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Wednesday, January 5, 2011

Goldman Sachs and Facebook

This story is interesting. Goldman Sachs made an investment in Facebook, giving it a valuation of approximately $50B. They are going to package the shares up and sell them in a special hedge fund.

Those two zero hedge articles were interesting. Goldman Sachs profits from the lucrative hedge fund management fees. It makes no difference if Facebook shares go up or down. It makes no difference if the clients make money or lose money. Even if Facebook goes bankrupt in 3-5 years, Goldman Sachs might make more money off the fund management fees than they lost on the equity "investment".

A lot of hedge fund money is "stupid money". Many hedge fund investments are pension money, where the manager is wasting other people's money. A typical deal is "I'll invest in your fund if you hire my brother-in-law/friend." It's corruption capitalism.

I wonder if the "man of the year" was arranged by Goldman Sachs, so that they could have an easier time peddling Facebook shares.

Suppose I create a corporation. I issue 10 billion shares. I sell you one share for $1. Does that mean my corporation is now worth $10B?

Similarly, this deal doesn't mean Facebook is worth $50B. Goldman Sachs only paid for a tiny slice. According to what I read (but some sources disagreed), other Facebook shareholders did *NOT* have the option of selling their shares at the $50B price. Facebook employees did not have the option of selling their "units" at the $50B price. The investment went to Facebook, buying newly-issued shares.

Goldman Sachs has an incentive to overpay for Facebook. Why? Goldman Sachs is creating a special hedge fund, which will only own Facebook shares. Goldman Sachs will now sell Facebook shares to "clients" at a valuation of $50B or more!

Why does this matter? Facebook is *NOT* a public corporation. Partially due to Sarbanes-Oxley compliance costs and other costs, Facebook remains private.

However, the SEC has a rule "Any corporation with 500 or more shareholders must make a SEC filing, even if its shares are not listed on an exchange." Facebook and Goldman Sachs are exploiting legal loopholes and technicalities.

Facebook no longer gives its employees share grants or stock options. Instead, employees get "performance units". These units track the share price. However, they don't have the same rights as shareholders. They are only convertible to shares when/if there's an IPO. Employees can't sell the "units" like they could sell shares. (If you own shares in a pre-IPO corporation, you may sell them. You can't sell them on an exchange, but you can make an OTC sale to anyone. Facebook "units" aren't real shares, so the employees can't do this.)

Goldman Sachs is creating a special hedge fund that will invest in Facebook shares. Legally, this counts as only *ONE* Facebook shareholder, no matter how many hedge fund shareholders there are. The hedge fund is the legal owner, and not the hedge fund investors. Goldman Sachs can sell these hedge fund shares to 1000+ people, and Facebook still isn't breaking the "500 shareholder" rule. It's a legal technicality.

Facebook's "units" and Goldman Sachs' special hedge fund are explicitly designed to dodge SEC rules. Unfortunately, the SEC is a "captured regulator". Facebook got an SEC waiver, for their "units" arrangement. Goldman Sachs probably also got legal permission.

Here's another story that illustrates how sleazy Mark Zuckerberg and Facebook are. Some early Facebook employees hit the jackpot on their options. Rather than let the options vest, Facebook fired them and hired cheaper replacements. Those replacements also had equity grants waived in their face! Facebook had a much higher valuation by then, and the grants were smaller.

This illustrates the fallacy of getting paid equity/options instead of cash. Suppose a Facebook employee was hired when Facebook had a valuation of $50M. Suppose that, eleven months later, Facebook had a valuation of $500M. With one year cliff vesting, that employee can now be fired and the options were worth $0. Even if some options did vest, firing the slave means you don't have to pay out the rest of them.

If you own options that are somewhat in-the-money, the value of the unvested options gives the employer less incentive to offer you a raise. Suppose I work at a startup, and I have unvested options worth $100k over two years. I don't have the leverage to ask for a cash raise, because I give up $50k/year if I quit.

As a minority shareholder, there's too many ways to get cheated. Eduardo Saverin made an early cash equity investment in Facebook, and was cheated. Mark Zuckerberg re-incorporated Facebook, moved the IP, and left Eduardo Saverin with nothing.

You don't get to be the CEO/owner of a large corporation, without being a sleazy character like Mark Zuckerberg. He's the role model. The people he robbed were clueless losers who deserved it. Does Mark Zuckerberg really have awesome business skills? Or, was his best skill that he cheated his early partners out of their share of the business? I haven't met him, so I can't be sure, but he's probably a psychopath.

Facebook and Goldman Sachs are using legal loopholes to avoid SEC rules. Unfortunately, the SEC is a captured regulator. The people disadvantaged are Facebook "units" owners, Facebook minority shareholders, and Goldman Sachs' "special hedge fund" customers.

The "special hedge fund" customers have less rights than shareholders of a public corporation. They can only sell their hedge fund shares if they find someone else dumb enough to buy them. They have to pay a hefty management fee to Goldman Sachs.

Facebook shareholders and "units" holders were not allowed to sell at the $50B valuation. (I read different opinions on that. I'm pretty sure that all Facebook shareholders and employees didn't have the option of selling at the $50B valuation.) The hedge fund shareholders probably won't be able to convert their investment to Facebook shares, until an IPO.

Facebook probably isn't really worth $50B. Goldman Sachs had an incentive to overpay. They can trick customers into buying at even-higher prices. Goldman Sachs makes money off the lucrative management fee, even if the underlying Facebook investment tanks.

Suppose that I believe that public XYZ corporation is overvalued. I can short-sell or buy put options. Suppose that I believe that Facebook is overvalued. I can't short sell. In fact, Goldman can now short sell Facebook! They can sell more "hedge fund shares" than they own Facebook shares! They can bet against their own hedge fund! It's like "The Producers"!

You might say say "So what? Some idiot hedge fund investor loses money. Why should I care?" Suppose the NY State pension fund invests in this turkey, and loses money. Then, I pay higher taxes to support the pensions. The pensions who make lousy investments may be later bailed out.

Facebook and Goldmans Sachs are flagrantly ignoring SEC rules. They are exploiting legal loopholes to dodge the "A corporation with more than 500 shareholders must make a SEC filing." rule. The Goldman investors are getting a worse deal than a straight equity investment in Facebook, because they have limited liquidity and they pay a hefty management fee to Goldman Sachs. Goldman Sachs makes more money off the hedge fund management fee than off anything else. In fact, Goldman Sachs (or other hedge funds) can now short sell this fund, and bet against Facebook! Goldman Sachs might maximize profits if Facebook tanks, if the "right" people short sell that hedge fund!

If the SEC wasn't a "captured regulator", they wouldn't allow nonsense like this.


Anonymous said...

I once worked for a little tech company. I was promised share options. I got a letter telling me how many I owned after working there for a time. A week or two later I was fired.

The only tech people they fired (that were not managers) were people that had been there long enough to own share options.

Laughingly the new director of software at the company went around one day telling a couple of employees they were not eligible to share options because they had to be in the company 1 year after a general company meeting where share options were discussed. These two employees believed when they joined the company they only had to be in the company 1 year to be eligible. As one of them pointed out the revised method stretches 1 year into 2 years i.e. you wait a year for a company meeting and then it is a year after that.

The big joke was the director had a document of company share rules but this document was clutched close to this chest so nobody could see it. The document was not distributed so theoretically the company directors and managers could change the rules over time and nobody would be the wiser.

The company was sold later after I was fired. The incumbents and people hired because there was friends of managers got big payouts.

I got nothing.

Scott said...

Agree with your article.

Goldman's scheme and fixing the Time vote worked to fan the flames of hysteria.

WSJ just announced that the hedge fund is bought out at full value. Sounds like this means that Goldman's was able to "flip" the dud investment, and now will get rich running a private exchange in the guise of a fund, with the actual value of the company irrelevant.

Just more scams from these con artists

Anonymous said...

Anonymous' story about options is exactly what happened to me on several different occasions.

With rare exceptions, shares and equity granted to non-founders, non-VCS is utterly useless, nothing more than a scam. It doesn't matter that it's all in writing and signed, it's been worded in such a way that you get nothing no matter what happens.

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