Ultimate friend request isn't cheap

SAN FRANCISCO - Facebook's soaring valuation is spurring shareholders to slice and dice their stock, giving investors from Silicon Valley to Wall St a chance to bet on the company.

EB Exchange Funds, based in San Francisco, as well as New York firms Felix Investments and GreenCrest Capital, have opened Facebook funds for investors looking to get a piece of the social-networking company and its half-billion users.

By creating derivatives of the stock, the investment firms are helping Facebook keep its shareholder count at 499 or less, the maximum number a company can have before it has to disclose results to the public.

They're also potentially creating a new class of assets for investors, letting them tap fast-growing private companies such as Twitter, Zynga Game Network and LinkedIn - all valued in the billions of dollars.

"It's proving to be a really effective way for accredited investors to invest in private companies," said Larry Albukerk, founder of EB Exchange Funds. "I don't necessarily know if it's a good investment or not - I just know people want to invest and we provide a means for them to do that."

Facebook, based in Palo Alto, California, has more than tripled in value since March to US$40.7 billion ($53 billion), according to SharesPost, an exchange for private companies.

Zynga, the creator of online games such as FarmVille, is worth US$5.4 billion, and social-networking service Twitter is at US$3.4 billion. SharesPost values professional-networking site LinkedIn at US$2 billion.

EB Exchange is buying as much as US$15 million in Facebook shares for a limited liability company that's open to outside investors, according to a letter to prospective shareholders obtained by Bloomberg.

While Albukerk confirmed that he created the LLC entity, he declined to comment on whether it was investing in Facebook, citing regulatory restrictions that limited what he could say.

A United States Securities and Exchange Commission filing from October says EB Exchange is raising US$15 million for a "pooled investment fund". According to the investor letter, units in the LLC are offered in US$10,000 multiples, with a minimum investment of US$100,000.

EB Exchange makes money by charging a 5 per cent fee to enter the LLC and then another 5 per cent when the shares are distributed after an initial public offering or acquisition. An LLC can have no more than 99 participants.

Across the country in New York, Boaz Rahav, an 18-year veteran of the financial industry, founded GreenCrest earlier this year after talking to institutional investors who were having trouble finding a way to invest in Facebook. He expects to raise at least US$100 million for his Facebook-specific fund.

"There are quite a large number of institutions, large and small, that missed the boat or missed the opportunity to invest in Facebook when Facebook was going through their capital-raising campaigns," said Rahav.

"They're facing the challenges of identifying blocks of shares, negotiating a price and going through the negotiating process with Facebook."

Jonathan Thaw, a Facebook spokesman, declined to comment. Albukerk and Rahav both said they eventually expected to open multiple company-specific LLC entities.

The trend is a concern for Laurence Allen, managing member of Nyppex in Rye Brook, New York, because of the lack of transparency. For more than a decade, his firm has specialised in so-called secondary transactions - deals that involve buying stock from existing shareholders, including employees.

Primary transactions, by contrast, are investments from venture capitalists and other backers working directly with the company.

Because private-company financials are opaque, investors were buying based more on hype than actual knowledge about how the businesses were performing, Allen said.

"There's less discipline than in the typical investment process," he said. "Firms like Facebook may have stupendous growth, a successful exit someday, and yet the investors in some of these funds may have overpaid so much that the returns are small and maybe even negative."

Nyppex estimates that secondary-transaction volume for private companies will more than double this year to US$4.9 billion. SecondMarket, an online market for private companies, expects its volume to at least triple this year to US$300 million-US$400 million.

For Facebook, the emergence of the secondary market has enabled early employees and investors to sell all or part of their stakes, reducing pressure on the company to go public.

Facebook is likely to put off its IPO until 2012, three people familiar with the matter said in July.

Felix Investments opened its first fund more than a year ago and now has them for 14 companies.

The firm has two funds for each company - one for investors with at least US$1.5 million in liquid net worth, and the other for those with at least US$5 million. Felix has raised about US$250 million for the funds, said Frank Mazzola, a partner at the firm.

Similar to EB Exchange, Felix charges 5 per cent upfront. It then takes 5 per cent of the profit until an investment doubles. After that, it takes 10 per cent. All of the investments are in fast-growing technology companies that are beyond early stages, Mazzola said.

"The companies we're trying to get exposure to don't need money, don't want money, won't take money," Mazzola said. "So how do you get exposure to them? It's by networking and finding some early employees and investors that have an interest in lightening up on some of their stock."

Alex Bernstein, a San Francisco investor, bought a stake in EB Exchange's fund. While he's optimistic that Facebook's value will continue to rise, he recognises the risk of investing in a pricey security that will be difficult to sell until the company goes public.

"It's an unproven path to liquidity and we're all hopeful that it will work out," said Bernstein.

- Bloomberg

FACE VALUE
* Facebook is not yet publicly listed. Shares are closely held by a group including early investors and employees.
* Facebook wants to keep its shareholder count to 499 or less, to avoid having to disclose results to the public.
* To allow investors to get a stake in the social-networking site, limited liability companies are being set up to buy in.
* One of these companies, EB Exchange, is buying as much as US$15 million in Facebook shares.
* Investors can then buy units in EB Exchange, offered in US$10,000 multiples.