Goldman Sachs' history of 'friending'

Goldman has already begun the process of wooing its wealthy clients to invest alongside it in Facebook, forming an investment vehicle that seeks to raise as much $1.5 billion for the Internet company.

But Goldman’s bold move is also likely to focus the attention of regulators at the Securities and Exchange Commission, which last month began an inquiry into the surge in trading shares of privately held Internet companies.

While the investment by Goldman is being hailed as a huge coup on Wall Street, the deal — in particular, the investment pool being formed for its clients — could become a lightning rod for regulators and policy makers as they examine the growing shadow market in Facebook shares.

For Goldman, the investment in Facebook is in many ways a return to the firm’s roots.

Long before Facebook became a social and cultural phenomenon, Goldman was “friending” America’s hottest companies and their chief executives, from Sears Roebuck in the 1900s to Ford in the 1950s to eBay in the 1990s. By collecting so many important friends, and obsessively tending to those relationships, Goldman generates big fees.

In addition to the potential banking fees generated by an initial public offering of Facebook, there is the unlocked paper wealth realised by Facebook chief Mark Zuckerberg and his fellow executives. Goldman, as a lead Facebook investor, will most likely have a leg up in winning the assignment to manage that money, too.

The firm’s Facebook investment came together over the last month, according to a person involved in the deal who spoke only on the condition of anonymity. After the spike in trading in Facebook over the last several months — in a November auction, Facebook shares traded at a $56 billion valuation — Zuckerberg expressed an interest in raising money to legitimise the $50 billion valuation.

Zuckerberg felt that gaining the imprimatur of a major investor at such lofty levels would validate Facebook in the eyes of its Silicon Valley competitors with whom it is negotiating deals.

Helping play matchmaker was Yuri Milner, chief executive of Russian firm DST Global, which invested $50 million alongside Goldman. Goldman has a close relationship with DST and Milner, who has emerged as a leading venture capital investor in Internet companies.

Mail.ru, the publicly traded sibling of DST Global, has an existing stake in Facebook, as well large positions in Groupon and Zynga, two other popular Web-based businesses. Goldman was a lead underwriter of Mail.ru’s successful $1 billion initial public offering on the London Stock Exchange in November.

The Facebook investment, made from Goldman’s balance sheet, also sheds light on the firm’s private equity strategy in the wake of the Dodd-Frank regulatory overhaul.

Although the Facebook investment represents a negligible percentage of Goldman’s roughly $900 billion balance sheet, it is symbolically significant because it had been unclear whether the firm would, after the financial crisis, be using its balance sheet to make these types of illiquid, risky investments.

The closest analogue to Goldman’s Facebook investment may be the firm’s longtime alliance with the New York fashion designer Ralph Lauren. In 1994, Lauren was looking for money to expand his business, and Goldman invested a minority stake and took a seat on the company’s board. Goldman underwrote Ralph Lauren’s initial public offering in 1997. Today, Lauren’s company remains a loyal client of the firm. And when Lauren sold $1 billion of stock last year to cash out one-quarter of his stake in his company, Goldman handled the trade. Perhaps even more intriguing than Goldman’s direct stake in Facebook is the “special purpose vehicle” that it is creating to allow its wealthy clients to invest in Facebook alongside the firm.

Goldman is charging stiff fees for the privilege — a 4 per cent placement fee and a 5 per cent cut of the investment’s profits, according to two people with direct knowledge of the deal. Despite the rich price of entry, the firm has told clients it suspects the deal will be substantially oversubscribed.

Clients of Goldman will have to invest a minimum of $2 million and will be prohibited from selling their shares until 2013, according to one of those people. The firm has warned prospective investors that if they invest, they will not be able to trade Facebook stock in a private marketplace.

Goldman did not pioneer this type of investment structure. Over the last several months, a number of smaller Wall Street brokerages have formed vehicles to enable individual investors to acquire shares in private Internet companies like Facebook and Twitter. Two of these brokerages are EB Exchange Funds of San Francisco and J P Turner & Company in Atlanta.

These are the vehicles that have drawn the scrutiny of the SEC. On Monday, a spokesman for SecondMarket, a leading marketplace for these transactions, said that it had received a request for information from the SEC about “pre-IPO pooled investment funds” and that it was cooperating with the inquiry.

The SEC generally requires companies with more than 499 shareholders to report their quarterly earnings and audited financial information to the public. Under a technical interpretation of the statute, the vehicle that Goldman is creating for its clients would be considered a single Facebook shareholder of record. But several securities lawyers say the SEC could argue that these structures subvert the spirit of the law and look through the vehicle to count the investors individually.

“This is one of those arcane technical and policy questions that are debated at securities law conferences,” said San Fransisco-based securities lawyer and Blue Mesa Partners managing partner Marc Morgenstern. “Companies forming today, like Facebook, are growing so quickly, and their stocks are being distributed so broadly, that they may not fit neatly within securities laws enacted decades ago.”

The SEC’s inquiry could have collateral consequences for the venture-capital firms that invest in fast-growing companies like Facebook, lawyers say.

“I would be surprised if the SEC simply creates a rule that says you must look through investment pools to determine the number of stockholders you have,” said Stephen E Fox, a securities lawyer at Herrick, Feinstein, who points out that venture capital firms have hundreds of investors, yet have historically been counted as one investor.

Although the Facebook investment looks promising at the moment, Goldman and its investors could be buying into a social networking investment mania at a nosebleed valuation. During the dot-com bubble, Goldman invested about $100 million in Webvan, the online grocer that never got off the ground and eventually collapsed in bankruptcy.

Even amid the questions over possible regulatory issues and skepticism over Facebook’s price, Goldman’s Wall Street rivals were grousing about the investment on Monday.
“Despite the vertigo-inducing valuation, any of Goldman’s competitors would have loved to have taken their place in this deal,” said William D Cohan, the author of a forthcoming book on the investment bank. “In that sense, it’s classically brilliant Goldman.”