Goldman once passed on Facebook deal

Before Goldman Sachs bought a stake in Facebook and started offering shares to wealthy clients, a powerful investment group within the firm turned down the chance to buy a piece of the social networking behemoth, according to several people briefed on the internal discussions.

Goldman Sachs Capital Partners -- a group that manages and invests for pensions, sovereign wealth funds and other prominent clients -- was given the initial opportunity to invest $450 million in Facebook, said the people, who were not authorized to speak publicly on the matter.

Goldman gives the "first look" on many investment opportunities to the $20.3 billion fund. While most of the group's clients are big institutions, the investors also include current and former Goldman partners.

But the unit's head, Richard A. Friedman, a longtime Goldman partner, decided the Facebook deal was not suitable for his clients, in part owing to the high valuation and to a mismatch with his investment criteria. The $450 million investment values the Web company at $50 billion. After Goldman's deal, some industry experts cautioned that Facebook's growth would need to accelerate rapidly over the next couple of years to justify such a steep price -- a risk with many brand-name technology upstarts.

Last year, Facebook recorded revenue of approximately $2 billion, with roughly $400 million in profit, according to people briefed on the company's results. That is up from $220 million in earnings on $770 million in sales in 2009.

After Mr. Friedman passed, the Wall Street bank itself made the $450 million Facebook investment, taking the deal on its balance sheet. (About $75 million of that amount is coming from an internal hedge fund, Goldman Sachs Investment Partners, according to a person who reviewed the offering memorandum sent to investors.) The firm is trying to sell $1.5 billion more of shares in the company to wealthy clients -- a deal that is expected to be oversubscribed when it closes this week, as early as Thursday, these people said. All Goldman partners will also be able to invest in this fund.

Goldman, knowing the deal had the potential to draw regulatory attention, briefed the Securities and Exchange Commission before making the offer to wealthy individuals, according to people with knowledge of the conversation who were not authorized to speak publicly on the matter. The agency is currently looking at trading in private technology companies like Facebook.

The S.E.C. declined to comment.

The decision by Mr. Friedman, who holds a seat on the firm's vaunted management committee, has raised concerns among some of Goldman's most sophisticated clients who have been pitched on Facebook in recent days. Several wealthy individuals approached about the offering said they had declined, in part, because of Mr. Friedman's rejection. The clients spoke on the condition of anonymity out of fear that making a public comment would hurt their relationship with Goldman and their opportunity to have access to future investments.

A Goldman spokesman declined to comment. Mr. Friedman did not return a call.

People briefed on Mr. Friedman's decision said he was concerned about Facebook's $50 billion valuation and the terms of the deal. Goldman Sachs Capital Partners frequently likes to take large positions in companies with expectations of holding them for several years or even longer. A $450 million investment in Facebook would have represented less than 1 percent of the firm.

One person briefed on the discussions with Mr. Friedman, however, said he would have "thrown out" his typical investment philosophy if he had believed a Facebook investment was an "easy home run."

Goldman's critics have long complained that the firm puts its own interests ahead of clients. In the Facebook deal, Goldman is investing $450 million, at an implied $50 billion valuation. However, Goldman clients are paying a 4 percent placement fee and a 0.5 percent expense reserve fee for their shares, as well as giving up 5 percent of gains. That means Facebook would need to be worth closer to $60 billion before they make any money.

Beside those fees, Goldman is likely to earn additional money from ancillary business -- with the biggest victory coming from an eventual initial public offering, perhaps as soon as 2012.

Given all that, Goldman could still make money even if Facebook's value drops to $40 billion, according to analysts' estimates.

"If by doing this investment they get Facebook's I.P.O., then the fees that they make -- no matter what size -- make this investment a better deal for them, than all of their clients," said Barry Schuler, managing director of venture capital firm Draper Fisher Jurvetson.

Unlike Wall Street brokers who sell shares to investors, Mr. Friedman manages money for other people. That means he has a fiduciary responsibility to act in the best interests of his clients.

Goldman does not have the same obligation to many of its private wealth management clients, because it is not giving investment advice.

The firm is simply facilitating the offer. Wealthy individuals can buy into the Facebook deal with a minimum $2 million stake due Friday, which they must hold until 2013.

One reason Mr. Friedman may have shied away from the Facebook offer was that his fund was hurt a decade ago after loading up on technology and telecom darlings during the dot-com bubble. The unit's third fund, a $2.8 billion vehicle raised in 1998, invested roughly 70 percent of its portfolio in such companies, according to the fund's documents.

Early on, the fund's performance was helped by the initial offerings of portfolio companies like the telecom Storage Networks.

But then the bubble burst. One of the most notable investments, Webvan, enthusiastically backed by Goldman's chief executive at the time, Henry M. Paulson Jr., collapsed.

Goldman's private wealth managers have tried to sell Facebook shares to clients by describing the situation as "an intimate party with only so many seats around the table," according to one person briefed on the pitch.

Goldman, which set up a special purpose vehicle for the $1.5 billion Facebook investment, can hand out shares to only 499 individuals. Otherwise, the firm risks violating federal rules governing investments in private companies. Financial firms often create such entities to invest in private companies.

But a few weeks ago, the S.E.C. started taking a closer look at trading in Facebook, Twitter, LinkedIn and other tech companies on private, secondary exchanges -- in part over concerns of violations of the 500-investor threshold.

The extra scrutiny prompted Goldman to contact the S.E.C. before marketing the Facebook deal to investors, said people briefed on those discussions who were not authorized to speak publicly on the matter.

The S.E.C. had nothing substantial to say on the matter at the time, said one person with knowledge of the conversation.