Andrew Ross Sorkin’s missive on mistakes made in the Facebook IPO has given rise to some strong emotions. While Andrew sought to lay much of blame at the feet of Facebook’s CFO, some others (here and here) view the CFO’s responsibility as simply being to get the highest price for the shares offered, full stop, and in that light David Ebersman did an absolutely flawless job. I personally find it easy to put myself in either mind-set. I had deep concerns about the aftermarket performance of Facebook stock, and shared my thoughts in May. I felt that those who played the Facebook IPO game, especially retail investors who were unlikely to get fills both long and short and times and prices that gave them a chance to make money were likely to get smoked. But this fact or today’s perspectives on the Facebook IPO miss the central question:
What is the nature of relationship you want to have with investors?
I’d posit that if the intention is to have a long-term relationship with your investors, then that should have a meaningful impact on how your price your offering and to whom you offer your shares. And this is the same for public and private companies alike.
The Facebook (FB) offering was priced as a win/lose – those doing the selling won and those doing the buying lost. Those who bought and who hoped to cash in on the euphoria get little sympathy, and they shouldn’t. But by continually raising the offering price it is easy to imagine that the stable, supportive, long-term investors who believe in the Company’s long-term prospects got forced out because of valuation concerns. At $38, those with more sober financial models would see it taking years to grow into that price. No surprise there. So what’s left is “hot money” investors who care little about the long-term and only about the flip. Now one can argue that why should Facebook care about this? The Company and its insiders reaped a cool $10 billion at a premium price – isn’t that all that really matters? It is, if you expect that Facebook won’t be tapping the public markets again for the foreseeable future and that potential hires don’t look at its price action and sharply undervalue restricted stock and option grants. And the argument that existing option grants can simply be repriced? They can, but this also comes at a cost: savvy long-term investors hate this, especially if they believe the restructuring is too heavily skewed in Management’s favor. It can be highly dilutive and is a terrible way to start life as a public company. Google’s repricing happened five years after they first went public. They had lots of public operating history and a lot of credibility with the investment community. People had already made lots of money investing in the public Google. No such thing can be said about Facebook, and won’t be said for a long time. So that line of argument is a bit of a red herring.
The dynamic in “hot” private companies can be very similar. Sometimes founders can focus exclusively on valuation, riding a wave that brings in a boatload of cash at a price that sets the bar extremely high. The investors in question were willing to pay the highest price, but may or may not be the best and most value-added long-term partners for the company. In these cases managements’ have effectively bet the company: if operating performance doesn’t hit the metrics which justify the lofty valuation, if product releases take longer than expected, if new competitors enter which make the environment more competitive, it becomes painfully hard to move forward. Sell the company? The post-money valuation has sharply reduced exit opportunities, as the last-in investors will balk at poor cash-on-cash returns. Raise more money to buy additional time? You will invariably not like the terms. So unless progress is up-and-to-the-right and of sufficient magnitude to justify the valuation, investor goodwill will not be there to soften the blow.
Finally, there is the argument that these seemingly touchy-feely issues are a bunch of BS and that the Company should be focusing on one thing: product and customer satisfaction. I am here to tell you that this perspective is BS. Once a company, be it public or private, has taken third-party money, its relationship with investors and the stability it has created in its capital structure is an essential element of delivering the best product to customers. This is one of the key reasons for having a finance function. Financial control, budgeting and strategic planning are critical, but long-term access to capital is and strong investor relationships are, without question, a key element of a company’s ongoing success. How Facebook and its bankers dealt with the offering did not detract from the Company’s focus on product: it should have helped its ability to block out the distractions of a disappointing offering and protected its focus on product and customer satisfaction. Much of the blogosphere, in my opinion, has this dynamic backwards.
The issue with Facebook isn’t who to blame: it doesn’t really matter. But if the Company believes it has best positioned itself for a stable and constructive long-term relationship with the investment community, it is sorely mistaken. They may have “won” the battle, but the war is still very much in question.