Will Facebook Virtual Currency Credits Derail Their IPO?

In an act of desperation or genius ,depending on how you perceive Facebook, the company's adoption of  a virtual currency economy may very well propel them to a much sought after IPO. Despite their creation of a "proprietary" Internet world (a topic for another blog) where they control the applications and content that a user sees or participates in they have struggled with how best to monetize their exclusive Facebook community and the applications that serve the community. Generating revenue exclusively from Ad impressions clearly was not an adequate revenue source even for a  large community of 500 million plus users.  This conundrum has been a head wind that the company has faced since their inception stalling its IPO aspirations. It appears virtual currency and virtual goods are coming to the rescue.

To date Facebook has not revealed any numbers relative to revenue generated by virtual currency transactions. However, if you look at the Facebook credits being issued to companies such as Zynga and RockYou and the 30% haircut they take and give back to Facebook for these transactions the numbers are very good indeed.

Despite this much needed revenue boost there is a significant problem associated with this new found revenue source. Virtual currency inflation is already rampant in the Facebook economy devaluing the virtual currency bought to date and paid for by people playing games in Facebook applications.

The inflation issue is growing for a number of reasons. Facebook is arbitrarily issuing large blocks of currency to Facebook application providers without any consideration for the total amount of currency in the system.  Another contributing factor for Facebook credit inflation is the lack of another currency to peg the value of the currency against. With Zynga and RockYou discarding their own currencies and exclusively using Facebook credits Facebook credits lack a reference point to control their valuation. Of course the biggest issue is that there is no exchange or trading with traditional virtual currencies like the Euro, Dollar, Pound Sterling, etc.

So how could this inflation impact the Facebook IPO? Well if purchasers of Facebook credits realize that they bought a bunch of credits and now they want to buy something with them and the purchase price of that item continues to go up relative to the currency the holder of the currency will be less than happy.  On the flip side, if the virtual good they did buy with the credits decreases in value over time the desire to transact with Facebook credits will also diminish. Essentially the faith and trust in the currency will wane and cease to have value for consumers.

Certainly demand for a product also impacts the price of a commodity impacting  pricing. However, this could create a more serious problem with high demand products going stratospheric making sought after virtual products difficult to buy.

This phenomena could easily result in consumers and application developers abandoning Facebook credits and the transaction medium thus removing Facebook credit as meaningful source of revenue for Facebook.

Regulatory scrutiny by the SEC will also be a problem. They are not going to be keen on floating a company on the NYSE with an unregulated currency exchange system propping up their revenue numbers.

This is all very solvable if Facebook begins to let its currency float in relationship to some other viable currency. Unfortunately, the close association of Facebook game play and Facebook credit accumulations by gamers will squarely put Facebook in the online gambling penalty box if they peg Facebook credits against the Dollar or Euro. This is certainly something Facebook is  very aware of.

This situation leaves Facebook in a bit of a jam. They have only two virtual currency management alternatives that could save their virtual currency revenue stream and IPO. They could begin to control virtual currency issuing based on overall valuation of the currency within their system. This would require them to monitor all Facebook credit transactions in their closed economy to determine the true value of the currency at any given time. If they see inflation occurring they could buy back virtual currency from application providers to keep the currency stable. They could also peg their virtual currency against another virtual currency. This is a bit more complex and requires them to create a virtual currency trading system that let's institutions, companies and individuals trade other virtual currencies with Facebook credits.

Clearly the scrutiny associated with IPO preparation will reveal Facebook's weak virtual currency revenue management and cause the company to deal with this issue. If they do not it is unlikely that Facebook will be going public anytime soon. 

Kevin Flood is the CEO of Gameinlane, Inc. Kevin writes extensively about online games and their impact and integration into iGaming and E-commerce environments. Kevin is a frequent speaker at online game events and conferences in Asia, Europe and the US. Kevin and his Gameinlane team are currently working with online gambling, social gaming and e-commerce companies integrating social gaming with online gaming operations and integrate game mechanics into e-commerce applications. 

How Do I Structure My Startup For Investment And Acquisition?

I recently attended one of the usual Silicon Valley conferences where a group of startup CEO's, lawyers, bankers, VC's and entrepreneurs get together to keep the dream of the holy grail sale or acquisition of a startup company alive. It was interesting because one of the newly minted entrepreneurs immediately asked the question "How do I structure my startup for an easy exit?".

I will have to admit that I chuckled under my breath and thought to myself "wrong question". You should be thinking about how you are going to keep your company above water to survive long enough to get to the point where someone actually cares about you and your company. With that said many entrepreneurs do make decisions early on in the life of their company that impede their ability to sell or go public.

The following are approaches that entrepreneurs can take in the early formation of their company that will make the company more attractive for sale or investment.

LLC Versus Incorporation - Many entrepreneurs start out forming their companies under the LLC form of business organization. Frequently, entrepreneurs are driven to this approach because they have concerns about the reporting and expense associated with incorporation. They also harbor the hope that their company will be profitable one day allowing them to distribute those profits(profit interests) to the founders. These are all good reasons to start a company as an LLC. However, they are not good reasons from an investment and exit perspective.

Realistically, revving up your startup to profitability is no easy task. Secondly, even if you get there you are more likely to plow those profits right back into your company to keep it growing. For investors or potential acquirers the reinvestment behavior is what they are looking for in an entrepreneurial company.

From a structural perspective investors and acquirers do not like the LLC format because it is inconsistent with the format they are accustomed to investing in and purchasing. They prefer the vanilla corporate structure because it is well understood when it comes to merger and acquisition.

Yes, you can convert your LLC over to a corporation if a sale or investment is imminent. However, why go through the hassle and expense. Start out as a corporation to make your company more attractive to potential buyers.

The Team - Unfortunately investors are subject to being influenced by impressive resumes. This is unfortunate because many successful companies are started by people that have great ideas and good business skills that never went to designer label schools or worked for Fortune 500 companies. Despite this well known fact, investors and potential acquirers may overlook your startup and even pass on an acquisition if they do not see well known labels attached to team members. If you or your company fits this description I suggest you add someone to your team that has "credentials". Even if the credential holder is an adviser it will help your cause.

Investment Categories - Interesting enough investors and acquirers are not that creative when it comes to the investments and acquisitions that they make. Even in the high flying Tech/Internet world investors have a tendency to only invest in areas that they deem to be "hot". This means that even if you have a great idea, good growth and even some profits to prove it investors may overlook you because you are not in a space that they care about. Before you pick an idea, product and or service to form a company around determine what investors care about. This is easy enough. Take a look at their portfolios and track recent IPOs. Granted, this may be difficult if you are looking for an exit two or three years away. However, most investing trends have a history and a trail you can follow and extrapolate from to determine where investment is headed.

Conclusion - Asking the questions how do I structure my company for exit at the start of a business may not be the best thing to be thinking about at that stage in your company's history. However, there are actions you can take early on in your company history that will make you more attractive to investors when the time comes to cash out.