The forthcoming Facebook IPO gives us lots to talk about. It is likely to be the largest in history (cool). It is predicated on an established business model (good), plus a future growth path into the mobile space that is uncertain (not so good). And it will make its 27-year-old founder incredibly rich (good, for him). But perhaps the most significant thing is the control structure (novel).
As Matt Yglesias pointed out at Slate, Mark Zuckerberg will remain totally in control of Facebook. Lots of control is something that many CEOs have, but Zuckerberg will have something else entirely: he can’t be terminated. Even if he were to die, control would be transferred to his successor. Basically, the governance structure of Facebook appears to be a bulletproof shield for Zuckerberg. And that is making some people nervous about investing.
But should it? Let’s start with the basic economics. According to the dominant viewpoint on corporate governance, control should rest in the hands of those who also own the claim to a large stream of revenues. That way, they have the maximum incentives to ensure that revenue stream remains as high as possible. But in most cases, CEOs don’t own such a claim and yet still have quite a lot of control. Why? The first order explanation is that the founding CEO didn’t have the wealth to keep the revenue stream and so had to sell the claim to finance the company’s expansion: they gave up a large share of the claim on revenue but kept control. In Zuckerberg’s case, though, Facebook was already profitable, which means that Zuckerberg didn’t need the capital injection to keep going. He could have done what he wanted with Facebook regardless.
So why IPO? Even if CEOs don’t need tosell their equity, they might want to anyway: there are third parties who want a claim in the company’s future and are willing to pay for it. That is, the IPO is a good way to get rich, quick.
But note that even in these cases, there usually is some loss of control. Zuckerberg, on the other hand, appears to have studied the history of Silicon Valley entrepreneurs — notably, Steve Jobs — and placed heavy weight on not taking that risk.
There is, however, a flip side to the “match control with incentives” theory. The person gaining control had better be up to the task. This is difficult to judge. In some cases (think Google), a loss of control can appear in the form of “adult supervision” — someone to show the CEO the ropes until he or she is ready to take them back. But quite often, equity investors keep hold of the right to dismiss the founding entrepreneur, allowing them to audition a founder without significant risk. In the case of Facebook, Zuckerberg is basically saying that you’ll have to convince him, and not your fellow shareholders, that he isn’t up to the job.
The newness of that will make people nervous. Some will claim that the nervousness comes from the possibility that Zuckerberg may not act to maximize shareholder value. That’s a given, not an uncertainty. He told us in his Letter to Shareholders, as Wired noted, that he’s aiming to make the world a better place, not just make money. But pursuing broader goals will not necessarily put an end to maximizing shareholder returns.
Deep down my guess is that one reason for this nervousness is that Zuckerberg has yet to fail. So many of the great entrepreneurs, inventors, and creative people generally have had a life story involving a significant failure before their success. Tim Harford in his book Adapt documents this and puts forward the thesis that success may in fact require failure first. Part of this is learning to get what you are doing right — to refine the business model, for instance. But a broader implication is that you learn how to deal with failure during a time when you can be tested without too much fallout.
Zuckerberg has not had to face such a test. Every goal he has set for himself has panned out. Every challenge he has faced (including legal ones and possibly adverse publicity from The Social Network) has worked out without anyone considering it a true failure. He has not faced rejection. And he has not been forced to take a break to reconsider his values or vision. It is rare for people to have been dealt that lucky hand. However, that is perhaps what investors in Facebook will be really betting on: that he does not need to fail to succeed.
This post was originally published in HBR Blogs, 6th February 2012.