Friday, January 21, 2011

How many rich fools are there?

Two weeks ago we were inundated with reports that Goldman Sachs was launching a private fund, open exclusively for its rich retail cients, that would invest in the still private shares of Facebook. Facebook, as we all know, is the current darling in the tech industry, and is widely expected to be a sure seller in a potential IPO.

Nonetheless, there was something peculiar about the financing route taken by Facebook, as arranged by Goldman Sachs. It was going to do a private placement transaction, and rather than do a public listing via the IPO, it was going to place share via this fund set up exclusively for Goldman clients. Now a lot of people have speculated about the reasons for this: that founder Mark Zuckerberg doesn’t really want Facebook to be a public company, what with all the public disclosures and the public scrutiny that comes with being public. It was speculated that he wanted to get the benefits of a widely held share base, via the Goldman fund, without the costs of being public. Should he or any of his staff ever want to unload his shares, he does not have to go through the public market, and would just sell it to this fund composed of his rich admirers.

Now the question I have yet to see asked, or answered, is just what kind of investor is interested in this kind of investment? What motivates them to put a minimum $2 Million dollars of their money to take part in what probably has to be the most non-transparent financing in history?

Let’s ask the following questions, for example: Did the investors in the fund see an actual prospectus detailing Facebook’s operations and detailed financial statements? Did they get to see adequate disclosures about Facebook’s major suppliers, directors, employees, partners, ventures, and activities, so as to give them adequate confidence that they are getting what they are paying for? (The transaction puts Facebook’ value at about $50 Billion).

Now given that they are buying into a fund, and not individually as shareholders, they are likely buying without the requisite voting rights. And though the fund itself may have some voting rights, will the voting control be large enough to matter in Facebook decisions? Sure, investors give up their proxy votes to fund managers all the time when they put money into funds, but they are putting their money into a fund that owns nothing else but Facebook shares. Are these investors confident that the fund manager (that would be Goldman) has their best interests at heart, or should they be worried that their interests are subordinate to the lone client at the other end of the transaction (that would be Facebook)?

How about selling their shares? Since they are essentially buying into a fund that is closed to people who are not Goldman clients who already have $2 Million in change lying around, are they essentially buying into an illiquid investment? And how long do they expect to hold onto the investment? Should they ever need the money ASAP, will they get it without large haircuts on their investment?

These questions lead me to believe that there can possibly be two strongest motivations or reasons any investor have in joining this elite group of Facebook ‘friends’. They are either, as I said, the biggest Zuckerberg fans, who believe in his long-term vision of growing the company…. or they are pure speculators who know a Facebook IPO is on the horizon. They are buying blind into an entity with negligible voting rights, at a stage when Facebook is expected to provide negligible disclosures (otherwise Facebook would have done the IPO now, outright), and at terms that clearly give Facebook the upper hand (they are investing into a fund investing exclusively in Facebook shares).

My guess is that more of the eventual investors came from the latter, and many probably had their eyes on an IPO exit from the get-go. In short, they are rich dudes praying for the IPO to happen, and hoping for greater fools to come begging for shares down the line (unless Facebook does eventually show reasons for them to stay, in pubic disclosures later on).

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