, investors become sensitive to even small changes in price. While the best venture capitalists don’t mind waiting patiently for a big return, even if it takes a couple bad quarters to get there, the great mass of investors is far less patient. Facebook will face enormous pressure to raise revenue through new users, ads and payments that, if done too quickly or the wrong way, could seriously hurt the firm in the longterm.

Defenders of the decision point out that Zuckerberg has taken extraordinary steps to maintain personal control of the company despite its public status. Normally, the shareholders elect a public company’s board of directors based on how much of the company they own, but through a variety of complex structures and deals, Zuckerberg will control 57 percent of the company’s voting stock and the company won't have any independent directors—Zuck's still the man, and if he’s not worried about market pressure, neither is Facebook.

That could mean trouble for investors. In theory, one of the great benefits of a public company is that management is separate from ownership—in exchange for their money, stock owners exercise some oversight over the people running the company. But Zuckerberg’s unique control over the company means that investors aren’t buying something they have control over, they’re just betting Zuckerberg won’t screw it up. If he does ignore the markets to do his own thing, the value of your stock will drop and there will be little you can do about it.

This huge decision, then, isn’t great for the little investor, and its benefits to Facebook’s operations and users is unknown at best—conventional wisdom suggests that the company will face more challenges as a public company, not less, though Google was able to beat the haters. Meanwhile, Zuckerberg, his co-founders and the venture capitalists behind his company will reap millions without ceding control of the company. It's a very different picture from the traditional IPO indeed.

But, given the opportunity to go public and cash in without giving up the central advantage of private ownership, it’s hard to imagine Zuckerberg and his team choosing any differently. Which leaves us to wonder if we’re giving entrepreneurs and investors the right set of choices that balance the rights of founders, investors and customers.

Photo via (cc) Flickr user mauricesvay

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