Why Investors That Bought Facebook Shares Got Screwed!

Before Facebook announced it has filed to go public in a much anticipated IPO due out this year (May 14th to be exact), its shares were trading in the private market (Second Market) on a valuation of over $100 billion. Today, Facebook released its quarterly results and there’s a very piece of information there. Everyone has been waiting to see how Facebook will price and at what valuation. The valuation is about $75 billion at a price of $30.89. That’s a lot less than what many investors bought into at $45/share thinking they would make a huge profit when Facebook opens for trading.

Lucky for us normal folks, we will have a splendid chance at getting Facebook shares at a fair price. I will be a buyer of these shares under $40.

Why did Facebook buy Instagram for 1 billion dollars?

If you’re like any normal person, you have to wonder why Facebook would spend $1,000,000,000 on a startup that’s less than 2 years old, losing lots of money and probably will never make a profit, and basically shares a user base that widely overlaps with Facebook itself. The merger today was a perfect explanation of what I like to call the “Everybody Wins Rule.”

This is how it works:

Venture capitalists will fund a new company. It’s almost always a dot com because they’re the easiest to get started. (I started this blog within 2 minutes)

These venture capitalists are the same ones that invested earlier on in all the big Internet companies we see today: eBay, Yahoo, Google, etc. They still control those companies by having their own buddies on the board of directors at each company.

New investments are evaluated within the first couple of years (usually). If it looks like the company is doing well, then they’ll hold on to it and take it to the public market for riches. If the company is not doing so well, which is most often the case, then they will have one of their bigger companies swallow their new company at an insane valuation.

Let’s say Google has 50 billion in cash in their bank account. Google does not pay dividends (Google’s excuse is that it will need the money for innovation and expansion – it all sounds good). So the same investors at YouTube will have their buddies on the board of Google pay a couple billion dollars so they can get paid. In this case, the venture capitalists win, the YouTube founders win, and the shareholders of Google win too! Why do the shareholders of Google win when it spent all this ridiculous amount of cash on something it could have done itself for less than $10,000? Because shareholders think Google is using its cash just for the purpose it has kept it there – to innovate and expand! So everyone wins.

Now, back to Facebook. Same people who invested in Instagram are investors in Facebook. Believe me, if Facebook wasn’t working out early on, it would have been sold to Yahoo. Now that Facebook is working, they’re taking it public at a $100 billion valuation. Today, they’ve made a statement with their Instagram purchase: We are worth more than 100 Instagrams! So if Instagram can sell for $1 billion then imagine what Facebook is worth. Great timing.

One last note, there is a lot of shady business on Wall Street and Silicon Valley. There is always shady things happening when there’s money. Even though all this business is shady, this is not a bad situation because EVERYONE WINS (PS: It was reported that some of those VCs got in on a round of Instagram valuing the company at $500 million just a couple days before Facebook bought the whole thing for $1 billion).