Greylock Partners

The Facebook distribution dilemma

August 17, 2012: 9:53 AM ET

Facebook is unlocked. So who held, and who sold?

FORTUNE -- Approximately 271 million shares of Facebook (FB) stock were "unlocked" yesterday, under a provision that had prevented certain investors from selling shares until 90 days after the company went public. And, as happens after most lockup expirations, Facebook took a tumble – down 6.27% to finish trading at $19.87 per share. For context, the IPO price on May 18 had been $38 per share.

Fortune has learned that venture capital firms Accel Partners, Greylock Partners and Meritech Capital Partners were among those that distributed shares to limited partners. The only one of those that had been previously reported was Accel, with CNBC saying that it had distributed a total of 50 million shares from various funds (which still represented less than half of its holdings).

We've also learned that several unlocked shareholders decided to retain their entire positions, including Andreessen Horowitz and Microsoft (MSFT). So did tiny shareholder Kleiner Perkins Caufield & Byers, perhaps because it's hoping for a rally that helps salvage its underwater investment.

I heard some people yesterday suggest that Accel's distribution was a signal that Facebook stock would continue to sink. Don't count me among them. Proper portfolio management, particularly for an LP base that has been looking to lock in more of these distributions for several years.

But, that said, I'm not thrilled with the way Accel went about it. That also goes for Greylock (I don't have the Meritech details).

Here's what I mean: Both Accel and Greylock priced their shares at over $21 a piece, for the purpose of calculating carried interest (i.e., the profit VC firms receive from successful investments). Greylock's was a couple of cents higher because it used a 10-day trailing average -- $21.05 compared to $21.03 -- but both firms charged LPs significantly more than was actually available yesterday for Facebook shares on the open market.

Let's imagine that an LP received 100,000 shares of Facebook stock from Accel or Greylock. And let's also imagine that each fund has a premium carry of 25% (which I believe to be true, but have not been able to confirm). In that case, Accel or Greylock would receive the equivalent of $525,750 or $526,250, respectively, in carried interest (minus the cost basis). But had carry been marked at the market open price of $20.44 per share – the price closer to which many LPs were forced to sell -- the carry only would have been $511,000 (again, minus the cost basis).

[UPDATE: If both the Accel and Greylock funds already had paid back 100% of their principle (which they likely have), then the distribution would have been a straight stock split of 75/25 minus a possible repayment of the cost basis. If the cost basis needed to be repaid and was calculated in shares, then that is where the slight pricing discrepancy could lie. The firms also get to use the higher price for calculating total fund returns, which get used in future fund marketing efforts.]

This is yet another example of why VC firms either should distribute cash to their LPs, or give LPs the option of cash or stock. Remember, many LPs don't have in-house equity trading desks. That means that they are effectively forced to liquidate shares immediately via a third-party broker, thus receiving less for their positions than "charged" by Accel or Greylock.

And the VC firms have to know that the shares will trade down upon lock-up expiration, because it happens almost every single time! 

If general partners insist on stock distributions, then they should use both a pre and post average for carry, in order to better balance out the volatility (apply the recalculation to a future distribution). It's still not perfect for those liquidating upon receipt, but it should be a bit more representative (and also would discourage a VC from flooding the market via a single distribution).

To be clear, limited partners of Accel and Greylock have made oodles of money off of Facebook. For example, Greylock bought in at a $500 million valuation. So my complaint is largely a rounding error on that massive multiple. And it also is true that some of the LPs may hold the shares and ultimately sell at a price far higher than the carry marks.

But when you've managed to hit a grand slam in Game 7 of the World Series, there's no reason to deny the fans a tip of your cap. The hit is what matters most, but the modicum of added respect is also remembered.

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