Facebook has 499 New Friends Almost
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Facebook has 499 New Friends Almost

Bar & Bench

Lexpert analyses the Goldman Sachs strategy of evaluating Facebook at $50 billion and how the investment banking firm went all the way to close the deal. The roleplay of Section 12(g) of the Securities Exchange Act has been discussed alongside bearing in mind the total number of investors below 500 in Facebook.

If it makes real money, Goldman Sachs is in it. And everyone believes Facebook will probably make real money someday. So it was no surprise that these two would get together sooner or later. And when they did, their combined strategy displayed both Goldman’s talent for making money as well as Facebook’s reputation for innovation.

Facebook is currently a private company. As such, it is barred from issuing shares to the public without registering with the U.S. Securities Exchange Commission (SEC) start filing annual and quarterly reports with the SEC. Facebook was not quite ready to go public just as yet. Enter Goldman Sachs.

The New York Times revealed that Goldman was brought in as a Facebook investor through its relationship with DST, a Russian investment firm led by Yuri Milner. DST is a major Facebook shareholder and has invested in several other popular Internet companies.

By January 2, 2011, it was learnt that Goldman had invested $450 million in Facebook. Goldman proposed to create a special-purpose investment vehicle to allow a limited number of clients to invest $1.5 billion indirectly in Facebook by investing in the special purpose vehicle. Goldman valued Facebook at a staggering $50 billion and the minimum private investment was to be $ 2 million. The shares in the special purpose vehicle would be locked in till 2013.

Goldman’s strategy was quite simple. Section 12(g) of the Securities Exchange Act of 1934 requires that a company register its securities with the SEC if it “has total assets exceeding $1,000,000 and a class of equity security … held of record by five hundred or more … persons…” Therefore, if the total number of investors in Facebook was kept to below 500, Facebook would not have to register with the SEC. These 500 holders are holders of record. But, as with many publicly traded companies, the holder of record may not be the person who actually owns and exercises control over the shares, i.e., the beneficial owners of the shares.

In Facebook’s case, the Goldman transaction would involve just one holder of record, i.e., the special purpose vehicle. Investors in the vehicle would hold securities issued by the vehicle, not shares in Facebook. Thus, Section 12(g) would not apply. It’s a simple idea – but is it effective?

Not quite. The SEC had apparently anticipated this when it defined the term “record holder”. It said that “[i]f the [company] knows or has reason to know that the form of holding securities of record is used primarily to circumvent the provisions of [the Securities Act], the beneficial owners of such securities shall be deemed to be the record owners thereof.” So, under this definition, all those who invested in Goldman’s special purpose vehicle would be considered investors in Facebook…..unless, there were less than 500 investors in Facebook in total.

Goldman went to extraordinary lengths to make the deal work. First, as we mentioned above, it required that the minimum investment be $2 million. Second, in order to minimize the possibility of SEC scrutiny, Goldman decided to limit the opportunity to non-U.S. investors.

Ultimately, it didn’t work. The deal got a lot of publicity, not much of it positive. Some questioned whether $50 billion was a reasonable sum to pay for a company that might evaporate in a matter of weeks. Others wondered whether Goldman was creating a blueprint for getting around U.S. securities laws. Yet others reported that Goldman’s U.S. clients were not thrilled about being shut out of the deal. Ultimately, Goldman decided to withdraw.

So that’s that. Or is it? First, there’s the policy questions that it raises. If 1,000 highly sophisticated and wealthy individuals or institutions decide to invest in a company, do they really need the protection of the securities laws to the same extent as the average investor of limited resources. On the other hand, if a company can pick and choose a large number of investors, does that effectively shut the average investor out of the market?

What is also clear is that the Goldman strategy is just the beginning of what might well be a series of increasingly sophisticated transaction structures designed to facilitate investment in companies which are not yet ready to IPO. Watch this space…

Lexpert is an Indian lawyer currently working in the United States.

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