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Whether Facebook executives sell their shares on Thursday is beside the point: Social media companies are facing big challenges. (Scott Eells/Bloomberg)
Whether Facebook executives sell their shares on Thursday is beside the point: Social media companies are facing big challenges. (Scott Eells/Bloomberg)

Why Facebook insider sales aren’t so bad Add to ...

The number of early investors now ditching their shares in Facebook Inc. is scaring investors in the social media company, or anyone thinking about wading in now that the shares have fallen about 50 per cent since their debut in May.

If the people who helped create this company are cashing out as the share price stumbles, the suggestion is that insiders see no upside in the years ahead.

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But perhaps the fears are overblown. Aren’t insiders wired to cash out?

This week, it was reported that Facebook director and early investor Peter Thiel had sold 20.1 million shares between August 16 and 17, valued at nearly $396-million (U.S.). And that’s after generating sales of about $640-million during Facebook’s initial public offering in May.

Not bad for an initial investment of $500,000 in 2004: That’s a 2,000-fold return.

Mr. Thiel is not the only one selling shares. Last week, the company lifted the first of several lock-up periods, giving a number of early investors the right to sell their shares in the company, raising concerns that the already-fragile looking stock will encounter a lot of selling pressure in the months ahead. By November, another 1.4 billion shares will hit the market.

While the sight of insiders selling their shares is hardly comforting to investors, their concerns fail to acknowledge that early investors tend to have good reasons for moving on: They need the cash to invest in other start-ups.

Jeffrey Carter, an investor who also writes a blog called Points and Figures, argued that venture capitalists and angel investors – the sources of money for companies in their early stages of development – tend not to be stock market wizards.

“When the early investors sell, it says nothing about the long term future or viability of the company,” he said. “They are just getting their capital back so they can reinvest it in more early stage companies. That’s what they do best.”

By investing in companies in their early stages, these investors have already taken risks – enormous risks, in most cases. Their influence shrinks as the companies grow bigger and become public, so it often makes sense for them to move on.

Fred Wilson, a venture capitalist and principal of Union Square Ventures, adds that early investors also tend to emerge from an IPO holding an absurdly large number of shares, often representing 15 to 20 per cent of a company.

“When an investor is looking at a single holding being worth three, five, or possibly ten times their entire fund, you can be sure they are looking to lock in that gain,” Mr. Wilson said on his blog, AVC. “That’s a recipe for fantastic performance and the downside of not locking that in is a lot bigger than the upside of another one or two times their fund size.”

Add in his belief that venture capitalists make terrible stock market investors and the fact that many firms have a policy of removing publicly traded stocks from their portfolios as quickly as they can, and it is hardly surprising that Facebook’s early investors are moving toward the exits.

“This has been going on since I got into the venture capital business in the mid 80s and I expect it has been going on for a lot longer than that,” Mr. Wilson said.

“So to all the folks out there who are shocked and outraged at all the insider selling going on, I would suggest they park their outrage at the door of capitalism.”

 

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