As a former founder and CEO of a public company, I understand why Facebook founder Mark Zuckerberg wants to raise money without taking his company public. During the dot.com bubble ten years ago, many companies, including mine, went public too soon – most before they were profitable, some before they even had revenue. Nevertheless, the announced deal between Goldman Sachs (NYSE:GS), Russian investor Digital Sky Technologies, and Facebook is disturbing both because Goldman was one of the banks considered too big to fail by the Federal Reserve and because the federal regulations on how many investors a company can have before going public is being used, as regulation often is, to favor big banks and big companies.
The details of the deal as described in a New York Times article by Susanne Craig and Andrew Ross Sorkin:
Facebook has raised $500 million from Goldman Sachs and a Russian investor in a transaction that values the company at $50 billion, according to people involved in the transaction. As part of its deal with Facebook, Goldman is expected to raise as much as $1.5 billion from investors for Facebook.
Further according to The Times article:
On Sunday night, a number of Goldman clients received an email from their Goldman broker, offering them the opportunity to invest in an unnamed 'private company that is considering a transaction to raise additional capital.' Another person briefed on the deal said that Goldman clients would have to pony up a minimum of $2 million to invest and would be prohibited from selling their shares until 2013.
So what's not to like about the deal? Don't we want private sector investment? Risk taking?
Too Big To Fail
The deal reportedly values Facebook at $50 billion. Could be too much; but that's certainly a risk that Goldman and its wealthier clients are equipped to take, isn't it? Sure, unless we are expected to bail them out again if their investments go sour. Nothing substantive has changed since the last bailout , when the Federal Reserve gave Goldman 52 separate infusions with a high balance owed of $18 billion (all of which has been paid back). Goldman is, if anything, an even bigger and more important part of the entire financial structure. It's not that this one deal could even dent Goldman; still, they are playing a heads-we-win, tails-you-bail-us-out game. Goldman gets a privileged seat at the investment table; and, if it doesn't play its cards right, the bank gets lent new table stakes by the Fed at concessionary rates, while the smaller players are forced to fold for lack of capital.
We don't want the government regulating what risks Goldman and its clients take; that a sure way to freeze and politicize the risk taking and private investment we need. That means we either have to change the law so that the Fed cannot repeat the kind of bailout it did last time around – and investors know this and can act accordingly – or we need a preemptive round of financial trust-busting, leaving no entities standing that are too big to fail.
Access to Public Markets
In an over-reaction to the dot.com bust, a law known as Sarbanes-Oxley was passed requiring much greater disclosure by publicly-traded companies. A consequence of this, whether intended or not, is that small companies can no longer afford the accounting required to be public. It is also true that the transparency required of a public company may be a bad idea for a startup which has good reason to keep its successes and failures secret from competitors and imitators. Moreover, quarterly reporting with an emphasis on short term results is not a great way to run any company and can easily be a fatal distraction to a company which needs to focus on long term value.
The SEC allows a company to have up to 499 investors without being public (state law varies). A secondary market in the shares of private companies has grown up including online exchanges like SecondMarket, which says it has "More than 30,000 participants, including global financial institutions, hedge funds, private equity firms, corporations and high net worth individuals". This is a largely unregulated market in which participants invest at their own risk. An investor can decide whether she wants to invest in a company which is not making public disclosure of its results and is not regulated by the SEC.
But the restriction that a company have less than 500 investors is leading to the formation of investor pools which act as a single investor. Certainly this is legit when the investment pool, a VC firm or a pension fund, has many investments; but what if the pool was formed just to skirt the rule on having too many investors in a single private company? According to Bloomberg, the SEC is investigating this practice. It seems from the little information available, that this is exactly what Goldman is doing in the case of Facebook to allow its favored accounts to buy shares.
I'm not convinced more regulation by the SEC is a help to anyone; the illusion of oversight is dangerous to investors. Remember Enron and Bernie Madoff – remember the underreporting of underfunded pension plans, particularly in the public sector, and all those publicly-traded banks which were suddenly insolvent. An honest caveat emptor might be more helpful. The simplest thing may just be to lift the arbitrary limit on the number of investors a company can have without being forced to be "public".
There certainly shouldn't be one rule for Goldman and its clients and another rule for everyone else. Small companies need access to risk equity (not a guarantee of funding, just access) to allow them to compete with companies big enough to make their own deal with Goldman.
See Socialist Senator Sanders Saves Capitalism for more on the bailout of Goldman.
See Public Company – Deciding To Do It for the price a small company makes pays to go public.
See AT&T: Lesson From the Crypt #1: Don't Manage for Quarterly Results for why neither large nor small companies should manage for quarterly results.