How to Create the Next Facebook: Seeing Your Startup Through, From Idea to IPO (20 page)

As you begin hiring engineers, it’s a good idea to form small teams. This is often best for increasing productivity and avoiding complexity. Consider Jeff Bezos’s “Two Pizza Rule,” which declares that an engineering team should be no larger than the number of people who can be fed with two pizzas!

It’s a myth that if you build a great product, customers will come. This is not the case even with Facebook. Over the years, the company has invested substantial amounts in building a global sales force.

Keep in mind that big brands like Coca-Cola and Proctor & Gamble aren’t easily convinced to use a new ad system, even if it’s from a well-known company like Facebook. They want to see results. They also want to get help when putting together effective ad campaigns.

Building a sales organization takes someone with lots of experience. It also takes several years to get momentum, because it’s tough to find good sales people. Just like uber engineers, there aren’t many around, and they prefer to work for larger organizations where the compensation is often much more lucrative. As a CEO, you will have to do some wooing to get top sales people interested in your company.

You also need a way to weed out lackluster sales people. One interesting approach is to ask for a person’s W-2. Sales people are often the top-paid employees in an organization, so if a sales candidate is not willing to show their W-2, move on. They should be proud to show it!

In terms of running a sales organization, here are some techniques that can help improve results:

• Constant analysis:
  There’s a lot of talk about
  meritocracy
  in Silicon Valley, and this is absolutely the case with sales people. Success can be measured, so there is nowhere to hide. Either sales people are meeting their goals or they aren’t. And if they aren’t, there shouldn’t be much leeway.
  
• Teams:
  This concept is often alien to sales people. Sales is a Darwinian environment. But this can be harmful for the overall success of the company because it can hurt the customer experience. At Facebook, the company is known for making all best practices and learnings available to everyone—including the sales people.
  
• CEO’s role:
  It’s important for the CEO to make sales calls. It helps improve the performance of the sales organization and also shows that they care about its success. Another benefit: the CEO gets a better view of the company’s customers.
  
• The money machine:
  This happens when the sales team begins to gel. You’ll notice it when your company’s revenues become more profitable as volume increases. At this point, you know you’re reaching critical mass.
  
• Quality:
  A sale is only the first part of the process and means little. The real sign of success is when a customer is delighted. In this case, you benefit from ongoing business and should get referrals. Ideally, your customers will ultimately become rabid fans.
  

When it comes to compensation, a sales person gets a package that heavily emphasizes commissions. But a lot of thought needs to go into the scales, and this requires someone who has expertise.

You must also take a broader look at other forms of compensation, such as salary and equity. Of course, this is the case with any employee, even the office assistants.

Let’s examine some good approaches when thinking about compensation.

For a tech company, try to minimize salaries. You want to keep as much cash as possible available for investing in areas like infrastructure, marketing, and sales. Compensation should instead focus on the equity upside, which means shelling out less cash and also motivates employees to work harder. It’s usually better when they think like owners, not hired help.

The most common type of equity incentive is the stock option, which gives an employee the right to buy a fixed number of shares at a certain stock price. In the early years, the stock price is often below $1. But if the company grows, the stock price is likely to grow substantially, creating strong gains for employees. In the case of Facebook, about a third of the employees were millionaires by the time of the IPO, thanks to equity compensation.

The exercise price of an option should be at or above the current fair market value (FMV) of the stock price. If it isn’t, the IRS says the employee has received income and that a tax payment must be made. This also has adverse tax consequences for the company. So, it’s important to get expert tax advice when issuing equity compensation. There should also be annual valuations, especially after the first major funding.

An option has a
vesting schedule
, which means an employee needs to stay with the firm for a period of time to earn the right to buy the shares. The most common approach is a four-year vesting period with a one-year cliff. To understand this, let’s consider an example. Suppose you grant 80,000 shares to a new employee. They have to work for the company for one year to vest a quarter of the shares: 20,000. After this, a portion is vested each month until the end of the four-year period.

Over the past few years, some tech companies have been issuing
restricted stock
as well. This is a transfer of stock to an employee that isn’t earned until the shares vest. When this happens, there will likely be a tax hit. Again, make sure you get help from a tax pro before making these types of decisions.

Outsourcing can be a good strategy, but be careful. If you need work done on a core function, you probably should hire a person. A freelancer will not have the same kind of commitment or passion.

For the most part, freelancers are useful for short engagements or projects. But don’t select one based only on a low rate; many freelancers are terrible and a huge waste of money. Before making a hiring decision, be sure you get referrals.

Another good way to get quality freelancers is to use sites like oDesk and Elance, which provide ratings for each service provider. They even give exams and tests for freelancers’ skills and abilities.

In some cases, you may want to try
crowdsourcing
. This means you leverage a user base to develop something.

A variety of sites can help with this, such as 99designs. You post a project, and service providers submit mockups, such as for graphic designs. You then reward the best one with a bounty. Crowdsourcing can be a low-cost way to get quality results.

Facebook has also used crowdsourcing: for example, to translate Facebook into other languages. The cost of doing this using employees would have been prohibitive. Instead, Facebook created a platform that allowed its users to translate the content. It turned out to be a tremendous success.

Layoffs are brutal, but they are a natural part of the capitalist system. A decade ago, the dot-com industry went from a growth industry to a disaster. Layoffs were large and swift. In many cases they did little to help, because companies went bust anyway.

A CEO needs to be attuned to major economic downturns and big shifts in a market. The silver lining is that you can take advantage of a prior boom by diversifying your customer base and building a profitable business. This should help the company to survive. Interestingly enough, the economic downturn may be an opportunity, because you have less competition.

But dealing with the situation is critical. You can’t live in denial. If you see clear signs of a major shift in the market or economy, you need to take quick action. As much as possible, make sure the layoffs are a one-time event. You don’t want them to drag out over time, which will take a toll on morale and may wind-up destroying the company.

Let’s hope you don’t have to deal with something like this. If your company is successful, you will most likely be hiring lots of people.

As described in this chapter, you can use many approaches for recruiting success. The key is to experiment and hone those that work for you.

The next chapter looks at how to buy a company. It’s been a highly effective strategy for Facebook and critical for getting top-notch talent.

Business opportunities are like buses, there’s always another one coming.

—Richard Branson

In July 2007, Mark Zuckerberg made his first acquisition. It was a deal for Parakey, which was a startup based in Mountain View, CA. The company was developing technology to make applications work while online or offline, but this didn’t matter to Zuckerberg. He wanted the company because of its talented co-founders, Blake Ross and Joe Hewitt. This type of deal became known as an
acqui-hire
.

Since then, Zuckerberg has gone on to strike over 25 transactions; the deal-making has accelerated over the past couple of years. All were acquire-hires but one: the $1 billion purchase of Instagram, which was a hugely popular mobile photo sharing site. Zuckerberg said the following:

This is an important milestone for Facebook because it’s the first time we’ve ever acquired a product and company with so many users. We don’t plan on doing many more of these, if any at all. But providing the best photo sharing experience is one reason why so many people love Facebook and we knew it would be worth bringing these two companies together.

A key to acquisitions is having a clear thesis. Zuckerberg has certainly done this with his deal-making.

It’s important because the failure rate of acquisitions is generally high. There are many risks, especially with integration. This chapter looks at some strategies to improve the odds.

It’s easy to get
deal fever
: you become convinced that a deal is a must-have and that you should pay any price for it. But this approach often leads to disastrous results.

Before pulling the trigger on a deal, you need to be disciplined and have a solid rationale regarding the benefits. Let’s look at some of the key ones.

Some companies are good at creating technologies but don’t have the core team to commercialize them. It’s a common problem.

The good news is that it can be a great opportunity for an acquisition. Keep in mind that a strong technology doesn’t necessarily have a high value. It gets a premium only if it has traction with customers. A company like Facebook has the advantage of a huge user base and can often get immediate benefits from a new technology.

Another key technology asset is a company’s patent portfolio. As has become apparent over the last few years, patent portfolios are extremely valuable, especially in categories like mobile and social networking. It’s important to have an outside expert put a reasonable value on the intellectual property.

You may not necessarily need to purchase a company—a better approach may be to buy the patents directly. This is what Facebook did with Friendster in May 2010: it used 3.6 million shares to buy some of Friendster’s social-networking patents.

As you’ve seen, sometimes a deal is about getting top-notch engineers, not a product or technology. But an acqui-hire is not easy to put a valuation on. For the most part, it involves getting a sense of the value of the numerous kinds of engineers in the marketplace, which can range from $150,000 to $1 million. The purchase price is mostly be in the form of equity, such as options and restricted stock grants.

But there must be more than a nice payday. The buyer must make a convincing case that their company offers greater opportunity. (
Chapter 11
talked a lot about this.)

It’s also critical that the CEO get involved in the pitch, regardless of the size of the deal. Zuckerberg is a big believer in this approach and has spent considerable time wooing founders.

An acquisition can be a quick way to get a footprint in a critical market. Google is one of the best at this. Deals for companies like Android and YouTube have been critical for the company’s success.

But there are risks. A user-base acquisition often involves a high price tag. This is inevitable if the company has become the category killer and is growing at hyperspeed.

The problem is, the buyer may wind up stifling growth. Cultural disagreements can be immediate issues and result in key people leaving.

Sometimes the best deals are the ones you pass on. This is probably what Zynga’s Mark Pincus thinks about his $180 million purchase of OMGPOP. When he struck the deal in March 2012, the company’s Draw Something mobile game reached 14.6 million daily active users (DAUs). But within a few months, it plunged to 3.4 million.

The acquisition may still wind up being helpful. OMGPOP should provide Zynga with lots of expertise in the mobile market. But the goal of buying a user base has a good chance of being a failure.

Because of such risks, it’s always a good idea to consider alternatives to an acquisition. One approach is to form a partnership, which may involve sharing technology or gaining access to a distribution channel. The partnership may provide the basis of an acquisition down the road.

The letter of intent (LOI) is the first offer to purchase a company. It’s a few pages long and sets out the main terms of the transaction, such as the valuation, retention bonuses, and protections in the case of misrepresentations or fraud.

After the parties sign the LOI, the buyer then engages in the due-diligence process, which can last a month or two. It should be obvious that confidentiality is of utmost concern in all discussions and exchanges of documents between the buyer and seller. Any inadvertent disclosure of sensitive information to competitors could be greatly damaging.

A smart buyer has already done some level of due diligence even before a deal is struck. You can do so by studying the market and keeping tabs on the seller.
Before Facebook bought Instagram, Zuckerberg already knew a lot about the company and had discussed a potential transaction with his board. When the time came that Instagram was ready for a deal, he was able to act swiftly.

But much of the due diligence comes after the LOI is signed. It involves a combination of activities including meetings, phones calls, and e-mails. It’s extremely important to have a single point person for all the information. This manager is responsible for collecting and codifying the various reports and documents. In the end, it will make the process much smoother.

In some cases, the buyer uncovers undisclosed information that is damaging. It may be a technology that the seller doesn’t own, or an imminent lawsuit. Such things may not be deal killers, but they probably mean the purchase price needs to be renegotiated. It’s also a time for the buyer to have a frank discussion with the founder, with the main question being “What else hasn’t been disclosed?” The buyer needs to emphasize that a strong relationship is key to the success of the acquisition, and that means there should be complete transparency.

Buying a company is not difficult. It’s the post-deal integration that causes problems and often is the key reason for failed deals. The merger was the courtship; now both sides must find ways to make the marriage work.

Too often, the buyer underestimates how long it will take to get the two companies to act as one. When you take ownership of a second company, you’ve essentially created a new organization. You have to manage two: your old one and this new entity.

It’s nearly impossible to conduct an effective integration without thorough planning. With a well-formulated plan, you have benchmarks against which to gauge your progress.

But even having a sound plan is no guarantee that you will avoid serious problems. The bottom line is that integration is tricky and tough. Some of the process requires a knack for dealing with people and new technologies. It’s not a skill that can be rapidly taught—it’s learned by doing.

Here are some things to consider when embarking on integration:

• Customer care:
  Rivals may try to poach customers. Often they use marketing campaigns to convince customers to move over. You need to make sure customers have a clear understanding of the acquisition.
  
• Cost cutting:
  Many tech acquisitions are about getting engineers, and there is a tendency to lay off the other employees. But this can be a blunder. The sales people may have strong relationships with customers, and the marketing people could have a good understanding of the target market.
  
• Over-allocated resources:
  Another big problem buyers run into is that they haven’t factored in sufficient resources in terms of money and personnel time. It’s smart to reserve additional money beyond what you’ve estimated.
  

Integration should be a joint effort, with representatives from both the buyer and seller (yes, integration is a team sport!). Try to involve the CEOs of both companies as well as some of the senior managers. Make sure the HR leaders participate actively as well. Much of the integration plan is about dealing with HR matters, especially layoffs and compensation.

Start the planning as early as possible, preferably when the LOI is signed. Developing a solid integration plan can take a month or so. And remember that the plan is not set in stone: it’s a guide. If you realize that additional steps need to be taken, then do so.

An integration plan should cover compensation and benefits, organization integration, communications, and technology. For every category, establish a start date, a completion date, a list of people involved, and a desired outcome. To do this, you can use an online project-management tool like Zoho or Clarizen.com.

After the integration, you should have a post-mortem analysis. What were the problems? What worked? What lessons were learned along the way?

It’s extremely rare for a buyer and seller to have the same compensation and benefit programs—in fact, it’s virtually impossible. As a result, you need to spend quite a bit of time dealing with the differences. Pay, benefits, and stock options are matters of immense concern to employees, so this part of the integration needs to run smoothly. Even if the new employees don’t like every modification of their old way (and they won’t), it’s critical that you present the overall package clearly and conclusively. And of course, if you want to avoid a stampede out the door, it’s vital that the new deal be fairly equivalent to their old one.

Assuming you’ve conducted the due-diligence process thoroughly and systematically, you should have all the necessary documents to analyze the other side’s compensation and benefit programs. You can then look at the features of both and make line-by-line comparisons. Doing so makes the process much more productive—and should help avoid major problems with employees.

Once the acquisition is announced, employees need swift communications. If this doesn’t happen, expect rumors to spread. When an information void exists, it’s filled—usually by false information. It’s not uncommon for headhunters to try to poach employees when there is an acquisition.

When communicating with employees, here are some tips:

• Announcement/FAQs:
  You should send out e-mails and post information on the internal company web site. It can explain the deal and provide a timeline.
  
• External communications:
  Provide information to customers and vendors, too. Will the product change? Will it be kept? It’s important to be clear-cut about the game plan for the acquisition.
  
• Honesty:
  If there is a question you can’t answer, don’t make something up. Instead, say you will get an answer promptly.
  
• Layoffs:
  Any layoffs should be done in personal meetings.
  

Expect lots of mistakes when acquiring a company. Even with a well-thought-out plan and a solid rationale, a deal may still be an abject failure. It’s part of the nature of acquisitions. But Facebook has shown that such transactions are critical for building a successful company and are worth the risk.

The next chapter looks at the potential exit of your own company. This happens when you decide it’s the best decision to sell out to a larger player.