McNamee, a co-founder of the private equity firm Elevation Partners, whose best known principal is the musician Bono, knows a thing or two about the shadowy markets where private start-ups like Facebook trade hands. His fund paid $120 million over the summer for a stake in Facebook that valued the company at just $14 billion. On paper, McNamee has more than tripled his money in just over six months.
But McNamee is starting to worry about a spate of copycat offerings that may come along in the coming months from dozens of Internet companies spurred by overzealous investors.
“If history is any guide, both sides will eventually overplay their hand on this, eventually leading to problems,” he said, resigned that the boom in private fund-raising may end badly. Venture capital investments used to be made only by venture capitalists – professionals with an appetite for risk.
But today, with billiondollar rounds of fundraising for the likes of Facebook and Groupon, money is flowing into these businesses from big institutional investors to wealthy individual clients of Goldman Sachs to plain old retail investors.
Then there are more indirect ways to buy into the hot private stocks. Some financial firms are creating vehicles, giving wealthy individuals a chance to get in on the action in secondary markets, where Facebook, Groupon, Zynga and other tech startups are trading at a frenetic pace.
Last week, a group of technology executives started a closed-end mutual fund that will try to buy shares directly from companies or on private exchanges. Think of the soon-to-be publicly traded NeXT BDC fund as away for mom and pop to acquire shares of Facebook without being a wealthy client of Goldman Sachs. According to McNamee, investors are handing over money by the boatload because of a deep-seated insecurity of missing the next big thing. Call it the Google Effect.
“Almost every institutional investor screwed up Google’s IPO by not buying aggressively. No one wants to repeat that mistake with Facebook,” said McNamee, referring to the fact that Google’s original price at its public offering was a measly $85 a share; the company’s shares closed on Monday at $614.21.
Memories might be long about the Google IPO, but that does not mean that investors should take the plunge. Those heaving money at companies like Facebook are doing so with only a modicum of information about the companies’ performance.
In the case of Facebook, investors were told only about the company’s revenue and profit for the last two years – hardly the kind of granular detail that most investors, even rich ones, typically require.
“Let’s call a spade a spade,” said Barry Schuler, managing director of the venture capital firm Draper Fisher Jurvetson. “This is a faux IPO, no matter how you slice it,” he said of last week’s private Facebook offering.
Investors “are just going on Goldman’s word and Facebook buzz, and they’re bypassing all the regulation that a public company has to comply with.” He added, “A lot of people are stepping back and saying, Isn’t this the kind of behaviour that created the last two meltdowns?”
Not all Wall Street denizens are worried. “It’s high stakes. But I don’t think it should be outlawed,” said Alan J Patricof, a long-time venture capitalist who was an early investor in Apple. “There’s a large amount of individual investors that would like to participate in this. It may be a new really late stage form of venture capital”. For companies, raising money in the private market over pursuing an IPO makes eminent sense.
“An IPO is like a bomb,” McNamee said, ticking off a list of downsides of going public: extra scrutiny, compliance costs and schadenfreude from rivals.
“It creates a big crater, whereas these private offerings are like a laser beam. They allow issuers to raise large amounts of capital with a minimal regulatory or governance burden.”
And for investors, “the benefit of these deals is the ability to buy a substantial block of stock, something that is not possible in the IPO market,” McNamee said.
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