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What's the Big Rush?

Who are the winners in Zynga's impending IPO?

The following is a repost of my blog.

Times are tough.  The US is teetering on a double dip recession.   Europe has been struggling to sort out its credit crunch.  Fear is looming of an economic slowdown in China.  The domestic and global markets are not looking so hot right about now.  Even amidst these unfavorable market conditions, Zynga was pushing for its IPO the week before Thanksgiving.  It seems like Zynga is taking its foot off the gas pedal and will now be trying to go public after Thanksgiving.

So who really benefits when a company goes public and what compels a private company to do so?  It’s a complicated process that I don’t claim to fully understand.  However, this is what I have been able to gather from public news.

Zynga has been trying to go public since July 2010.  However there have been numerous delays to bring us to today where we are still holding with bated breath.  Some of the delays have been attributable to the U.S. Securities and Exchange Commission (SEC) continuing review of Zynga’s financial results. Zynga was required by the SEC to restate their financial results due to accounting errors back in August.  This has been one contributing factor to the erosion of Zynga’s projected valuation.

The owners of Zynga are supposedly bolstering their voting power over common shareholders.  This is not out of the ordinary.  However the ratio of how many votes the owners will maintain to a common shareholder’s vote seems heavily engineered to maintain voting control.  In the case of the founder Mark Pincus, one of his super votes counts for 70 votes to just 1 for a common shareholder.  The venture capitalists get a more tame 7 votes to 1.  This allows him to maintain a controlling interest over the company, 38% of the votes, while the venture capitalists maintain a 26% share of the votes.  Moreover, Pincus only has a 20% economic stake in Zynga while the venture capitalists have a larger 35% economic stake.  

Now let’s get to why a private company typically goes public.  One motivation is to raise additional capital.  The common stock sold does not have to be repaid to common shareholders.  Typically if there is a voting ratio of 1 vote to 1 share, the downside to the current private owners is that they are giving up a percentage of their ownership.  In the case of Zynga, Pincus and the venture capitalists thanks to their super votes will still maintain 64% of the votes even though they are not as equally financially invested in the company.   That does not seem like an equitable trade for a common shareholder.  While this is not necessarily bad, it does make you wonder what is going on.

In a positive scenario, by maintaining control of the company, it could be steered more effectively by the people who got it to where it is now instead of opening it up to shareholder demands that can often be short-sighted.  From a more cynical view, it allows Pincus and the venture capitalists to have their cake and eat it too.  They get the infusion of public money and also get to control it.  I will let your imagination take it from here.

Looking at the actual execution of an IPO, there are multiple parties that would benefit from the sale of an IPO.  Investment banks and the venture capitalists have a large stake in seeing a company go public.  Investment banks do the underwriting of the company in preparation for the IPO.  They typically get paid a commission based on a percentage of the value of the shares sold.  Without an IPO there’s no commission.  In the case of venture capitalists, they typically don’t see a return on their invested money until there is a realized event, such as an IPO.

With the looming threat of of a rocky and depressed global market, unclear financial results, an inequitable public ownership model, and a strong incentive for venture capitalists and investment banks to get paid out, the winners at Zynga's IPO finish line don't appear to be the common shareholders. 

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