Goldman Sachs’ old-school Facebook deal brings a new set of challenges. The bank is raising up to $1.5 billion from clients to invest in the social network while putting in $450 million itself. Like Morgan Stanley’s reported deal with online coupon service Groupon, it looks like classic merchant banking. With hot firms in the driver’s seat, however, the banks could find themselves in for a wild ride.
Internet darlings, with their growth, profitability and cash, face little pressure to go public yet still have some use for what a fundraising can provide. So instead of an IPO, they rely on so-called D-rounds. This allows them to raise money at favorable valuations for internal use, while buying stock back from employees or early-round investors who want to cash out.
It’s a calculated pay-to-play on the banks’ part. By stumping up for Facebook and Groupon, Goldman and Morgan Stanley put themselves in a strong position to underwrite the eventual IPOs. They make the tech firms happy by providing stronger headline valuations, in Facebook’s case $50 billion. And the intermediaries score points with their well-heeled clients by enabling them to put money into hard-to-access investments.
Finally, the deal appears to align the interests of Facebook, Goldman and its customers. During the dot-com bubble, stocks of unprofitable – and often revenue-less – companies were floated cheaply to orchestrate a first-day pop. But when Facebook does go public, Goldman should be well incentivized to convince the market Facebook is worth well north of $50 billion.
The arrangement isn’t all rosy, though. Regulators may question whether Goldman’s Facebook collective skirts the spirit of a rule that private companies either disclose more information or go public once they reach 500 investors. What’s more, it creates a potentially risky triangle of expectations that may make setting a stable IPO valuation more difficult.
Investors are baking an extraordinary amount of growth – far greater profit gains than the average company for a decade – into their Facebook valuation. It’s true, many scoffed at the $15 billion valuation ascribed to the social network following Microsoft’s investment three years ago. But any sign that Facebook is slowing down could create headaches for the bank now at the center of the situation. Another year, another sticky situation for Goldman to manage.
Robert Cyran is a Thomson Reuters Breakingviews columnist based in New York.