A lot of traditional VCs (particularly those based in the West Coast) woke up this morning and tossed some chairs around and broke some really expensive shit because of this article in the Wall Street Journal, lauding Peter Thiel and his partners over at Founders’ Fund, which include Sean Parker, Luke Nosek, Ken Howery. The fund’s investments include:
- Iron Port Systems: email security software (recently sold to Cisco for $830M).
- Slide: the #1 or 2 widgets maker on Facebook.
- Facebook: apparently, a popular social networking site.
- Powerset: the natural search language company launched on the heels of a XEROX patent.
Anyone who has ever read anything on HipMojo.com knows that while I respect VCs, I think the entire industry is one big game of smoke and mirrors. Fred Wilson deserves some credit for introducing transparency to the industry, as does Brad Feld, and a slew of others. While we’re handing out props, TheFunded.com has done a great job of giving some Vulture Capitalists a much deserved public ass-whooping in a fairly open and direct manner, though yes, it has its drawbacks, too. The guys at VentureHacks.com deserve a lot of props for sharing their know-how, because let’s face it, indeed VCs work on term sheets 24/7/365 whereas us hapless entrepreneurs don’t.
But while Wilson and Feld still represent the VC establishment, and TheFunded.com and VentureHacks.com remain outsiders with little direct, material influence; Thiel and his partners in crime are insiders by virtue of being investors, and have a big impact because regardless what any entrepreneur thinks about the value of his or her company, said value is a function of demand and supply… and in an environment where less capital is required to build an empire (and in less time), Thiel’s fund definitely tips the scales in favor of the entrepreneur.
As an entrepreneur, there are no two ways about it: you love what Founders’ Fund is doing, even if they hitherto only invest in limited segments, amongst people they know, and in a specific geographic area.
Moreover, Thiel and Founders’ Fund differs in one more significant way: their track record is actually very impressive, both as investors and operators. Thiel was CEO of Paypal, which we ranked as one of our 13 most explosive startups ever and its acquisition by eBay as one of the best Web M&A deals of all time.
The experiences at Paypal - which has become a GE-like super factory of technology entrepreneurship and investing (in how it has churned out so many founders, investors and managers) - is actually inspiring.
The experiences the men have had individually - such as the rumor that Thiel resents how Mike Moritz pushed Max Levchin’s then-named Confinity to merge with Elon Musk’s X.com to form Paypal and thus dilute his holdings, or pretty much everything pertaining to Sean Parker at either Napster, Plaxo and Facebook, etc. gives them a lot of street cred with entrepreneurs who have grown wary of anything that comes out of a VC’s mouth. You need not read between the lines: I don’t trust VCs, thankfully I’ve not needed VCs to grow WatchMojo.com thus far. While I am not alone thus far, most entrepreneurs don’t have a choice and throw caution into the wind and accept draconian terms.
The main point of objection I have is that it’s not as if VCs - either individually or as a cohesive group - even have an enviable track record. VCs brag about 5 investments crapping out, 2 to 4 being so-so hits, and 1 being a grand slam that makes up for the others. Huh… note to PR team, draft another elevator pitch, pal. I would not brag about taking other people’s money and then sinking 50% of the investment in a toilet… but I digress.
If I have a beef against VCs, it’s not personal; it’s professional. I see through their spin, I can BS better than them, and being a media content oriented company, it’s not traditional VCs that I really count on to find a financial partner. But again, I digress. Technology startups I advise welcome VCs’ interest though I almost view it as a kiss of death (reference Zantaz, Filmloop, and many others).
Anyway, that out of the way… Some gems from the article:
- “Mr. Thiel, the former CEO of online-payment company PayPal, is making waves in Silicon Valley with an investment strategy that differs significantly from the traditional approach. His company invests only modest amounts of money, sometimes just a few hundred thousand dollars, and focuses on entrepreneurs Mr. Thiel and his partners often know personally. He also takes an uncharacteristically hands-off approach to company management.”
- “Many VCs “have these very cushy jobs, they get paid a lot,” and often can’t relate to founders, he says.”
- “Most traditional VC companies want to invest larger sums, several million dollars, say, for large stakes in start-ups and then exert control over the companies’ operations. Some demand “liquidation preferences,” or guaranteed returns if companies are sold.”
- “Significantly, the fund often buys only a 5% or 10% stake in a company and sets up a special class of stock that start-up founders can sell while they are building their companies — and before venture-capital investors see profits. That way, the thinking goes, the company founders can reap some financial reward and stay motivated to build the company before an IPO or company sale, which can take years.”
- “Some traditional investors don’t think founders should make money before backers do, since early paydays might distract them from the task at hand. All of this is causing traditional VC firms to re-examine the way they invest in tiny tech start-ups. VC concerns including Trinity Ventures, for example, are now letting a few of their entrepreneurs “take money off the table” early on by selling stock.”
- “Mr. Thiel acknowledges his company faced resistance from blue-chip investors when it set out to raise money for its latest, $220 million venture-capital fund. One large institutional investor, who declined to be named, said he was put off by Founders Fund’s anti-establishment pitch. Others wonder whether Founders Fund could soon tap out its close-knit network of entrepreneurs and run out of companies to fund.”
I won’t comment on each one, suffice to say it’s refreshing and a welcome change from VC’s draconion rules of engagement in standard term sheets, something I covered recently here. I’ve also long argued that one reason we don’t see any grand slams anymore is because of the greatest mistake VCs and entrepreneurs make, which is not taking any money off the table in financing rounds. What’s that saying? Bulls make money, bears make money, but hogs get slaughtered… yeah, that one.
A cynic would highlight, however, that Founders’ Fund it too young, too early, and too idealistic to have hit some rough patches. In other words, it’s not what Thiel et al. think and do now in good times, but how they will react in a downturn. Judging by many economic indicators, the economy won’t be spectacular in 2008, but as we’ve outlined before, that will actually help the Web sub-economy in a few ways.
To conclude, Founders’ Fund won’t even be the biggest wave to shake down VCs in the US. That, my friends, will be foreign capital, trickling in more and more in 2008 and flooding American startups in 2009 and beyond. Foreign financial institutions - be it in China, Singapore, Saudi Arabia, etc. - are investing 5-10% in American financial giants. Over time, the same trends will lead many investors to start to invest in US startups as well. For more on this, see our sister publication WorldMojo.com’s post World to USA: Who’s Your Daddy?.
Peter Thiel’s initial claim to fame was as the CEO of Paypal.
Today he runs Clarium Capital Management and the Founders’ Fund. The former is a hedge fund with $2B under management, the latter is a $50M venture capital fund that has raised the ire of uber angel investor Ron Conway, mainly for allowing entrepreneurs to partially cash out when they sell equity to VCs in funding rounds.
Paypal was included in our 13 Explosive Web Startups of All-Time. The merged company went on to be acquired by eBay for $1.5B, placing in our Top 10 Web M&A of All Time.
As President of Paypal, Thiel made a lot of money by most Americans’ standads, but a paltry sum by Silicon Valley standards: his 3.7% stake in Paypal converted to a $55M payoff. Paypal was the product of a merger between Elon Musk’s X.com and Thiel and co-founder Max Levchin’s Confinity.
Paypal: What Could Have Been?
Today Paypal drives a lot of value at eBay each quarter, as outlined in this Bank of Paypal article in Business Week. Had Paypal not sold to eBay, eBay could have squeezed Paypal’s revenues by shutting it out of the largest auction service’s community. On the one hand, Thiel saw what a successful merger could do to grow his baby, on the other hand, he knows just how much larger and more valuable Paypal could have been. One day, after all, Paypal might generate over 50% of eBay’s revenues.
The Man with the Midas Touch?
Thiel of course, is also known for being one of Facebook’s initial investors, having funded Facebook with $500,000 in 2004. Facebook is this year’s MySpace. In addition to Facebook, he has also invested in LinkedIn, Friendster, Rapleaf, and IronPort. Of course, Facebook is the one horse that Thiel is most happy to have bet on.
Peter Thiel’s Stake in Facebook?
While everyone is wondering just how rich Facebook will make Mark Zuckerberg, it’s interesting to see just how successful Facebook.com might make Thiel. Thiel’s LinkedIn is also slated to go public next year, but it is Facebook.com that has captured the imagination of Silicon Valley and the bankers that monetize the startups that Thiel and his cohorts finance.
Like many angel investments, Thiel’s $500,000 capital might have come in the form of a convertible note from Facebook.com, whereby he did not dilute in the first VC round of funding, but one that got him anywhere from 5 to 10% of the company. More on this below.
Who are Facebook’s Investors?
Facebook seems to boast as many investors as it does founders, though not as many as would require it to file for an IPO, something that happened to Google.
It’s very common to see different investors have different goals for a company they have invested in. A VC wants to maximize return, they don’t want a 25% or 100% return, they want 10x their money back.
According to BusinessWeek.com, “Facebook’s first round came in at a $100M valuation, its second was a $500M valuation”. Since you can’t trust everything in a traditional media’s publication (in my experience: the more established a media, the less effort they seem to put in to ensure all the facts are 100% accurate), I’m going to add a note that BW is referring to funding rounds by VCs, and not indivuals’ angel round.
After all, according to Wikipedia, the $100M round led by Accel Partners was done in May 2005 when they raised $12.7M. This was supposedly the first VC funding round, but second in all, since Peter Thiel had invested $500,000 in late 2004.
By March 2006, Business Week reported that Facebook turned down a $750M buyout offer from Viacom, which at the most recent funding valuation was for 7.5x return.
Later that year, in April, 2006, Peter Thiel, Greylock Partners, and Meritech Capital Partners invested an additional $25 million in the site for a reported $500M valuation. So this was in fact the second VC funding round, which Thiel participated in as well. My theory is that he was not diluted in the first VC Round of 2005 but would have been in 2006’s second VC round.
Timeline of Buyout Offers to Acquire Facebook.com
It was throughout 2006, too, that Yahoo!’s $1B and $1.62B buyout offers came in, as well as the less-reported $2.3B buyout offer from Google (source being Jason Lee Miller on WebProNews).
As you can see, the $1B and $1.6B buyout offers represent a 10x and 16x return for Accel Partners, but far less for Greylock and Meritech (2x and 3x, respectively). I don’t think that either Greylock and Meritech had the same leverage and rights as did Accel Partners… in other words, had Accel wanted to cash out, they probably would have forced Meritech and Greylock to accept the deal.
But, even at the alleged $2.3B price tag that Google supposedly threw out, this represents a 23x return for Accel but a far less interesting 4-5x for Meritech and Greylock.
Then again, the relative multiple is one thing, the absolute return in dollars is a different story. As a side note, this is what makes Private Equity an altogether different beast: they invest in less deals but the numbers are much larger, meaning that a hit drives substantial dollars back into the coffers.
Thiel’s Stake in Facebook is Worth Hundreds of Millions
Back to Thiel, say the initial angel funding was for at most a valuation of $10M (I’d suspect maybe even as low as $5M), then Thiel had until VC Round 1 a 5-10% stake in the company. That might have gotten diluted, it might have not, depending on the structure of the deal, until Round 3 (or VC Round 2), where Thiel probably maintained his stake.
In other words, Thiel has far more to gain as an early angel investor than Accel, Meritech and Greylock do.
Because a 5-10% stake in Facebook, which could command by our analysis anywhere from $3.3B to $6B in a sale could translate to $165M to $600M to him individually.
Thiel’s Mammoth Ambition
These are big numbers, for sure, but since Thiel made millions in Paypal’s sale, can we blame him for wanting to strike a billion dollars in the Facebook deal? If Thiel owns 10% of the company, this means that a $10B sale would earn him $1B. If he owns 5% of the company, a $20B would get him there. Obviously, despite all of the buzz, hype and flash surrounding Facebook, no one thinks that Facebook could command anything north of $10B (yearly revenues are at $100M, after all)… that is why I would guesstimate that Thiel probably owns 10% of Facebook.
I don’t even think that if a sale were to be entertained, it need to go above $6B, mainly because few bidders could afford it. I’m not even comfortable to state on record that Facebook is worth more than a $1B, but I think that in an auction, many bidders could afford to pay $1B, so it can rise to $2 or $3B before the price tag gets too rich and the would-be bidders disappear. And, as I’ve stated, if Mark Zuckerberg does own 30% of Facebook, then a $3.3B would yield him a $1B payoff, an offer and payout that would make it very hard to resist.
Facebook’s Capital Structure?
We’ve read in numerous places that Zuckerberg owns 30%. According to Facebook’s PR rep Brandee Barker, Facebook’s other co-founders are Chris Hughes and Dustin Moskowitz. This is a crapshoot because not all co-founders are created equally, but I’ll estimate that Hughes and Moskowitz own anywhere from 7.5% to 15% each. So for the sake of this analysis, let’s just assume that co-founders Hughes and Moskowitz own 10% each, or 20% in all.
So according to this, the three co-founders own 50%. Bear in mind this seems very high for a startup with $35M in funding, but:
1 - It would not really make sense for Zuckerberg to have 30% now and the other two have far less, if they were in fact co-founders (At the very least, they would have 5% each… or 10% in all).
2 - When your first and second rounds of institutional funding come in at $100M and $500M, you better hope the founders managed to retain lots of equity.
We’ve outlined above why we think that Thiel owns 10%. Right there, that’s 60%.
Accel invested $14.7M at a valuation of $100M. Depending on whether this was pre- or post- money, let’s just assume this gave Accel a roughly 15% stake in Facebook.com. So, we’re now at 75%.
Greylock and Meritech and Thiel invested $25M at a valuation of $500M, so that gave them 5% in all. Assume then that Greylock and Meritech own 2% each (that seems low but by then, at a $500M valuation, what can you expect?) and the other 1% went to Thiel who also invested in that $25M round for a valuation of $500M to maintain his stake. In other words, and this is purely speculative, we project that Thiel invested $5M of that $25M to maintain a 10% stake, alongside Greylock and Meritech who invested $10M each for a 2% stake. Accel did not invest, and probably diluted, but to avoid numerous scenarios we’ll leave them at the approximate 15% stake.
In all, that makes the shareholding as follows:
Note that Facebook.com just recently made its first acquisition, for Parakee, and everyone presumed it was a stock and cash deal… so that would fall under the 21%.
If those percentages are correct, then a sale from anywhere from $1B to $10B would yield the following windfalls:
If this breakdown is correct, you start to see why the amount it takes to please investors is widely different, and a potential stale mate might materialize, with Zuckerberg and Thiel holding out for the insane offer whereas Accel would want something reasonable to liquidate its holding. Greylock and Meritech, I would presume, are just happy to be part of the ride.
Last week, I was interviewed extensively (but not credited, quoted or anything, mind you) for an article by David Shabelman in TheDeal.com named “Facebook to remain swinging single”.
After reading it, you walk away with a feeling that Thiel is aiming for the parking lot across the fence, and not just the fence. Here’s why:
If these numbers are close to being accurate, the higher the purchase price, indeed Accel makes more money than Thiel, but in absolute terms, Thiel’s payoff relative to Accel’s payoff becomes a rounding error (well, sort of anyway). Of course, Zuckerberg stands to make more than anyone else, and good for him… but at these levels, the urge for Thiel and Zuckerberg to hold out for a massive grand slam might cause a rift between them and Accel, Meritech and Greylock. Note that Thiel bills his VC as the founder’s fund, so there is merit in anticipating a showdown down the road when the buyout offers range from $1 to $5B.
In fact, in TheDeal.com article, Thiel shed some light on what his expectations in a deal would be:
There’s a fairly simple explanation for why Facebook Inc. is not for sale and won’t likely be acquired anytime soon - there is a big gap between what the company and what potential buyers think the social-networking Web site is worth.
That’s the view of Peter Thiel, a Facebook director who invested $500,000 in the Palo Alto, Calif.-based company’s
In an interview, Thiel said despite having serious talks with Sunnyvale, Calif.-based Yahoo! Inc. about an acquisition during the past year, the company has better things to do than listen to low offers from potential acquirers.
“We’re so far apart with what we think it’s worth and what other people do it doesn’t make sense for us to have conversations,” Thiel said. “Either they’re underestimating it or we’re overestimating it, but given that disconnect, it would be a complete waste of time for the company to be talking with people.”
In other words, while Facebook has been a popular subject of takeover speculation, Thiel estimates it would command a price tag between $7 billion and $10 billion. The market, on the other hand, values the company closer to $3 billion, he admitted to TheDeal.com. One of the problems, frankly, is that while it generates $150M in revenues, about 50% come from one deal from MSFT. MSFT, it should be noted, is the one company that can pay it what its investors might want. Problem? MSFT has an inside peek inside Facebook’s kimono and if the ad returns don’t justify a mammoth price tag, it won’t offer anything getting close to the $6B I think it will take to outbid everyone else, let alone the $7 to $10B Thiel feels Facebook is worth.
Bear in mind, too, that some of the strengths Facebook has can very quickly turn into weaknesses:
“We have an extremely rich amount of data about our users, so we believe there will be some way to monetize it better than what people have done in the past,” he said.
A week ago, that sounded great. But in light of the government’s reaction to Google’s purchase of Doubleclick over privacy concernes, and IAC’s Ask.com’s move to delete user’s search histories, Facebook’s investors should weigh all of the pros and cons of not cashing out now because the Web climate changed quickly, and with little warning.
“If we have a fully developed revenue model, it would be much easier to value, and we would see if it made sense as a standalone business or with something larger,” he said. “But we’re very, very far from that point.”
As we highlighted in Memo to Facebook’s Sales Team, much the same way that Google looked beyond Yahoo! dominance in CPM-priced banner display ads to master CPC-priced text ads, Facebook can look at maximizing its Database of Connections to fine-tune referrals and recommendations and champion CPA-style ads. Then again, there are a million things that can go wrong with that theory, too. Then again, if I was Facebook’s Chief Revenue Officer, I’d recommend something very very different to hit $10B in revenues by 2014 (ten years after being founded, the time it took Google to hit $10B in revenues).
Of course, it helps that Thiel is patient:
Thiel said the “earliest” Facebook would go public is 2009, “and hopefully not until significantly after that.” One route could be to emulate Mountain View, Calif.-based Google Inc. and go to the public markets after its business is well established.
If anything, this shows that Facebook has little foresight into Facebook’s potential billion dollar revenue stream, because 2008 seemed to be the year that many expected Facebook to make a move (related: Facebook’s 2008 to do list: File for an IPO). But, like my old employer IGN did, the company can file only to put the interested parties on its timeline:
“I think the preference we have would to do neither - to neither take the company public or sell it,” he said.
If it were to consider a sale, it would take a large number to get the company’s attention, Thiel said.
“If we got an offer from someone for $10 billion, we probably would listen to them,” he said. “I don’t think we’re going to get that offer, and we’re not going to solicit it.”
Ultimately, Facebook is providing great fodder for pundits and analysts alike, and time will tell if it will end up becoming this cycle’s Friendster, MySpace or Google.
Do you think that seeing Paypal’s success after its sale make Thiel more or less willing to sell Facebook to see someone else ride into the sunset with all of the riches? Time will tell, indeed…
- Facebook’s Valuation? $3.3B to $6B.
- Facebook’s Valuation is Maximized If and Only If…
- Why Facebook’s VCs will Fund Facebook App Developers
- Facebook’s Mark Zuckerberg’s Entrepreneurial Dilemma
- Memo to Facebook’s Sales Team
- Facebook: IPO vs. M&A.
- Facebook’s 2008 to do list: File for an IPO.
- Should MSFT Turn its Attention to Facebook?
- Peter Thiel: Facebook is Worth $8B (by 2015).
- Murdoch: “MySpace worth $6B”, if so, then break up FIM!
- Facebook to be worth $2.35B by 2010.
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