Friday, February 3, 2012

The Capitalist Wants an Exit, Facebook Edition

In today's FT, John Gapper reads the Facebook prospectus. [1] And he doesn't like what he sees:
There is still time to cancel its IPO and the filing provides plenty of reasons why it ought to... It begs a question if a company trying to raise capital from investors cannot think of anything to do with the money. Yet this is Facebook’s predicament – as it admitted in its filing on Wednesday, its cash flow and credit “will be sufficient to meet our operational needs for the foreseeable future”. ... So what are its plans for the additional $5bn it may raise from an IPO? It intends to put the cash into US government bonds and savings accounts...
Gapper, looking at the IPO from the perspective of what it does for Facebook the enterprise, understandably thinks this is nuts. Why incur the costs of an IPO and the ongoing requirements of a public listing, if you have so little need for the cash that you are literally just planning to leave it in a savings account. But of  course, the purpose of the IPO has nothing to do with Facebook the enterprise.
Given that it doesn’t need capital..., why the IPO? ... Facebook’s motivation is clear: to gratify its venture capital investors and employees. This is not a cynical statement; it is a quote from Mr Zuckerberg’s letter to new shareholders. “We’re going public for our employees and our investors,” he writes. “We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment.”
In terms of Silicon Valley’s logic, it makes sense... For the company itself, however, the logic is far less obvious. As a corporate entity, Facebook could clearly thrive without seeking new shareholders, whose main purpose is to allow the insiders to get rich and eventually exit.
 As I've written before, the function of the stock market in modern capitalism is to get money out of corporations, not put money into them. The social problem they are solving is not society's need to allocate scarce savings to the most promising investments, but wealth-owners desire to free their fortunes from particular firm or industry and keep them as claims on the social product as a whole.

[1] It's been said before, but can I just point out how unbearably stupid is the FT's policy of actively discouraging people from excerpting their articles?


  1. As far as I know, nothing prevents a company from IPOing without raising cash, just selling existing shares. Of course it's in the interest of Wall Street to maximize the size of the offering since they take a cut.

    It's quite understandable that venture funds want "out" since Facebook has passed well beyond the venture stage.

  2. Thing is, it seems like this (media, digital, tech) sector of the economy --- while almost certainly overvalued --- is the part of american capitalism that is actually working, no?

  3. I enjoy your blog and the way it makes me think. This post got me thinking about whether the change in the purpose of financial markets for firms like Facebook is a bad thing.

    Historically (in my simplistic understanding), financial markets were intended to allocate capital from where there was an excess supply to to where it was needed. Now, for certain firms, financial markets serve the purpose of disgorging cash. Is this a conflict or simply an evolution in the relationship between certain firms and their markets (business and financial)?

    When large sums a capital were required to fund certain businesses, markets developed to fund large fishing ships in Amsterdam or to enable the British to set up colonies or to enable the US to build large factories, railroads and steel mills.

    During this era, large amounts of capital and large numbers of people were required to produce fish, commodities and automobiles which these firms sold to consumers for cash. Some of that cash was then, presumably, returned to the shareholders.

    However, the types of business and how some of them them generate the revenue changed. Especially in developed countries. If you are writing software or designing furniture (think Ikea, which is private) or creating entertainment; you do not need large amounts of capital or very many people. Equally, the way you generate the revenue has changed. Google doesn't charge me for search, neither Adam Carolla nor the NFL charge me to download their podcasts and Facebook doesn't charge me to create a profile.

    For all these types of businesses, the way they generate revenue from their business market has entirely changed.

    So, if the business markets' relationship to these firm has changed, why shouldn't their relationship to the financial markets change?

  4. Just to be clear, I'm not mainly making a normative claim here. I'm not saying there's something wrong with the desire for liquidity, just that it's not the way the role of stock market is normally presented.

    (Now in fact, I do have objections -- big ones! -- to this way of organizing things. But that's not what this particular post is about.)

  5. To play devil's advocate: as Zuckerberg said, his goal is to make the equity liquid. Isn't this a prerequisite to allocating "scarce savings to the most promising investments"?

  6. "Historically (in my simplistic understanding), financial markets were intended to allocate capital from where there was an excess supply to to where it was needed. "

    My simplistic understanding is that the stock market doesn't play this role hardly at all. When you buy stock in a company, the company gets absolutely nothing from you -- every penny goes to another shareholder, none of is used by the company. There is an indirect sense in which the VCs and IPO buyers participate because they expect to be able to sell at a good price, and if they can sell at a good price it is because those buyers also expect to make money, and so on, so the fact that people are buying/making money on stock long after IPO was anticipated by those who actually invested in the company and their prediction of future stock activity was why they invested, but shareholders do not directly contribute to their companies post-IPO.