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Summary:

Facebook founder Mark Zuckerberg’s reported pledge to donate $100 million in stock to Newark schools has sparked a heated debate over the valuation of the company, which has been estimated at $33 billion. Some argue this is absurd, but the truth is not quite that simple.

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Facebook CEO Mark Zuckerberg

Facebook founder and CEO Mark Zuckerberg’s reported pledge to donate $100 million in stock to Newark, N.J. schools has sparked a heated debate over the valuation of the company, which has been estimated at $33 billion based on private share transactions. Forbes magazine added fuel to the fire with its annual ranking of the world’s richest people, which puts Zuckerberg at number 35 with an estimated net worth of almost $7 billion, based on what Forbes says is Facebook’s overall value of $23 billion. Zuckerberg’s ranking puts him just ahead of Apple founder and CEO Steve Jobs.

So is Facebook really worth $23 billion, or $33 billion? The short answer is that it depends on what you mean by the term “worth.” David Heinemeier Hansson, co-founder of software developer 37signals, argues in a blog post that it’s absurd to say that the social network is worth that kind of money in any real sense, because it isn’t publicly traded the way that stocks such as Google are, so there’s no easy way to determine its actual value as a company. He also argues that the company’s worth is vastly inflated based on the revenue people estimate that it’s pulling in.

So the Facebook valuation based on minority investments is in my mind a complete joke in the sense that there was $33,000,000,000 dollars on the table. Irrational investor exuberance indeed.

In a heated response at Y Combinator’s Hacker News site, however, software entrepreneur Joel Spolsky takes issue with Hansson’s argument. There is a very active market for shares of Facebook, he notes, through services such as SecondMarket, which specialize in trading the restricted stock of private companies such as Facebook and Zynga (which is reportedly worth as much as $5 billion based on the activity in that market). So Facebook is worth $33 billion in the same sense that Google is worth $165 billion, Spolsky argues (there’s also a lot of back-and-forth in the YCombinator comments about the relative merits of Chicago — where 37signals is based — vs. Spolsky’s home of New York, but we’re leaving that part out).

The whole section “Minority investment evaluations aren’t real” is 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 5′ tall boy as 5′ tall because he’s often sitting down.

Hansson counters that the private market is not as liquid (meaning there isn’t as much activity as the public markets) or as transparent to outside observers. And what about the sale of stock to companies like Microsoft — which bought 2 percent of Facebook for $240 million in 2007 — or Russian venture fund Digital Sky Technologies, which also bought a stake last year? Elevation Partners invested $120 million in June, the deal that implied a valuation of $23 billion (just to complicate things further, Elevation bought its stake through private share trades on secondary markets). Hansson says these don’t count because they involve such a small portion of Facebook’s outstanding stock.

But Spolsky is right that this criticism doesn’t really apply; only a small amount of Google’s stock is freely tradable on public markets as well (since insiders control an estimated 30 percent and institutional holders have another large chunk locked up) and yet we’re quite comfortable saying that the web giant is “worth” $165 billion. Hansson is also on thin ice when he argues that bond markets are more transparent than the market for private stock: In fact, the bond market is still incredibly opaque to anyone but a registered bond trader. Until recently, current bond prices weren’t even posted and updated regularly the way stock prices are.

In reality, of course, every economist knows that things are only worth what people will pay for them, and since no one has actually paid $33 billion for Facebook, we shouldn’t really say that it is worth that much, or that Zuckerberg is worth $6.9 billion. But then, no one has paid $165 billion for Google either. The fact is that market valuations — whether private or public — are really just a convenient method of tracking what some people are currently willing to pay for a small chunk of the company. It may not be totally realistic (in fact, an acquirer would likely have to pay much more than just its $165-billion market cap in order to buy Google), but it is the way things are done, and by that rationale, Facebook has just as much claim to its “worth” as Google does.

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Post and thumbnail photos courtesy of Flickr users John Adams and Ryan McFarland

  1. Good points, Mathew.
    The one thing that I’d add is that with a private company with little float and a high perceived demand for shares there can be a scarcity premium.
    Is Google worth $165B? Yes, IMO, because there are an abundance of investors in the open market who have invested at that value.
    Is 1% of Facebook worth $330M? Apparently yes, because there have been enough private investors who have bought shares on the secondary market at that price. But, there’s no evidence that they would be able to sell 25% or 50% of the company at that valuation.
    What are the reasons people have invested in Facebook either directly or in secondary markets? For companies like Microsoft, it could be strategic, where the relationship is worth more than the shares themselves. For Digital Sky it could be legitimacy. For others it may be ego – being able to own shares in the hot company carries some cache.
    That doesn’t suggest that Facebook isn’t worth $33B, but I think there is a definite premium being paid due to the scarcity of shares available.

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    1. Yes, that’s a very good point, Barry — scarcity tends to drive up market value. Of course, Google’s shares are relatively scarce as well, as I tried to point out in the post.

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  2. Wow. A post on theoretical arguments about a hypothetical scenario, spoken in the future tense, if Facebook is worth __X___ billion or __Y__ as it would be written on a non-existent term sheet.

    Good grief. Up next? GigaOM brings you breaking news that the 1040 form has had an edit to its printed instructions on page two, paragraph five.

    :/

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    1. Thanks for the comment, Todd — but we write about theoretical things all the time. It’s part of our job to look at what might be coming, not just what is here already.

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  3. The problem is Zuckerberg has started using his future value to try to repair his image through philanthropy. I sure hope he’s confident that bet will payoff because when you pledge money to schools and then fail to meet expected contributions, you become a villain; not a hero.

    Anyone reading this article, should read the last paragraph of David’s post…
    “Now this was all fun and games until somebody promised the Newark schools $100 million in stock based on the fantasy valuation of his under-profiting company. But now it’s real. They’re selling the skin before they shot the bear or peeing their pants to get to the hut or whatever you want to call it. It’s just not good, alright?”

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  4. Right Matthew, the more important question here, and the impetus for DHH’s original post, is does Zuckerberg even have $100 million to pledge to Newark schools?

    We can all be pretty sure he doesn’t have $100m in liquid cash to spare, so Zuckerberg is pledging non-liquid value which could easily disappear before it could ever be liquefied…thus DHH’s “monopoly money” comment. Its irresponsible to promise liquid money to a public school system when you can’t really guarantee that money will ever be available for them to use. You can’t buy computers or schoolbooks with shares of Facebook stock.

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    1. That’s a fair point, Marc — the reality is that billionaires of all kinds do that all the time. As far as I know, Bill Gates and others routinely pledge stock rather than cash, and charities are pleased to accept it. I agree that Facebook’s pledge is somewhat more of a gamble though.

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  5. I don’t believe you took the middle road or even lean towards saying Sharespost and others are valid markets. Would you invest your 401K into it? Your nestegg? Seriously. I would hardly call secondary markets for startup shares a valid market or even try to compare it to public stock marets with millions more data, infrastructure, researchers and participants. Come on!

    So you would agree with the valuation of Slide or Ning a few years ago? Maybe. Would you now? No. Valuation of private companies is not a science but an art. That’s startup 101 stuff.

    You should really analyze how valuations were created for various startup companies and then explain how any startup’s valuation is justified as much as Google, Cisco, Apple, etc. It’s a frenzy that valued Slide at $500 million not some analysis based on revenue, cashflow or industry comps.

    “Hmm, you guys are pretty hot, so I’ll agree with that $100 valuation…”

    “5 engineers from Google and 10 signed deals with Fortune 100 companies… (and 3 competing term sheets) okay, $50 million pre-money for your Series B sounds fair.”

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    1. Thanks, Bernard — also a fair point. But the simplest definition of value (as I mentioned) is whatever someone is willing to pay for something. Extrapolating from what someone pays for a small chunk is done all the time, on public and private markets. You may not like it, but it happens.

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  6. [...] We TrustForbesForbes: Zuck Already Richer Than JobsMediapost.comGossip Jackal -CNET -WebWorkerDailyall 160 news [...]

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  7. Do you realize that when you compare Google with Facebook you are comparing a company that has its books available for anyone to see v/s a company whose books are completely closed to public (A black box). (They are not bound by ANY law to provide an accurate accounting of their books)
    Facebook’s numbers will be ENRON numbers until they are available for scrutiny to outsiders. Until then comparisons with other publicly traded companies is non-sensicle.

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  8. Sorry Matthew, I have to disagree with you when you suggest Facebook and Google have both as much to claim for their worth. The key question is: Does Facebook make enough money to justify their valuation? Or will it? Well, I guess so (like Eddie Murphy’s stupid nerdy character said in Bowfinger)… I guess so… you see? I can only guess because this is not as sure and transparent as the profits Google is cashing in from AdSense and AdWords. This is where David Hansson has a point. Now to Spolsky who said about Hansson criticism that “It’s like you wrote a blog post arguing that it is incorrect to refer to a 5′ tall boy as 5′ tall because he’s often sitting down.” I think he should understand that what people are expecting a baby to be 5′ one day based on the fact he’s so cuuuuuuuuute, the all world is falling for him.

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    1. Thanks, AK. It’s true that Google’s current profits and revenue are more public, and therefore investors have more to go on — but they are still making projections about the future, since Google’s stock trades at relatively large multiples based on expectations for future profits. Facebook’s numbers are somewhat more opaque, but not much.

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  9. The bottom line is that no money can be made on perceived worth until it is sold. Unless somebody would happily purchase Facebook for $33bn, it simply isn’t worth it. Surely that’s just ‘case closed’?

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  10. I have a very hard time believing that he would offer to donate that much money on the highest ranked talk show in the nation (if not world) if he really did not have it. I just think that its sad and appauling in this world, that a young man that got rich off of the same tactics and backdoor deals as our government does, is being condemned for such generosity. I think every American should learn from the man.

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