Why Facebook’s investors want it privately-traded

January 6, 2011
John Abell asks a very good question about a privately-traded Facebook:

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John Abell asks a very good question about a privately-traded Facebook:

Aren’t all the people investing at this moment assuming that a $50 billion valuation is a bargain? What will drive a higher valuation — let’s limit it to the Goldman Sachs Golddiggers — that makes the investment savvy?

Can a relatively illiquid market (one open to only ultra-high net worth individuals) do that? Or are these new investors buying at what they hope will be pre-IPO bargain prices? Would they otherwise, i.e., would they put up $2 million to get a upside potential based solely on privately-reported earnings?

For the answer, it’s worth looking to Justin Fox. Yes, public markets are much more liquid and transparent than private markets. But, as accounting firm Grant Thornton says,

Generally speaking, economists and regulators have maintained that competition, and reduced transaction costs are of great benefit to consumers — but only to a point. When it comes to investments, higher front-end or transaction costs and tax structures that penalize speculative (short-term) behavior can disincent speculative behavior and incent investment (buy-and-hold) behavior that may be essential to avoiding boom-and-bust cycles and maintaining the infrastructure necessary to support a healthy investment culture. As markets become frictionless (i.e., when there is little cost to entering into a transaction), it becomes easier for massive numbers of investors to engage in speculative activity.

Goldman is requiring that investors in Facebook commit to holding their shares for an indefinite period of time: the bank does seem to be making a good-faith effort to find long-term investors rather than people looking to flip their shares the minute there’s an IPO. And for those people, the speed and efficiency of public markets, where the average stock is held for just 22 seconds, looks much more like a bug than a feature. It means that stocks become highly correlated with each other, and that the value of a stake in Facebook becomes much more a function of the performance of the stock market as a whole than it is a reflection of the value of Facebook.

Goldman’s clients are looking for uncorrelated investments, and Facebook will become much more correlated to other stocks the minute it becomes public. That’s why the clients will be happy with Facebook remaining privately-traded. After all, private markets have already bid the value of Facebook up to $50 billion: there’s no reason why they can’t bid it higher still.


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