In this blog, we explore Facebook’s early fundraising rounds, and how Mark Zuckerberg picked his angel and Venture Capital investors. We examine the importance of picking value add investors, equity vs control dilution and how to pitch Sequoia Capital in Pyjamas!
Facebook’s seed round
Let me take you to 2004, back when Mark was building Facebook from his college dorm room. “thefacebook” was going viral and expanding from one college campus to the next in record time. The cost of this expansion (in particular the cost of additional servers) required Mark and his co-founders to raise external capital.
Mark started his search for an investor, just like any normal entrepreneur. He went through his network. Looking for people who would be likely to invest in an internet startup.
It seems like Mark did a good job, as Peter Thiel (a serial entrepreneur who was part of the founding team at PayPal) has said that he had to fight other angel investors to be picked by Mark.
Despite the competition to invest, several famous angel investors turned down the opportunity to invest in Facebook. According to David Kirkpatrick’s book “The Facebook Effect,” many investors were skeptical about Facebook’s long-term potential and uncertain about its ability to generate revenue.
It’s easy in hindsight to think that Facebook was a great investment. But at the time, Facebook was the seventh social network to launch and its rivals were quite established (MySpace, Friendster and SecondLife). MySpace alone had raised $40 million from VCs.
With all that context, here is the actual pitch deck Eduardo Saverin was showing investors in 2004:
Facebook Seed round metrics
At the time of Thiel’s angel investment, Facebook had around 70,000 users, but not only did it have no revenue, there wasn’t a formal plan to generate any!
The early signs of exponential growth that Facebook was showing was enough to convince Peter and some other angels that this was going to win the social networking war. And once the site had enough scale, it would find ways to monetise the platform.
Interestingly, Peter Thiel and the other angel investors negotiated a board seat and a provision that prevented Mark from diluting their equity stake in Facebook without first gaining their approval. These deal terms gave the angel investors a greater level of control and protection in the company that helped them reach the $5 million valuation Mark wanted.
This high valuation allowed Mark to minimise his personal equity dilution, but these deal terms came with risks to him and Facebook if it didn’t maintain its growth trajectory.
Here’s an interview with Mark back when Facebook had a beer keg in the office:
Pitching to Sequoia Capital in Pyjamas
Sequoia Capital is one of the most famous and successful VC firms in the world. Having caught wind about the growth of Facebook, they reached out to Mark and invited him to pitch them for investment.
Now most entrepreneurs would be flattered at this opportunity, given the reputation of Sequoia and their large cheque sizes. But, Mark wasn’t. He accepted their offer to pitch, but:
- He intentionally showed up late
- He wore his pyjamas
- He presented a PPT deck titled:
“The Top Ten Reasons You Should Not Invest”
Sequoia didn’t know, but Mark had formed a new friendship with Sean Parker (the co-founder of Napster and one of the earliest employees at Facebook). Sequoia had invested in one of Parker’s previous startups, and the board had fired him on allegations that he wasn’t showing up to work, and rumours that he had provided drugs to some of his employees.
It’s an understatement to say that there was bad blood between Sean and Sequoia Capital as a result.
If you are interested in startup founders who were fired by their venture capital investors, this blog is worth a read: https://findvc.co.uk/master-blog-how-to-pick-the-right-venture-capital-investor/
In addition to deterring Mark from taking Sequoia’s capital, Sean was instrumental in helping Mark retain control of Facebook. Sean himself had been caught on the wrong side of control disputes at two of his own startups. He had seen first-hand how easily a founder becomes diluted in their own company as they raise additional capital in the future.
The median ownership of a Unicorn founder when their company IPOs is 15%. This makes them a minority shareholder and if the company only has common stock, then their votes could be overruled by the other shareholders.
Sean and Peter Thiel engineered a dual share class structure at Facebook. This required the creation of a new share class that only had voting rights. It had no economic value, but they allowed Mark to retain control of Facebook without being the majority shareholder.
Normal shares had one vote each. But these new voting shares had 10 votes each. As long as Mark retains enough of these voting shares he will always have the final say at Facebook.
In 2021, Mark owned 360 million of the 440 million voting shares (Class B stock). When Facebook went public, he owned 28% or ordinary stock (this has come down to 13% as of 2022, as he has sold shares to fund his philanthropic organisation). Here is a good illustration of the dual-class share structure:
Facebook’s Series A
Facebook’s Series A took place in 2005. By this time Zuckerberg had a lot more promising user data to show potential investors. Facebook was now generating revenue, and had grown to an annual run rate of $6 million. But more than this, the company was growing exponentially and every VC in the valley wanted to get in on the deal.
Accel Partners ended up leading the round giving Facebook a valuation of $100 million and investing $12.7 million of capital.
However, Facebook was far from a sure bet at this point in time as both MySpace and Freindster were still much larger social media sites. Here’s a quote from the VC at Accel who pushed for the fund to invest into Facebook:
“There were still a lot of questions at that point, once people graduate from universities will they still use Facebook? I remember a VC coming in and telling me the valuation Accel paid is crazy.”
Peter Thiel has since said that the key differentiation he saw at Facebook was that it was “the first social network that mattered.” He knew the rivals were bigger and had more funding, but he could see the user data at Facebook and given his experience of exponential growth at PayPal, he could see a future where Facebook overtook all of its rivals to become the dominant social networking site.
Mark was a talented negotiator and some of the reasons as to why he was able to get such a high valuation from Accel come down to the deal terms Accel were able to invest at. Here is an extract from Facebook’s original S-1 that shows the liquidation preferences of their venture capital investors:
The deal terms of this funding round were fairly aggressive. They included a liquidation preference, anti-dilution rights, and a board seat for Accel. According to reports, Zuckerberg was initially resistant to the terms but ultimately agreed to them.
Again this was probably a result of Mark optimising for minimum equity dilution. He was willing to give his investors some extra rights in order to get the highest valuation for Facebook that he could at every stage of fundraising.
This tactic, coupled with the excitement investors had for Facebook, enabled Mark to retain double the average equity in Facebook that most unicorn founders today have at IPO.
Two Lessons learned from Facebook’s early fundraising rounds
A) The value of a high-profile investor who gives a startup credibility.
Thiel was already a well-known entrepreneur and investor in Silicon Valley. His decision to invest in Facebook gave the company instant credibility. Much like the credibility Uber got once Bill Gurley (a famous Silicon Valley VC investor) decided to invest.
Beyond just credibility, Thiel gave Zuckerberg access to his network of world-class coders and entrepreneurs, which proved invaluable as Facebook continued to grow.
B) The importance of building relationships with investors.
Zuckerberg was very selective about who he allowed to invest in his company, choosing people who shared his vision and were willing to take a risk on a young entrepreneur. He knew he was very young to be a CEO, but a non-negotiable for Mark was the ability to retain control of his company.
He wanted investors that believed in him and would allow him to retain this control. Ultimately this confidence in his ability to grow Facebook led to Mark retaining 56% of the voting rights at Facebook when it went public, despite only owning 22% of the common equity.
Facebook Returns to early investors
When Facebook went public in 2012, the shares were priced at $38 each, this meant that:
- Peter Thiel made over $1 billion from his initial investment in the company
- Accel Partners made over $10 billion from their investment.
IV. Conclusion
Facebook’s early fundraising rounds played a critical role in its journey to becoming one of the biggest companies in the world. The angel cheque made by Peter Thiel and the Series A funding round led by Accel provided enough capital to help Facebook capitalise on its growth potential.
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