Platt Perspective on Business and Technology

Open marketplaces, closed markets and exit strategies – an emerging lesson

Posted in in the News, startups, strategy and planning by Timothy Platt on January 24, 2011

(Note: January 18, 2011 – I generally write and upload my blog postings a week or so in advance of when they go live. That creates potential for fast moving events to overtake what I write between the writing and when it goes live on my blog. This morning Goldman Sachs announced that it is not going to offer its largest investors a special inside track for buying up large amounts of Facebook pre-IPO as a closed market and insider opportunity. Their expressed reason was that this investment option might not meet regulatory requirements and as I discuss in the posting itself they are most likely correct in that assessment. I have decided to offer the posting itself as originally written as this particular scheme is more a poster child example of a more fundamental underlying problem, than it is a story as an endpoint in and of itself. Now, with the embarrassment that Goldman Sachs leadership must be facing to have this happen, and when we are still coming out of a Great Recession that was brought on in large part by financial institution mismanagement, I end this appended note with a question. Will Goldman Sachs be announcing a leadership change at the top? That aside, here is my posting on this complex of issues as originally written.)

A number of months ago I posted an installment on exit strategies in a series I was writing on building and managing an online store (see Online Store, Online Market Space – Part 18: exit strategies and long term planning.)

I made note of a number of key variations on the exit strategy in that posting including:

1. Maintaining your business yourself as a privately held, wholly owned entity.
2. Maintaining your business yourself as a privately held entity but with a restricted set of shareholders in the form of angel and/or venture capital investors backing you.
3. Going public as an initial public offering (IPO)
4. Selling your business for incorporation into another, probably larger business through merger and acquisition processes.

These approaches to business and to managing the transition from startup and early stage differ from each other in a variety of ways and they offer some sharply distinctive pathways for moving forward. But they all hold one key point in common. They all take place in an open marketplace.

A new and troubling approach, as alternative to these strategies, has recently been tried out and most notably in the pre-IPO, private sale of shares in Facebook through Goldman Sachs. Google cut Goldman Sachs out of its IPO strategy when it went public because it saw the problems inherit in closed market deals in the sale and ownership of its public shares. Facebook decided to take a different approach and go for IPO but with special, closed door and closed marketplace sale of some $15 billion or more in declared valuation to a select set of high investment level clients of Goldman Sachs.

There are immediate problems with this that US Federal Courts could use to very significant impact and against both Facebook and Goldman Sachs. Among other things, if there are 500 or more shareholders in a company it is legally considered to be publically traded in the United States, and that would call for a very public and through opening of the Facebook books and declaration of its financials – as well as activating a wide range of other compliance requirements for them (e.g. see Sarbanes-Oxley Act). All a court would have to do is to disallow the legal fiction that because the Goldman Sachs clients involved in this all hold Facebook ownership through one single company, all of their respective individual account holdings should be collectively considered as constituting a single shareholder of record.

Basically, this investment tactic is a repeat of the same corner cutting and short sightedness that got Goldman Sachs and others into so much trouble going into our recent Great Recession. And it is corporate behavior like this, at least in lack of due diligence and foresight that caused the Great Recession in the first place.

This tactic is also a direct challenge to the concept and practice of an open marketplace and to the free market. I will leave it up to the reader to decide how this exit strategy decision meshes or clashes with Facebook’s declared mission and vision, as to what they are as a company and as a corporate citizen.

And as a final thought here, this is not simply a one time strategy for cornering a marketplace for just one company and its public ownership. The same thing looks to also be on the way for Groupon and a number of other social media startups and early stage companies that would otherwise be planning and developing towards IPO.

My guess, and right now I can only guess on this, is that a court will declare that separate account holders with a company such as Goldman Sachs are in fact separate shareholders of record for the stakes they hold in companies like Facebook and Groupon. This would force any of these companies so sold in closed markets into immediate need to meet full disclosure and accountability requirements as publically traded entities, among other things.

Any such court ruling would be appealed but the end result will be that this loophole will be closed. And if it is not closed by court order it will be by act of Congress, and perhaps particularly because the Republican Party now controls the House of Representatives. 2012 is coming up with a presidential election that the Republicans want to win. Many, many people blame our recent and still ongoing economic downturn and its ongoing high unemployment rate on big banks and other financial institutions. So a law to rein in what could perhaps best be viewed as a return of imprudent excesses on the part of companies like Goldman Sachs would be a politically popular and a strategically valuable move for them to take.

I am not going to add this one to my list of basic exit strategies, and I would council any startup or early stage I worked with to avoid this tactic too.

As a final word in this posting I also point out a fact should be obvious to all, but that is not always sufficiently noted. The people who recently got us all into financial and economic trouble are still in power in the businesses they mismanaged then, and they have learned very little if anything from the experience of the last few years. So as business people we have to do our own due diligence ourselves and not rely on the judgment or prudence of executives at companies like Goldman Sachs. And we should put some trust in the open and free marketplace. Businesses that operate there do generally rise to their true market value, and even when they do shift between being under and over-valued the marketplace generally course-corrects on that. That, I add, holds with or without Adam Smith’s invisible hand and even when both reason and emotion drive marketplace decisions.

Any further discussion of this set of issues would delve into marketplace bubbles and I will probably be posting on them, with this as a starting point.

One Response

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  1. Timothy Platt said, on January 29, 2011 at 1:54 pm

    When I wrote my posting on Goldman Sachs’ closed market investment scheme as went live to the blog on January 24, 2011 I asked a question towards the top.

    “Now, with the embarrassment that Goldman Sachs leadership must be facing to have this happen, and when we are still coming out of a Great Recession that was brought on in large part by financial institution mismanagement, I end this appended note with a question. Will Goldman Sachs be announcing a leadership change at the top?”

    The immediate effect of this investment offering collapse was a sharp drop in the stock price of Goldman Sachs as a spasm response. The company regrouped and it was announced yesterday afternoon that their senior management and their CEO in particular have just been awarded massive increases in both base pay and bonuses – so much for learning curve experiences and so much for accountability.

    Tim Platt
    January 29, 2011

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