June 8 (Bloomberg) -- Zynga Inc. plans to sell a small number of shares in its initial public offering, adopting a strategy used by LinkedIn Corp. to maintain control of the company while raising money to expand, according to a person with direct knowledge of the matter.
Zynga may make less than 10 percent of its shares available to the public in its IPO, said the person, who declined to be named because the plans are private. That compares with a 24 percent average among U.S. technology IPOs in the past year, according to Bloomberg data.
By selling little stock in the IPO, companies protect the value of existing investors’ stakes. A jump in the stock price would let them raise cash at a higher value months later. LinkedIn is up 73 percent since its IPO, and Zynga Chief Executive Officer Mark Pincus is likely betting on a similar rise, yet there’s no guarantee the stocks will stay high, said David Menlow, president of IPOfinancial.com, a research firm.
“Companies in this space realize there’s a feeding frenzy afoot,” said Menlow, whose firm is based in Millburn, New Jersey. “The risk is that as a CEO you believe you are better than you actually are. The reality may be something very different.”
Zynga and LinkedIn have another connection: LinkedIn Chairman and co-founder Reid Hoffman is also on the board of Zynga and was an early investor.
Zynga, the top developer of games for Facebook Inc.’s site, has yet to submit an IPO filing, and its plans may change. The San Francisco company is in talks to have Goldman Sachs Group Inc. lead the stock sale by the end of the month, a person familiar with the matter said last week. Dani Dudeck, a Zynga spokeswoman, declined to comment on the IPO or the number of shares that will be sold.
LinkedIn, the largest professional-networking site, held its IPO on May 18, becoming the first social-media company to go public. Other Internet companies are now preparing to follow, with online-radio service Pandora Media Inc. expected to start trading next week. LinkedIn sold 8.3 percent of its stock in the offering, while Pandora is selling 8.6 percent.
Groupon Inc., the leading online provider of daily deals, filed for its IPO last week. In a memo to employees, Groupon CEO Andrew Mason said the Chicago-based business would “make a small piece of our company available.”
The approach, known as a low-float IPO, also was used by OpenTable Inc. in its 2009 offering. The restaurant-reservation service sold about 15 percent of its shares initially. After a 40 percent price jump, it offered more than twice that number four months later. The stock is now up more than fourfold since the IPO, bolstering gains for early investors and employees.
The strategy was more about preventing the value of shares from getting watered down, said Bill Gurley, a board member at San Francisco-based OpenTable.
“The goal wasn’t low float, it was low dilution,” said Gurley, who also serves as a partner at Benchmark Capital in Menlo Park, California, an OpenTable backer. “They just come in the same package.”
Companies using this tactic often see their stocks rise, in part because of the small supply of available shares. That helps them build excitement around their brands, said Lise Buyer, founder of IPO advisory firm Class V Group. Often, the companies will use the initial sale to gauge market demand for a bigger offering later, she said.
Zynga makes its money from selling virtual items within games -- for instance, a townhouse in “CityVille.” The worldwide virtual-goods market is expected to more than double to $20.3 billion in 2014, from $9.28 billion last year, according to ThinkEquity LLC, a San Francisco-based research firm. Still, Zynga will be the first of its kind on the U.S. public markets.
“If you’re in a new business model that nobody understands, this is a way to test the market,” said Buyer, who helped run Google Inc.’s IPO in 2004. “No one knows how to value these companies, so why not put a little bit out there and then do a bigger one later once you’ve seen what the market will pay?”
It doesn’t always work. MakeMyTrip Ltd., an online travel site based in India, sold 5 million shares, or 15 percent of the company, in August. The stock rose 89 percent on the first day of trading. In March, it filed to sell an additional 6 million shares, only to reduce it to 5.24 million last month due to lack of demand. The shares then fell 5.6 percent.
For Zynga’s Pincus, selling less of the company may be more about maintaining control than boosting the stock price. Even after raising hundreds of millions of dollars in private capital, Pincus still owns about 30 percent of the company he founded in 2007, according to a person familiar with the matter. He’s talked openly about it in the past.
“I would fight to the end for control because if you don’t have control of your company then you are an employee,” Pincus said in 2009 to students at a Stanford University forum. “If you’re going to give up control, go home.”
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