ASSIGNMENT 2- FACEBOOK

1) Facebook is a global, online social-networking company. However, Facebook is a private company

and is therefore not listed on the stock exchange. How then, does Facebook earn money? With more
than 500 million active users worldwide, the Facebook page is attractive to businesses wishing to
advertise and promote their products. With advertisements appearing on the sidebar of the page,
Facebook is able to raise funds which ultimately finance their operations. In fact, revenue from
advertising is expected to double to $4.05 billion this year. (businessweek, 2011)
Facebook is also financed through what is known as a private offering. This involves the sale of large
parcels of securities to one or more investors. As of this year, Facebook has struck a private deal
with Goldman Sachs and a Russian investor in which they have sold them a $450 million and $50
million stake, respectively, in Facebook. (businessweek, 2011) On top of this, Goldman Sachs clients
are able to buy into an additional $1.5 billion. While this seem a lot of money, it is clear that
Facebook can earn more money through a public offering (IPO). So why does Facebook persist with
remaining private for the time being, and why may it decide to become public in the near future?
An IPO can be considered as the initial sales of shares in a company that is seeking listing on the
stock exchange (Hunt & Terry, 2008). There are major benefits in becoming a public company, no
more so than receiving access to substantial amounts of equity capital. However, a trade off must
occur, as when investors purchase stock in a company- in this case Facebook- they provide money to
the company in exchange for part ownership of that company. It is this very reason why founder
Mark Zuckerberg is reluctant to go public, as his personal percentage of ownership will fall. This
reduction in ownership as new investors come in is known as dilution. Furthermore, a public
company must be held accountable to all shareholders, and therefore make decisions in their
interests. As a private company however, Zuckerberg could make executive decisions on strategies
based on what he alone thinks is best. Private companies also have the right to disclose any financial

information from the general public, whereas a public company must reveal all information to the
public. Another major advantage of going public is the creation of liquidity, so that owners are able
to sell a proportion of their interest in the company. Summing up, if Facebook were to go public they
would receive access to unprecedented equity capital, but would have to give up its degree of
ownership as a result.

2a) Facebook would consider issuing equity rather than debt for the following reasons:

Equity is less risky than debt. Companies have an obligation to pay back debt regardless of
their financial performance. Debt is paid before equity. Therefore, Facebook would be under
no obligation to pay equity if the company no longer made profits.

Start up costs of debt finance can be high.

In debt, owners face risk as they must pledge assets of the company to the lender as
collateral. Equity financing doesnt involve such risks.

Debt often involves restrictions on company activities, where the company is restricted in
pursuing alternative financing options.

b) Capital structure (ratio of debt to equity) is a way of measuring by how much a company is
financed by debt. A high ratio indicates a high amount of debt. Facebooks total equity is
approximately $2 billion (businessweek, 2011), while its total debt can be estimated to be $1 billion.
The debt to equity ratio is therefore $1 billion divided by $2 billion and comes to 0.5, indicating
Facebook relies more on equity than debt to raise funds. Other companies such as Microsoft have a
debt to equity ratio of 0.14 (Business Accounting Guides, 2011), while Yahoo has a debt to equity
ratio of 0.01 (Forbes, 2011). This indicates in comparison to other technology companies, Facebook
has a higher reliance on debt rather than equity, which would be expected due to Facebook
remaining private.

3a) Facebooks main source of revenue is through advertising. Facebook has a substantial market
share, and currently consists of more than 500 million users. Therefore, a small advertisement
appearing on the side-tab of the Facebook page would be exposed to millions, and is therefore very
valuable to companies. Facebook is expected to receive $4.05 billion from advertising this year
(businessweek, 2011). This advertising comes in the form of brand advertising and performance
based advertising. Facebook also generates revenue through customers purchasing credits for
Facebook applications.
As Facebook continues to expand around the world, so must its infrastructure. Infrastructure,
whether it be data analysis centres, or just offices around the world, needs to be built so that the
company is able to keep up with its increasing popularity. A large amount of money needs to go into
market research and analysing the competition, before implementing effective changes and
innovations itself.
b) It is expected that Facebooks revenues and profits will continue to drastically grow,
exponentially, over the next five years. InsideFacebook predicts that Facebook will take hold of the
market share for online advertising, and will single handedly lift online advertising revenue well into
the billions over the next five or so years. Given that Facebook is expected to earn $4billion in
revenue this year, and that its revenue has more or less doubled over the past five years, this trend
is likely to continue. It is possible that in five years time Facebook is earning as much as $100billion
in revenue. Given the relatively low variable cost in maintaining the site, profits would be expected
to also significantly increase.
c) I do consider the revenue forecasts of approximately $100 billion to be realistic. Facebook is
continuing to dominate market share and does not show any signs of slowing down. With the
amount of Facebook users approaching $1 billion, the value of advertising will substantially increase.
Facebook is truly a world-wide phenomenon and companies would simply have to pay the additional
costs of advertising with the increased market audience.

BIBLIOGRAPHY
Tilak, A. (2009). Case Study: Facebooks Capital Structure and Ownership
dilution. Available: http://www.buzzom.com/2009/11/case-study-facebooks-capitalstructure-and-ownership-dilution/. Last accessed 15th May 2011.
Levy, A. (2011). Facebooks Value Tops Amazon.com; Trails Only Google on
Web. Available: http://www.businessweek.com/news/2011-01-28/facebook-s-valuetops-amazon-com-trails-only-google-on-web.html. Last accessed 15th May 2011.
Eldon, E. (2010). Facebook Revenues Up to $700 Million in 2009, On Track Towards $1.1
Billion in 2010. Available: http://www.insidefacebook.com/2010/03/02/facebook-madeup-to-700-million-in-2009-on-track-towards-1-1-billion-in-2010/. Last accessed 15th
May 2011.
Farzad, R. (2011). Facebook's Initial Private Offering. Available:
http://www.businessweek.com/magazine/content/11_03/b4211004007471.htm. Last
accessed 15th May 2011.
(n.a.). (2011). IPO challenges. Available: http://www.trustcapital.com/page.php?id=74&. Last accessed 15th May 2011.
(n.a). (2011). Financial Statement Analysis and the Debt Equity Ratio.Available:
http://business-accounting-guides.com/debt-equity-ratio/. Last accessed 15th May
2011.
(n.a). (2010). Will Facebook reach total Revenue of 1.1 billion in 2010 ?.Available:
http://www.vincentabry.com/en/will-facebook-reach-total-revenue-of-1-1-billion-in2010-256. Last accessed 15th May 2011.
Hunt, B & Terry, C 2009, Financial Institutions and Markets, Cengage Learning, Accessed
15th May 2011.