Four funding lessons from the founding of Facebook

It certainly made for compelling viewing. But it was just one day in what has been a very dramatic year for Facebook, from the Cambridge Analytica scandal to questions about fake news and the biggest one-day loss in stock market history.

All of this would make a great movie. But, of course, Facebook has already been given the Hollywood treatment. The Social Network is all about how the company was founded and the conflict between Zuckerberg and his co-founder Eduardo Saverin.

The accuracy of the film is up for debate and nothing should be taken at face value. But watching the movie recently I was struck by the useful lessons it teaches about building a growing company, regardless of accuracy. Be warned – there are spoilers ahead.

1.  No Funding, No Facebook
   Firstly, Facebook simply could not have got to where it is today without funding. Peter Thiel’s seed investment of $500k was critical in allowing Mark Zuckerberg to build something ‘cool’ (in his own words) without commercialising too early and affecting user traction.
   
   Fundraising is a critical moment in the growth of a business, enabling critical hires, expansion or simply the development of your product. It’s vital that scaling businesses take the right approach.
   
   
2. Founders, read the small print
   The Social Network underlines the fact that investment transactions can be more complex than you may at first imagine. In the film, Eduardo Saverin didn’t read his documents properly and, unlike Mark Zuckerberg et al, received a separate share class that would be diluted by future investment.
   
   This relatively complex term of the contract would have been buried away, but it was certainly there. This serves as a reminder for founders to be diligent. Know what you are walking into with fellow investors. Shareholder disputes are more common than you may imagine and while first time founders can be most at risk, the same applies for everyone.
   
   But, having said that, as long as you do your homework there’s no cause for panic. Directors have a fiduciary duty to look after shareholders – so in the end, Saverin was awarded 4-5% of Facebook under a settlement.
   
   
3. Timing is everything
   Zuckerberg understood the importance of timing – and that seems to have been a key factor in how he dealt with Saverin. In his own real-life words:
   
   "Eduardo is refusing to co-operate at all…We basically now need to sign over our intellectual property to a new company and just take the lawsuit… He has to sign stuff for investments and he's lagging, and I can't take the lag."
   
   Due to Saverin’s delay Zuckerberg faced the very real prospect of running out of cash for his business, with the alternatives of funding the deficit himself or simply folding the company. This is an extreme example, but any growing business has to carefully consider timelines for funding, or risk being put in a critical position.
   
   
4. You can cut more pieces, but there’s only one pie
   
   It sounds obvious, but the film underlines the very important point that there is only 100% of a company that can be owned. Saverin’s stake was ultimately reduced not because he gave up his shares but because his ownership was diluted when new shares were issued. So what’s important about this?
   
   It comes down to the fact that investors want to have a management team that is incentivised to build the company and grow value. Saverin had a very large portion of Facebook (30%) but wasn’t working full time to build the business – so in the eyes of his co-founders, and investors, he wasn’t adding value.
   
   The only way to give more of the company to those who are growing it is to reduce the share of someone else. Issuing more shares, and so reducing Eduardo’s proportion, allowed more of the share capital to be given to those who were at the coal face,  who would be growing value for all shareholders.

Dramatic year aside, Facebook remains the ultimate scale-up story. Whether operating out of a university room or office block, there’s plenty that aspiring tech companies can learn.

But however accurate it is, The Social Network really drives home how important the early finances of a business can be.

To discuss your fundraising options contact
Andy Hodgetts
E: hodgettsa@buzzacott.co.uk