Timing: It is everything for Facebook investors

Some lucky venture capital firms will be reaping gains from Facebook's initial public offering, but other investors won't be so fortunate.

For a few early venture capital investors, the social networking company's May 18 IPO was the biggest home run in the history of the asset class. Those VC funds should be big winners for their investors.

But it won't necessarily be as big a win for limited partners as it will for the general partners, because many expect institutional investors will be paid their share of the profits in Facebook stock, which has sunk to $31.91 from its $38 a share IPO price. Some analysts expect the stock could eventually dip to around $24 or $25 a share.

The Facebook investment scenario is not what investors had anticipated. The most highly anticipated IPO in history had institutional money managers — including hedge funds — selling other technology stocks the day before the IPO to make room in their portfolios for bigger chunks of Facebook, sources said. But since then, the falling stock price, analysts' doubts and mounting legal problems have turned the Facebook IPO victory tale into a media sideshow.

This has institutional investors watching their portfolios as well as the headlines. Already, Facebook's rocky first days of trading have resulted in lawsuits seeking billions in damages against Facebook Inc., Nasdaq Stock Market Inc. and IPO underwriters including Morgan Stanley, J.P. Morgan Chase & Co. and Goldman Sachs Group Inc. for alleged trading irregularities.

The SEC launched an investigation into Facebook's trading debut. The Financial Industry Regulatory Authority is still considering whether to launch an official investigation.

Of course, the venture capital firms that invested in Facebook when it was a private company “have already reaped tremendous benefits,” said David Fann, president and CEO of TorreyCove Capital Partners LLC, a La Jolla, Calif., private equity consulting firm. “Unless the stock completely falls apart, this could be the most successful venture deal of all time. And even if the stock falls apart, the venture capitalists that sold on the private exchanges and in the IPO have already locked in one of the best returns of any investment.”

The funds' remaining shares will be locked up for a few months, and then TorreyCove executives expect the stock to be distributed to limited partners, he said.

Early Facebook investors are expected to earn more than 50 times their original investment even with the stock decline, Mr. Fann said. “Most venture capital firms that invested in Facebook are sitting on millions, and in the case of a couple firms, several billion in unrealized gains,” he said.

One of those venture capital investors is Andreessen Horowitz Fund II LP, which owned 3,571,431 shares of Class B common stock in Facebook as of May 18, according to documents filed by Facebook with the Securities and Exchange Commission.

When Facebook's purchase of Instagram Inc. closes, Andreessen Horowitz Fund I LP will be issued 1,783,084 shares of Facebook Class A common stock, including 178,308 shares to be held in escrow, SEC documents state.

Accel Partners' funds had 201,378,349 shares of Class B stock as of May 18, but the venture capital firm planned to sell 57,726,901 shares.

Founders Fund LP owns 5,978,140 shares of Class B common stock, while Founders Fund II LP owns 740,960 shares. The Founders Fund II Principals Fund LP has 36,640 shares and the Founders Fund II Entrepreneurs Fund LP, 22,400 shares.

Venture capital firms Elevation Partners as of May 18 owned 40.1 million Class B shares but planned to sell about 4.6 million; Greylock Partners, owned 36.7 million Class B shares but planned to sell at least 7.6 million shares; and Meritech Capital Partners owned about 40.4 million Class B shares but planned to sell at least 7 million shares.

Valiant Capital Opportunities LLC owned 36.3 million Class B shares, but was not planning to sell at the IPO.

Other venture capital firms Felarmon Group Ltd., Technology Crossover Ventures and Kleiner Perkins Caufield & Byers also have ownership interests in Facebook, although the SEC document didn't specify the amounts. (The documents list those with more than 5% ownership interests and selling shareholders with more than 1%.)

Shifali Erasmus-Bhagat, spokesman for Palo Alto, Calif.-based Technology Crossover, said in an e-mail before the IPO that the venture capital firm owns about 1% of Facebook. He did not respond to e-mails seeking information after the IPO.

One of the largest holders of Facebook stock as of May 24 was early stage venture capital firm Accel Partners, which still owns 127.5 million shares, according to SEC filings.

As for institutional investors, Facebook stock could be hard to avoid because it is expected to be sprinkled throughout their equity portfolios.

“For the public investors, especially those that track or benchmark to either large-cap or tech indexes, owning Facebook is almost a forced requirement,” said TorreyCove's Mr. Fann.

“Many active managers may avoid the stock altogether given valuation concerns or doubts about its revenue growth,” Katie Reichart, a Morningstar Inc. senior fund analyst in Chicago, said in en e-mailed response to questions.

Matt Stroud, head of strategy and portfolio construction at Towers Watson & Co. in New York, said institutional investors' ultimate exposure to the stock will depend on how well it performs in coming months.

“Facebook was a very large IPO and expectations are also high. It will be subject to an intense amount of scrutiny, which will be driven by growth in revenue and growth in the bottom line,” he said.

He said hedge funds are taking a close look at Facebook, and their exposure would depend on their orientation, whether long/short or value or growth.

Pre-IPO Facebook investor Tiger Global Management LLC, a hedge fund manager, owned 4,207,500 Class A common stock and 49,630,486 of Class B shares as of May 18. In a filing with the SEC before the IPO, the firm indicated it was planning to sell more than 19 million shares in the IPO.

Before the IPO, a number of stock mutual funds had Facebook exposure. Funds sponsored by T. Rowe Price Associates Inc. was one of the biggest holders— with 6,033,630 Class A and 12,158,743 Class B shares as of May 18, according to SEC documents. Documents filed by Facebook with the SEC showed T. Rowe Price was not planning to sell any of its shares.

T. Rowe Price executives are not commenting on the firm's Facebook shares, said Robert Benjamin, T. Rowe Price spokesman.

Morgan Stanley, Fidelity Investments, VALIC, Principal, MassMutual and Putnam also held pre-IPO stock in their funds, according to Morningstar.

Another issue is what will happen when Facebook gets added to the major stock indexes, said Ms. Reichart, who believes that listing “could increase demand for shares down the road and bid up the price.”

Wilshire Associates Inc. already added Facebook to the Wilshire 5000.

Facebook “has a small amount of float; we are waiting for final values, but it looks like under 20% of the shares outstanding. The float amount is what will be added to the index,” Kim Shepherd, Wilshire spokeswoman, said in an e-mail. She added Wilshire does not have an estimate of the number of index funds based on the Wilshire 5000.

Morningstar's Rick Summer, senior stock analyst, said that before the IPO, Morningstar cautioned investors to stay on the sidelines because the firm anticipated a big drop in the stock price, due to decelerating revenue growth and deteriorating fundamentals.

Revenue is not growing because social media companies have no way of measuring whether advertisers are getting a return on their advertising dollar, Mr. Summer said. “It is unclear whether Facebook will continue robust growth until analytics (exist) to give advertisers information that they are getting a bang for their buck,” he said. “Because of that, Facebook will be a highly volatile stock and will trade south of where it is worth.”

And even while Facebook is expected to be a rousing success for early venture capital investors, the fallout is expected to slam the door on IPOs of other social media companies, said TorreyCove's Mr. Fann.

“The macro impact is that social media investments post-Facebook will have a harder time going public. No one expected that the game-changing aspects of Facebook would be the bubble bursting before the first stock trades have cleared,” he said.