Facebook IPO: The ‘smart money’ really got burned

There’s a lot of anger around Facebook’s botched IPO, but much of that is from the “smart money” that wasn’t able to convince retail investors, the regular people who invest in stocks, to take their shares.

The point of a “pop” in an IPO is to provide an incentive for retail investors to acquire the risk — the shares from investors and insiders — and then to continue holding that stock and limit volatility.

But the smart money had already decided what the stock was valued at because of trading activity in secondary markets, which was in a range of US$38 to US$42 and only wanted to price a 10% pop, which is why the US$38 price was chosen. That’s not much of an incentive to take on a very risky investment.

The fact that retail investors disagreed with the valuation and largely stayed away is a very good sign because it shows that they are far more sophisticated than the Wall Street bankers and their clients.

So let’s not shed tears for the “smart money”. They were the ones that literally bought the hype about Facebook’s future prospects. The SEC isn’t going to help them because they are considered to be sophisticated investors that know the risks.

The good news is that few small investors bought shares; the bad news is that few small investors bought shares.

This means that the smart money, in its zeal to leave as little money on the table in the IPO (it’s called fair pricing), has messed things up for future tech IPOs and prospects for getting their money out of their other positions. Greed has its consequences.

The Facebook fiasco also puts the spotlight on secondary markets and the role they play in helping private companies raise capital and for early investors to find an exit.

It should be good news for private stock markets such as Sharespost and Second Market because tech IPOs will be cutback leaving these markets in a great position as the only alternative to being acquired.

The problem for the smart money is that these private markets have little liquidity and share prices are far more susceptible to hype and manipulation than in public markets. It could quickly become be a dumb investment.