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15: IPO, Facebook

David LiuMay 28, 2025About 4 min

15: IPO, Facebook

If you encounter unfamiliar terms when reading the financial aspects of our case studies and related articles, there are useful glossaries of related terminology available at http://www.investopedia.com/dictionary/ and https://pitchbook.com/blog/private-equity-and-venture-capital-glossary and https://www.cooleygo.com/glossary/.

In today's class, we will debrief from our VC Investment Negotiation exercise and answer questions about the VC Method example. Review the Note on VC Method (Rev 2510).pdf for the latter.

In addition, we will begin our discussion of the Initial Public Offering (IPO), combining our discussion of IPO's, "exit" strategies, merger & acquisitions and IPO data with the Facebook case. We will focus our attention on the standard principles of initial public offerings rather than the exceptions (i.e., dual-class stock, direct offerings, SPACs, etc.) that have received a disproportionate amount of attention. As with venture capital, IPO's have a lot of associated jargon, making our focus on the basics of standard, book-building, IPO's even more critical.

Read "Note on the Initial Public Offering Process". This reading summarizes the advantages and disadvantages of an initial public offering (IPO) of a company’s stock and it provides an introductory overview of the process leading up to an IPO. As you read this article, think about how you would answer the following questions:

  • What are the internal and external factors that may impact a company’s decision to pursue a public offering?
  • What is the role of the underwriter? What criteria should be considered when selecting an underwriter?
  • To what extent, if any, are the company’s and the underwriter’s incentives aligned when it comes to pricing the offering? What influence, if any, does the underwriter have over the pricing decision?

Read the "Facebook, Inc: The Initial Public Offering (A)". This case covers a fictional investor considering whether or not to buy Facebook shares in its much-anticipated initial public offering. Think about how you would answer the following study questions during your analysis of the case:

  • How does Facebook make money? What are the value drivers of its business? What is its comparative advantage relative to other social networking companies?
  • Why is Facebook going public? What is the planned use of proceeds from the offering?
  • What was going on in the U.S. IPO markets prior to Facebook’s offering? What has been the performance of recent IPOs?
  • What is the intrinsic value of a Facebook share? How does this valuation compare to the price talk from the underwriters?
  • As a potential shareholder, what are your concerns about Facebook or its stock offering?

Be prepared to discuss the above readings and important elements of this case in class.

OPTIONAL READINGS

To reduce the workload for most students and provide those interested in IPO's, I am providing some additional readings about IPO's.

Review the “IPO Process Overview” note from the IPO Readings folder in Canvas Files. This document, compiled from training materials by a leading IPO underwriter, provides interesting insight and advice about the IPO process.

Read the series of brief IPO-Related Articles 2510.pdf Download IPO-Related Articles 2510.pdf also posted in IPO Readings folder in Canvas Files. These include:

  1. Leaning Toward an IPO_ Think About It - WSJ 9 13 10
  2. Lyft Founders to Tighten Grip With Supervoting Shares in IPO - WSJ 2 12 19
  3. Biotech Companies Going Public Earlier - FierceBiotech 6 12 19
  4. Paltry IPO Proceeds Spell More Trouble for Venture Investors - WSJ 10 08 24
  5. They’ve Been Waiting Years to Go Public - NYT 02 18 25

These optional articles discuss the pros and cons of IPOs both from the issuers’ and the investors’ perspectives and the condition of the IPO market today.

DUE:

There will be a short 12-minute closed-book, closed-notes quiz on one or more of today’s readings at the beginning of class. The quiz will be available via Canvas, so be sure to bring a laptop or tablet to class to take the quiz. Make sure your laptop/iPad is configured for Respondus Lockdown Browser.

Quiz questions are typically derived from the study questions provided above as part of the day’s assignment. While the quiz question may not exactly duplicate a study question, it usually will relate to the substance of one or more of the study questions. To prepare for a closed-book quiz, be sure you are prepared to address each of the posted study questions.

NOTE: Days on which we have quizzes, no essays will be due.

1. Internal and External Factors Affecting the IPO Decision

  • Internal: Need for substantial capital to fund expansion, early investors’ desire for liquidity, the company’s readiness for public scrutiny (organizational maturity, stable financials), and potential benefits from being a public firm (e.g., reputation, recruiting).
  • External: Market sentiment (favorable or bearish), overall economic conditions (e.g., a financial crisis), industry trends, and the availability of private financing alternatives.

2. Role of the Underwriter & Criteria for Selection (investor banker)

  • Role of the Underwriter:
    • Conducts due diligence, prepares offering documents.
    • Markets the shares via book-building and roadshows.
    • Sets the final offer price and share allocation.
    • Provides price stabilization and aftermarket support.
  • Selection Criteria:
    • Reputation and track record in similar IPOs.
    • Strength of research analyst coverage in the firm’s industry.
    • Ability to distribute shares to institutional and retail investors.
    • Underwriting fees and additional services (e.g., follow-on offering support).

3. Alignment of Incentives & Underwriter Influence on Pricing

  • Alignment: Both the company and underwriter want a successful IPO with healthy demand. A “pop” (rise on day one) is often seen as success.
  • Potential Tensions:
    • Companies may want a higher price to maximize proceeds,
    • while underwriters aim to set a price that investors will accept (sometimes leaving “money on the table”).
  • Influence: Underwriters typically lead the book-building process; they gauge market demand and guide the final offering price. Their institutional client relationships can affect how aggressively the price is set.

4. How Facebook Makes Money, Value Drivers & Comparative Advantage

  • Revenue Streams:
    • Primarily advertising (targeting users based on demographic and activity data);
    • secondary revenue from virtual goods and payments (e.g., social gaming).
  • Value Drivers: Enormous global user base, high engagement, and rich data for targeted ads.
  • Comparative Advantage: Strong network effects, brand recognition, and the “social graph” that competitors found hard to replicate.

5. Why Facebook Went Public & Use of Proceeds

  • Reasons:
    • Provide liquidity for early investors (venture capitalists, employees).
    • Raise capital to fund ongoing growth (e.g., data centers, acquisitions).
    • Gain public share currency for future strategic moves.
  • Proceeds:
    • Planned for general corporate purposes, expansion,
    • possibly more acquisitions (like Instagram).

6. U.S. IPO Markets Before Facebook’s Offering & Recent Performance

  • Market Context:
    • Recovering from the 2007–09 financial crisis, but still volatile.
    • Mixed investor sentiment and concerns over global economic slowdowns.
  • Recent Tech IPOs: LinkedIn (large first-day pop), Groupon (initial jump but later decline), Zynga (price dropped shortly after listing). Investor appetite for high-growth tech was strong, yet valuations were volatile.

7. Facebook’s Intrinsic Value vs. Underwriters’ Price Talk

  • Intrinsic Value: Some analysts’ DCF models suggested valuations in the $70–80+ billion range depending on growth assumptions.
  • Price Talk: Underwriters raised it from the mid-$20s–$30s up to $34–$38, which implied a valuation over $100 billion. This was seen as aggressive, relying on very high future growth.

8. Concerns for Potential Shareholders

  • Growth & Monetization: Slowing ad growth, especially on mobile.
  • Dual-Class Stock: Founder Mark Zuckerberg retained significant control with Class B shares.
  • Insider Selling & Lock-Up Expirations: Large share sales by early investors; lock-up periods could flood the market with shares later.
  • Valuation Risk: High price multiples left little margin for error if growth disappointed.
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