The Ultimate Guide to Facebook's IPO

The elaborate dance with regulators and investors has begun

Facebook executives have fallen silent. Having filed paperwork on Feb. 1 with the Securities and Exchange Commission to raise $5 billion in an initial public offering, the social network site is now in a “quiet period” where federal rules limit what company executives can say in public.

Behind the scenes, it’s a different story. The Menlo Park (Calif.)-based company is just beginning a months-long slog that involves appeasing regulators, wooing investors, and dealing with endless amounts of paperwork. While it will follow a familiar pattern, this is no routine deal, what with the epic media attention (and possible $100 billion market valuation) a Facebook offering will attract. “When you’re doing one of these offerings that’s high-profile, you know that you’re under a microscope,” says Martin Wellington, a partner at Davis Polk & Wardwell who worked on the Pandora IPO. “In addition to SEC scrutiny, you expect there will be a high degree of interest from the press, the blogosphere, and the investment community. Everyone working on the deal is going to be particularly careful.”

Here’s a look at what probably lies ahead for Facebook, based on interviews with regulators and people involved in previous Silicon Valley IPOs. Spokesmen for Facebook and Morgan Stanley, Facebook’s lead banker, declined to comment.

When Facebook’s S-1 filing landed in the SEC’s computers, it made its way to the Division of Corporation Finance and the desks of a lawyer and an accountant who specialize in the industry. These staffers will go through the document page by page, noting anything that might mislead potential investors, need more supporting evidence, or warrant further explanation. They bring their recommendations to a more senior lawyer and accountant who complete the SEC’s first “comment letter,” which typically lays out 50 to 100 queries that the company must address. An agency spokesman declined to discuss the Facebook IPO.

The SEC may challenge various aspects of the filing. It asked LinkedIn how it could back up its claim to be “the world’s largest professional network on the Internet.” It queried Zillow on how the real estate website ensures it’s not double-counting users who access it both online and on mobile apps. It told Zynga that a graphic at the beginning of its filing, which showed the number of users, “should not be used to present only the most favorable aspects of its business” and asked why it hadn’t mentioned more prominently that “the vast majority” of users play its games for free.

Questions about how companies track and count their users have come up in several recent Internet IPOs. The issue could arise with Facebook, which boasts 845 million “active monthly users,” though that number includes people who don’t visit Facebook’s main site and instead interact with the social network through partner sites.

The regulators also scrutinize corporate governance and accounting policies. Groupon diverged from standard accounting methods and didn’t include the costs of online marketing when calculating its operating income. Eventually the SEC forced it to restate its financials. “Don’t mess with the SEC” is the lesson Seth Priebatsch, chief executive officer of SCVNGR, a Groupon competitor, told Bloomberg Businessweek at the time.

The agency told buyout firm Carlyle Group that it wouldn’t approve its IPO unless the private equity firm abandoned provisions that banned shareholders from filing class actions. On Feb. 3, Carlyle capitulated. One issue that may come up in the Facebook review is the power that founder and CEO Mark Zuckerberg, 27, will have once the company is public—a question that’s already been raised by the second-largest U.S. pension fund, California State Teachers’ Retirement System. Zuckerberg will control 56.9 percent of voting rights at the social network under the terms of the current filing.

Once the SEC completes its comment letter—usually within 30 days of the filing—it will e-mail it to Zuckerberg with a copy going to Gordon Davidson, an attorney at Fenwick & West who is Facebook’s lead outside counsel. “Within minutes it’s in the hands of anyone who has involvement with the transaction,” says Lise Buyer, a consultant who worked with Google on its IPO.

At Facebook, Chief Financial Officer David Ebersman, 42, who joined the company from Genentech in 2009, is in charge of getting the deal done, according to a banker involved with the deal. He’s managing a team that includes Morgan Stanley bankers, accountants from Ernst & Young, and Facebook’s and Morgan Stanley’s lawyers.

Many IPO teams set up shop at the offices of a financial printer such as Donnelly. Financial printers do much more than prepare deal documents. They now offer full-fledged meeting spaces with 24-hour staff, catering services, and rooms to take a catnap. Sitting around the table, laptops open, the team writes a response to the comment letter, question by question. “Imagine there might be 20, 25 people in the conference room, and you might spend the better part of a week there,” says Brian Erb, a lawyer at Ropes & Gray who represented the banks involved in Zynga’s IPO. He says people barely leave the conference room and often eat all their meals there: “It tends to be a little dicey after a while.”

Companies may push back on some SEC requests, hoping to shield confidential information. Executives can pick up the phone to call the agency’s examiners or take their concerns to a more senior official if need be, says Alan Mendelson, a partner at Latham & Watkins who has worked on IPOs in Silicon Valley. “You can resolve most of the issues, typically,” he says. Still, the SEC has the final word, so a company “might have to cave and put something in the document that you prefer not to,” he says. Companies and the SEC can go back and forth six or seven times over two to four months. Over time, the number and complexity of the comments shrink—a signal that the agency is getting closer to approving the offering.

While Facebook and its banks conduct their dialogue with the SEC, they will also start creating a slideshow and marketing materials for the roadshow, where Facebook execs, almost certainly including Zuckerberg, Ebersman, and Chief Operating Officer Sheryl Sandberg, 42, will play the role of traveling salesmen, hopscotching across the country to meet with major investors and entice them to buy the stock. Executives generally practice their presentations to refine the pitch. Bankers—and sometimes outside consultants—pepper management with challenging questions that might be asked by prospective investors. Even a hot company like Facebook has to have a persuasive story line. “Facebook doesn’t have to work as hard to convince people that there’s a use for their product,” says Buyer. “I would assume the bulk of their presentation will be to convince investors that the growth is not in the rearview mirror but rather out in front.”

Roadshows typically kick off at the lead bank’s offices, where the company’s CEO revs up the bank’s sales force. That’s followed by a series of hour-long, one-on-one meetings with institutional investors such as mutual funds, hedge funds, and pension funds. There may also be group lunches for smaller investors—which can be a buffet for 20 at an airport hotel or something grander: Google invited 800 people to dine at the Waldorf Astoria in Manhattan.

Jive Software CEO Tony Zingale and CFO Bryan Leblanc met with more than 100 investor groups in 10 cities during the two-week stretch leading up to their company’s IPO on Dec. 12. “We started at 6 in the morning and went until 6 at night, and then we went on an airplane somewhere,” says Zingale. “It’s repetitive and grueling, but you better be on your toes and energetic in every one of those meetings.”

Once the roadshow starts, all the banks participating in the offering open their order books so clients can tell them how much stock they want to buy and at what price. In the case of Facebook, where demand is expected to far outstrip supply, the problem for the banks won’t be finding enough customers but allocating shares in a way that will keep their best, revenue-generating clients happy. “There will be a lot of people jockeying to get allocations,” says David Weild, senior adviser at accounting firm Grant Thornton, adding that bankers are already trying to manage expectations to limit investors’ disappointment.

Immediately after the final roadshow session ends, bankers and company executives sit down to set a price for the stock, which starts trading the next day. There’s an art to the pricing. Along with raising money, says Zingale, companies want investors who won’t flip the stock. “And you’d love to have the stock trade up on the first day or days” and then stay at that level, he says. “Those are the headlines that you’re seeking.” The financial printer drops the pricing into the final revised prospectus and uploads the documents to the SEC.

That same night the company signs underwriting agreements with its banks that it has been negotiating over the previous months. The banks buy the stock before turning around and selling it to clients. To minimize the risk of getting stuck with unsold shares, they may ask for escape clauses. To protect against investor lawsuits, they often want the contracts to include assurances that the company’s accounting is truthful. In the past, banks would be paid 7 percent of the amount raised; these days 5 percent is typical. Because the Facebook deal is so large, bankers will collect fees of as little as 1 percent to 1.5 percent, or a total of about $50 million to $75 million, say two people with knowledge of the matter who declined to be named because the information is private.

The next morning, if he follows the footsteps of Zynga’s Mark Pincus and Groupon’s Andrew Mason, Zuckerberg will ring the opening bell on the New York Stock Exchange or Nasdaq (the company still hasn’t decided where the stock will trade) to celebrate Facebook’s debut. After weeks on the road, Zuckerberg and his team will likely head back to Silicon Valley and get back to running the business—now on behalf of their new public owners.

— With assistance by Brian Womack, Ari Levy, and Serena Saitto


    The bottom line: The path to Facebook’s $5 billion offering involves months of negotiations with the SEC and presentations to investors.

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