Why Facebook went west

The Harvard students were Mark Zuckerberg and Eduardo Saverin, and they were at the Charles to talk with a senior associate at Battery Ventures of Waltham. It was the senior associate's job to spot interesting companies for the partners at his firm to consider as investments. (The firm where this person now works allowed him to be interviewed only under the condition that he not be named.)

He'd heard about the website that Zuckerberg and Saverin and a few other students had built because he himself was a Harvard alum, and a few days earlier, he'd run into some current students who had told him about it. It was called Facebook, and at the time it only had 1,000 or 2,000 users.

Zuckerberg told the senior associate that he was planning to go to California for the summer, and he wasn't sure whether he would return to Harvard for his junior year. Summer was less than two months away. The senior associate was pretty sure that if Battery Ventures didn't invest before then, a Silicon Valley venture firm would discover the deal. For venture capital firms, getting in first can often mean getting a bigger chunk of a start-up for less money - especially if the start-up isn't talking to other firms. And Facebook wasn't.

After a second meeting at the Charles, and a visit to Battery's offices above the reservoir in Waltham, Zuckerberg said he thought Facebook was worth about $15 million, and was willing to accept an investment ranging from $1 million to $3 million, which would have given Battery a substantial chunk of the start-up.

But Battery had already made an investment in an earlier social networking site, Friendster, which was foundering. Zuckerberg struck some partners at the firm as a little too brash. And no one was sure whether Facebook would appeal to anyone oth er than college students, its target.

There were also turf issues with Battery's Silicon Valley office, which had invested in Friendster. "There was a question about whether we on the East Coast side were going to lead an investment with a sophomore in college who was considering a move to the West," says the senior associate.

The firm passed - even though Scott Tobin, the Battery partner who evaluated the opportunity, could have invested a few hundred thousand in Facebook without putting the deal to a vote of all the partners. (Tobin had earlier invested in Akamai Technologies Inc., now a member of the S&P 500 index.)

Zuckerberg, who grew up in Westchester County in New York and attended Phillips Exeter, went to California in June 2004 with two of his Facebook cofounders.

Through a chance connection, Zuckerberg was introduced to Peter Thiel, a cofounder of the online payment system PayPal, who was running a hedge fund called Clarium Capital. He met with Thiel in August, at Thiel's office in downtown San Francisco.

Thiel had also been an investor in Friendster, and he knew that the conventional wisdom was that all the social networking sites "were just fads that would come and go," he says. Thiel listened to Zuckerberg's pitch in the morning, asked him to go out and grab lunch, and by the time Zuckerberg returned in the afternoon, "we said we'd invest, and we agreed to the basic valuation parameters," Thiel says.

"It seemed like a good company," he said, adding, "Most of the time, we're not that fast."

Thiel put in $500,000 of his own money in return for 10 percent of the company.

Zuckerberg set up shop in Palo Alto, and by the end of the year, Facebook was approaching a million users. In 2005, the company took in $12.7 million from the Silicon Valley firm Accel Partners, and by the end of that year, the site had more than 5 million users, having decided to allow high school students to join.

"Facebook was perhaps the most controversial deal we've done in several years," says Jim Breyer of Accel Partners. "Some of my best friends in the business were wondering why we'd write a check to a company that had very little defensibility to their business." Indeed, anyone could potentially build a better site and lure Facebook's users away.

Last year, the company passed 12 million users, and raised another $27.5 million; this time, Greylock Partners, a Waltham firm that has a branch office in San Mateo, Calif., invested. Greylock partner David Sze, who works on the West Coast, admits that he had the opportunity to invest in Facebook in 2005, but says, "I was too busy - I just didn't have the cycles to look at it. In retrospect, that was a mistake."

Facebook now has 39 million users and is the sixth most popular website in the United States, according to the measurement firm comScore Inc. An average of 150,000 new users create a free Facebook account every day, according to the company.

A Bear Stearns analyst recently estimated that the company, which has already spurned several acquisition offers, is worth as much as $6 billion, and will bring in about $140 million in revenue this year. That's with just over 300 employees.

(Looming over Facebook's success - and any eventual public offering - is a lawsuit filed by several fellow Harvard students who allege that Zuckerberg built Facebook using software code he had originally written for their site, ConnectU.com, and that he also borrowed parts of their business plan. A Facebook representative said that none of its founders were available to comment.)

What makes Facebook so appealing is that once users join and create connections with their friends and colleagues, it becomes an incredible hub of information: friends can share photos, tell you where they are, show what music they're listening to, what parties or conferences they're planning to attend, or how much money they've raised for next weekend's charity walkathon.

Facebook also decided, in May, to allow other companies to develop applications that users can easily incorporate in their profile pages. Each of these apps - there are now more than 3,000 of them, according to the tracking firm Adonomics - adds new features without the company investing a penny. And unlike MySpace, Facebook is allowing the companies that develop these apps to use them for marketing purposes or to make money, which provides a great incentive.

So even if Boston didn't end up as Facebook's home base, there are plenty of companies here now developing applications for it. Needham-based TripAdvisor, Inc. offers a world map that you can stick virtual pushpins in, to show your friends where you've been.

Fafarazzi.com in Somerville has an app that allows Facebook users to send each other photos of celebrities, to reflect their mood. StyleFeeder Inc., a Cambridge shopping recommendation service, launched an app in June that has since been installed by 45,000 people.

"We don't want to make Facebook the cornerstone of our growth strategy, but we're happy to ride the wave," says Dina Pradel, StyleFeeder's vice president of marketing.

Could Facebook have succeeded if it had gotten an investment locally before Zuckerberg & Co. went West, and kept its headquarters here?

When I put that question to Accel Partners' Breyer, who is a native of Natick, he had a one-word answer: no.

"So many of the Facebook employees have come from top Internet companies like Yahoo, eBay, and Google that the culture that has been built at Facebook is fundamentally more consumer Internet savvy than if it would've been built anywhere else on the planet," Breyer says, after praising the engineering talent in Boston.

"Folks in the Valley are incredibly geo-centric to a point of snobbery," writes Battery Ventures' Scott Tobin via e-mail. He acknowledges that Silicon Valley is producing more companies than Boston but "to make an argument that great companies can't be built in any one place is bunk in my mind."

He mentions Microsoft Corp. in Redmond, Wash., and Qualcomm Inc. in San Diego as examples. "It just takes a good driving attitude to make it happen."

As for passing on Facebook, "that may turn out to have been a mistake," Tobin admits.

Innovation Economy is a weekly column focusing on entrepreneurship, technology, and venture capital in New England. Scott Kirsner can be reached at kirsner@pobox.com.