The company responsible for the most popular social network on the Web took its first step toward going public on Wednesday. Facebook filed a 200-page regulatory document with the Securities and Exchange Commission as it prepares for an initial public offering in the spring.
Even though investors have been clamouring to get a piece of Facebook for years, the company's regulatory filing reveals a number of previously undisclosed details about its inner workings – and not all of them good.
Looking over the filing reveals a number of challenges that will ultimately determine whether Facebook continues to dominate the social Web, or becomes this decade's MySpace.
More than half of Facebook's 845 million monthly active users have also used the company's various mobile products, such as Facebook apps for the iPhone, BlackBerry and Android-powered phones. In of itself, that's positive news for the company, given that social media users are increasingly moving from desktops and laptops to smartphones and tablets.
The problem is, Facebook derives the vast majority of its revenue from third-party ads. And when it comes to its mobile offerings, the company has no ad strategy to speak of.
"Growth in use of Facebook through our mobile products, where we do not currently display ads, as a substitute for use on personal computers may negatively affect our revenue and financial results," the company stated in its regulatory filings.
Once it goes public, Facebook will likely come under significant investor pressure to start monetizing its mobile products, most likely through the inclusion of ads. However mobile advertising is a different beast, and the company will have a hard time simply recreating its desktop Web ad strategy on the smaller screen.
In one of the fastest-growing markets on Earth, access to Facebook is still severely restricted. Chinese Internet users still face ubiquitous censorship, and Facebook has so far not tried to work with Beijing to deliver even a watered-down version of the social network to the country.
Facebook will likely find China's 450 million Internet users too alluring a market to pass up. However, in its regulatory filing Facebook mentions three other social networks – Renren, Sina, and Tencent – that are already well-established in China. Because social network users tend to join networks their friends have already joined, a head-start in a country can be hugely beneficial.
In addition to the established players, Facebook will have to deal with the well-known complexities of the Chinese markets. These include heavy government regulation, censorship requirements and potential hacking (which at one point forced Google to abandon much of its presence in the country). Facebook's filing says the company is still evaluating whether to give China a shot. "However, this market has substantial legal and regulatory complexities that have prevented our entry into China to date."
For all its phenomenal growth, Facebook is, at its heart, a company that makes money predominantly off advertising. Like Google , Facebook derives most of its revenue from selling ads to third-parties on its site. Three years ago, 98 per cent of Facebook's revenue came from ads. Last year, that number dropped to 85 per cent, largely because the company began taking advantage of payment revenue from the many social games that run on the Facebook platform.
But even that new source of revenue is lopsided. Virtually all of Facebook's revenue from games comes from Zynga, the massive social games maker and creator of such hit titles as FarmVille. In fact, Zynga accounted for 12 per cent of Facebook's revenue last year – such a significant share that Facebook included the possibility of a deteriorating relationship with the company as a significant risk factor in its regulatory filing.
Facebook's reliance on ad revenue tends to make it susceptible to overall economic trends, which tend to impact advertisers' willingness to spend money. And even though the company notes that the majority of its ad clients are smaller, short-term advertisers, rather than big players, that disclosure adds even more uncertainty to its business model.
4: User growth
Facebook estimates there are roughly two billion Internet users on Earth today. Already, more than 800 million of them use Facebook at least once a month, and more than 400 million use the social network at least once a day. And since investors will be buying Facebook shares based on prospects for future growth, the company will have to explain where it plans to get its next 800 million users.
In its regulatory filing, Facebook offers some hints as to where its growth plans are directed. The company notes that in countries such as Brazil, Germany and India it has an estimated penetration rate of 20 to 30 per cent. In Japan, Russia and South Korea, that rate is less than 15 per cent (by comparison, Facebook's penetration rate in the U.S. hovers around 60 per cent, and in some countries, such as Chile, it's closer to 80 per cent).
Facebook – like Twitter, Google and many other Internet companies – will have to go overseas to look for revenue and user-base growth. But that means navigating various logistical hurdles. Already, Facebook has offices in more than 20 countries, and will soon likely have to deal with local laws and regulations in many other parts of the world if it wants to maintain its breakneck growth rate.
5: Mark Zuckerberg
The man who founded the company in his Harvard dorm room in 2004 is now its CEO, chairman of the board and controlling shareholder. In its regulatory filing, Facebook credits Mr. Zuckerberg with the vision to create what has become the largest social network on Earth. But as Facebook morphs into a public company, its 27-year-old founder will still have final say over all major decisions, largely unchallengeable by investors or the board of directors.
Following Facebook's initial public offering, Mr. Zuckerberg will continue to own the majority of the company's voting shares. He will also own the largest single stake of the company as a whole. Even though Facebook has brought on more experienced business and technology leaders as the company has grown – Mr. Zuckerbeg is the youngest member of the board, by about a decade – it is unclear how much influence they will have over the man who founded the company.
Ideally, a founder-centric structure would allow Facebook to have one point of authority, enabling the company to make decisions faster. However there are plenty of examples – most recently, Research In Motion – of public companies that were forced to relieve their founders of some of their responsibilities in order to better compete. If such a situation arises at Facebook, Mr. Zuckerberg will be difficult to unseat.