Five risks Facebook faces ahead of its IPO

The timing of Facebook’s initial public offering has been the subject of intense speculation for a few years.

Spectators were disappointed in 2011, but this year seems unlikely to disappoint. Tech blogger Kara Swisher, of AllThingsD, reports that the big day is likely to come in the third week of May.

Given the fact that Facebook will have to start reporting to the SEC in April, the timing makes sense.There’s more to the Facebook IPO guessing game than timing. Many are openly wondering about every choice the social media giant will make, from the investment banks it will appoint for the deal, to how the company’s stock will actually be sold. Of course, there are governance considerations, as well.

Since the internet sector generally fell short in this regard in 2011, it’s safe to assume that Facebook’s attention to governance issues will be watched closely.

Before giving in to the hype of a Facebook liquidity event, take a look at the top five challenges the company faces:

1. The IPO itself: though difficult to predict at this point, it seems as though Facebook is headed for a traditional IPO, despite having been pitched on a variety of exotic alternatives, including a Dutch auction. For Facebook, a traditional IPO appears to carry the lowest risk – which is significant because the company’s valuation has some institutional investors wondering about its financials.

2. The early shareholders: Facebook is among the new wave of tech companies with a dual-class share structure that favors founders and early employees. Facebook converted to this structure in 2009, with Class B shares carrying 10 times the voting rights of the Class A shares issued after 2009. Ostensibly, the purpose of the Class B shares is to allow the early employees to execute their strategy without external disruption, but the net effect is the relative weakening of later shareholders.

3. The earliest shareholder: there is one person at the helm of Facebook: Mark Zuckerberg. The founder has reportedly retained 24 percent of the company’s voting rights, with venture capital firm Accel Partners next at 10 percent. Despite the fact that Zuckerberg is said to focus more on the product than on running the business, his ability to set Facebook’s direction is salient. With this level of control, it will be difficult for other shareholders to have a voice.

4. The future: Facebook doesn’t have a strong track record as a deal-maker. Its most recent acquisition, location-based service Gowalla, was small and completed only with Facebook stock. Unlike the other behemoths of Silicon Valley – such as Google and Apple – it hasn’t had to complete complex acquisitions and integrate large operations into its own. To compete effectively in the future, Facebook will probably have to turn to acquisitions for new products, rather than stick to its traditional approach of internal development. Doubtless, there will be some growing pains along the way.

5. That big valuation: one of the greatest risks Facebook faces heading into its IPO is the $100 billion valuation it must live up to. The company fell short of a third-party forecast of $4 billion in revenue for 2011. Even at $4 billion in revenue, however, a $100 billion valuation at IPO is tough to justify, and that includes the assumption that Facebook will have to ‘grow into’ its valuation over time.

Obviously, the market has much to learn about the intricacies of Facebook, the risks it faces and the governance structure it will have in place for its IPO. Many of these questions will be answered by Facebook’s S-1 filings. At this point, we’re left to wonder: will Facebook break with recent tradition and favor its shareholders? Or, will we see Zynga and Groupon redux?


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