The Facebook Effect Page 13
Cohler talked to a bunch of friends trying to figure out if he should really consider Parker’s offer. He was almost twenty-eight—no longer a college kid—and had even spent time at the venerable McKinsey consulting firm. He wasn’t one to make rash moves. Cohler called his brother, an undergraduate at Princeton, to ask if he knew about this thing Thefacebook. “The answer was like, ‘Duh!’ as if I’d asked ‘Do you guys have electricity at Princeton?’” remembers Cohler. But he found the numbers Thefacebook was claiming hard to believe.
He asked Zuckerberg if he could spend some time poking through the service’s database on his own. Cohler was blown away by what he found. He, Parker, and Zuckerberg came to an agreement shortly afterward. At that point everybody in the company was earning $65,000 a year, plus—and this was critical to Cohler—a fair amount of stock. Cohler was convinced Thefacebook could get big. He had no interest in Wirehog. His job was to help Thefacebook become a real company. His role, as he later put it, was to be Zuckerberg’s “consigliere.”
5
Investors
“I’ve got to invest in this company.”
One of Chris Hughes’s friends at Harvard’s Kirkland House was Olivia Ma, whose father, Chris, was a senior manager for acquisitions and investments at the Washington Post Company. Ma’s daughter urged him to take a look at Thefacebook, and between Christmas and New Year’s of 2004 he took Zuckerberg to a Sunday lunch in Menlo Park, near Facebook’s offices in Palo Alto.
The Post was already an investor in Tribe.net, and Ma found Thefacebook enticing because of its focus on a promising demographic—college students. He also immediately found himself impressed with Zuckerberg. “I concluded in that first lunch that the key to Mark is that he is a psychologist,” says Ma. “His central thought was that kids have a deep-seated desire to have certain kinds of social interactions in college and that what drives them is their extreme interest in their friends—what they are doing, what they are thinking, and where they are going. He had some simple but deep insights.” Ma talked a little about the Post’s hands-off aproach to its investments and suggested that the company would be interested in putting money into Thefacebook. Zuckerberg said he would think about it. He and Ma formed a bit of a bond not only because of Olivia, but because Chris had attended Exeter Academy, Zuckerberg’s prep school. Two weeks later Zuckerberg called and told Ma he wanted to come to Washington to discuss the possibility of an investment.
Sean Parker, whose family lived near Washington, joined Zuckerberg for the trip, and when they arrived at the Post, they found not only Ma and another investment executive, but Post CEO Don Graham crowded into a tiny conference room. The Post’s offices were in the midst of a renovation. Ma had asked Graham to join them briefly to meet this impressive young entrepreneur. The ruddy-faced Graham is a renowned leader of American business and a member of the family that has controlled the Washington Post since the 1930s. Zuckerberg explained Thefacebook to Graham, who recalls being immediately taken. “I thought it was a simply stunning business idea,” he says. Hearing about Thefacebook’s success at Harvard elicited an oddly relevant recollection in Graham, then fifty-nine. He too was a Harvard man and was taken back to his days as a reporter and president of the Harvard Crimson in the mid-1960s.
In those days the Crimson kept several large ruled ledger books on a shelf in its newsroom. Articles from each day’s paper were pasted into the books, and staffers wrote comments about them right there. In another book they wrote anything that was on their minds. “I vividly remembered that every time any of us would walk into that room we would read every word written in those ledgers and write our own comments,” says Graham. “I have often thought about the power of those comment books and wondered whether there was some way to replicate them in a place like this.” (At his newspaper, that is.) “When I heard Mark describe the idea of Thefacebook, I thought ‘Oh my God, I see exactly what he is shooting for.’” Graham was then deeply immersed in efforts to build the Post’s own Web businesses.
He was amazed to hear how many hours users were spending each day on Thefacebook. He was also somewhat amazed by Mark Zuckerberg. “Mark was ever so slightly more awkward than he is now,” continues Graham. “If you said something he would pause and think about it before he’d comment or react. But every single thing he said in the course of that conversation made a lot of sense. It was remarkably impressive for a twenty-year-old.”
Graham began recounting a bit of the company’s history, and Parker remembers him saying something like “… and then a man named Warren Buffett came into our lives.” Neither Zuckerberg nor Parker knew much about the Graham family before their visit, but they had heard of Buffett, the legendary investor and one of the world’s richest men. The Berkshire Hathaway company, run by Buffett, has been a large investor in the Post since the 1970s. “He said the arrival of Buffett was a transformative moment in the life of the company,” says Parker. Graham explained that the Post was able to take a very long-term view of its corporate strategy, both because the Graham family controls a huge portion of its voting stock and because Buffett has made clear he intends to hold his shares for the long term.
At some point in their conversation, Graham made an offer more spontaneous than any he says he had ever made before or has made since. He recounts it: “I said, ‘Mark, in the end you will not do this, but if you wanted an investor who wasn’t a venture capitalist and wouldn’t pressure you in any of the ways VCs normally do’—he had talked a little about how he did not want to go that route—‘we’d probably be willing to invest.’”
Zuckerberg was deeply impressed with how Graham thought about business. He explains: “A lot of VC firms had approached us, but I didn’t want to play this whole Silicon Valley game of—take VC money, try to go public or sell the company really quickly, bring in professional management on an accelerated time scale—things like that. But the Washington Post is a completely different kind of company than these technology companies. I was just blown away by the difference in culture, that it’s just such a long-term focus there, and that they’re so focused on the brand of the Washington Post and the trust it has. I was just like ‘Wow. I want to be more like this guy.’ And that’s when I seriously started thinking about doing another [investment] round. And I was looking forward to doing it with them. Don was a guy I could work with.” Graham stayed ninety minutes, far longer than he had planned. When he finally had to get up to go, Zuckerberg rose as well. The twenty-year-old looked Graham in the eyes. “You’re cool,” he said. Graham smiled broadly.
Things began moving quickly after that. The Post Company sent another, larger delegation out to Palo Alto. The top managers of the Post’s online division joined the trip—including newly named CEO Caroline Little, along with the vice presidents for finance and business development. Little says Thefacebook seemed like a potential gold mine. “Mark was kind of against ads, as far as we could tell,” she says. “But I just sat there salivating and thinking how easy it would be to monetize this. I had to bite my tongue because Don didn’t want to hear it.”
Sean Parker interpreted the turn in Zuckerberg’s attitude toward investment as a license to more aggressively beat the bushes and see what else was out there. “I thought we should be valued at half a billion dollars even then,” Parker says now, a bit bombastically. “It was pretty obvious to us that we were taking over the world.” But in reality, at this point even Parker was talking about a relatively low valuation. His friend Seth Sternberg (now CEO of messaging company Meebo) recalls Parker asking for valuation advice. Though Sternberg was only twenty-six, he had worked in corporate development at IBM, so his opinion counted. Sternberg recommended shooting for a valuation of at least $40 million. So Parker raised his expectations to a target range of $40–60 million, company documents show. Anything like that would be phenomenal for a year-old company led by a twenty-year-old with seven employees and annualized revenues of less than $1 million. But Parker was wrong. He got more.
Investor interest was further heightened when the Los Angeles Times wrote a front-page story about Thefacebook on January 23, the first big story ever about the company in a major media publication. SITE INTRIGUES COLLEGIANS ACROSS U.S., read a headline. “Clever, goofy, or profane, the website has a powerful hold on its members,” Rebecca Trounson wrote, “most of whom log on to it almost every day.”
Parker got his friend Sittig, now Thefacebook’s design guru, to design a few PowerPoint slides and started meeting with potential investors. The six-page presentation was modest but compelling. It claimed Thefacebook had 2 million active users (this was mid-February) and was deployed at 370 schools. But what got investors’ attention was the data about how engaged users were. An amazing 65 percent of them were returning to the site daily, and 90 percent came back at least once a week. Growth was so torrid that it occasionally hit 3 percent per day.
What most wowed those who saw the presentation was a simple growth chart. Parker and Sittig had designed it to afford a little drama. At first Parker would put up a chart showing colleges where the service had opened. It looked like a staircase, because Thefacebook opened schools in batches and then didn’t add new ones for a while. Then another slide would overlay on top of the school chart. It showed the trend in total users. Vividly apparent was a correlation between opening schools and growth in users. After each step in the staircase of schools, the number of users leapt upward with minimal delay. That implied the possibility of near-guaranteed growth, at least until Thefacebook saturated the available population of 16 million American college students.
The simple business plan Parker presented explicitly avoided mentioning conventional Internet banner ads, even though they had been the primary source of the little income Thefacebook had gotten thus far. Page four of the PowerPoint was titled “Local Advertising.” It projected that on-campus text-based “flyers”—used by campus organizations to announce events—would yield net sales of $3.65 million a year if Thefacebook was at 400 schools. But the separate, yet-unlaunched local advertising product—the one Parker had hired Ezra Callahan to spearhead—was projected to be much bigger, yielding annual sales of $36.6 million. That assumed sixty businesses would advertise at each of 400 schools, offering students discounts, coupons, etc.
Then there was a page of sheer marketing chutzpah. The presentation touted what it called “AdSeed,” defined as “Google AdSense for social networks.” Google’s AdSense is a program that gives websites revenue in exchange for allowing the search company to place textual advertising on their pages based on the content there. At the time it was beginning to take off. With the AdSeed name Thefacebook was trying to feed off Google’s buzz. The slide explained: “Products, brands, and media properties (movies, books, music) receive a ‘home’ in social-space.” At the time, Thefacebook was just beginning its lucrative arrangement for Apple’s sponsored page, and that was the model. The slide claimed Thefacebook was at that time making $40,000 a month from pilot customers for AdSeed. The name, by the way, was never actually used.
By February 9, twelve venture capital firms, four major technology companies, and the Post were actively pursuing Thefacebook for some kind of deal, according to a company document. Parker had decided not even to pursue investors who needed convincing. A few well-known outfits were out of the running. Kleiner Perkins and Benchmark, two of the Valley’s most eminent firms, were both already up to their ears in social networks thanks to their troubled investments in Friendster. Neither wanted anything to do with Thefacebook.
For all the impressiveness of the PowerPoint data, there remained significant skepticism toward Thefacebook. After all, the only way any potential investor could even log on and take a look was with an alumni email address from their alma mater. A limited-access consumer website was something new. Then there was the personnel matter—an inexperienced twenty-year-old CEO and a partner with a profligate reputation.
But even as the talks with the Post and others were heating up, Thefacebook needed money right away. Parker decided to borrow some more from his friend Maurice Werdegar at WTI. The initial $300,000 credit line had been used up after less than two months, even though it was expected to last for eight months. Parker wanted to borrow another $300,000. But he and Werdegar couldn’t agree on how to value the accompanying warrants that would give WTI the right to purchase Thefacebook’s stock. WTI typically only invests following a financing by venture capitalist firms, and the prices of its warrants are typically pegged to what the VCs have already paid. It had stretched its practice somewhat by putting money in alongside an angel investor like Thiel.
Werdegar thought WTI was taking a significant risk, because after this loan its total outlay for Thefacebook would be $625,000, counting both loans and the $25,000 equity investment. He wanted the warrants attached to this new loan to be priced at the same level as the ones for the first one only months earlier—the price that Thiel had paid for Thefacebook’s stock.
Parker started talking about how great the company’s next fund-raising round was likely to be, which meant that WTI would be very likely to be repaid with little difficulty. If that was true, the risk was small. Parker wanted the warrants to be priced based on the upcoming venture capital round. Parker said the valuation was likely to be at least $50 million, which Werdegar found ridiculous. Parker also asserted that an investment was imminent. Werdegar didn’t believe him.
So they made a bet. Written into the loan’s terms was a provision that if Thefacebook closed a venture round of $2 million or more by May 15, 2005 (about three months later), WTI’s warrants would enable it to purchase a fixed number of shares of stock at a slightly lower price than whatever the venture capitalists paid in the new round. However, if Thefacebook failed to make the deadline. WTI’s warrants would enable it to pay much less—something much closer to what Peter Thiel (and WTI itself) had paid in the earlier investment round. The $300,000 Parker borrowed this way paid for most of the servers the company bought that spring as membership burgeoned.
In late March, as talks with the Post continued, Viacom entered the picture out of the blue. It expressed interest in buying the entire company for around $75 million. It wanted to combine Thefacebook with MTV.com. That was a complete surprise to everyone at Facebook. The overture was testimony to how much buzz was starting to surround Thefacebook. If Zuckerberg accepted such an offer, he would have put about $35 million in his pocket for a year’s work. But that didn’t matter to him. He had no interest in selling. Nonetheless, the existence of such an offer took a while to digest. At least one company adviser urged Parker to take it. He and Moskovitz would have gotten close to $10 million each.
After some back-and-forth, the Post in late March sent Thefacebook a term sheet for a very rich deal. It would invest $6 million for 10 percent ownership, after which Thefacebook would carry a value of $60 million. That’s what’s called in VC lingo “$54 million pre”—or before the investment: $60 million minus $6 million. Parker was thrilled. This was better than he’d hoped for. He called up adviser Conway in San Francisco. “My God! $54 million pre?” the excitable Conway shouted into the phone. “Take it! Close that sucker!” But Parker and Zuckerberg weren’t in any rush. Zuckerberg’s well-connected new aide Matt Cohler was urging his colleagues to keep talking to venture capitalists. Many started calling him at all hours seeking a chance to invest as soon as they heard he’d joined Thefacebook.
In any case, there was still haggling to be done with the Post.
Its negotiators wanted a board seat, but Zuckerberg and Parker didn’t want to give it to them unless it would be held by Graham himself. Graham thought that would be inappropriate given that his newspaper, with which he was then closely involved, might be covering Thefacebook. Zuckerberg talked it out with him by phone and they pretty much wrapped up a deal that didn’t include a board seat.
The Accel Partners venture capital firm in Palo Alto was looking for a big new score. It had done a number of hugely successful investments in the previous decade. It had made its mark in the 1990s with a series of big telecommunications and software investments that paid off, like UUnet, Macromedia, RealNetworks, and Veritas. Now Internet opportunities were reemerging, but it didn’t have a major consumer Net play. Some in Silicon Valley were muttering that Accel had lost its mojo.
In the aftermath of the dot-com crash of 2001–2002, Accel had reduced the size of its funds, returning money to investors unused. But by the end of 2004 it was again raising money—a new fund of $400 million. Yet some of its longtime investors were unhappy that Accel was continuing to charge more for its services than most VCs—a 2.5 percent management fee and 30 percent of any profits. Among those who decided not to continue with this latest fund was the endowment fund of Harvard University. As things turned out later, Harvard would thus end up without a stake in the creation of one of its most entrepreneurial former students.
Jim Breyer, Accel’s co-managing partner, was eager to prove the firm’s mettle to its latest investors. Optimism was returning to Silicon Valley, and now was the time to start taking risks again. With thick black hair, a back slapping sense of good cheer, and piercing blue eyes with which he often wryly yields a sort of knowing wink, Breyer is by nature upbeat. He likes to laugh and to share a confidence. He is a lover of music (“from Bach to Nirvana,” he likes to say) and art (he collects paintings by everyone from Picasso to Gerhard Richter). And his bona fides as a master of the universe are impeccable. He is deeply embedded in the elite of American businesss—a member of the board of directors of Wal-Mart, no less. Breyer, the largest investor in Accel, knew the Internet was turning around.