At long last Facebook has filed for its initial public offering, the most eagerly awaited event in Silicon Valley since Google went public in 2004. Having read the prospectus, with its details of how profitable and cash-rich the social networking enterprise is, may I suggest it call the whole thing off?
There is still time to cancel its IPO and the filing provides plenty of reasons why it ought to, and why Mark Zuckerberg, its founder and chief executive, would probably be happier if it did. He could carry on running Facebook as a private company and would not have to justify himself to outsiders.
It poses a question if a company trying to raise capital from investors cannot think of anything to do with the money. Yet this is Facebook’s predicament – as it admitted in its filing on Wednesday, its cash flow and credit “will be sufficient to meet our operational needs for the foreseeable future.”
Facebook is far from the average Silicon Valley start-up, which has plenty of growth and little by way of revenues. In fact, it is turning into a veritable cash machine. Its free cash flow rose from $190-million (U.S.) to $470-million between 2010 and 2011, while its shareholders’ equity increased from $2.2-billion to $4.9-billion.
So what are its plans for the additional $5-billion it may raise from an IPO? It intends to put the cash into U.S. government bonds and savings accounts, and perhaps use some to pay the tax due on converting into shares the “restricted stock units” it has given to its 3,200 staff.
That’s right. Its sole tangible purpose for the IPO proceeds is to meet a tax obligation that will be triggered by going public. Welcome to the Catch-22 world of the venture capital liquidity event.
Meanwhile, Mr. Zuckerberg does not want to cede any of the grip that he has exerted on the company for the past seven years by allowing the ordinary shareholders voting rights. Even the dubious dual-class equity structure used by Google and others for Silicon Valley IPOs, with insiders having 10 times the votes of others, is not enough for him.
As well as having 28 per cent of Facebook’s privileged B class shares, Mr. Zuckerberg wields proxy control of a further 30 per cent of Facebook’s voting shares. That gives him a similar level of voting control to that held jointly by Larry Page and Sergey Brin following Google’s IPO.
Mr. Zuckerberg also has the right to appoint the directors, and “control the management and affairs of our company.” He even granted himself the ability to pass control to his chosen successor when he dies, in true dynastic fashion.
Given that it doesn’t need capital and doesn’t want shareholders to get in the way of its autocratic founder, why the IPO? Apart from meeting US regulations for a private company to go public when it gains more than 500 investors, Facebook’s motivation is clear: to gratify its venture capital investors and employees.
This is not a cynical statement; it is a quote from Mr. Zuckerberg’s letter to new shareholders. “We’re going public for our employees and our investors,” he writes. “We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment.”
In terms of Silicon Valley’s logic, it makes sense. The returns from occasional winners such as Facebook make up for venture capitalists’ losing bets on thousands of other start-ups – provided the winners are sold either to other companies or to the public markets.
Meanwhile, start-ups attract the best software engineers by giving them preferred equity and restricted stock units in the hope that they will get rich one day. As the New York Times reports, even the graffiti artist who painted Facebook’s walls took stock rather than cash, and may gain shares worth $200-million.
For the company itself, however, the logic is far less obvious. As a corporate entity, Facebook could clearly thrive without seeking new shareholders, whose main purpose is to allow the insiders to get rich and eventually exit. Facebook’s IPO is mainly taking place to encourage the others in Silicon Valley.
There is an alternative. Since Mr. Zuckerberg regards shareholders as a necessary inconvenience, he should study Cargill, the privately held commodities firm that also operates in 70 countries and “helps customers succeed through collaboration and innovation.” Founded in 1865, it has yet to file for an IPO.