The Genius of the Facebook IPO

2012 May 22 01:30 PM

There is a lot of misguided chatter about how the FB IPO has gone horribly wrong. The situation is in fact the opposite: FB IPO is the most successful IPO in history.

Contrary to popular myth, the purpose of an IPO is not to enrich wall street investment banks. The purpose of an IPO is to raise capital for the company, fueling rapid expansion without the downsides of incurring debt. The success of an IPO is determined by how well it meets this purpose.

Unfortunately, most companies kowtow to wall street, reducing the amount of capital raised, for various reasons:

  1. They company is unable to generate sufficient demand and so is forced to lower its wholesale share price. This price is what the investment banks pay for the stock, and they profit by selling it at a higher price to the public. Of course, they are performing a vital function, but they often have enormous leverage in negotiating the wholesale/retail spread. Note that as the spread widens, the company raises less capital and the benefits of IPO accrue to the investment banks in increasing proportion.

  2. The founders/internal shareholders want to cash out as much as anyone. They may agree to a wider spread in order to win terms that enable them to make more money at launch.

  3. Founders/Internal shareholders need the price of the stock to jump so they can keep their jobs. Typically, by the time of IPO, founders hold less than 20% of corporate stock.

Facebook didn’t face any of these problems, and so they were able to raise the maximum amount of capital to fuel growth - capital that, in a standard IPO, would be used for investment banker bonuses:

  1. You would be insane to bet against Facebook. They have employed the very best individuals to build their future, and they are starting from a base of close to one billion users. One Billion Users.

  2. Mark Zuckerberg has repeatedly stated that he takes the long view and is uninterested in short term payouts. And thanks to secondary markets and tertiary investment rounds, internals shareholders have already been afforded the opportunity to cash out to whatever degree they desire.

  3. Mark Zuckerberg holds well over half the voting rights in FB, meaning that investors have no option to fire him, short of an extremely expensive civil case.

I expect there to be a lot of fallout from this IPO.

  1. Wall street executives have extensive connections in the political world. They will almost certainly seek new regulatory rules that will protect their profits, for example by mandating a minimum spread between wholesale/retail prices. Of course, they will lobby in the name of protecting ordinary investors, even though only large institutions capable of participating in the pre-IPO process will benefit.

  2. Wall street will lobby to adopt European-style rules where multiple-class stock structures are illegal. The FB IPO absolutely could not have happened if Mark Zuckerberg didn’t possess super-voting founder stock.

  3. Founder’s will do their best to push for similar IPO structures, because the benefits to the company and employees vastly outweigh any perception problems. Sure, the stock may suffer a little bit because retail investors have a herd-like mentality and want to invest in winners. But, the additional capital should help the company grow better than it otherwise could have, meaning the perception problems will resolve themselves in the medium term.

blog comments powered by Disqus