Comparative Economics

Mary Eng

August 2010

Facebook Venture Capital

Introduction

The purpose of this paper is to uncover the complexity of venture capital acquisition for

Internet technology start-ups, with a specific look at Facebook as an example of a venture

capital success story. In the paper, I would like to expose the complexity of factors which

would affect the risk analysis of potential investors. It is necessary to distinguish between

types of investors, angel or VC based, as well as to establish a chronology of investments. I

would also like to draw forth the increasing atmosphere of transparency in which investments

occur, especially as the technology sector is so profoundly focused on self-documentation

and commentary. The impact of that transparency has larger ramifications for the

corporate social responsibility image-making as well as the seduction of future investments.

For the task of tracing the investments I have relied heavily on Crunchbase, a hyperlinkable

database chronicling the history and sourcing for all capital investments. Crunchbase is

produced by the Techcrunch blog, which offers up to the minute analysis of all aspects of

technology sector development. As the hesitant angel investor or venture capitalist weighs

the risks of investment, it is important to make mention of the factors which influence their

willingness to invest. With that in mind, legal vulnerabilities as well as public relations issues

are important aspects of a company’s net worth to asses. Governmental interest also plays

a key part of the firm’s success, in addition to the viability of their innovative business plan

or charismatic marketing buzz. It is also important to evaluate how the company performs

in relation to its peers, and in this sense looking at Facebook as a part of a larger social

networking revolution, will help us understand its leadership in guiding the trends, as well as the

ingenuity of investors who have propulsed it to a main stage.

Facebook is an interesting example of a company which has grown over a few years

due to unprecedented venture capital investment, despite operationally not turning a profit

until September 2009. As Facebook has pushed the limits of many norms, they have both
challenged the old guard and rewritten the rules, shaping a new system of technology sector

growth and changing the ways people and businesses communicate. Indeed Facebook

has become a part of a larger marketing revolution which demands attention to social

networking presence as well as brand strategy innovations within the Facebook community.

Monetization strategies are an essential part of technology sector growth. For a technology

sector company, the economic climate can be made more or less favorable with the assistance

of government intervention. In Facebook’s case, their primary investors benefit greatly from

the National Venture Capital Association’s constant advocacy. They are a lobby group which

specifically advocates for technology sector venture capitalist, seeking Federal Communications

Commission and Federal Trade Commission favor, as well as lobbying for favorable legislation

which affects the viability of future growth. Aspects of this include everything from weakened

anti-trust standards to liberal immigration visa norms which encourage foreign investment and

the immigration of a highly skilled international talent pool.

From Angel Investment to Venture Capital

Venture capital is an essential part of the growth of creative and technological sectors. A

venture capitalist distributes the risk across a wide portfolio of companies, whereas an angel

investor puts a private amount of money into one particular worthy company. A look at the

venture capital and other capital sources for the Facebook company will provide an interesting

subject for investigation. As Facebook, inc. has topped the social networking gamut in

popularity, it’s innovation and company strategy has relevance for many industries who either

rely on Facebook for marketing or use it as a part of an integrative Internet strategy. While the

average Facebook user may have no concern for the financial underpinnings of the technology

phenomenon, a look at the financing structure and company history may have a broader

relevance for understanding the motivations behind various finance groups and investors.

In this paper I plan to explore the relevance of the National Venture Capital Association, a

lobby and trade group, the Accel venture capital infusion, and more recent capital assets as

provided by Elevation partners. Techcrunch, the leading technology blog, has a whole page
devoted to Facebook. Their very excellent Crunchbase provides a tracible link to investor time

lines and profiles of start-ups of all sizes and the investment history of individual angel investors

and the investors in venture capital firms. It is possible through hyperlink to understand a graph

of investment in a chronological schema, or a branching network.

Facebook as an entity has a story which is a common myth known to many. There are

numerous websites detailing the many issues which beset the industry behemoth.

It is necessary to distinguish the difference between angel investors and venture capital

investing. Angel investors have a solid amount of funds they want to bestow upon a promising

firm. venture capitalists pool their funds in a venture capital network, which distributes the risk

of their investment across many firms.

The venture capitalist sees the risk in the technology start-up as a worthy risk. Many

technology entrepreneurs who sell their successful start-ups immediately pour their financial

capital into new ventures. Noteworthy among those are Paypal’s Peter Theil a Facebook angel

investor, who now sits at the head of Clarium Capital. The atmosphere of high risk is mitigated

by the actual enjoyment of the flourishing of new technology trends. Upon selling Paypal, Theil

poured his wealth into other start-ups, a pattern which can be seen widely in the technology

sector.

Accel and Everybody Else

Accel was one of the first firms to see the potential in Facebook and put major investments

towards its growth. Its investments are 12M. It is important to note that Facebook did not

come out of the red until September 2009. A look at Accel’ investment portfolio will reveal

numerous lesser known companies in the technology sector. Successive rounds of investment

are grouped in tiers pertaining to chronology of investments. Notable are The Founders Fund,

Greylock capital, and Meritech Capital Partners which as the series B. investors contributed

27M as a group. It is very important to note that Peter Theill and Reid Hoffman’s original angel

investment of 500M collectively outpaces all of the other venture capital infusions. Microsoft’s

hefty 250M series C investment came in 2007, after talk of the sale of Facebook. Facebook
became famous as it turned down aquisition by Yahoo, a defiant move which inspired future

investment.

Total $836M

Angel, 9/04 9 $500k

Peter Thiel

Reid Hoffman

Series A, 5/05 10 $12.7M

Accel Partners

Series B, 4/06 11 $27.5M

Greylock Partners

Meritech Capital Partners

The Founders Fund

Series C, 10/07 12 $240M

Microsoft

Series C, 11/07 13 $60M

Li Ka-shing

Series C, 1/08 14 $15M

European Founders Fund

Series C, 3/08 15 $60M

Li Ka-shing

Debt, 5/08 16 $100M

TriplePoint Capital

Series D, 5/09 17 $200M

Digital Sky Technologies

Unattributed, 6/10 18 $120M

Elevation Partners

credit: Crunchbase

Monetization Strategies

The Financial Times in April 2010 profiled the Facebook corporate strategy to reach out for

advertising links with a new program the “like” feature in which users can express themselves

via “liking” various brands. Programs like this which seek to divert attention to demi-adverts

seek to monetize Facebook, an ultimate duty for the venture capital investors. The digital gift

economy or the Facebook dollars are other such schemes towards infusing the dreamy start-up

with a measure of profitability. The schemes involving strategic ad revenue, data mining, digital

gift schemes, and Facebook cash have yet to prove themselves in terms of long-term viability,

and some are indeed subject to litigation regarding fraudulent overcharging (as with digital gifts

which demand credit card data which then bill on automatic basis high figure sums).

An indirect monetization strategy involves the way Facebook has placed itself as

the irreplacible digital billboard for other corporate marketing strategies. In that sense,

Facebook has a guaranteed client base from which to later extract cash. Fully exploring

corporate “taxation” or enhanced feature modules will play out in the future. As compnies

like Twitter were whispered to toy with charging for a deluxe service, or as Craigslist charges

emloyers seeking laborers, there may be future ways of extracting income from the easy

corporate Facebook captives.

Boom, Bust, And Government Stabilization

The early 2000’s brought infusions of cash into the Silicon Valley landscape. Many ventures

were fiscally disastrous. A look at venture capital climates will still find that the cash infusion
made possible in the United States exceeds many other economic climates. Paul Carr’s spoof

of a book, Bringing Nothing to the Party, details the struggles of an aspiring technology start

up’s quest for venture capital. The company, a social networking site for hip young Londoners,

faces immanent financial peril. Carr’s portrait of the London venture capital scene pits the

fledgling technology scene as far inferior to the stateside technology riches. Another approach

to measuring the atmosphere for technology start-ups are the amount of governmental

participation in fostering growth. In Finland for instance, the government when faced with

depopulation and a bleakly performing agrarian economy, infused cash into the technology

sectors and subsidized advanced technology degress and education which helped the young

Nokia ascend the charts in the pre-smart phone cell phone revolution. And while capital

investments may be exceptional in the United States, whether or not a host of political factors

are entirely hospitable is debatable.

everything from labor costs to investment visa availability pertain to the flourishing of technology

start-ups. venture capitalists must consider these factors as well as possible legal threats which

will undermine their business.

Market Leaders: Shaping the Industry

What makes Facebook such an interesting company to follow, is that not only have they

anticipated cultural trends but they have shaped them, and they have quickly adapted as new

technologies shaped the zeitgeist. The Twitterification of their interface rapidly followed the

Twitter ascendancy, which in a sense showed a loyalty and duty to their investors, to keep the

company at the cutting edge for as long as possible. In a digital marketplace, aesthetics and

trendiness rule the day. If an interface becomes stale, boring, or aesthetically out of fashion, it

ceases to be relevant, and will decline, as we have seen with Myspace.

The recent “Google Me” media buzz has alerted the technology community that there may

be a very immenant demise of the Facebook, even with its 500 million strong. The company

seeks to return the venture capital investment as it serves as a model for sociological transitions

and adapts to a host of factors including the viability of ad revenue, the crunchability of
statistics for ad revenue microcash, the sale of raw data, and or government support or subsidy,

and decline in trendiness.

Accel, as one of the most premier investment companies involved in technology growth,

has a close relationship with the National Venture Capital Association which rewarded Jim

Swartz with a Lifetime achievment award. The National Venture Capital Association has

shared several figures from the Accel group, and holds their interest and future at heart as it

represents over 400 similarly situated firms. The National Venture Capital Association lobbies

the United States Congress for more easily available investment Visas, which promote tech

start up growth. The seek to influence the Federal Communications Commission regulations

for the benefit of their firms and increase braodband strength for the increased viability of social

networking platforms.

The most pre-eminent VC concerns will thusly benefit from a close relationship with lobby

groups and political affiliations which benefit their prosperity.

Privacy and Surveillance Concerns

When following the trail of Facebook capital investment, it is important to ask whether any

of the investment firms have any particular political or other aims. Do they see Facebook as a

valuable tool for civic surveillance? Or are they affiliated with groups that do? As Facebook

hosts a panoply viewpoints, no one viewpoint predominates, but certain overarching norms

prevail: namely, recession of privacy norms, increasing levels of participatory surveillance,

increasing mythologizing of the cult of identity. In late 2009, the Electronics Frontiers

Foundation sued the United States Department of Justice, Department of Defense, and Central

Intelligence Agency for failing to disclose as per the Freedom of Information Act, the level of

their utilization of social networking for surveillance or other purposes. Might it be possible

to show that the state has a direct interest in supporting the growth of the social networking

phenomenon?

The company In-Q-Tel is a venture capital firm directly and officially and openly linked

to the development of technologies useful for the Central Intelligence Agency. They were
implicated by the Electronic Frontiers Foundation in the 2006 surveillance via telephone’s

in the case Electronic Frontiers Foundation v. ATT. In-Q-tel’s capital investment is geared

towards the development of advanced technologies such as speech recognition, in addition to

Skype surveillance and phone call surveillance. The latest notice on their Crunchbase profile

shows their investment in an aggregation service which allows corporate interests to watch

and compute the success of their social network advertising penetration. The social media

monitoring software in a sense becomes a derivative industry which crunches a much larger

data base, of which Facebook is only a part. In that sense, Facebook becomes an inextricable

part of state interest, and this is obvious via simple Internet searching, even despite the

Electronic Frontiers Foundation’s inability to use the FOIA to obtain more specifics. Indeed, the

CIA uses Facebook to recruit new employees. That much we know.

Facebook as Premium Advertising Real Estate

Bono Rockstar is a primary investor in the Elevation Partners firm which provided a

substantial infusion to Facebook in June 2010. According to British technology mag The

Register, the 120M venture capital infusion gives Elevation a mere .05% ownership in

Facebook. What motivation would the Bono empire have in Facebook? Facebook serves

a high level of traffic. For some users, the rest of the Internet does not exist. Potential Ad

revenue schemes, and a stadium full of adherents might be more suseptible to the Bono

humanitarian agenda. In a certain sense we could easily hypothesize that Bono’s Facebook

share is geared towards advancing his larger philosophical agenda. It is also interesting to note

that Silicon Valley magazines ridicule Elevation Partners investment strategies. Perhaps it is

their lateness in the game. Indeed, the Elevation investment in June 2010 comes sharply on

the heels of the Facebook v. Google Me debate, in which the eclipse of Facebook is forecast.

Are future investments likely to be ridiculed out of jeolosy in the technology community? Or

is there a real concern that Facebook, like its predecessors will quickly fade? This is a very

important risk factor which a venture capital firm must asses.

 Profitability and Legal Risk Management

The Facebook venture capital investigation might also beg the question, why invest in

a company that has not yet turned a profit? Risk management is a company’s duty to its

investors. The most significant predictable risk monetarily is legal assault, especially in the

technology sector, which is beset with patent, copyright, programming, software, and other

intellectual property law issues.

What can other start-ups gain from this finance model? How can new companies compete

for venture capital investment or the honors bestowed by angel investors? How can technology

start-ups protect their capital investment from crippling litigation? Many a firm finds itself

in protracted litigation, which can either slow, or sometimes halt growth altogether. Indeed

Facebook is currently being sued by a software programming contractor who alleges he found

a contract entitling him to 85% of Facebook. As Richard Susskind details in the book The End

of Lawyers the future of many technology companies will involve engaging legal services on

a per anum basis, rather than after costly litigation has ensued. And then the law firms will

conduct extensive review of all accounts and potential intellectual property vulnerabilities prior

to litigation, so as to head off unnecessary squabbles and be prepared for any legal assault.

Susskind points out that the emerging technological sector has a new kind of need for legal

services, and the legal industry is adapting to suit their needs. A company which is financed

by the good graces of angel investment and venture capital does not need to involve the

company in unecessary protracted litigation. So indirectly the comprehensive management of

a company must involve a legal risk analysis and the engagement of appropriate preventative

legal services. Mark Howitson, a Silicon Valley attorney has represented Facebook as deputy

general legal counsel since 2007.

Contextualizing Facebook

Contextualizing Facebook as a viable investment risk involves using an entirely new way of

assessing information. As a digital product it has created value out of ether, or nothingness, or

rather out of component computer parts and broadband and Internet service provider services
and human participation. The economics of Facebook, and all tech companies, exist in a new

realm which must recognize the intangible value of cognitive activity, as well as the other

potential values in crowd sourcing, advertising potential, data mining, surveillance, forensic

investigation, and social cohesion. A general survey of Facebook and cyberlaw questions,

which often involve the confluence of sociological issues, investment, government involvement,

and citizen participation can be found at the Center for Internet ans Society, hosted by Stanford

University’s cyberlaw domain. The Berkman Center at Harvard is the east coast cyberlaw

counterpart and hosts conferences joining the worlds of programmers, the developers of the

DARPA net, the future of Internet micro-cash, crowd sourcing, and other exciting trends in

Internet as they take place across an economic and regulatory landscape.

Remarkably, unexpected consequences of the Facebook cultural revolution have turned

Facebook into a digital courtroom to a certain extent. It is important to note that the state has

a vested interest in keeping the Facebook digital realm in order. Australia has ruled Facebook

to be an adequate way to serve summons for a lawsuit notification. Numerous instances of

law enforcement using Facebook to establish identity or whereabouts of suspects are known.

In a certain sense, government could not live without Facebook, or some equivalent. Online

predators are seduced through various Internet media channels, of which Facebook, is but one.

In-Q-tel, which is the CIA’s venture capital group is invested in new technologies such as Visible

Technologies and Recordedfuture.com which aggregate Facebook statistics in a broader social

networking context.

Conclusion

Facebook as a company, has a history which will not ever be replicated. Facebook’s

investment history shows a high level of trust in the innovation and promise of a new idea. A

look each level of cash infusion reveals a high level of investor interest, which might be the

envy of any new start-up. A vigilant attention to publicity and media review, as well as legal

vulnerabilities, provide a sense of security for the venture capitalist’s initial investment. Tech

companies of the future will look at the Facebook model and strive to imitate its successes,
while perhaps steering clear of its many PR nightmares and privacy breeches and IP

controversies. The company of the future will follow the investment trail of Facebook and other

tech wunderkind to gauge a pattern for sustained growth and investment. They will look for

hospitble environment in which to flourish which involves government regulations favorable to

start-ups and the tech sector. Facebook in this sense will become a pivotal story of Venture

Capital wealth putting into motion a great idea which shapes many derivative companies, and

revolutionizes the face of marketing. In that sense, a look at Facebook will benefit any who

seek a similar pattern of growth, or an understanding of the legal, advertising, or e-commerce

effects which emerge from this social networking revolution.