How to Create the Next Facebook: Seeing Your Startup Through, From Idea to IPO (24 page)

If I hadn’t launched [Facebook] that day, I was about to just can it and go on to the next thing I was about to do.
¹

—Mark Zuckerberg

This book has covered quite a bit. But you shouldn’t take everything as gospel. Each company is different, and you must be alert to finding ways to innovate—not only with regard to your product but also the business model and go-to-market strategy.

You need to figure out one major thing: your company needs to solve a difficult problem. Facebook did this by replacing the antiquated ways people kept in contact with each other, including snail-mail, phone, and e-mail. Zuckerberg knew there was a better way.

But he did more than code a web site. He built a platform that focused on the types of relationships that were important to people—and he did this with complex algorithms. He also made the system more robust by allowing third-party developers to create apps for it. In the end, Facebook had tremendous barriers to entry, which made it extremely difficult for competitors to be a threat.

Making this possible was not easy. It took lots of hackathons and sleepless nights. Of course, Zuckerberg had to spend a lot of time recruiting some of the world’s best minds. But he understood his mission and how to get there.

This is not to say that you should focus on social networking or the Internet or mobile. True, these areas hold great opportunities for entrepreneurs, but don’t get tunnel vision and get sucked into the latest hot area. There are many
categories to look at when searching for problems to solve. Your impact can perhaps be even more important than Facebook’s.

Here are just a few that come to mind.

Although computers are mostly a commodity, a fortune is waiting to be made by someone who can go beyond the silicon chip. The reason is that within the next 20 years—and probably much sooner—Moore’s Law will grind to a halt. Simply put, there will no longer be a doubling of processing power every 18 months. Silicon chips have natural limits in terms of etching transistors, and the technology will become unpredictable due to quantum mechanics.

Without Moore’s Law, the computer industry will be in deep trouble. To deal with this, strong research is required into new types of chips, such as those using innovative chemistry or nanotechnology concepts.

Back in the 1960s, a geophysicist for Shell Oil, Dr. M. King Hubbert, came up with something called the Peak Theory of oil. His contention was that production of oil inevitably reaches maximum levels and then experiences a steep drop.

Hubbert predicted that the US would suffer its peak in oil production in the early 1970s. He came under criticism, but he was eventually proven correct.

His theory points to a peak in Saudi oil in 2007 to 2011 or so. True, he could be wrong on this point. But the fact is that oil prices have remained persistently high over the past decade. At the same time, it’s getting tougher to find new deposits.

If the world hits a peak, it could be devastating. Oil is a key driver for wealth.

So for entrepreneurs, this seems like a great opportunity to look at new energy concepts, such as fusion, magnetism, and superconductors. These areas are still in the early stages and should be ripe for tremendous breakthroughs.

There have been tremendous breakthroughs in this area. The decoding of the genome is incredible.

In 2012, it’s possible for you to have a company completely decode your genome for about $1,000. Within ten years, the price tag could drop to $100. If it does, the world will have access to hundreds of millions of genomes that will be key for curing intractable diseases like diabetes, Alzheimer’s, cystic fibrosis, HIV, Parkinson’s, and cancer. But doing so will require entrepreneurs who have the ability to apply advanced computer systems to biotechnology systems, a process known as
bioinformatics
. This area is definitely worth looking into.

My point is that you need to expand your horizons and go beyond your comfort zone. The next few decades will involve amazing new technologies.

With some helpful tools from this book—and the inspiration of companies like Facebook—it’s time for your journey!

83(b) Election:
Part of the tax code that allows for the immediate vesting of stock. It often results in a lower tax. The election must be made within 30 days of the grant of stock.

Accelerated vesting:
When part or all of a person’s stock options are vested on the event of a change of control.

Accelerators:
Similar to angel groups but may instead have their own office space for the ventures they back. Accelerators tend to provide considerable ongoing advice and mentorship. The top ones include Y Combinator and TechStars.

Accounts receivable:
An asset created when a company has sold a product or service but the customer has yet to pay.

Acqui-hire:
An acquisition of a company with the main purpose of hiring top engineers. Facebook has made more than 25 such deals.

Angel:
A person who invests their own money in early-stage ventures. Such people are usually wealthy and former entrepreneurs.

Anti-dilution clause:
Gives existing investors the right to obtain more shares when the next round of funding is at a lower valuation (known as a
down round
).

Asset purchase:
An acquisition during which the buyers buy all or most of the seller’s assets for stock or cash (or a combination of the two). It helps to avoid liabilities and often has certain tax advantages.

Auditor:
A firm that vouches for a company’s financial statements. For an IPO, the auditor must be registered with the SEC.

Balance sheet:
Financial statement that includes a company’s assets, liabilities, and equity. It should always balance according to this equation: Assets = Liabilities + Equity.

Board of directors:
A group, ranging from three to ten or so members, that meets every month or so to review progress and weigh in on major decisions. All corporations have them. The board also has the power to appoint and fire the CEO.

Business model:
The way a company generates revenues. For Facebook, the primary business model is advertising. But the company also generates substantial revenues from its Payments business.

Capitalization table (also known as the cap table):
A list of all the shareholders and their ownership stakes, before and after the proposed financing.

Change of control:
Occurs when a company is sold or liquidated. It is a critical event for a person’s stock options or equity.

Common stock:
The representation of ownership in a company. It usually has some rights, such as voting on important matters.

Conversion right:
An investor’s right to convert their preferred stock into common stock.

Convertible note:
A loan to a company, usually in the early stages. It has a term of anywhere from 6 to 18 months. Once there is a Series A funding, the note is converted into common or preferred stock.

Co-sale agreement:
Agreement stating that if a founder sells shares, the rest of the investors have the right to sell a proportionate number of their own shares.

Cost of revenue:
Includes all expenses directly related to the delivery of the company’s products.

Crowdfunding:
Leveraging a public web site to raise funds from the public.

Crowdsourcing:
Leveraging a user base to develop something, such as a graphic design.

Daily active user (DAU):
A user who visits a site at least one time every day. The DAU is a key driver for Facebook’s success.

Data room:
A secure online portal where a company can put its due diligence and other investor materials.

Deck:
The PowerPoint presentation used for raising capital.

Dividend:
A payment from a company to its investors. It can be in the form of cash or stock.

Down round:
When the valuation is lower on the next round of funding. Investors try to protect against this with an anti-dilution clause.

Drag-along provision:
Requires founders and other key shareholders to vote in favor of a major corporate transaction, such as a sale or merger.

Dual-class structure:
When the founder has a special class of stock that grants considerably more voting rights. It is a way to maintain control over the company.

Due diligence:
The process of investigating a company’s finances and liabilities before an investment is made or an acquisition is completed.

Earnout:
Extra cash or stock that employees receive if they hit certain milestones. This is often part of the consideration for an acquisition.

Emerging growth company:
Defined in the JOBS Act as a company that has less than $1 billion in revenues. These operators have fewer regulations when coming public.

Engagement:
The level of activity for things like wall posts, messages, Likes, comments, and photo uploads.

Freemium model:
When a company has a fully functional free version of its product. The goal is to convert a small part of the user base—say, 1% to 5%—to adopt a premium version. The free product is essentially a form of marketing.

GAAP (Generally Accepted Accounting Principles):
An extensive set of accounting principles that have been developed by authorities such as the Securities and Exchange Commission, the American Institute of Certified Public Accountants (AICPA), the Financial Accounting Standards Board (FASB), and the Public Company Accounting Oversight Board (PCAOB).

Goodwill:
The value from an acquisition. It is the purchase price minus the net asset value of the target company.

Gross profit:
Revenues minus the cost of revenue.

Gross profit margin:
Gross profit divided by sales.

Hackathon:
A contest for coders to create an app in a short period of time, such as over the weekend. It’s something Facebook created to improve creativity.

Hold-back:
Money set aside in an escrow in case of any breaches of representations and warranties from an acquisition.

Income statement:
Financial statement that starts with revenues and then subtracts all costs. The result is either a profit or a loss.

Indemnification:
Guarantee that a corporation will cover the liabilities of investors and the board, such as in the event of a shareholder lawsuit.

Information rights:
An investor’s right to inspect a company’s books.

Invention assignment:
Transfer of all intellectual property created by an employee to the employer.

Investment bank:
A firm that provides advisory services for mergers and acquisitions and IPOs.

IPO (Initial Public Offering):
The first time a company issues stock to the public.

JOBS Act:
Legislation passed in 2012 to make it easier for smaller companies to raise capital and come public. One of the areas it legalized is crowdfunding.

Late-stage funder:
An investor such as a private equity fund, hedge fund, or mutual fund that invests in a company when it becomes large enough. Often, the money is used to buy shares from existing investors and employees; this is known as a secondary purchase.

Letter of intent (LOI):
The first offer to buy another company. It sets the main terms, such as the valuation, the type of consideration, and the legal protections.

Liquidation preference:
Gives priority to the investor when there is a liquidity event, such as an acquisition. The most basic is a 1X preference. This means the investor gets back up to 1 times the investment before anyone else receives any cash.

Market capitalization (or market cap):
The stock price times the number of shares outstanding. It shows the overall value of a company.

Noncompete clause:
Agreement that forbids a person to compete against a former employer or client, usually for a period of time. In some states, including California, such clauses generally are not enforceable because they prevent people from pursing employment opportunities. However, if a noncompete is part of an acquisition, it is usually enforceable.

Nondisclosure agreement (NDA):
A legal agreement that forbids a party from disclosing certain information, usually for a period of time. Such agreements are generally enforceable.

Nonsolitication:
Agreement that says you are not allowed to poach customers or suppliers from your former employer. Interestingly, California looks unfavorably on these types of arrangements.

No-shop clause:
Agreement that says a company may not seek out an alternative deal when there is a proposed funding or acquisition.

Option pool:
The percentage of total options available to grant to employees. It is usually 5% to 20% of the outstanding stock.

Pay-to-play provision:
Encourages existing investors to participate in the next round of funding by requiring them to convert their shares to common stock if they don’t participate.

Post-money valuation:
The valuation of a company after an investment is made. It is equal to the pre-money valuation plus the total amount of the financing round.

Preferred stock:
Representation of ownership in a company, with special rights and protections such as liquidation preferences, veto rights, and board seats.

Pre-money valuation:
The valuation of a company before outside investment.

Protective provisions:
Veto rights for investors. They cover areas such as the sale of the company, amendments to the certificate of incorporation, and issuances of new securities.

Redemption right:
An investor’s right to get their money back after a fixed period of time.

Registration rights:
The rights of investors when there is a filing of an IPO.

Representations and warranties:
Promises made by a company that is in the process of being sold. If there are any breaches, the buyer has the right to seek damages.

Resale restriction (also known as a right of first refusal or ROFR):
The right of a company to buy back shares at the current valuation or select its own buyer.

Restricted stock:
Stock that a company grants to an employee but that is subject to vesting. When the vesting requirements are earned, the employee has ownership rights to the stock.

Road show:
The presentations that senior management makes to investors a couple of weeks before an IPO.

S-1:
The document filed with the Securities and Exchange Commission to go public. It includes the prospectus, which is the key document that sets forth a company’s business plan, financials, and risk factors.

Sarbanes-Oxley Act (SOX):
A law passed in 2002 to prevent accounting scandals. It introduced higher disclosure requirements and increased criminal penalties.

Secondary market:
An online exchange that allows investors and employees of a private company to sell their shares. The two main operators are SharesPost and SecondMarket.

Securities and Exchange Commission (SEC):
The federal agency that enforces securities laws, such as for IPOs and private fundings.

Seed funding:
A company’s first financing from outside investors.

Series A:
The first round of financing when institutional investors participate, such as venture capitalists.

Social context:
Advertising that is based on engaging friends based on activities such as Liking an advertiser’s Facebook page. The idea is that people will probably value a friend’s recommendations more than a straight ad.

Sponsored stories:
Ads than let an advertiser broadcast messages to more of its fans.

Stealth startup:
A company that remains secret as it develops its product.

Stock option:
An employee’s right to buy a fixed number of shares at a certain price. The employee must stay with the company for a period of time to have the right to exercise the option; this is known as vesting.

Stock purchase:
Acquisition during which the buyer purchases all or a majority of the shares from the seller. It tends to be favorable to the seller.

Strategic investor:
A large company that invests in early-stage companies.

Super angel:
A high-profile person who invests in early-stage ventures. Such investors usually invest substantial amounts, such as over $1 million. They may also invest other people’s money.

Term sheet:
The offer of funding from an angel or VC. It is a few pages long and sets forth the key terms, such as the valuation, amount, and protections.

Underwriter:
A Wall Street firm that manages the IPO process.

Venture lender:
A financial firm that provides loans to early-stage companies. The terms are usually 6 to 18 months.

Vesting:
The process of earning the right to buy shares of a stock option. This usually means an employee must continue to work for a company for a set period of time. A typical vesting schedule is for a one-year cliff and then three years of monthly vesting. That is, after one year, the employee has the right to buy 25% of the shares of the option. After this, an incremental amount of shares vest each month.

Virtual good:
A digital item that a person can buy. Often, this is for a social game, such as from Zynga. Facebook has a Payments platform to allow for these transactions.

Warrant:
Similar to an option, which gives the right to buy a fixed number of shares for a certain price. There is no vesting. A warrant is usually granted as part of a funding.