EXCLUSIVE: How Mark Zuckerberg booted his co-founder out of the company

Facebook co-founder, Eduardo Saverin, no longer works at Facebook.

He hasn't since 2005, when CEO Mark Zuckerberg diluted Saverin's stake in Facebook and then booted him from the company.

Saverin's exit from Facebook was the central plot of "The Social Network."

Maybe you remember this scene?

"The Social Network" is a work of fiction, of course. But it's based on a true story.

This is that story.

This is the story of how Saverin got so angry at Zuckerberg—how, from Saverin's perspective, Zuckerberg screwed him out of a huge chunk of Facebook stock.

It's also the story of how Zuckerberg solved an early problem at Facebook, one that could have potentially prevented the company from becoming the global behemoth it is today.

The story is sourced from people involved in the founding year of Facebook, people close to Facebook, and documents viewed by Business Insider.  It is an update to a previous story of ours, which included previously unpublished emails and instant messages between Mark Zuckerberg and early Facebook colleagues and confidants. This new version includes new material: Previously unpublished email correspondence between Zuckerberg and Facebook's early lawyers.

Eduardo Saverin

"A sucker born every day."

In late 2003, Harvard sophomore Mark Zuckerberg asked a Harvard student named Eduardo Saverin, a junior, to deposit $15,000 in a bank account that would be accessible to both of them. The money, Mark promised, would go toward the servers needed to host a site that Mark wanted to develop. The site would be called TheFacebook.com. Eduardo agreed.

Why did Zuckerberg choose Saverin to be his first business partner?

Zuckerberg, Facebook, and Saverin declined interview requests for this story, but we can infer some of Zuckerberg's thinking from instant messages he wrote during the time.

In one IM to a friend, Zuckerberg described his new partner, Saverin, as the "head of the investment society." Saverin was rich, Zuckerberg went on to say, because "apparently insider trading isn't illegal in Brazil." 

Zuckerberg also partnered with Saverin because Saverin gave the impression he knew something about business. Saverin was the kind of guy who wore suits to class at Harvard, and he left people—including Zuckerberg—with the impression that he was connected to the Brazilian mafia.

In another IM conversation, this one from January 8, 2004, Mark described the arrangement this way:

Zuckerberg: Eduardo is paying for my servers.

Friend: A sucker born every day.

Zuckerberg: Nah, he thinks it will make money.

Friend: What do you think?

Zuckerberg: Well I don't know business stuff

Zuckerberg: I'm content to make something cool.

So Zuckerberg appears to have approached Saverin because Saverin had money and a vision for how to make more of it. Zuckerberg, meanwhile, wanted to "make something cool."

With Saverin's money paying for the servers, TheFacebook.com went live in February 2004. It was an instant sensation at Harvard. Students from other schools quickly clamored for the site's expansion, and Mark and his colleagues obliged.

By April, the site was doing so well that Zuckerberg, Saverin, and a third Harvard sophomore named Dustin Muskovitz formed The Facebook as a limited-liability company (LLC) under Florida law.  Two months later, on June 10, 2004, a Harvard commencement speaker mentioned the amazing popularity of thefacebook.com. 

It was the high point in the relationship between the cofounders. Things quickly went south from there.

Eduardo Saverin

"I maintain that he fucked himself"

Six months after thefacebook.com launched, as the summer of 2004 began, Zuckerberg and Moskovitz moved to Palo Alto, California where they planned to work on TheFacebook.com in a rented house. Saverin went to New York for an internship at Lehman Brothers.

According to instant messages from this period, before Zuckerberg left for the West Coast, he asked Saverin to work on three things: "to set up the company, get funding, and make a business model."

Almost immediately after the move, the relationship between cofounders began to fray.

At first, it was just a cultural divide. One awkward IM exchange reveals how different Zuckerberg's life in Palo Alto was compared to Saverin's life back on the East Coast:

Saverin: So you guys go out a lot to partiens [sic] and such there?

Zuckerberg: But in general we don't do fun things.

Zuckerberg: But that's OK because the business is fun.

Saverin: Lol yeah it is fun. No fun things though?

Zuckerberg: Eh, enough.

But then Saverin did something that really pissed Zuckerberg off: He ran unauthorized ads on Facebook.

Worse, the ads were for a startup Saverin was running entirely on his own, a job boards site called Joboozle.

Zuckerberg blasted Saverin for this in an email:

You developed Joboozle knowing that at some point Facebook would probably want to do something with jobs. This was pretty surprising to us, because you basically made something on the side that will end up competing with Facebook and that's pretty bad by itself. But putting ads up on Facebook to advertise it, especially for free, is just mean.

What finally ruined the relationship between Saverin and Zuckerberg for good was Facebook's need for funding.

As that first summer went on and TheFacebook.com grew more popular than anyone imagined, the company needed money to keep running. Finding investors wasn't hard. As early as July, Silicon Valley bigwigs like Mark Pincus, Reid Hoffman, and Peter Thiel were lining up to give Mark cash. Things were going so well, in fact, that Mark soon decided to commit to the company and not return to Harvard for his junior year.

What was hard, however, was getting Facebook co-founder Saverin's attention, getting him to make a decision, and getting him to sign off on the reformation of Facebook as a company under Delaware law —a crucial step before any funding deals could be completed.

At one point, Zuckerberg emailed Saverin to offer him frequent flyer miles if it would get him out to Palo Alto. Saverin didn't take the offer. The situation soon became critical, because without financing, TheFacebook.com would end up running on Zuckerberg family loans.

Eventually, Zuckerberg decided to solve the problem by cutting Saverin out of the company.

In an IM with Moskovitz, Zuckerberg explained why:

I maintain that he fucked himself…He was supposed to set up the company, get funding, and make a business model. He failed at all three…Now that I'm not going back to Harvard I don't need to worry about getting beaten by Brazilian thugs.

Sean Parker Ellis Hamburger, Business Insider

"I'm just going to cut him out."

When Zuckerberg and Moskovitz moved out to Palo Alto in June 2004, they ran into Sean Parker, an Internet startup kid best known for cofounding Napster. Parker soon joined TheFacebook.com.

Parker's first task was to do one of things Saverin was supposed to do, but hadn't yet: help Facebook find money.  Parker had raised money for Napster and he knew his way around Silicon Valley. He quickly proved himself capable. For Zuckerberg, this only reinforced the idea that Saverin was expendable.

The only problem was: How would Zuckerberg cut Facebook's third-biggest stakeholder and co-founder out of the company?

In an IM exchange with Parker after a meeting with Peter Thiel, who would soon become Facebook's first outside investor, Mark and Sean discussed the Saverin problem. Zuckerberg hinted at a hardball solution, one based on some "dirty tricks" used by Peter Thiel.

Thiel had learned these tricks, Parker said, from one of the most legendary venture capitalists in the Valley, Michael Moritz of Sequoia. Sequoia has funded Google, Yahoo, PayPal, Zappos, and many other massive tech companies.

Parker: Peter [Thiel] tried some dirty tricks. All that shit he does is like classic Moritz shit.

Zuckerberg: Haha really?

Parker: Only Moritz does it way better.

Zuckerberg: That's weak.

Parker: I bet he learned that from Mike.

Zuckerberg: Well, now I learned it from him and I'll do it to Eduardo.

In later emails and IMs, we learn what "dirty tricks" Zuckerberg intended to pull to get TheFacebook.com funding without having to wait for sign-off from Saverin.

His plan: Reduce Saverin's stake in TheFacebook.com by creating a new company, a Delaware corporation, to acquire the old company (the Florida LLC formed in April), and then distribute new shares in the new company to everybody but Saverin. Mark discussed this plan with confidants over IM several times.

Here's one instance:

Confidant: How are you going to get around Eduardo?

Zuckerberg: I'm going to buy the LLC

Zuckerberg: And then give him less shares in the company that bought it

Confidant: I'm not sure it's worth a potential lawsuit just to redistribute shares. You have nothing to gain.

Zuckerberg: No I do because until I do this I need to run everything by Eduardo. After this I have control

In another, Mark writes:

"Eduardo is refusing to co-operate at all…We basically now need to sign over our intellectual property to a new company and just take the lawsuit…I'm just going to cut him out and then settle with him. And he'll get something I'm sure, but he deserves something…He has to sign stuff for investments and he's lagging and I can't take the lag."

Zuckerberg pulled the trigger, sending an email to his lawyer telling him to put the plan into effect.

In this previously unpublished email, Zuckerberg writes of Saverin: "Is there a way to do this without making it painfully apparent to him that he's being diluted to 10%?"

In response, Zuckerberg's lawyer issues a prescient warning:

"As Eduardo is the only shareholder being diluted by the grants issuances there is substantial risk that he may claim the issuances, especially the ones to Dustin and Mark, but also to Sean, are a breach of fiduciary duty later on if not now. "

The plan works

In the middle of that summer, Zuckerberg's plan to oust his cofounder went off without a hitch.

On July 29, 2004, the new company, TheFacebook.com was incorporated in Delaware. Then it acquired the old company, formed back in April as an LLC in Florida.

On September 27, 2004, Peter Thiel formally acquired 9% of the new company with a convertible note worth $500,000. Before the transaction, Facebook ownership was divided between Zuckerberg, with 65%, Saverin, with 30%, and Moskovitz, with 5%. After the transaction, the new company was divided between Zuckerberg, with 40%, Saverin, with 24%, Moskovitz, with 16%, and Thiel with 9%. The rest, about 20%, went to an options pool for future employees. From there, a good chunk of equity went to Eduardo's replacement, TheFacebook.com's new COO, Sean Parker.

On October 31, 2004, Saverin signed a shareholder agreement that alloted him 3 million shares of common stock in the new company. In the agreement, he handed over all relevant intellectual property and turned over his voting rights to Mark Zuckerberg. Zuckerberg became Facebook's sole director.

On January 7, 2005, Zuckerberg caused Facebook to issue 9 million shares of common stock in the new company. He took 3.3. million shares for himself and gave 2 million to Sean Parker and 2 million to Dustin Moskovitz. This share issuance instantly diluted Saverin's stake in the company from ~24% to below 10%. 

Mark's plan had succeeded. Eduardo was, for all intents and purposes, gone.

Bringing down the house

In a testament to how little Saverin was involved in Facebook's operations after Zuckerberg left Harvard, Saverin apparently only found out how badly he'd been diluted in April 2005, when TheFacebook.com sent him a letter seeking approval for its second formal round of funding.

Fifteen days after that letter was sent from TheFacebook.com's HQ, one came back from Eduardo's lawyers. The next day, Zuckerberg finally fired Saverin.

It was this moment in history that "The Social Network" attempted to capture in the scene we embedded at the start of this story.

The lawsuits predictably followed. 

First, Facebook filed a lawsuit against Saverin, arguing that the stock-purchase agreements he had signed in October were invalid. Then Saverin sued Zuckerberg, alleging he spent Facebook's money (his money) on personal expenses over the summer.

The jilted Saverin grew bitter. At one point, he reached out to Cameron Winklevoss, Tyler Winklevoss, and Divvya Narendra – the Harvard students who allege that Mark Zuckerberg stole their idea for the company in the first place.

Eventually, sources say, Saverin decided to attack Zuckerberg's reputation.

He approached Ben Mezrich—the author of Bringing Down The House, a book about how a group of MIT students made it big in Vegas—and offered him a book about how a group of Harvard students made it big in Silicon Valley.  Bringing Down The House makes its characters out to be rock stars and scoundrels; the Facebook book, Accidental Billionaires, does the same.

Then in 2010, Columbia Pictures made a movie based on the book. It features cocaine, models, and dark, moody, lighting from David Fincher, the director who brought you "Fight Club."  It's a good flick. Because of its source material, it makes Saverin into more of a victim than he really was.

After Saverin began talking to Mezrich, he and Facebook settled their lawsuits.  Facebook went from officially denying Saverin's status as a cofounder to listing him as one on its Web site. As a part of the settlement, Saverin stopped talking to the press.

Like the Winklevoss brothers, Eduardo Saverin clearly felt he got screwed by Mark Zuckerberg in Facebook's early days, and in one way, he did.

We can tell from the previously unpublished letter included in this story that Zuckerberg didn't really want Saverin to notice his stake in Facebook was being diluted.

But also like the Winklevosses, Saverin won huge in the end. Thanks to Zuckerberg and the rest of the Facebook team, most of Saverin's $10 billion wealth still comes from his little $15,000 investment, with no further effort from himself.

Having renounced his US citizenship to avoid paying a boatload of taxes on his Facebook wealth, Saverin now resides in Singapore.

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