How to Buy Into Facebook Before It Goes Public

You can invest in the social-networking giant (and other private companies) through two Web sites offering secondary-market services. But should you?

Goldman Sachs caused a stir in early January when word broke that it would invest $450 million in Facebook. Even more intriguing, though, was the news that Goldman would create a fund through which its clients could buy some $1.5 billion worth of shares in the fast-growing, privately held social-networking company.

But you don’t have to be a well-heeled Goldman client to get in on Facebook or other hot, privately held companies before they go public. Two Web sites -- (opens in new tab) and (opens in new tab) -- provide electronic platforms that allow qualified investors to buy shares from company insiders and employees who want to cash out before a company goes public. By offering a way to enter an area previously open only to Wall Street’s elite, "we democratize the opportunity to invest in private company stocks," says David Weir, chief executive of SharesPost.

Since 2004, SecondMarket, a registered brokerage, has been offering a marketplace for alternative investments, such as asset-backed securities, mortgage securities and limited-partnership interests. Last year, $400 million worth of transactions closed on SecondMarket, up from $100 million in 2009. At present, 40 private stock issues trade on the platform, with Facebook, Twitter and LinkedIn the most active.

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SharesPost, founded in June 2009, is not a brokerage but works with brokers to manage transactions. Currently, it lists 150 privately held companies, with the total number of buy and sell orders available (not actual trades) worth roughly $400 million.

Why would you want to invest in a nonpublic company? You could become an insider before a firm goes public, presumably at a much higher price than you paid for your shares. Facebook is at the center of attention because of its extraordinary growth and the perception that its initial public offering could be as successful as that of Google (symbol (GOOG (opens in new tab)). Facebook hasn’t yet announced plans for an IPO, but many market watchers expect the Palo Alto, Cal., company to go public next year.

But although Facebook is seen as eating into Google’s supremacy as an information source, its stock may not perform as well as Google’s has. That’s because Facebook shares are likely to be extraordinarily expensive when they reach the public market. The Goldman Sachs deal values Facebook at $50 billion. According to published reports, the company earned $355 million on revenues of $1.2 billion in the first nine months of 2010, and experts think sales for the entire year may register at $2 billion. That means Wall Street is valuing Facebook at roughly 25 times the past 12 months’ revenues, and the company is sure to receive a much higher valuation in the IPO. Google, by contrast, was valued at about eight times the previous 12 months’ revenues when it went public in 2004 and today trades at a bit more than seven times revenues.

Signing up with the secondary-market services is as easy as joining Facebook; actually getting to trade is another matter. Neither outfit requires clients to pony up $2 million or more and hold the shares until 2013, as Goldman is stipulating for its Facebook offering. However, both companies require clients to be accredited investors. According to the Securities and Exchange Commission, this means investors must have enough knowledge and experience to evaluate an investment's risks and be able to bear them, and they must have a net worth of at least $1 million or income exceeding $200,000 per year for the preceding two years. After the company verifies your information, a process that typically takes 48 hours, you’re ready to trade. In addition, once you make a purchase, both SharesPost and SecondMarket require you to hold the shares for at least one year.

Privately held stocks don't trade quickly, or even every day. Typically, the seller sets a price, but buyers and sellers can -- and do -- haggle. And agreeing to a price doesn't mean the trade will actually go through. Mark Murphy, a spokesman for SecondMarket, says companies have the right of first refusal. So even if the seller accepts the deal, his or her company has 30 days to check you out to determine if they want you as a shareholder. If not, the company can deny the trade and buy the shares from the seller itself. If a trade goes through, you can expect to pay a commission of 2% to 5% of the size of the transaction. Murphy says the typical SecondMarket transaction is about $2 million. SharesPost says its transactions range from $10,000 to millions of dollars.

Contributing Editor, Kiplinger's Personal Finance