Facebook IPO Will Boost 1%, But the Rest of Us Won't Be Sharing
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Unless you’ve been under a rock, you know that last week Facebook filed papers for an initial public offering. This is possibly the largest (and most hyped) IPO since Google’s 2004 debut. The company will likely go public in May in a move that could place its valuation at an eye-popping $100 billion. That’s a big deal. And there are big questions emerging about issues ranging from privacy to corporate governance to what the company’s founders owe the public. Just who are the real winners and losers in this deal? And what, if anything, will the 99 percent get out of it?
How IPOs Make the Rich Richer
So FB is putting itself on the stock market for the first time. An initial public offering (IPO) is one of the ways a company can raise loads of cash to expand its business. Or buy private jets. Or whatever.
Word is that FB will be selling $5 billion worth of equity (a small percentage of its shares) to outside investors. Doing a big initial IPO has been an iffy proposition in the last couple of years because of the recession, which may have caused FB to hang back. Now, though, there are signs that another high tech bubble is forming. A company wants to strike while the iron is hot and sell shares for as much as it can (possibly more than they are truly worth). Partners are eager to cash out and make a fortune. If FB waited too long, the company might lose the moment, so Mark Zuckerberg & Co. are going for it.
An IPO is definitely not designed for the benefit of the 99 percent. The company’s founders, the venture capital (VC) investors, and the bankers orchestrating the deal (Morgan Stanley, JP Morgan, Goldman Sachs, etc) are poised to make a pile of money. Zuckerberg, who owns 28 percent of the company, stands to make tens of billions. Not bad for a 27-year-old. If you were lucky enough to get a job with FB early, you’ll do nicely because you were likely given stock options as part of your job compensation package.
And what about everybody else? There are only a limited number of shares of the company that will be sold to bring in that $5 billion, and most of these are probably already spoken for. The investment banks involved in the deal will be offering first dibs to their big institutional clients like Vanguard, top executives at companies whose business they crave, and fatcat customers like Mitt Romney, rather than average consumers.
By the time you and I are able to buy the stock, shares will likely be priced higher than for those who got the inside track. And if the excitement over FB was just another bit of high tech euphoria, then the ordinary purchasers who bought at the high price are the ones left holding the bag if the value takes a nosedive. That’s why, as Barry Ritholz of the Big Picture put it, “the VC money is often called the smart money, where as the public IPO is often the dumb money.” Early, privileged investors have a good chance of doing well. Others roll the dice.
Facebook has turned a profit for the past three years, according to the documents filed with the SEC. The company reported revenues of $3.7 billion last year and earned a $1 billion profit. That’s a heck of a lot more than other Internet companies that recently completed their IPOs. LinkedIn, for example, was just barely profitable when it filed for its IPO in 2011. FB’s reported 845 million active monthly users is a staggering number (though definitions of ‘active’ and ‘user’ have been questioned). Long and short: People are ready and willing to bet that FB’s stock will go up, and that’s why the company can do an IPO at such a stratospheric price.
But skeptics say that FB is likely to have an overvalued IPO. There are concerns that the company’s growth will prove difficult, maybe impossible, to sustain. Can FB monetize users as effectively as Google? What will happen if the company fails to add new users or keep existing users engaged? How can FB be sure its platform will get along with mobile devices whose operating systems it can’t control? How will it compete with China’s already-established local platforms?
And, um, what exactly is the business model? The difficulty of answering that last question is a good sign that we may have a bubblicious situation. Zuckerberg likes to talk about how his company is different, how it wasn’t built to be a company, how it’s all about a new way of sharing, etc. etc. We’ve heard this before – from Google, whose practices are now under increasing challenge as abusive and monopolistic. Are Zuckerberg’s noises the sound of a visionary? Or a bubble inflator?
A big concern is that Zuckerberg will retain unusual control of the company after the IPO. If he makes a bad call, the company’s value could tank. Which will not suck for Zuckerberg, who will be quite rich no matter what happens, but will possibly suck a lot for shareholders. Which brings us to another question. Does he owe anything to the rest of us?
Sharing the Wealth
Companies are often run by powerful CEOs, but they are usually owned by shareholders and governed by a board of directors meant to look out for shareholder interests. At least that’s how it’s supposed to work. But FB will be doing things differently. After the IPO, Zuckerberg will keep control of the company in two ways. First, he has set up two classes of stock, one of which (Class B) has ten times the voting rights of the other (Class A). Guess which kind Zuckerberg has? That’s right. His stock is Class B. This practice is pretty common. But Zuckerberg has done something less common in setting up voting agreements that give him final control of the company. (For details, see article by the WSJ’s Ronald Barusch.). Bottom line: Zuckerberg will be calling the shots. And no one can replace him with different management. In all US companies, the notion that public shareholders can influence corporate decision-making is typically a sham. But with FB, from the outset Zuckerberg has ensured that, as CEO, he will be accountable to no one.
Slate’s Matt Yglesias sees this as a new form of corporate dictatorship. As he put it:
“To purchase a share in Facebook is to bet that at some future point some future person will want to take it off your hands for more money. You’re not getting even a notional slice of control in the company. There are no limits on the CEO’s ability to channel Facebook’s profits directly into his own pocket rather than yours. There’s not even a cheap-talk promise that he’s going to try to maximize the value of your investment. He created the company, he controls the company, he will always control the company, and he’s graciously allowing you to turn some of your working capital over to him.”
After the IPO, Zuckerberg will be one of the world’s richest people, at least on paper. Well, hasn’t he earned it?
Not so fast, says economist William Lazonick, an expert on the history of American business. Like Elizabeth Warren, Lazonick reminds us that CEOs like Zuckerberg don’t create companies in a vacuum. They had a lot of help along the way. “Facebook exists because of decades of US government investment in computing and the Internet plus the work of hundreds of thousands of people to develop the underlying technologies,” says Lazonick. “Yet because Facebook is positioned with its particular popular application, Zuckerberg and his partners grab all of the returns. This inequity could be partially remedied by high taxes on the capital gains of Facebook's shareholders that could be used to fund the next round of innovation, including the funding of higher education. Rather, of course, the taxes on these gains have been cut to 15%.”
Lazonick reminds us that this problem dates back to ‘80s when the IPOs of two young companies, Apple and Genentech, netted their founders and venture capitalists ginormous fortunes. And you will not be surprised to learn who it was that lobbied to lower the capital gains tax rate. Lazonick explains that “as members of the National Venture Capital Association, which emanated from Silicon Valley (as did Apple and Genentech), it was these same venture capitalists who had successfully lobbied US Congress in the late 1970s to lower the capital gains tax rate, which was almost 40 percent in 1976. The IPOs that brought them these riches were only possible because of NASDAQ, founded in 1971 to provide national price quotes on highly speculative companies.” In the early ‘80s, high-tech entrepreneurs and venture capitalists raked in stunning amounts of money from IPOs. Corporate executives then caught the fever and demanded that their boards shovel over mounds of stock-based pay so that they could catch up with these new zillionaires.
And so on. The result is what Lazonick calls "contagious compensation,” which has stoked economic inequality in the US. The 99% has been largely left with food stamps or flat wages for a generation.
Zuckerberg is also able to take advantage of a one percent-friendly concept in our tax code known as “realization,” which says that individuals are not taxed until they actually sell property and realize their gains. When it comes to the publicly traded stocks of the superwealthy, this system shortchanges the public of hundreds of billions of dollars of revenue and favors founders and investors over wage earners.
As tax lawyer David S. Miller explained in the New York Times, Zuckerberg will exercise stock options worth $5 billion when FB goes public. This $5 billion will be treated as salary, and he will have a tax bill of over $2 billion. But the stock he does not sell will not be taxed. “Instead,” explains Miller, “he can simply use his stock as collateral to borrow against his tremendous wealth and avoid all tax.” He can borrow to buy yachts, vacation homes, fancy cars, etc, which will be cheaper for him than selling shares because of tax avoidance. If he never sells his shares, he never gets taxed, and he can pass them on to his heirs. Steve Jobs never paid taxes on his Apple stock after rejoining the company in 1997 and did not pay a cent on the $2 billion he held until his death.
Your Identity for Sale
When FB or any company goes public, there’s more pressure to increase short-term profitability and generate new revenue. FB doesn’t really make anything or provide any particular service in the traditional sense. It makes money from obtaining and compiling the personal information of users, which is attractive to advertisers. As FB explained in its IPO documents, “Advertisers can engage with more than 800 million monthly active users (MAUs) on Facebook or subsets of our users based on information they have chosen to share with us such as their age, location, gender, or interests.”
Unlike Google or other Internet companies, FB’s content is entirely created by users. But users aren’t going to be paid for it. That’s not fair, says Nick Bilton of the Sydney Morning Herald. He reckons that Zuckerberg owes him fifty dollars for liking, poking, and sharing on his site. As Bilton argues, “I helped build this thing, too. Facebook laid the foundation of the house and put in the plumbing, but we put up the walls, picked out the furniture, painted and hung photos, and invited everyone over for dinner parties.” His article points out that FB could create a “two-way financial street” in which users could be paid for content and our personal information.
As FB tries to monetize users, it may well get more intrusive about mining our information and distributing it, which it has done in the past, much to the disgust of many sharers and consumer watchdogs. FB claims that users control what they share through the website’s privacy and sharing settings. But there are plenty of concerns about improper disclosure, which can lead to things like identity theft and other scenarios which may harm the ordinary user, from hacking to stalkers.
An IPO makes a company like FB worth an enormous amount of money, and if there’s one thing we know about our political system, it’s that money talks. FB already has a very big lobbying presence in Washington, and even a political action committee. And that influence is only going to get bigger. Would FB lobby for lax laws on privacy issues? You bet it would. And since we have a president who likes to be seen as friendly to high tech, it will likely be heard.
Much has been made of the role of FB in the Arab Spring, in which the social media site offered a useful platform and tool for organizing. The impact of social media on global political change is an interesting thing to debate, and it may have real meaning for the masses. But when it comes down to business, FB just looks like another triumph of the one percent. With friends like that, who needs enemies?