Transcription
The climax of The Social Network movie lives in every Founder's head rent-free. My brother's at the cleaners, and what was your ownership? Shear diluted down to .03. But it's also a complete lie. I mean, kind of. Yes, it's Hollywood. Yes, we know, or we should know, that all stories are twisted for dramatic effect. Holy. But even the book that inspired the movie script was criticized for its accuracy. And more importantly, the main consultant, the source of details for the story, was Eduardo Saverin himself, precisely during the time that he was suing Mark Zuckerberg.
But for an entire generation of future entrepreneurs, and I'm including myself in there, this film gave us a first glimpse into a startup world. The Social Network. Mark Zuckerberg has turned his social networking website, Facebook, into what it could be to become a tech entrepreneur, or so it seems. Every three minutes. [Applause] First time I had ever heard about Peter Thiel or venture capital or shares of stock. In all honesty, I thought they were my lawyers. Even what we think of Mark Zuckerberg today is inevitably influenced by what we saw in this film, and it's measurable. In 2021, Forbes determined that most Americans saw Mark unfavorably, which was disconnected from the perception of the brand or the company. So what the hell actually happened here? Did Mark actually do anything illegal? Or was it just Eduardo signing without reading, like to use my pen? Or was it Mark intentionally trying to screw his best friend? We went on a hunt for the original story, for the real story, the facts, not the fiction, the numbers, and the legal paperwork. And this is a mandatory cautionary tale for any startup founder. Here's the real story of how Mark Zuckerberg screwed his best friend. Thank you. [Music]
Now, you're going to see in a minute the tricks that Mark was able to pull to screw Eduardo Sovereign in this transaction. But the truth is that as Founders, we have to make these decisions. We have to sign these documents, incorporate companies without a real understanding of what it means or what it could mean for the company in the future. And that's where our sponsor for today comes in. First Base helps Founders incorporate a company, stay compliant, and grow their business all inside one platform. You can streamline filings and reports, documents. You can access third-party tools that you might need to scale, and of course, raise money from top-tier VCs. First Base is also introducing its new Agent product, which is a business compliance solution that lets you handle compliance needs like state filings, federal taxes, foreign qualification, payroll tax registration, and a lot more. Also, tax season is quickly approaching, so if your business isn't ready, First Base Agent can help you file annual reports, franchise taxes, and a lot more automatically. And if you already use an old-school agent, don't worry, First Base does the change of agents for free, so that you can enjoy all the benefits it gives you. This automated peace of mind. You can view all compliance documents in this centralized dashboard. You can eliminate clutter, drawers, and missed government alerts, and stop stressing about overdue fees. It's also a hassle for you, payroll tax registration, which lets you quickly set up your payroll taxes, your unemployment insurance, and your withholding in each state where your business operates. If your company needs to incorporate, you can use the code SLIDEBEAN10 for a 10% off on that. And if you use the code SBAUTOPILOT10, you can get a 10% discount on the Agent Autopilot product. Or, of course, just click the link in the description to learn more. Thanks again to the First Base team for sponsoring today's video.
Now, this video, this story, honestly, is inevitably about judging good. We have facts, yes, but you're going to afford an opinion about everybody who's involved in this story. You're going to judge, and by all means, do it. Do it in the comments. It's no wonder that the script for the movie, The Social Network, written by this guy, by the way, one of the greatest screenwriters of our time, plays during two lawsuits. And to understand what happened between Mark and Eduardo, we must also understand what happens with the other lawsuit. Lawsuit one is from the Winkle bosses. We have an idea. We want to talk to you about it. It's called The Harvard Connection. You create your own page, interest, bio, friend. Isn't this the exact project that we were working on? And isn't this the exact person that we were working on? They sued Mark for stealing their idea for a social network. And for the most part, the version of the story that's portrayed in the film is real. So the Winkle bosses and Divine Narendra did reach out to Mark to build their website, Harvard Connect. Mark agreed to partner with them and to help them build their website. And after that initial conversation on November 25th, Mark sent a bunch of emails to them telling them how the project was sometimes moving along, but also not, because he was very busy. I'm also really busy tomorrow. Okay, anybody else feel like there's something up with this guy? All of these emails are real. When the lawsuit happened, these emails were made public, and Facebook's lawyers didn't question them. So essentially, a fact. But years later, another set of messages was leaked to the public, private messages from Mark that showed his real intention surrounding Harvard Connect. It's, it's hard to argue for Mark Zuckerberg on this one. I mean, the whole evidence points to what we all understood from the film. He stalled the team to get the upper hand on the release of the Facebook.
Now, the movie thankfully doesn't bother you with all the details about the absolute legal chaos that was all of these lawsuits, because it wasn't just the Winklevosses and the company ConnectU suing Mark. It was Facebook suing back ConnectU, and then a company called i2 Hub over their attempt to copy Facebook with another platform called Social Butterfly. And then they settled this lawsuit. Facebook agreed to pay ConnectU with a combination of cash and shares. But then more lawsuits happened. ConnectU, weeks, just weeks after the settlement, again questioning the value of the shares that they have received as part of the settlement. They sued their law firm for malpractice, who actually sued them back. I mean, let me be a judge here for a second. The Winklevosses are bad losers. They were screwed by Mark, yes, but even after their first settlement, they were still sour and they wanted to squeeze more out of this deal. Let's get the freaking nerd. Now, how much of Facebook should they be entitled to? I really don't know, and I really want to hear what you guys think. But the matter was finally settled by a panel of three judges in San Francisco years later, who ruled that they were entitled to what they agreed that they were going to be entitled to when they settled that lawsuit originally. In other words, they said, no backseats. Nobody put a gun to your head back in 2008 to take whatever, however many millions of dollars. Why do these guys deserve a second feeling? The spirit of the agreement that we entered into has not been upheld by the other side with respect to part of the consideration being in equity. They misled us to the evaluation of the company and the actual stock that we were to receive. They were even sour about that, and they even threatened to take this case to the Supreme Court, which eventually stopped them.
Now, the lesson that many Founders will extract out of this whole story is, don't tell your idea to anybody because they might steal it. And I think that's a lesson. The real lesson to me is that execution is everything. It's not the first one to launch. It's not the one that comes up with the idea. It's who does it better. More than an idea, more than how smart or how cheating Mark might have been here, Facebook had one advantage over ConnectU: its ability to execute with in-house talent, no contractors, no external developers. But the key skills to build Facebook were contained within the founding members of the company. I see so many Winklevosses, really, I do, in my work. Maybe, maybe not as rich, but the type of founder with an idea that is just looking to recruit a developer to build it. And there's always that relationship. It's my idea, you're just my employee, and you're building it. So just do what I say. And that's not how things work. If your startup can't exist unless you recruit that person with that specific skill, coding, then they are as important to the company as you are. So you must treat them as partners, as your peers, which is not the case in this story. You guys were the inventors of Facebook. You'd have invented Facebook. And that, of course, brings me to Mark and Eduardo's relationship. Not before throwing she had one last time at the Winklevosses, not because of the actor who played them, but the real ones. More recently, because their crypto exchange crashed after they put too much trust in another Kiki character. But that's a story for another day, which we actually already covered. But let's go back to Eduardo's story.
Now, for us middle-class people, it's always, I guess, it's always easier to relate to a rags-to-riches story. Steve Jobs, who was an orphan, or, you know, that type of story. Zuck was not that. Eduardo Saverin was not that. Eduardo was Brazilian. He's the son of Roberto Saverin, a well-known rich businessman in Brazil, investor in retail and real estate and logistics. That story in the movie about him learning hurricane patterns and predicting the price of oil, the weather, you can predict the price of heating oil. Like he also did, wear a suit to class. But remember, the main source material for the film comes from a sour Eduardo Sovereign with an active lawsuit against Facebook. The screenwriter also took some liberties from the books. So here's really how much Sovereign was involved with Facebook. On October 28th, 2003, a drunk, married Zuckerberg hacked Face Mash after breaking up with his girlfriend. That's a fact. It crashed Harvard's server after a few days, not overnight. And Sovereign was piers supporting him through the breakup and the mischief. After the success of Face Mash and some inspiration from the Winklevosses, he figured what he needed to build the Facebook. Now, what we know about this comes from a combination of interviews with people close to Facebook during those first few years. It partly comes from the leaked instant messages that we mentioned earlier, and from the research on the book, which there is some truth to it. Anyway, apparently Mark didn't just want Eduardo next to him in the company because of the money. Eduardo was connected. He was head of the investment society. And to an engineer like Mark, who loves coding, he needed this understanding of business. And that's why Eduardo was key. In exchange for his participation, Mark offered him about two-thirds of the company. Eduardo is CFO. Knows 30% of the company. Now, the first company investment was actually $1,000 each, according to Rolling Stone. And even in one of the lawsuits, Sovereign stated that they both had agreed to contribute $20,000 each in cash for the company, and he actually claimed that Mark never brought that money in. Through an instant messaging conversation, it was apparently clear that Eduardo was the one covering most of the server costs during that time.
Now, a new member, Dustin Moskowitz, joined the company, got 5% out of Mark's share. That's also a fact. 65% for Mark Zuckerberg, 30% for Eduardo Severin, and 5% for Dustin Moskowitz. Now, in the summer of that first, first year, Dustin and Mark moved to a house in Palo Alto. Fact. Well, where's Eduardo? He got an internship in New York. Eduardo didn't come out. Eduardo was tasked with three things during this separation: to set up the company, to get funding, and to write a business model, which is not a thing you need these days. Imagine if sleeping had existed at the time, they would have been done in a day. Now, he actually did set up the company in April of that year, a Florida limited liability corporation, which was a bad idea. We also made a whole video about that. Anyway, the coast-to-coast separation between these two guys seemed to cause some trouble. Now, Eduardo was running another startup called Jabberjoo, which was this job board site. He was running it on his own, and apparently he put ads on Facebook for it without asking Mark first, which of course sparked a discussion. Now, during the summer, Mark and Dustin met Sean Parker. And you have heard of him. I'm Sean Parker. What do you do? You must be Eduardo and Christy and Mark. Sean was really one of three co-founders of Napster. Having been in this startup world in California for a while, he understood how to navigate all of this. So Mark decided to skip school next year and to work entirely on Facebook as long as he could secure some funding. Hey guys, come on back. And Sean Parker was able to rally investors around the starter, mainly Peter Thiel. Now, Peter Thiel was already a big, well-known investor in the Valley. He co-founded PayPal and was therefore one of the so-called PayPal Mafia, along with others like Elon Musk and the founders of YouTube. And there's a whole video about it. But there was still a problem. There was a 30% problem here, because the company CFO, a huge chunk of the cap table, was on the other side of the country, working on a different startup, and seemingly not really interested in the Facebook. And Mark tried. Business Insider found an email from Mark offering Eduardo frequent flyer miles so that he could come to California. But regardless of what Mark thought, for a VC, one-third of debt equity in the company is a really, really bad deal. It means that every future round of investment, you're going to have to explain why somebody who isn't bringing value to the business owns such a big chunk of it. It can be truly a deal-breaker for investors in the future. And so Dustin Moskowitz, Mark, and Sean Parker started plotting, really, how to get Eduardo out.
In Mark's head, Eduardo had failed at his job. He had a bad company structure, he hadn't secured any funding, and he hadn't written a business plan. He was kind of right. And Sean could do all these things. Heck, he already started. And he made it quite clear. Insider found several instant messages discussing this with various people. He wanted to get Eduardo out, and he did. And here's exactly what he did. So an LLC had been created in Florida, but LLCs are really bad if you want to raise venture capital. That's true. There's no trickery in that. So it made a lot of sense to create a new Delaware C corporation and have this corporation absorb the Florida LLC and its IP and the code and everything. That's fine so far. Now, LLCs and C-corps work differently in one fundamental way. An LLC is a partnership between people. The rules are set in this operating agreement that defines what percentage of the partnership each member owns. Now, they are really not shareholders, but partners with a percentage of ownership. Now, in order to change that distribution, every single time, a new agreement would need to be put in place. And this is one of the reasons why LLCs are really bad for companies that are going to go through multiple rounds of funding, because you don't want to be rewriting these agreements all the time. Now, on a C-corp, on the other hand, distribution works by shares. When you own shares in a C-corp, you don't really transfer or sell those shares to anybody. Instead, when new investors come along, the company issues brand new shares to the new stakeholders. Now, issuing shares, creating shares means everyone keeps the same number of shares, but since the company has created more shares, the ones that you own represent a smaller percentage than the total. This is called dilution. Your shares are essentially diluted in value. That is again, a completely normal and expected practice companies around the world as they raise money from investors. Now, the rules of how these shares can be issued are based on a different document that's called the bylaws. Now, the bylaws are like the Constitution, the governing document for everything that the company does, and it's going to be really important in a second.
Now, in Facebook's specific case, a new C-corp was established with a shared distribution that looked something like this. Different accounts vary in the exact numbers, and we've been digging through a lot of data and documents to find the right numbers, and this is the closest that we could find, sourced from a combination of again, Business Insider articles, the book, and The Facebook Effect, another book that tells the story. Now, accounts say that when the new C corporation was established, Mark agreed to change the distribution a little bit to increase Dustin's share ownership, as well as carving out a portion for Sean Parker, while leaving Eduardo's percentage ownership untouched for now. Now, Peter Thiel and a couple of extra investors invested $510,000 via a convertible note. A convertible note is like a loan that's eventually meant to convert into equity, into stock in the company, but it happens later in the future with the next round of funding for the company. The convertible note has something called an evaluation cap, which is about $5 million in this case, which meant that when the company secured additional funding, this capital would convert to around 10.2% of the company's stock. We have a whole video detailing how these convertible notes work. We have a financial model template with a cap table section to run your own math in these cases, and I'm going to put it in the comments. But the point is, everything so far has been perfectly done by the book.
Something about this restructuring didn't sit well with Eduardo. He, he became suspicious. And it was around this time that he froze the bank account to the Florida LLC bank account, which he still had some control over. That's a fact. I'd like to freeze this bank account and cancel all existing checks and lines of credit. Now, we know about this because of the lawsuits. We know that Mark's family had to step in and inject up to $85,000 to help the company survive through these days. While Peter Thiel's money came into the company, it pays off to have rich parents. But soon enough, Peter Thiel's money came in, things continued to operate smoothly through the end of 2004, and that's when the company hit its first million users. And here comes Mark's trick. At the beginning of 2005, when signing for his 3.4 million shares in the new company, Mark convinced Eduardo to renounce the voting rights of his share years and to delegate those voting rights to Mark's shares. Now, so Mark became the only director in the company. The company bylaws and the rules allowed him to make certain decisions without the need of approval from the other shareholders. And then finally, when signing his shares, Eduardo also accepted that he was not going to be an employee of Facebook. It's going to be like, I'm not a part of Facebook. And then finally, in January, Mark finally had everything he needed to execute his plan. He issued millions of new shares, and he didn't need shareholder votes for this. He didn't even need to ask Eduardo about it because, remember, this is a convertible note. His investment is still considered a loan, so he isn't a shareholder yet. Peter Thiel and the other investors were still going to get that 10.2% on the future round of funding. It didn't matter how the rest of the shares were distributed. This was a real master plan devised over months by the Facebook team and confirmed by many leaked messages, and inspired apparently by dirty tricks that Peter Thiel had learned through his time in startup and venture capital.
Now, some accounts estimate that 9 million shares were issued by Mark during this time. And the point is that these shares were to be issued as compensation to active employees in the company in exchange for staying longer or for their hard work in the business. And this is also very normal. This is called a stock option pool, which is a common method to reward employees in startups. And once again, we made a whole video about it. The difference here is that this stock option pool was huge, and it was deliberately made to benefit, to give those shares to the existing shareholders, everyone except Eduardo, to dilute his shares without him knowing, because his number of shares was not changing. It's just that the company had suddenly created many more shares and had given them to the same people. Mark would then double the shares for Sean Parker and for Dustin Moskowitz in exchange for their commitment with the company for another year, and he would also take additional shares himself in exchange for his own involvement. Now, since Eduardo was not an employee, he would never be entitled to any of these stock options or additional shares. By April 2005, the company closed another round of funding, $12, almost $13 million, at a $98 million valuation, led by Accel Partners. And this meant once again that the company was going to issue new shares that was going to dilute everyone's shares evenly this time. And when signing these documents, that's where Eduardo finally noticed. And what was your ownership share diluted down to .03? It was never 0.3, by the way, that was just made for dramatic effect, but for the movie, works honestly pretty well. He had suddenly been diluted from 30% of the company down to under 10%. This trick was dirty, but under the scope of the documents, I think it could be justified as legal, and it was really never judged by court. They reached a settlement.
The lawsuits were settled while the book was still in process. At some point, Facebook had even removed Sovereign from the co-founder list. My name's on the masthead, you might want to check again. That's a fact. Which they had to reinstate after the settlement. Sovereign stopped working with Ben. And new interviews, he speaks rather well of Mark. He says that there are no hard feelings, but damage was clearly already done. Now, it's unclear how many shares Eduardo got after the settlement. But here's how the cap table looked when Facebook went public in the stock market with a $104 billion valuation. Eduardo Scott was 5%, that's $5 billion for a $15,000 investment and not a lot of help. Eduardo, by the way, is a nationalized American. And when being in America required him to pay a few hundred of millions of dollars in taxes, he figured that it was just simpler to renounce his U.S. citizenship and move to Singapore, where there's no dividend tax. As for Mark, when Facebook IPO'd, he still had 29% of the company. This made him officially one of the youngest billionaires in the world. And the same was for the original founding team.
Now, Aaron Sorkin, again, one of the greatest screenwriters of our time, adapted the script from the book that came out of Eduardo's side of the story. It was called The Accidental Billionaires. What's special about it is that it captures this unique moment, this moment of an angry, desperate Eduardo trying desperately to sink Mark for what he did to him. Now, you'll, you'll read dozens of articles online blasting the author, questioning the veracity or the exaggerations in the book. But after everyone became a billionaire except for the Winklevosses, I guess many of them stopped complaining. The Social Network, the film, is brilliantly written to cause this clash of feelings. It's designed to leave the role of the antagonist open. Some of you will side with Mark because you identify with his nerdy character, or because you like Jesse Eisenberg. You ever end up, uh, seeing, seeing the film, that social, it was a wizard. But some of you will side with Eduardo. He has a valid case. An agreement is an agreement, and Mark intentionally schemed to walk out of it. I don't know if Sean Parker is a douchebag as Justin Timberlake portrayed him. But who is the antagonist? Who is the good guy here? Coming away, guys. See you next week. [Music]