A Big Bet on ZuckerbergBy STEVEN M. DAVIDOFF
Rose Lincoln/Harvard University, via Associated PressBuying Facebook is really a bet on Mark Zuckerberg.
Yes, we all know he is Facebook’s twenty-something visionary founder, as well as the person who has led Facebook to a potential market value of $75 billion to $100 billion. But there is another reason an investment in Facebook is really an investment in Mr. Zuckerberg: Facebook’s offering documents show he will retain control over Facebook even when it becomes one of America’s largest publicly traded companies.
Mr. Zuckerberg’s control is based on the structure of Facebook’s shares. Facebook is proposing to go public with a dual-class share structure. Public shareholders will purchase Class A shares that have one vote apiece. Mr. Zuckerberg, Facebook employees and current Facebook investors will hold Class B shares, which have 10 votes apiece. This is a deviation from the one share one vote norm followed by most publicly traded companies.
This alone does not give Mr. Zuckerberg total control over Facebook.
He has also entered into voting agreements with other Class B shareholders, including shares held by the Facebook co-founder Dustin Moskovitz and Facebook’s first president, Sean Parker. These agreements give Mr. Zuckerberg voting control over an additional 30.6 percent of the Class B shares. Mr. Zuckerberg even retains control over about half of these shares if he decides to leave Facebook. Post-I.P.O., he will control at least 57.1 percent of the Class B shares, potentially more if some investors sell their B shares in the offering. This will give him complete voting control over the company.
Mr. Zuckerberg’s consent will be required if the company is sold. Unlike most public companies, Facebook will not have a nominating committee for its directors comprising the independent directors on Facebook’s board. Instead, all of the directors will be selected by the board itself, a group that will be appointed by Mr. Zuckerberg. He can also remove and replace any director at any time.
Nor is this going to change any time soon.
Facebook’s organizing documents dictate that when Class B shares are transferred, they typically will convert into the low-vote Class A shares. It is likely that, over time, Mr. Zuckerberg will hold onto the bulk of his Class B shares as other holders of Class B shares sell off their stakes.
This is the rub of the dual-class shares.
Mr. Zuckerberg can also sell down his shares. But until the Class B shares comprise less than 9.1 percent of the outstanding Facebook shares, the holders of the Class B shares control Facebook.
Given this low threshold, Mr. Zuckerberg, 27, is likely to have enough Class B shares to give him control of the company for a long, long time, despite the fact that he will have a much smaller economic stake. In fact, other shareholders are more likely to sell their Class B shares more quickly than Mr. Zuckerberg, who appears to want to manage Facebook for the long-term.
As a result, his control over Facebook could increase over time.
Mr. Zuckerberg is not alone in using this type of structure to maintain ownership of a prominent technology company. The founders of Google, Larry Page and Sergey Brin, set up a similar structure and retain voting control over Google.
Yet they are two people who counterbalance each other, not a single individual.
Three other prominent company founders, Andrew Mason at Groupon, Mark Pincus at Zynga and Reid Hoffman at LinkedIn, have also adopted similar dual-class voting structures at their companies. At the time of those public offerings last year, Mr. Mason controlled 19.7 percent of the votes at Groupon, Mr. Pincus controlled 37.4 percent of the votes at Zynga and Mr. Hoffman controlled 21.7 percent of the votes at LinkedIn.
These companies, however, are much smaller than Facebook. And while their stakes are sizable, they do not entitle any of the three founders to remove and replace directors at will.
Even Bill Gates had less than 50 percent control over Microsoft at the time of its I.P.O. — he owned 49 percent of the company. Since he did not own dual-class shares, any sales by him were sure to reduce his controlling interest.
Mr. Zuckerberg thus stands alone in exercising this degree of control over a very public technology company. As DealBook’s Evelyn M. Rusli and Peter Eavis have reported, Facebook could be valued more richly than Amazon, Kraft Foods and Goldman Sachs.
In essence, Mr. Zuckerberg has created an empire that he will continue to rule.
This is not necessarily a bad thing. He is young, but he has already accomplished more than most of us will in our lives. He is the guiding force behind Facebook.
Mr. Zuckerberg had the foresight to obtain these voting agreements, arrangements which now ensure he will control the company for a substantial amount of time. By maintaining control, Mr. Zuckerberg no doubt hopes to continue to implement his vision free from intrusive shareholder influence. He is about to get his wish.
As for the public, whether they buy Facebook shares boils down to whether they believe in Mr. Zuckerberg and the control he will wield.