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The FTC may have blessed Facebook’s purchase of Instagram, but the deal faces one more regulatory hurdle.  Facebook is asking the California Department of Corporations for a ruling this week on the “fairness” of its plan to issue nearly 23,000 shares of stock as part of its deal to buy the photo-sharing start-up.

It’s because of that stock that the deal is worth considerably less than the $1 billion price tag that raised eyebrows when the purchase was announced in April.  Despite rapid growth in its user base, Instagram had only 9 employees and relatively little revenue when the deal was negotiated by Facebook CEO Mark Zuckerberg.

But the acquisition was structured so that Facebook would give Instagram roughly $300 million in cash, plus stock valued then at $700 million. Facebook’s stock today is worth roughly half that amount, which means the deal is worth considerably less.

Rather than go through a more cumbersome process with federal securities regulators, Facebook has opted to seek the state’s approval for its plans to issue stock to Instagram.  That shouldn’t be difficult to get:  Experts say the state’s hearing, scheduled to be held tomorrow in San Francisco, will focus on whether Instagram’s current owners object to the deal.

“Is it fair to (Instagram) shareholders that their revenueless company now gets only $350 million of stock, or some rough equivalent, and $300 million in cash now that Facebook’s shares have declined in value?  Sure it is,” wrote Boston College law professor Brian Quinn in his M & A Law Prof Blog.  “In hindsight, taking more of that in cash would have worked out better, but the Instagram board made a reasonable bet.”

Instagram has only 19 shareholders, including founder Kevin Systrom, who owns more than 40 percent of the company.  Quinn predicted it will be a “non-contentious hearing.”

Brandon Bailey Brandon Bailey (281 Posts)

Brandon Bailey covers Google, Facebook and Yahoo for the San Jose Mercury News, reporting on the business and culture of the Internet.