Lessons from Facebook’s failed IPO

By Lena Booth, Ph.D.

Questions remain nearly one year after the frenzy of Facebook’s initial public offering on May 18, 2012. Who pushed for the inflated $38 price? Who had the ear of Chairman and CEO Mark Zuckerberg in the days before his NASDAQ debut? When exactly did Morgan Stanley, the lead underwriter, revise Facebook’s earnings forecast downward? Who did Morgan Stanley warn right before the mandatory quiet period surrounding the IPO? Perhaps the biggest question is whether Facebook shares will ever climb back to $38. (Prices closed below $27 on April 18, 2013, after hitting a low of $17.55 seven months earlier.)

Some answers might emerge in the various lawsuits against Facebook and its underwriters. In the meantime, entrepreneurs and angel investors watching from the sidelines can learn from the debacle. For starters, the Facebook case shows what can go wrong when the original owners get too greedy on the first day of trading. Although company founders, venture capitalists and other financial backers want a big payday, these shareholders are often prevented from cashing out during a lockup period that typically lasts six months to one year.

A good price at the end of the lockup is what matters, and experience shows the best way to build momentum toward this target is through strategic IPO underpricing. Underpricing by as much as 15 percent to 20 percent creates excitement, generates free publicity for the company and increases trading volume. Underpricing also wards off lawsuits from angry investors who bought at the IPO.

When McDonald’s spun off Chipotle Mexican Grill in 2006, shares doubled from $22 to $44 on the first day. The resulting hype elevated Chipotle’s public image. LinkedIn experienced the same price hike in 2011, with share price rising 109 percent on the first day of trading. In contrast, Facebook shares dropped to $31 within the first week, and the resulting fallout likely dampened Zuckerberg’s honeymoon with his new bride in Rome.

Lena Booth, Ph.D., is an Associate Professor of Finance at Thunderbird. She served as the first Executive Director of the Thunderbird Private Equity Center, and specializes in corporate finance, capital raising, investment banking and financial markets.