Dan Primack

The latest on private equity, M&A, deals and movements — from Wall Street to Silicon Valley

No, the SEC investigation will not prompt a Facebook IPO

December 29, 2010: 11:26 AM ET

We are very mindful of privacy...

Facebook wants to go public... someday. In fact, it's wanted to go public someday for quite a number of days.

Now there is speculation that the SEC investigation into secondary market trading could accelerate the social network's IPO timetable. Makes for a great story, except that it doesn't make much sense.

Here's the background: Once a private company has 500 shareholders, SEC rules require the company to register its private stock and disclose financial results. Facebook employee shareholders do not count toward that threshold, via special SEC exemption, but lots of those employees have since sold stock on the secondary market. Some of those sales have been to "Facebook funds," or pools of capital raised specifically to invest in Facebook shares.

These Facebook funds posit themselves as singular shareholders, so even a couple hundred of them shouldn't matter. The SEC, however, is likely to have a different opinion.

Traditionally, regulators have differentiated between blind pools raised for a diversified portfolio (such as a venture capital fund) from pools raised to invest in a specific issuer (i.e., Facebook funds). The former is counted as a singular shareholder, because investors are handing money and investment decisions over to a manager. The latter is counted as the sum of its underlying investors, since the "manager" is really just a broker (providing access at a reasonable price). Not exactly sure where this is codified, but one fund formation attorney told me that it had been industry standard since he began practicing in 1988.

Considering the number of Facebook funds that have been raised, and that each one can easily have one hundred investors, it is likely that Facebook already has crossed the 500-shareholder threshold (unless the SEC allows Facebook's employee stock exemption to apply once employees sell their shares to a third party -- something which is currently prohibited).

So Facebook soon may be required to disclose its financial data, including to secondary market investors who currently trade in a haze of amenable ignorance.

Here's the "IPO" theory: Once Facebook no longer is allowed to keep its financial data private, it might as well go public. This theory basically plays into the "paranoid Zuckerberg" meme, in which his privacy is tantamount but yours is expendable. Moreover, Facebook will be subject to costly regulations like Sarbanes-Oxley, which could be offset by public offering proceeds.

Let me (literally) count the reasons that B doesn't necessarily follow A:

  1. Plenty of companies are forced to disclose financial information, but nonetheless choose to remain private. For example, virtually any company owned by private equity firms, but whose debt is publicly-traded.
  2. I cannot imagine that Facebook is not already in regulatory compliance (or damn close), even though it doesn't yet need to be. The company hired David Ebersman from Genentech more than a year ago to be its CFO, to get its financial records in order. The incremental cost increase of needing to provide his work to the SEC will be minimal.
  3. There are many benefits to being private, besides keeping financial data secret. As a private company, Facebook needn't meet quarterly earnings projections. It needn't meet regularly with bank analysts. Or with hedge funds. It also will be better able to keep quiet about non-financial events, such as product strategy and competitive pressures.

To be clear, I'm not saying that Facebook won't go public soon. After all, "someday" could always be today (or tomorrow).

But the decision will be Facebook's, and Facebook's alone. The SEC investigation's outcome might ruffle some Facebook feathers -- and even cause secondary market valuations to fall -- but will not directly precipitate an IPO. Even though, again, it does make for a great story.

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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