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Mark Zuckerberg’s audacious plan to control Facebook as he sells his stock, explained

Mark Zuckerberg Attends Mobile World Congress 2016
Facebook CEO and dictator-for-life Mark Zuckerberg.
Photo by David Ramos/Getty Images

Things are looking up for Mark Zuckerberg. While a lot of other major tech companies — including Apple, Google, and Microsoft — have posted disappointing financial results for the first quarter of 2016, Facebook announced yet another quarter of spectacular growth on Wednesday. The company's quarterly revenues have grown by more than 50 percent over the last year — an impressive achievement for a company of Facebook's size.

To some extent, Zuckerberg is simply riding a wave of popularity that started when he created the social network 12 years ago. But Zuckerberg has also made a series of savvy decisions that have allowed the company to maintain momentum as others have stumbled. And Facebook stock price is about 90 times its annual earnings (the stock market's overall average is about 24), suggesting that Wall Street expects the company to continue outperforming other companies of its size.

Zuckerberg believes Facebook's success has been enabled by Facebook's unusual corporate structure, which gives him permanent and near-total control over the company he founded — despite owning fewer than 18 percent of Facebook shares. On Wednesday, Zuckerberg announced a new plan that would allow him to sell most of his shares — or donate them to charity — further reducing his stake in the company without losing his majority of the firm's voting rights.

You might think Facebook shareholders would get nervous about the prospect of Zuckerberg having total control of Facebook — with no accountability to other shareholders — even as his financial stake in the company dwindles. So far there's been little sign of opposition, but there's a good chance Facebook will face a lawsuit before the new plan can go into effect.

Zuckerberg has skillfully managed the shift to smartphones

DLD Conference 2009
Zuckerberg in 2009.
Photo by Ralph Orlowski/Getty Images for Burda Media

Initially, Facebook was a website, and a less savvy CEO might have missed the significance of smartphones and tablets — as some other web companies did. Flickr, for example, was a popular web-based photo sharing service in the late 2000s, but its owner, Yahoo, never figured out how to turn it into a popular smartphone platform.

But Zuckerberg quickly grasped the importance of smartphones and ensured that Facebook would have a full-featured mobile app.

Zuckerberg further shored up Facebook's position in the mobile marketplace by buying other companies. When Facebook bought Instagram for $1 billion in 2012, the move was mocked by observers like the Daily Show's John Stewart. Now, of course, Instagram has more than 400 million users, and there's little doubt that it would be worth a lot more than $1 billion if it were an independent company.

Facebook also paid $21 billion in 2014 for WhatsApp, a mobile messaging company that had more than 400 million users at the time.

Facebook's focus on mobile platforms has paid off. In its most recent quarter, mobile ads accounted for a whopping 82 percent of the company's overall revenue.

Zuckerberg wants to sell off shares without giving up control

Most companies are run on a principle of one share, one vote. That means that as the company grows and raises money from outside investors, the initial founders wind up with a minority of the shares, making it possible for them to be fired if other shareholders become convinced that someone else would run the company better.

But some companies — notably Facebook and Google — are structured to avoid this situation. These companies have two different classes of shares, with the shares held by insiders like Zuckerberg (and Google co-founders Larry Page and Sergey Brin) having a lot more voting power than the shares controlled by the general public. The result: Zuckerberg owns just 18 percent of Facebook shares but controls 56 percent of the company's voting rights, giving him the right to hand-pick the board of directors that, in turn, selects the CEO.

That's a pretty sweet deal for Zuckerberg, because it means he can't be fired no matter how dissatisfied the other shareholders — who collectively own more than 80 percent of the company's value — get with his leadership. But even this isn't enough for Zuckerberg.

Zuck has vowed to give 99 percent of his wealth to charity during his lifetime, and he wants to get started on this now instead of waiting until after he leaves Facebook. But if he just sold a bunch of shares, his voting power would drop below 50 percent and he could lose control of the company.

So now Facebook is proposing to create a third class of shares, and give every existing shareholder — both insiders like Zuckerberg who have extra voting rights and members of the general public who don't — two extra shares for each share they already have. After this stock split, shareholders would have three times as many shares and each share would be worth one-third as much.

And crucially, these new shares would have no voting rights at all. That means Zuckerberg could sell them, liquidating two-thirds of his economic stake in Facebook, without diluting his voting power. In other words, he could go from owning 18 percent of Facebook to owning 6 percent, while maintaining total control of the company.

Shareholders sued to stop a similar Google proposal

You might expect this to trigger a backlash from shareholders upset at the idea of somebody with a shrinking share of their company keeping total control over it. And indeed, when Google proposed a similar move back in 2012, a large majority of non-management shareholders opposed it. But founders Page and Brin already controlled a majority of the voting rights, and they used their power to approve the plan to give themselves even more power. Shareholders filed a lawsuit, but the lawsuit was settled, clearing the way for the plan to go forward.

The Facebook proposal for a new class of stock is even more aggressive than the Google proposal was. The Google proposal issued one new share for each share outstanding. Facebook's proposal issues two shares for every existing share — allowing Zuckerberg to sell two thirds of his shares and still maintain a majority of voting power.

There hasn't been much sign of a backlash yet, but it's a safe bet that the proposal will lead to shareholder objections and a lawsuit. Facebook's lawyers argue that the proposal benefits public shareholders because it gives Zuckerberg a stronger incentive to remain as CEO for the long run. Because the Google lawsuit was settled, we never got a ruling on the merits, so it's not clear if the courts will buy this kind of argument.

The clear signal, however, is that Zuckerberg intends to maintain control of Facebook even as he diverts most of his Facebook wealth to charitable causes. Zuck could have followed the lead of Bill Gates, devoting his 20s, 30s, and 40s to running Facebook and then devoting the later years of his career to giving his wealth away.

But Zuckerberg is evidently in a hurry to get started on the philanthropic phase of his career while he's still the boss at Facebook. Last year, he created an organization called the Chan Zuckerberg Initiative that will serve a similar function to the Bill and Melinda Gates Foundation, allowing Zuckerberg and his wife Priscilla Chan to begin donating his billions to worthy causes. If he's able to donate two-thirds of his Facebook stake to the Chan Zuckerberg Initiative, the organization will have a $30 billion war chest that it can begin dispensing to worthy charitable organizations immediately.

Correction: This article originally mis-stated how Google's stock split worked.

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