As an alternative a company can raise finance through debt in various forms, for example: bonds, bank loans etc. Unlike equity finance, debt holders have no control over the firm. However, the corporation is legally obliged to repay the borrowed sum plus interest, usually with regular cash payments, these must be made regardless of the company’s financial situation. From an investors viewpoint this is the less risky alternative. Interests payments are always paid to bondholders before dividends to shareholders, in the absence of interest payment, bondholders have the ability to take action against the firm forcing them to sell assets or even enter liquidation to cover their debts. However, the potential wealth of a lender is capped to the interest payment amounts outlined in their contract whereas the potential of a shareholder’s wealth has no restriction.
There is however, a recent case regarding a company that is set to list on the stock exchange against its will…
The social networking site ‘Facebook’ is the fairy-tale of every investor’s dreams. The company was started by 19-year old Mark Zuckerberg in his university dorm room in February 2004 and is set to be publically listed on a stock exchange later this year. The networking site currently has approximately 850 million active users and made $1bn profit last year. There is currently an on-going heated battle between the two American stock exchanges NYSE and NASDAQ over which will be given the opportunity to list Facebook.
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| Zuckerberg in his Harvard dorm room, birthplace of Facebook |
Being offered the ability to list the internet giant would be hugely beneficial to either stock exchange, both of which are looking to ‘jump-start’ their equity markets after being ‘hamstrung by the European fiscal crisis’ (DeCambre & Sloane, 2012). The company is suggested to raise a $5bn initial public offering, this is the sales figure generated by Facebook stock as it becomes listed. Obviously either stock exchange would welcome such investment with open arms.
In preparation for going public Facebook must fulfil some of the regulations required by companies looking to list. For example, the company has recently released some financial statements regarding its performance. The firm’s growth is phenomenal, with revenue up from $153m in 2007 to $3,711m in 2012! I can’t calculate the company’s weighted average cost of capital at the moment as there are currently no figures for the market value of the firm’s equity or debt. However, I can see that the firm is sitting on a solid balance sheet in a very strong financial position producing a total liabilities to total assets percentage of just 22.6%, low debt means higher profits and greater returns for investors.
Why then does Facebook want to raise more finance through equity? The company already has huge growth and is very strong financially holding cash reserves on their balance sheet of $3,908m. The actual reason for the company going public is that, it doesn’t have a choice. According to the Securities and Exchange Commission rule from 1964, ‘any private company with more than 500 "shareholders of record" must adhere to the same financial disclosure requirements that public companies do’ (Sloan, 2012). This is a situation Facebook reluctantly finds itself in, passing the 500 shareholders figure at the end of 2011. As a result, Mark Zuckerberg (Facebook CEO) is eager to give the smallest volume of equity away to the public, he ‘is reportedly planning to sell just 10 percent of the company’ (Sloan, 2012) retaining the majority of control within his team. This is where the rules between the American stock markets and the LSE differ; if Facebook were being launched on the LSE Zuckerberg would have to make 25% of his shares available to the public.
In addition to losing equity and a level of control over the company Mark Zuckerberg will now have a greater volume of shareholders to appease creating more tension regarding key business decisions. The company must maintain strong financial consistency to keep investors happy and share price high. The majority of the company’s revenue is generated through advertising; increasing financial performance may mean selling greater volumes of its user’s information to advertisers. The site currently has over 800 million active users; these users are essentially the company’s product. Advertisers use the information provided by Facebook to specifically channel advertis to their target markets. Facebook must therefore manage to develop a system in which financial performance is improved to keep shareholders happy without damaging the user’s experience.
Floating on the stock exchange will allow Facebook access to a large volume of capital. This can be used to develop new ways of maintaining its lead in the social networking market, a lead that needs to be carefully maintained, particularly as Google+ has had significant growth recently producing statistics such as: ‘62 million users, adding 625,000 new users per day. Prediction: 400 million users by end of 2012.’ (Allen, 2011).
Despite Facebook’s strong financial performance the revenue generated from the stock market floatation will allow the company to grow. By only giving away a small percentage of equity Mark Zuckerberg and his team will have still maintain majority control. Had the company not had the opportunity to float on the market raising $5bn through debt would prove to be difficult, if they managed to raise the sum through loans and bonds the interest payments would be excessive. In addition, the company’s profit figures would take a hit as they would be legally obliged to pay off the enormous debt putting huge pressure on the company. I think that, had Facebook not been forced to float on the market this is a move that should be taken anyway, receiving $5bn in exchange for a 10% equity sounds like a ‘no-brainer’ decision it will allow the company the funds to continue funding growth, a necessity to maintain their dominant position in the market.
In addition to raising capital Facebook will benefit from some of the non-financial advantages of listing on the stock exchange. For example, it will enhance the company’s status, increasing public awareness and demonstrate the company is capable of meeting the rules and regulations enforced by listing authorities for example ‘company’s board of directors is required to have a majority of independent directors’ (Nasdaq, 2010).
The Facebook case represents every investors dream and demonstrates from the viewpoint of the shareholder one of the main advantages of purchasing shares as oppose to lending money through bonds. The bullet points below display some of the company’s main shareholders, the value at which they purchased equity and the value their stake is currently worth:
• Accel partners, purchased a 15% stake in the company back in 2005 for £12.7m, their current stake is currently valued at $12.75bn.
• Dustin Moskovitz, lucky enough to be Zuckerberg’s roommate at Harvard, co-founder, has retained a 6% stake currently valued at $5.1bn.
• Peter Thiel, purchased a 10.2% equity share of the company in 2004 for $500,000 currently retains a 3%share valued at $2.55bn.
It depends on an investor’s goal on which sort of finance they decide to invest their savings. An investor looking for a steady, relatively risk-free return should opt for bonds and debt finance. Whereas, the more daring should choose to invest in shares with unlimited potential returns, the earlier investors of Facebook could only dream of the possible success of the company, fortunately for them, that’s a dream that became reality.
DeCambre, M. & Sloane, G. (2012) ‘ NYSE, Nasdaq battle for Facebook Listing’, New York Post, [Online]. Available at: http://www.nypost.com/p/news/business/not_so_friendly_ChdwVK0UaV1krE1J3k0FoI. (Accessed: 17/02/12).
Sloan, P. (2012) ‘Three reasons Facebook has to go public’, C Net News, [Online]. Available at: http://news.cnet.com/8301-1023_3-57368449-93/three-reasons-facebook-has-to-go-public/. (Accessed: 17/02/12).
Allen, P. (2011) ‘Google + Growth Accelerating’, Google + Website, [Online]. Available at: https://plus.google.com/117388252776312694644/posts/ZcPA5ztMZaj#117388252776312694644/posts/ZcPA5ztMZaj. (Accessed: 19/02/12).
Nasdaq. (2010) ‘Regulatory Requirements’, [Online]. Available at: http://www.nasdaq.com/about/RegRequirements.pdf. (Accessed: 19/02/12).
When Facebook goes public it will need to satisfy its shareholders. Do you think the pressure of returning shareholder wealth will be to the detriment of its users?
ReplyDeleteI think it depends on how much of the equity is given away. I believe much of the success of Facebook is due to the company's mission statement: 'To give people the power to share and make the world more open and connected'. Although the company generates huge revenues Mark Zuckerberg has always stood by the fact that their main goal is to 'connect the world' it just so happens that by doing so, the company can infact make huge profits by selling information to advertisers.
ReplyDeleteIf the company can retain the majority of equity within Zuckerberg's team they can oppose the minor shareholders that wish to enhance the financial performance by expoliting further the vast amount of information the site holds.
The company has huge cash reserves held on their balance sheet, growth is and consistently high and the firm is set to raise an IPO of $5bn when it becomes listed, so I doubt they'll be strapped for cash and need to raise any more capital through equity finance.
However, in the event that more equity is sold to the public mounting pressure from shareholders for greater returns could transform the essence of Facebook's corporate culture, changing the site into more of a marketing tool as oppose to a social networking site could have a damaging effect on its users base, particularly with new players growing in the market, for example Google's "Google+" is set to become a strong contender for the social networking crown.