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The Value of a Piece of Facebook

Yep, it was another deal hatched in Sun Valley.

During Allen & Company’s annual mogul-fest in the Idaho mountains in July, Mark Zuckerberg, the founder of Facebook, devised a plan with Mayor Cory A. Booker of Newark to donate a $100 million challenge grant for the city’s troubled schools.

AP

The gift, announced with much fanfare Friday on “The Oprah Winfrey Show” (with all the requisite swooning over the 26-year-old Mr. Zuckerberg’s desire to give anonymously), attracted $40 million in matching gifts so far by Monday from the likes of William A. Ackman, the hedge fund manager, and John Doerr, the venture capitalist.

But Mr. Zuckerberg’s donation has some scratching their heads.

How is he going to pay for it? After all, Facebook has yet to go public. In Silicon Valley’s parlance, Mr. Zuckerberg is “paper-rich, cash-poor.”

While Mr. Ackman and Mr. Doerr are probably making their charitable gifts in cold hard cash, Mr. Zuckerberg is doing something different. He’s giving away $100 million worth of Facebook shares to Startup: Education, a new foundation he has started and on whose board he will sit. The foundation, in turn, will sell the shares for cash in what’s known as the “secondary market,” a nebulous world where big-time investors buy into companies before they go public — through the back door.

It turns out that there is a robust market for Facebook shares, even though most people can’t buy them. The going price has been about $76 a share, The Financial Times reported last month, implying a market value of $33 billion. Dozens of employees have sold their shares in the secondary market.

Elevation Partners, the buyout firm that counts Bono of U2 as a partner, paid $120 million for Facebook shares in June at an implied valuation of $23 billion. If the secondary market is accurate, Elevation has already made a pretty penny.

And Yuri Milner, a Russian entrepreneur, has managed to amass a 10 percent stake in Facebook largely through the secondary market. His Digital Sky Technologies paid $200 million for a 2 percent stake, then raised that amount by buying up shares from employees.

The party may soon be ending. Once more than 500 individuals or institutions own shares in Facebook, securities laws mandate that the company go public. Google staged an I.P.O. in part because it hit that same threshold.

But all this share counting raises a new question: Is Mr. Zuckerberg’s $100 million donation really worth just that?

Facebook isn’t saying how Mr. Zuckerberg, or the New Jersey school system, plan to value his shares. (Cynics have suggested that the donation is a publicity stunt to polish Mr. Zuckerberg’s image ahead of Friday when “The Social Network,” a fictionalized story of Facebook’s founding, opens in theaters. Give the guy some credit, he just gave $100 million to a needy school system.)

Lower valuation?

People involved in the donation process say that the Facebook shares pledged will be worth $100 million based on the company’s own internal valuation, not the value assigned by the secondary market.

It’s probable that Mr. Zuckerberg’s valuation of the shares will be much lower than that of the secondary market. As a result, the donation might ultimately be worth even more than his initial pledge once the foundation seeks to sell those shares, possibly over a period as long as five years.

And indeed, a look at the secondary market suggests that shares frequently trade at a premium to their real value — because there are so few of them.

The topic has ignited quite a bit of debate on the Internet, including on sites like GigaOm.

“Minority investment evaluations aren’t real,” David Heinemeier Hansson, a partner in the software developer 37Signals, contended on his blog, adding that Facebook’s secondary market valuation was “entirely based on what starstruck minority investors have paid for a tiny slice of the company.”

That prompted Joel Spolsky, another software developer, to reply that Mr. Hansson’s post was “so economically bizarre and incorrect that I don’t even know where to start. It’s like you wrote a blog post arguing that it is incorrect to refer to a five-foot-tall boy as five feet tall because he’s often sitting down. Every single day every single public company in the world is valued by the last share traded, usually for a tiny fraction of the company.”

In truth, Mr. Hansson is probably right. With so few shares available, it’s hard to extrapolate Facebook’s real market value. Microsoft directly invested $240 million for a slice of Facebook two years ago, valuing the social network at $15 billion. That might have been accurate — or might not have been. After all, Microsoft’s deal was partly a defensive move meant to block Google from forming a strategic alliance with the company.

Of course, one of the secondary market’s great disadvantages is that a company like Facebook doesn’t have to disclose its financials, so all these valuations are a bit of a guessing game.

But every stock sale in the secondary market has to be blessed by Facebook: it has the right of first refusal to buy the shares itself, and has used that provision to prevent shares from getting in the wrong hands, according to a person briefed on one such transaction.

What Facebook will ultimately be worth — $23 billion? $33 billion? $3 billion? — is anyone’s guess. But given the immense interest in the company, it’s hard to imagine that Mr. Zuckerberg wouldn’t be able to find $100 million in cash for some of his shares. The question is, how many will he have to give up?




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