So if you’ve been hoping to get in on the ground floor of the social network’s much-anticipated initial public offering, you might want to take to heart the advice recently offered by Facebook’s young founder, Mark Zuckerberg, when asked about an IPO: “Don’t hold your breath.”
Goldman is hardly the first blue-chip investor in Facebook. The first wave included some of the biggest names in venture capital — Peter Thiel and his partners at the Founders Fund, Jim Breyer and his colleagues at Accel Partners, and the investors at Greylock Partners. Then came Microsoft; Asia’s top billionaire, Li Ka-shing; and Bono and his colleagues at Elevation Partners. Then, last year, Facebook tapped into Russian coffers with an investment from steel-and-telecom oligarch Alisher Usmanov and his holding company, Digital Sky Technologies.
(Full disclosure: The Facebook board of directors now includes Washington Post Co. Chairman Donald E. Graham.)
With each new wave of private investment, Facebook has gained not only the cash it needed to grow but also the cachet to lure still more high-profile investors. And with each round, the company’s estimated market capitalization reached another eye-popping milestone such as this week’s $50 billion valuation.
It’s pretty clear that Facebook could achieve an even higher valuation through a public stock offering, but Zuckerberg and his directors know that’s not how the smart game is played. Rather, the better strategy is for the hot company and its hot investors to play off each other’s reputations, creating such excitement and pent-up demand for Facebook shares that when the public offering finally comes, the full value has already been captured by insiders — and the first wave of public shareholders can be played for suckers. Think of it as a sophisticated update of the old “pump-and-dump” strategy.
In the meantime, many of the insiders are reaping immediate benefits. The venture capitalists are leveraging their Facebook success to lure new investors. The share prices of Microsoft and the publicly traded arm of Digital Sky Technologies have shot up. And Goldman is anticipating $60 million in fees for placing its clients’ money in Facebook plus a cut of 5 percent from any profit they earn — that, along with hundreds of millions of dollars it will almost certainly collect as the lead underwriter for the Facebook stock offering, whenever it finally occurs.
It’s not just Facebook that is following this new strategy. So are Groupon and Twitter and game maker Zynga. By keeping it an insiders’ game for as long as possible, the founders and the insiders will capture most of the long-term value of companies whose dominant market positions are likely to prove short-lived as new technologies come along. An IPO will probably mark the high-water mark in terms of the growth rate of these firms, although investors are almost certain to believe otherwise.
Securities laws are designed to protect outside investors from this kind of manipulation. Any company that takes on 500 investors is supposed to make full public disclosures about all of its activities, just like a publicly traded company. But those clever Wall Street lawyers have figured out that if dozens or even scores of rich investors pool their money and buy their shares through a special-purpose vehicle or a private-equity fund, then each group can be considered a single investor. The Securities and Exchange Commission is not so sure, but if recent rulings are any indication, the courts are likely to buy into this fiction.
Of course, we’ve seen this movie before. During the tech-and-telecom boom of the late 1990s, Wall Street firms rigged the game by using analysts to overhype the prospects of the companies they were taking public and allocating most of the initial shares to themselves and their rich clients. What’s going on now is just an updated variation.
I’m not sure there is anything to do about this “injustice” other than to expose it. After all, nobody promised that financial markets would be fair to the average investor. In a free country and a free market, successful companies such as Facebook ought to be free to sell their shares to whomever they want, whenever they want, at whatever price they can get, as long as they don’t misrepresent what they are doing or their results.
At the same time, the rest of us should understand that the world of finance and investment continues to be rigged in favor of insiders and those rich enough to have access to the best investment opportunities. The “democratization of finance” has proven to be nothing more than a marketing ploy to give investment houses and money managers a bigger opportunity to pick the pockets of the middle class. And while I can’t quantify it, I’m fairly certain this disparity of investment opportunities and outcomes has made a significant contribution to the widening gap in income and wealth between the super-rich and everyone else in America.
So, yes, let’s celebrate the ingenuity and success of companies such as Facebook and enjoy the cool new services they provide. But let’s also remember that by the time those companies’ shares are available to the rest of us, most of the financial bonanza will have already been captured by someone else.