I simply love Goldman Sachs. The Facebook deal is a brilliant poke in the eye for just about everybody, and proof, yet again, that money, like water, finds its own level. If there are buyers and sellers to be matched, and a fee to be made in the process, the fine folks at Goldman Sachs will figure out how to bridge that gap. So much the better if there is regulatory friction to arbitrage against, it simply raises the fee.
For the last seven years, the venture capital industry has been saying that the IPO process is broken and start ups are the losers. In a fine display of Wall Street’s can do attitude, Goldman has gone and produced an alternative to an IPO; one where the clear winner is the start up. Make no mistake; this is a great result for Facebook. Consider the alternative. Going public is hard, and being public is harder. This is true for a company like Facebook, not because of the cost of Sarbanes Oxley compliance, which would be more than manageable, but because of the insidious nature of being public and having a focus on quarterly earnings, governance and the stock price. No matter how hard you try to avoid becoming short term focused, the constant drip of analyst meetings, quarterly updates and daily stock price tickers takes its toll. Your earliest and best employees, fully vested and now fully liquid, leave, and instead of building a company, the CEO is getting on quarterly analyst calls.
The best reason to go public was to get the money. Conventional wisdom used to say that the only way to raise $1BN plus, at an attractive valuation, was to provide investors in return the transparency and the liquidity that being a publicly traded stock entails. The company puts up with the analysts, the information requests and the quarterly filings in return for getting the cash. Goldman has given Facebook all of the benefits and none of the negatives of a public offering. They should have a happy client.
It is of course axiomatic that the other clear winner here at least in the short term, is Goldman Sachs . They have made a bet with their money that will either work or not in the next two years, but along the way they will make many hundreds of millions in fees. From all accounts, their retail client base is happy to be offered the chance to invest in Facebook, and Goldman will make a 4% fee and a 5% carried interest on the deal. If they sell enough, and can sell down some of their own piece, they can be money good day one. The demand sounds like it is there.
The clear losers here are the stakeholders in the IPO process, namely the exchanges (NYSE, Nasdaq), the SEC, and arguably the large institutional investors who are restricted to investing in public securities. The dearth of venture backed IPOs in the last ten years can be looked at in reverse as a loss of market share for the “IPO and beyond” team. There are numerous privately held companies that would, in an earlier time, be public and want to be public (because the Goldman Facebook option is not available to them) and are instead still private, because the IPO process is hard and the public market investors have been gun shy. Although this has been presented as a negative for the private investors, the reality is that it is arguably a bigger negative for the exchanges and investors. The exchanges have left trading fees on the table, and the public investors have not participated in the creation of value, that has instead taken place on the private side. Anyone with a 401 K should be wishing that Facebook had gone public at a $ 5BN value three years ago. The subsequent $45BN of value creation would be dispersed across thousands of 401k’s and not concentrated here in Silicon Valley.
What about the new investors here, are they winners? The honest answer is who knows and who can know? Would Facebook trade today at $ 50BN in an IPO? I don’t know. Could it be worth $100BN in the future? Quite possibly. All you can know for sure is that, because this investment is illiquid and will not be filing quarterly financial updates, the investors will not suffer the torture of knowing their investment is “under water” , if such should happen, along the way. No news means no bad news. Not, it would seem, that some of the investors care. In a wonderful quote from today’s Wall Street Journal a Goldman client said; “It’s hard to imagine how this thing is going to make money, still the deal is an attractive opportunity” . All the SEC regulation in the world cannot save people like that if they don’t want to be saved. Maybe it is best that instead, they just enjoy the privilege of being a special Goldman client.
The reality is that this is not a trend, it is a singularity. There are not ten Facebooks out there, instead there is, roughly one Facebook every ten years. As a small part of the fun of being an utterly dominant company, each decade’s winner gets to slap around the IPO process. Microsoft made the underwriters cut their commission, Google ran a Dutch Auction, Facebook for now has contracted out of the process entirely. None of this represented a trend that others could follow. For almost every other deal out there, this kind of financing is not an option and the IPO process will continue broadly as before. For those of us in the investing business who did not invest in Facebook, the only good news from this could be if the competition does sharpen the “IPO and beyond” team up a bit. The only bad news could be if the SEC, in an understandable effort to amend the rules to prevent this from happening again, changes them in such a way as to impact venture firms with more typical LP/GP structure. It shouldn’t happen, this really is a one off, but the SEC has got to be thinking dark thoughts about expanding the rule book.
Failing either of these outcomes, I am left saying bravo to the great vampire squid and the unstoppable chutzpah they have shown.
[UPDATE: The Squid Steps Back]
I wrote the above post and disappeared on Thursday into the maw of distraction that is Las Vegas for CES week. More has since emerged as the investment document gradually leaks to the press (pointing to a key difference again between this process and an IPO, where the information is available to all). Because the document slowly leaks the coverage evolves as more facts become known. It appears that Facebook has stated that they would “disclose or go public” by April 2012 because of the SEC’s 500 investor rule.
It raises an interesting question. Did they make this announcement because they were already going to hit the 500 investor limit before this deal and will have to comply with SEC regulations on disclosure anyway, or did they announce it because they never intended this “special investment vehicle” to be treated as a single investor and knew that the SEC would balk if the company took that position. Some of the early coverage seemed to imply that the company’s position was that this SIV, really was a single investor but, upon reflection, my gut is that the company and Goldman knew that this financing would not stand up as a single investor for regulatory purposes, and thus stated in the financing document that by April 2012, Facebook would disclose or go public. Given that, the timing of this financing is absolutely not an accident. The rule stated that a Company has to disclose financials 120 days after the end of the fiscal year in which the company goes above the 500 investor rule. This deal will close in early January, thus absolutely maximizing the “private time” before disclosure in April 2012. If it has closed a week earlier we would be seeing Facebook disclose all in April 2011.
The other point to note is that Facebook, contrary to some summary headlines, did not say it would go public by April 2012. It said it would go public, or comply with SEC disclosure requirements, in that time period. Facebook could easily choose not to list on the Nasdaq, but instead simply publish quarterly financial statements and thus discharge their obligations to the SEC. No analyst calls, no daily stock price, no continuous liquidity for investors.
In the end, Facebook, will almost certainly go public, because at some point it is probably less hassle to have Nasdaq manage your shareholders, than doing these more complex private deals. But the point this deal makes plain, is that for a market dominant company like Facebook, going public is not the only option and clearly, for now was not the chosen option. A world class company has been able to raise $1.5 BN plus in two days, on great terms, with little or no disclosure, road shows or any obligation to have the stock traded on an exchange. That is an amazing result. It should make the “IPO and after” crowd pause, when their best marketing approach is “go public or the SEC will get mad at you”.
Note: Goldman Sachs “Vampire Squid” Moniker Courtesy of Matt Taibbi in RollingStone
