They have agreed to drop their lawsuits and license each other's patents.
They are also agreeing to an advertising alliance that expands their existing partnership.
Friday's settlement comes after a months-long patent squabble between the two Internet icons.
The advertising alliance could help Yahoo recover some of the revenue that it has been losing to newer companies such as Facebook.
For Facebook, the deal ends a potential distraction less than two months after it went public. Although it has been growing at a robust clip, Facebook is still trying to win over skeptical investors. Its stock is trading below its $38 IPO price.