Private Company Stock Rules

 

This is how financial professionals ruined the long-term valuation of a new company. It is about the new-new-new greed of Wall Street.

LinkedIn, the social- looking- for- a – job- on-line site, just went public and their stock price went through the roof. Valuation of the company reminded us of the dot.com mania days. How LinkedIn managed their financing had a lot to do with how they were able to become a public company and get an insanely rich valuation.

I rarely recommend any of my clients to invest in an Initial Public Offering (MasterCard was the exception.) However if you must do it do it as a trade and not as long-term investment. In most hot IPOs the game is rigged mid to long term for the amateur to lose money. The pro’s will rig the game so they get in at the lowest price and walk away at the highest value leaving the amateur holding the bag. I won’t recommend anyone play the IPOs. If you have to or want to at least let the IPO excitement work for you, buy early and sell when you determine weakness-but do it that day. (If you were wrong to sell early you can always come back in and buy again another day.)

So how do the pro’s get their hands on stock of a new company? It’s all about the Benjamin's. Getting financing to start any business historically meant going to neighborhood banks, friends and family. Investment banks and venture capitalists are now stepping in and taking their place in today’s tech marketplace.

Financing a start-up is different today. These are not the Dell’s, Hewlett Packard or Microsoft type companies being created in basements and garages and getting a leg up to form an Initial Public Offering to gain access to money to expand their business.

Michael Dell started his business putting together computers in his college dorm until his family provided him with $300.000 of support. Even then it took several years before Dell emerged as a technology force.

Today a Twitter and Facebook have millions of people using their services before bringing their company public. Even though they are relatively new it seems that they have been around for ages.

What they do have going for them is a small army of very rich and deep pocketed firms and individuals who are willing to provide financing in exchange for pre-public market shares. This deep pocket financing allows fledging companies to mature and build a solid customer base before going public. The regulators have a phrase for this and it is Private Company Stock Rules.

LinkedIn set their price at $45 a share for their IPO (initial public offering and this price was at the top of their suggested range) and when it opened on the exchange where you, me and the candle stick maker could buy it the price almost doubled (due to demand and the small offering of shares) to $83. Later that same day it soared into triple digits before moving down and  finally closing the day over $94. a share. The venture capitalists who had been there long before the IPO liked the historic price increases. Average investors said no-thanks while others licked their chops and started planning on shorting what they saw as a pricing anomaly. The winners in this deal were those that got in around $15-$20 by buying into the company early in the game and the organizers.

There’s been a lot of talk of shorting the company stock because people think it is over-priced. Shorting the stock may be impossible since investors need to borrow shares in order to sell and then buy them back at a lower price to return to the lender and there are only 7.84 million shares available.

Unknown to many regular investors some mutual funds have dipped their toes into the  Private Company Stock investing. Those investors that hold shares in those mutual funds usually don’t know if their portfolio managers are involved in buying shares in companies prior to their going public unless they read the prospectus. Those assets held in Private Company stock are almost always illiquid and mutual funds were not created to hold illiquid assets. The other problem for the mutual funds is how to price those assets they hold in private companies and what to do if the company decides not to go public.

What the regulators allowed and investment professionals took advantage of is now going to have to come under close scrutiny.

The Exchange Trade Fund (ETF) business recently announced it has started to look at creating and selling an ETF that invests only in IPOs. On the surface this may seem a perfect ‘Hot’ investment for the average investor; long-term it may prove a disaster if the fund treats the IPO as an investment and not a trade.

We will simply have to wait and see if Wall Street continues their greedy ambitions with upcoming Twitter and Facebook IPOs. I have to assume there will be little  room left for growth in either of the two companies if the LinkedIn history is any indication.

But if you absolutely have to buy one or both your best chance to make money is in the first day of public trading and to be in and out.

Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.