Share dilution

by jamotide

If a company issues new shares, the total number of shares increases and the value of each share drops accordingly.
So why do only Eduardos shares get diluted? And even if that is somehow possible... How did issuing 20m new shares dilute his 1.2m shares from 34% to 0.04%?
Did they make this part up? Why does nobody else notice this?

What finally sent the relationship between Eduardo and Mark down the tubes was Facebook's need for funding.

As that first summer went on and TheFacebook.com grew more popular than anyone imagined, the company needed money to keep running. Finding investors wasn't hard. As early as July, Silicon Valley bigwigs like Mark Pincus, Reid Hoffman, and Peter Thiel were lining up to give Mark cash. Things were going so well, in fact, that Mark soon decided to commit to the company and not return to Harvard for his junior year.

What was hard, however, was getting Facebook co-founder Eduardo Saverin's attention, getting him to make a decision, and getting him to sign off on the reformation of Facebook as a company under Delaware law – a crucial step before any funding deals could be completed.

At one point, Mark emailed Eduardo to offer him frequent flyer miles if it would get him out to Palo Alto. Eduardo didn't take the offer. The situation soon became critical, because without financing, TheFacebook.com would end up running on Zuckerberg family loans.

Eventually, Mark decided to solve the problem by cutting Eduardo out of the company.

In an IM with Dustin Moskovitz, Mark explained why:

I maintain that he *beep* himself…He was supposed to set up the company, get funding, and make a business model. He failed at all three…Now that I'm not going back to Harvard I don't need to worry about getting beaten by Brazilian thugs.
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"I'm just going to cut him out."
"I'm just going to cut him out."

When Mark Zuckerberg and Dustin Moskovitz moved out to Palo Alto in June 2004, they ran into Sean Parker, an Internet startup kid best known for cofounding Napster. Sean soon joined TheFacebook.com.

Sean's first task was to do one of things Eduardo was supposed to do, but hadn't yet: help Facebook find money. Sean had raised money for Napster and he knew his way around Silicon Valley. He quickly proved himself capable. For Mark, this only reinforced the idea that Eduardo was expendable.

The only problem was: How would Mark cut Facebook's third-biggest stakeholder and co-founder out of the company?

In an IM exchange with Sean after a meeting with Peter Thiel, who would soon become Facebook's first outside investor, Mark and Sean discussed the Eduardo problem. Mark hinted at a hardball solution, one based on some "dirty tricks" used by Peter Thiel. Thiel had learned these tricks, Sean said, from one of the most legendary venture capitalists in the Valley, Michael Moritz of Sequoia. Sequoia has funded Google, Yahoo, PayPal, Zappos, and many other massive tech companies.

Parker: Peter [Thiel] tried some dirty tricks. All that *beep* he does is like classic Moritz *beep*

Zuckerberg: Haha really?

Parker: Only Moritz does it way better.

Zuckerberg: That's weak.

Parker: I bet he learned that from Mike.

Zuckerberg: Well, now I learned it from him and I'll do it to Eduardo.

In later emails and IMs, we learn what "dirty tricks" Mark intended to pull to get TheFacebook.com funding without having to wait for sign-off from Eduardo.

His plan: Reduce Eduardo's stake in TheFacebook.com by creating a new company, a Delaware corporation, to acquire the old company (the Florida LLC formed in April), and then distribute new shares in the new company to everybody but Eduardo. Mark discussed this plan with confidants over IM several times.

Here's one instance:

Confidant: How are you going to get around Eduardo?

Zuckerberg: I'm going to buy the LLC

Zuckerberg: And then give him less shares in the company that bought it

Confidant: I'm not sure it's worth a potential lawsuit just to redistribute shares. You have nothing to gain.

Zuckerberg: No I do because until I do this I need to run everything by Eduardo. After this I have control

In another, Mark writes:

"Eduardo is refusing to co-operate at all…We basically now need to sign over our intellectual property to a new company and just take the lawsuit…I'm just going to cut him out and then settle with him. And he'll get something I'm sure, but he deserves something…He has to sign stuff for investments and he's lagging and I can't take the lag."
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The plan goes into effect
The plan goes into effect

In the middle of that summer, Mark went forward with his plan:

On July 29, 2004, the new company, TheFacebook.com was incorporated in Delaware. Then it acquired the old company, formed back in April as an LLC in Florida.

On September 27, 2004, Peter Thiel formally acquired 9% of the new company with a convertible note worth $500,000. Before the transaction, Facebook ownership was divided between Zuckerberg, with 65%, Saverin, with 30%, and Moskovitz, with 5%. After the transaction, the new company was divided between Zuckerberg, with 40%, Saverin, with 24%, Moskovitz, with 16%, and Thiel with 9%. The rest, about 20%, went to an options pool for future employees. From there, a good chunk of equity went to Eduardo's replacement, TheFacebook.com's new COO, Sean Parker.

On October 31, 2004, Eduardo signed a shareholder agreement that alloted him 3 million shares of common stock in the new company. In the agreement, he handed over all relevant intellectual property and turned over his voting rights to Mark Zuckerberg. Mark became Facebook's sole director.

On January 7, 2005, Mark caused Facebook to issue 9 million shares of common stock in the new company. He took 3.3. million shares for himself and gave 2 million to Sean Parker and 2 million to Dustin Moskovitz. This share issuance instantly diluted Eduardo's stake in the company from ~24% to below 10%.

Mark's plan had succeeded. Eduardo was, for all intents and purposes, gone.

http://gawker.com/5643915/mark-zuckerberg-describes-the-dirty-tricks-that-led-to-the-facebook-movie