Van Natta’s forte is deal-making. He coolly played Microsoft off against its archrival. He knew that uttering the word “Google” was like a magic spell to tame Microsoft’s normally rapacious negotiating instincts. And in fact when Google heard that Facebook was looking for a partner for its international ads, it began aggressively pursuing a deal itself.
On October 10, 2007, Google hosted its signature annual event for its best advertising clients—called Google Zeitgeist. Not only did the biggest marketers and ad agencies come to its campus for the two-day conference, but Google’s board of directors converged too for one of their quarterly meetings. It was a good time to make deals. Tim Armstrong, Google’s ad chief, had talked to Van Natta and knew that Microsoft was well along in talks to win Facebook’s international ad contract. But it just so happened that Mark Zuckerberg was one of the signature speakers at Zeitgeist. Armstrong talked to Google’s board members and got an official go-ahead to use this opportunity to begin serious negotiations with Facebook to try to take the deal away from Microsoft. The board even approved talks about buying Facebook, if it made sense.
Google didn’t make any secret of its interest in an ad deal with Facebook. At a press conference during Zeitgeist, Google CEO Eric Schmidt called social networking “a very real phenomenon.” He added, “People don’t appreciate how many page views on the Internet are in social networks.” It was an early expression of what would become a long-standing concern—Google cannot search content that is behind proprietary walls on the Internet. A close relationship with Facebook might achieve even more than acquiring a bunch of new ad space. It could help Google stay dominant as the Internet evolved.
That evening everybody was bused to a nearby park where Google had erected a gigantic white tent. After a lengthy cocktail hour, all 250 or so Zeitgeist attendees sat down to a lavish, almost Bacchanalian feast. The first course was served on thick plates made of ice. Google was at the height of its powers—money was flowing in like manna. Here the company was thanking the people who were spending those billions on advertising while simultaneously proclaiming itself to be rich rich rich. At the center table, immersed in intense conversation, were Google co-founder Larry Page, Armstrong, deal expert Megan Smith, as well as Zuckerberg, Van Natta, and Facebook corporate development boss Dan Rose. The Facebook team said they were far along in negotiations with Microsoft. Armstrong impressed upon the Facebook executives that Google was serious about wanting to do the deal instead.
After the lavish dinner ended at around 10 P.M., Facebook’s trio and the Google executives retired to the company’s nearby headquarters building for some serious negotiating. They worked late into the night until they had the rough outlines of a deal. Google would take over both the U.S. and international ad deals. It also agreed to consider making a small investment in Facebook at the $15 billion level. For Google it made sense to buy the equity as a sweetener because Facebook would have to go through quite a bit of trouble to dislodge Microsoft. If Facebook pushed Microsoft out of the still-in-effect U.S. deal it was likely to result in legal unpleasantness. But Google had gone further. Executives told Zuckerberg that they were willing to consider buying Facebook outright, though at a price considerably less than $15 billion. This time, however, Zuckerberg was firm. Facebook was not for sale.
Even on the ad agreement, many on the Google side detected a lack of commitment on Zuckerberg’s part. They noticed he kept pushing for very specific concessions on things like the size and shape of display ads—the kind of thing usually left to underlings to iron out. It seemed to them he might be seeking specific promises from Google in order to strong-arm Microsoft to concede the same points. For all the talk, the Google team knew that Microsoft’s prior relationship with Facebook gave it a big advantage. The chances of pulling Facebook away remained small.
Microsoft had been carefully cultivating Zuckerberg. CEO Steve Ballmer had flown to Palo Alto to visit his young counterpart twice. Ray Ozzie, Microsoft’s Chief Software Architect, had also repeatedly visited Palo Alto. As Zuckerberg is wont to do, he took them on long walks. He told Ballmer that Facebook was raising money at a $15 billion valuation.
But Ballmer had come with something very specific in mind. “Why don’t we just buy you for $15 billion?” he replied, according to a very knowledgeable source. Zuckerberg, as usual, was unimpressed, even by this fabulously extravagant offer. It was so high that, had it been accepted, Microsoft’s shareholders might have raised serious obstacles to its completion.
“I don’t want to sell the company unless I can keep control,” said Zuckerberg, as he always did in such situations. He knew that keeping control once Facebook sold would be almost impossible, so for him this was effectively a way to end the conversation.
Ballmer took this reply as a sort of challenge. He was emphatic that Microsoft wanted to buy Facebook. He went back to Microsoft’s Redmond headquarters and concocted a complicated plan intended to begin a process of acquisition without compromising Zuckerberg’s ability to call the shots. According to people close to the situation, Ballmer proposed that Microsoft acquire a minority stake in Facebook at a $15 billion valuation. Then, in a provision loosely modeled on a deal arrived at almost two decades earlier between giant Swiss pharmaceutical firm Hoffman-LaRoche and Silicon Valley biotech star Genentech, Microsoft would have the option, every six months, to buy another 5 percent of Facebook. A complete takeover of the company would take 5 to 7 years, depending on how much of the company Microsoft bought at the outset. The price Microsoft was obligated to pay would rise steadily over time, making Facebook’s ultimate price considerably higher than $15 billion. But from Ballmer’s point of view, the deal addressed Zuckerberg’s key concern—it allowed him to retain control, at least for another few years.
Ballmer flew down to San Francisco again and brought along Kevin Johnson, who oversaw all Microsoft’s ad-related business. Van Natta suggested that they all meet at his Palo Alto home in order to avoid attracting attention. Ballmer didn’t make that any easier. He arrived in a big black Cadillac Escalade with a contingent of security personnel wearing earpieces and microphones. As the security men cased the yard, Van Natta delivered bad news to Ballmer and Johnson, while Zuckerberg sat quietly and Microsoft software chief Ray Ozzie listened in via speakerphone.
Facebook wanted to alter the U.S. deal, Van Natta declared. In fact, it was going to start selling its own ads soon, whether Microsoft liked it or not. Ballmer was nonplussed. If Microsoft wanted the international deal, Van Natta continued, it had to agree to concessions on the U.S. one. Facebook needed to try out some new ad formats of its own. If Microsoft wouldn’t agree, well, Google was waiting in the wings.
The encounter of Van Natta and Ballmer must have been a sight to see. Van Natta may be fearless, a belligerent and uncompromising negotiator, but Ballmer is big, loud, and consummately forceful himself. You don’t screw around with him. Not to mention he’s CEO of what is in financial terms still the most powerful technology company in the world. Van Natta must have had an exquisite sense of just how far to push, because Ballmer didn’t lose his cool. He reiterated that Microsoft had no interest in reopening the U.S. ad deal. What he was really interested in, he said, was buying Facebook.
Zuckerberg was cautious. The young CEO had learned his lesson the year before with Yahoo—once you open the door to a possible sale it’s hard to close it. Zuckerberg made it clear he was inclined not to sell, but suggested that Microsoft would have to agree to a raft of conditions, including even more autonomy for Facebook than the tiered proposal anticipated, with Zuckerberg remaining at the helm indefinitely. Says someone from Microsoft who heard about what happened, referring to Zuckerberg: “It wasn’t ‘If you pay $X billion we’ll do it.’ The guy’s not a seller. His expectations were too high.” Despite all the work Ballmer had put into his acquisition proposal, Zuckerberg wouldn’t bite.
While Microsoft was almost desperately seeking the international deal, Facebook took advantage of th
e software giant’s pliability to resolve another dispute, a problem with Hotmail, Microsoft’s free Internet email service. The biggest tool for Facebook’s growth was the contact importer it had launched at the time of open registration. New users entered their email username and password, and Facebook helped them send anyone on their email list an invitation to join. Hotmail was the largest source by far of such user referrals. But it interpreted many email invitations coming in from Facebook as spam—unwanted commercial messages. On some days Hotmail blocked the use of the contact importer altogether. Facebook’s user growth then dropped as much as 70 percent, says Moskovitz. So in the midst of the ad talks, uber-negotiator Van Natta, Moskovitz, and D’Angelo trooped up to Microsoft headquarters in Redmond, Washington, to iron out the conflict. “This was absolutely not something we could walk away from,” says Moskovitz. After a day or so of talks, Van Natta got Microsoft to stop interfering with the imports even though Facebook conceded almost nothing in return.
In a classic brinksmanship move, Microsoft’s executives told Van Natta they wouldn’t budge on letting Facebook sell some of the U.S. ads. Van Natta refused to release Microsoft from its minimum payments for ads next to photos. Microsoft ad chief Johnson replied that keeping the U.S. inventory was critically important to him. In order to keep it, he said, he was willing to lose the international deal. “Fine,” said Van Natta. “We’re going with Google.”
Johnson returned to Microsoft’s headquarters in Redmond, Washington. But Hank Vigil, the company’s top dealmaker, stayed in Palo Alto to continue talks with Van Natta. He made a breakthrough. Van Natta had told the Microsoft team that his job depended on a successful outcome of the talks. Now he waffled. Vigil proposed that Microsoft would let Facebook use 15 percent of the U.S. ad inventory if it made certain concessions. On Saturday morning Vigil set up a conference call with Kevin Johnson and Van Natta to expand on the offer. Johnson said he’d agree to release the inventory if Microsoft got the international deal and if Facebook eliminated the photos ad minimums and agreed to use Microsoft’s search engine inside Facebook. Johnson instructed Vigil to take his team to Facebook’s offices on Monday morning and not leave until he had a deal.
By 11 A.M Monday, all the players were ensconced in a conference room on the second floor of Facebook’s office on University Avenue in Palo Alto. Sitting at a big glass table, with sunshine streaming in through the walls of glass, the two companies’ teams conducted the top-secret negotiation that would transform Facebook’s reputation. In another Facebook building, a smaller group from Google met for part of this time, discussing its own possible deal.
For the next twelve hours the Microsoft and Facebook teams went back and forth on issues large and small. Microsoft got an agreement to move toward providing search technology inside Facebook, yet another blow in its near-feudal joust with Google. Facebook demanded Microsoft not display ad banners either at the top of the screen or on the lower left, just on the lower right side. (Google’s acquiescence on this point gave Facebook ammunition.) Unlike the year-earlier U.S. deal, there would no longer be any up-front guarantee of how many ads Microsoft would display nor how much it had to pay Facebook. The two companies would instead share the revenues from any ads sold. Facebook successfully pushed for a higher percentage than is usual in such deals. And the social network got its all-important flexibility to experiment and innovate on new ad formats on 15 percent of the U.S. display ads.
The Facebook team—Van Natta, Rose, Yu, and General Counsel Rudy Gadre—occasionally ducked around the corner to huddle with Zuckerberg, whose desk was only steps away. The CEO was much more involved than in past such negotiations. Whenever things bogged down, Van Natta loosened Microsoft up again with a vague allusion to Google. He implied, but didn’t exactly say, that Google was ready to do all the things Microsoft wouldn’t. It was close to true, anyway.
At about 11 P.M. it was apparent a deal was in sight, though many details remained to be resolved. Everyone’s energy was flagging. Just then, a blast of thumping house music invaded the quiet conference room. Several negotiators stepped out into the loftlike office to see what was going on. They found a Facebook programmer at a DJ stand, with the music turned all the way up. This was the signal to Facebook’s engineers that a hackathon was about to begin. These were the all-night sessions, legendary in Facebook’s engineering culture, when many of the site’s most interesting innovations emerged. Unlike a typical hackathon, though, this so-called “convertathon” had a specific agenda—to change Facebook’s underlying software code to make it easier to translate into languages other than English. Translation of the site was set to begin in a few months in order to further bolster already torrid international growth.
Back in the conference room, heads began to bob and feet to tap. It was ludicrous, but energizing. A Microsoft negotiator got up and stood cordially in line with Facebook programmers, waiting to dig into the bins of take-out Chinese food. Negotiations picked back up once the music was turned down. By 3 A.M, they had a deal. Essentially Facebook got everything it wanted. The negotiators left the engineers to their labors and went to bed.
The issue of an accompanying investment had not been a topic during the glass-room negotiations, but the next morning, Van Natta raised it bluntly. Says his then-deputy Rose: “We said to them, ‘Look, if you want to use the investment opportunity to cement the relationship, we want you to lead the round.’ We said, ‘We might be talking to your competitors.’” Microsoft had continued to make clear that if Facebook was willing to sell, it was interested in buying. But Zuckerberg was not about to sell. Van Natta was prodding Microsoft to buy a small chunk. Ballmer had in effect already agreed that Facebook was worth $15 billion, so the valuation wasn’t much in dispute. At that astronomical level even a small percentage of the company would net Facebook many millions that it could use to underwrite its money-losing operations. The Hong Kong billionaire Li Ka-shing, often called “Asia’s Warren Buffett,” had earlier approached Facebook to invest and had been negotiating hard during these very same days and had agreed to invest at that valuation. “It was a frenzied period,” says Yu. Everybody was acting as if Facebook could become a financial colossus, even though at the moment the only thing huge about it was its membership growth rate.
After some frenzied back-and-forth occurring mostly over the course of a single day, Microsoft agreed to invest $240 million at a $15 billion valuation for 1.6 percent of Facebook, alongside Li Ka-shing, who would put in $60 million for 0.4 percent. Microsoft’s executives were happy. “It was all about the search war with Google,” says one. “A $240 million investment that helped us fight them was definitely worth it.” The pressure was great to conclude the deal, so Microsoft had little time for any detailed financial due diligence. But it was critical to Microsoft that another investor participate alongside them in the round. Microsoft had to be able to demonstrate it wasn’t paying an inflated price in order to achieve an ad deal. Otherwise, were Facebook later to be determined to be worth less than $15 billion, accounting rules would require Microsoft to write down as a loss on its books the proportional difference between $15 billion and the actual valuation. So Li’s stake, while small, was crucial.
Microsoft did not get a particularly attractive deal in legal terms, either. In order to move quickly for this so-called Series D round, it agreed to abide by the same documents that had applied to investors in the Series C when several VCs had invested in mid-2006. The convertible preferred shares it bought had what is called a “1X nonparticipation liquidation preference,” which means if Facebook were ever sold outright, Microsoft would get back either its actual cash outlay of $240 million or 1.6 percent of the purchase price, whichever was larger. But it could do nothing to stop a subsequent investment round at a lower valuation. If there is eventually a public offering of Facebook’s stock, Microsoft will be forced to convert its preferred shares into common stock proportionate to its ownership, no matter how much the company is then worth, whether mor
e or less than $15 billion. Microsoft was willing to accept all these conditions because its primary goal was the completion of the advertising deal. But at the last minute it demanded one important condition: Facebook could not take any investment money from Google. And if it ever contemplated an outright sale to the search nemesis, Microsoft had to get advance notice.
The deal was announced on Wednesday, October 24, and prompted an outcry of amazement. The Wall Street Journal called Facebook “the newest Internet darling” and said the deal was “reminiscent of the Internet bubble that ended in 2000.” The Los Angeles Times called the $15 billion figure “staggering.” “It tips the scales in terms of totally ridiculous valuations,” wrote the influential TechDirt blog. This was by far the highest valuation ever given to a private technology company, and one with no profits to boot! Either Microsoft’s Steve Ballmer was insane, or Facebook mattered more than anyone had realized. But if the f8 platform event five months earlier had firmly put Facebook once and for all onto the technology industry map, this investment did the same thing for Facebook on Wall Street. Microsoft’s stock jumped markedly. The ad deal that precipitated the investment was barely noticed in the hubbub over the valuation.
Facebook’s timing on the deal could not have been better. Only two weeks earlier, the stock market peaked at a level it has not approached since. In 2008 the world fell into the worst recession of the postwar period. But Zuckerberg had a lot of crucial cash in hand to help him through the down times. In addition to the initial $300 million it raised in Series D, Li Ka-shing invested an additional $60 million several months later, and three Munich-based venture capitalists, the Samwer brothers, invested $15 million around the same time, bringing the total raised in the Series D round to $375 million. Zuckerberg has a simple explanation for how Facebook achieved such an amazing financial result. “Peter [Thiel] helped us time it,” he says simply. “He was like ‘Now would be a good time to raise money.’”
The Facebook Effect Page 28