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7.1 Introduction

Learning Objectives

After studying this section you should be able to do the following:

  1. Be familiar with Facebook’s origins and rapid rise.
  2. Understand how Facebook’s rapid rise has impacted the firm’s ability to raise venture funding and its founder’s ability to maintain a controlling interest in the firm.

Here’s how much of a Web 2.0 guy Mark Zuckerberg is: during the weeks he spent working on Facebook as a Harvard sophomore, he didn’t have time to study for a course he was taking, “Art in the Time of Augustus,” so he built a Web site containing all of the artwork in class and pinged his classmates to contribute to a communal study guide. Within hours, the wisdom of crowds produced a sort of custom CliffsNotes for the course, and after reviewing the Web-based crib sheet, he aced the test. Turns out he didn’t need to take that exam, anyway. Zuck (that’s what the cool kids call him)For an insider account of Silicon Valley Web 2.0 startups, see Sarah Lacy, Once You’re Lucky, Twice You’re Good: The Rebirth of Silicon Valley and the Rise of Web 2.0. (New York: Gotham Books, 2008). dropped out of Harvard later that year.

Zuckerberg is known as both a shy, geeky, introvert who eschews parties, as well as for his brash Silicon Valley bad-boy image. After Facebook’s incorporation, Zuckerberg’s job description was listed as “Founder, Master and Commander [and] Enemy of the State.”Timothy McGinn, “Online Facebooks Duel over Tangled Web of Authorship,” Harvard Crimson, May 28, 2004. An early business card read “I’m CEO...Bitch.”Claire Hoffman, “The Battle for Facebook,” Rolling Stone, June 26, 2008, 9. And let’s not forget that Facebook came out of drunken experiments in his dorm room, one of which was initially to have compared classmates to farm animals (Zuckerberg, threatened with expulsion, later apologized). For one meeting with Sequoia Capital, the venerable Menlo Park venture capital firm that backed Google and YouTube, Zuckerberg showed up in his pajamas.Claire Hoffman, “The Battle for Facebook,” Rolling Stone, June 26, 2008.

By the age of twenty-three, Mark Zuckerberg had graced the cover of Newsweek, been profiled on 60 Minutes, and was discussed in the tech world with a reverence previously reserved only for Steve Jobs and the Google guys, Sergey Brin and Larry Page. But Mark Zuckerberg’s star rose much faster than any of these predecessors. Just two weeks after Facebook launched, the firm had four thousand users. Ten months later it was up to one million. The growth continued, and the business world took notice. In 2006, Viacom (parent of MTV) saw that its core demographic was spending a ton of time on Facebook and offered to buy the firm for three quarters of a billion dollars. Zuckerberg passed.Steve Rosenbush, “Facebook’s on the Block,” BusinessWeek, March 28, 2006. Yahoo! offered up a cool one billion dollars (twice). Zuck passed again, both times.

As growth skyrocketed, Facebook built on its stranglehold of the college market (85 percent of four-year college students are Facebook members), opening up first to high schoolers, then to everyone. Web hipsters started selling shirts emblazoned with “I Facebooked your Mom!” Even Microsoft wanted some of Facebook’s magic. In 2006, the firm locked up the right to broker all banner ad sales that run on the U.S. version of Facebook, guaranteeing Zuckerberg’s firm one hundred million dollars a year through 2011. In 2007, Microsoft came back, buying 1.6 percent of the firm for two hundred forty million dollars and securing the rights to sell banner ads on all Facebook sites worldwide (70 percent of Facebook users are outside the United States).

The investment was a shocker. Do the math and a 1.6 percent stake for two hundred forty million dollars values Facebook at fifteen billion dollars (more on that later). That meant that a firm that at the time had only five hundred employees, one hundred fifty million dollars in revenues, and was helmed by a twenty-three-year-old college dropout in his first “real job,” was more valuable than General Motors. Then in May 2008 Facebook hit another major milestone: it passed MySpace to become the world’s largest social network. Rupert Murdoch, whose News Corporation owns MySpace, engaged in a little trash talk, referring to Facebook as “the flavor of the month.”Brian Morrissey, “Murdoch: Facebook Is ‘Flavor of the Month,’” Media Week, June 20, 2008.

Watch your back Rupert. Or on second thought, watch Zuckerberg’s. By spring 2009, Facebook had more than twice MySpace’s monthly unique visitors worldwide;E. Schonfeld, “Dear Owen, Good Luck with That,” TechCrunch, April 24, 2009. by June, Facebook surpassed MySpace in the United States;“Facebook Dethrones MySpace in the U.S.,” Los Angeles Times, June 16, 2009, http://articles.latimes.com/2009/jun/16/business/fi-facebook16. and by July, Facebook announced that it surpassed 350 million users and was cash-flow positiveWhen a company’s revenues can cover its operating costs..D. Gage, “Facebook Claims 250 Million Users,” InformationWeek, July 16, 2009. Murdoch, the media titan who stood atop an empire that includes the Wall Street Journal and Fox, had been outmaneuvered by “the kid.”

Why Study Facebook?

Looking at the “flavor of the month” and trying to distinguish the reality from the hype is a critical managerial skill. In Facebook’s case, there are a lot of folks with a vested interest in figuring out where the firm is headed. If you want to work there, are you signing on to a firm where your stock options and 401k contributions are going to be worth something or worthless? If you’re an investor and Facebook goes publicThe first time a firm sells stock to the public; formally called an initial public stock offering (IPO)., should you shortShort selling is an attempt to profit from a falling stock price. Short sellers sell shares they don’t own with an obligation of later repayment. They do so in the hope that the price of sold shares will fall. They then repay share debt with shares purchased at a lower price and pocket the difference (spread) between initial share price and repayment price. the firm or increase your holdings? Would you invest in or avoid firms that rely on Facebook’s business? Should your firm rush to partner with the firm? Would you extend the firm credit? Offer it better terms to secure its growing business, or worse terms because you think it’s a risky bet? Is this firm the next Google (underestimated at first, and now wildly profitable and influential), the next GeoCities (Yahoo! paid three billion dollars for it—no one goes to the site today), or the next Skype (deeply impactful with over four hundred forty million accounts worldwide, but not much of a profit generator)? The jury is still out on all this, but let’s look at the fundamentals with an eye to applying what we’ve learned. No one has a crystal ball, but we do have some key concepts that can guide our analysis. And there are a lot of broadly applicable managerial lessons that can be gleaned by examining Facebook’s successes and missteps.

Zuckerberg Rules!

Many entrepreneurs accept startup capital from venture capitalists (VCs)Investor groups that provide funding in exchange for a stake in the firm, and often, a degree of managerial control (usually in the form of a voting seat or seats on the firm’s board of directors)., investor groups that provide funding in exchange for a stake in the firm, and often, a degree of managerial control (usually in the form of a voting seat or seats on the firm’s board of directorsGroup assigned to govern, advise, and provide oversight for the firm. The board’s many responsibilities often include hiring and firing authority for the CEO.). Typically, the earlier a firm accepts VC money, the more control these investors can exert (earlier investments are riskier, so VCs can demand more favorable terms). VCs usually have deep entrepreneurial experience, a wealth of contacts, and can often offer important guidance and advice, but strong investor groups can oust a firm’s founder and other executives if they’re dissatisfied with the firm’s performance.

At Facebook, however, Zuckerberg owns an estimated 20 percent to 30 percent of the company, and controls three of five seats on the firm’s board of directors. That means that he’s virtually guaranteed to remain in control of the firm, regardless of what investors say. Maintaining this kind of control is unusual in a startup, and his influence is a testament to the speed with which Facebook expanded. By the time Zuckerberg reached out to VCs, his firm was so hot that he could call the shots, giving up surprisingly little in exchange for their money.

Key Takeaways

  • Facebook was founded by a nineteen-year-old college sophomore and eventual dropout.
  • It is currently the largest social network in the world, boasting more than three hundred fifty million members and usage rates that would be the envy of most media companies. The firm is now larger than MySpace in both the United States and worldwide.
  • The firm’s rapid rise is the result of network effects and the speed of its adoption placed its founder in a particularly strong position when negotiating with venture firms. As a result, Facebook founder Mark Zuckerberg retains significant influence over the firm.
  • While revenue prospects remain sketchy, some reports have valued the firm at fifteen billion dollars, based largely on an extrapolation of a Microsoft stake.

Questions and Exercises

  1. Who started Facebook? How old was he then? Now? How much control does the founding CEO have over his firm? Why?
  2. Which firms have tried to acquire Facebook? Why? What were their motivations and why did Facebook seem attractive? Do you think these bids are justified? Do you think the firm should have accepted any of the buyout offers? Why or why not?
  3. As of late 2007, Facebook boasted an extremely high “valuation.” How much was Facebook allegedly “worth?” What was this calculation based on?
  4. Why study Facebook? Who cares if it succeeds?