When Facebook goes public Friday morning, one large beneficiary will be San Francisco hedge fund founder Chris Hansen, who is also negotiating with Seattle and King County to obtain $200 million of low-interest and presumably tax-free public financing to build a new professional basketball and hockey arena in the city.
With the Facebook IPO, Hansen's hedge fund, Valiant Capital and its associated entities, stand to make hundreds of millions of dollars for clients and its founder.
Professional money is like professional sports. There's a lot of fun to be had geeking out on the stats. It's a good bet that none of us will never actually be on the court playing in an NBA playoff, but one can still get a thrill from watching it. The same is true for hedge funds on IPO day. Chances are good that none of us will ever make this much money in a single day, but that doesn't mean it's not fun to watch.
The attached Excel file is a Guesstimator. Try it yourself. Plug in any Facebook stock price you want and out pops a reasonable estimate of how much money Hansen stands to make. Not that anyone outside knows for sure. Hedge funds are barely regulated, but the Securities and Exchange Commission does require basic information to be filed. So it is possible to get a sense of the pieces and an outline of the structures but only Hansen and his lawyers know precisely how they've set everything up.
Generally, hedge funds work this way: managers, usually a General Parter in a Limited Partnership (LP) create a fund and put some of their own money into it. Not too much, sometimes less than 5% of the value of the fund. They develop a strategy and seek investors, limited partners, who invest many times more money. It is common for funds to be several hundred million, even a billion dollars' or more in size. Later on, a fund may seek to increase its size as it becomes popular or encounters a very large opportunity.
Funds usually charge a flat management fee every year, right off the top. For a fund run by star managers or with access to sought after opportunities, chances are that the annual management fee will be towards the top end of the scale. 2% is common.
The place where vast piles of money is made is "the carry," which is the fund's share of the profit it makes for clients. Many funds charge 20%. If one invests a million dollars and it goes to two million, the investor gets $800,000 and the fund would "carry" the other $200,000, for example. It's called "carried interest" — not profits — as part of complex strategies for averting taxes and the details are both arcane and valuable.
Because a fund keeps the carry, say 20% of the gain, from all of its clients, this amounts to giant piles of money when an investment appreciates.
In the case of the fund creator's own original investment -— when it grows with the fund, they get to keep the other 80% of the gain on that, too.
So for Chris Hansen, the Guesstimator crunches some basic math, sketchy back-of-the-envelope style, and coughs up some really big numbers: If Facebook shares end Friday near $40 a share, Hansen stands to make hundreds of millions of dollars today. (At $37.50, for instance, we calculate he could earn $208 million.) That's just on his Facebook investment. Keep in mind that the Valiant funds include many other holdings reportedly amounting to billions of dollars. The fund may clip the management fee on all of that. And if the fund does its job and makes money on those investments, it keeps the carry, too.
Hedge funds being hedge funds, the next objective is to find ways to avert taxation on that income. Strategies for that are as numerous as tax attorneys. Some of the popular strategies might include offshoring the money, finding ways to have it classified as capital gains instead of ordinary income, buying up large swath of bonds on which to earn tax-free interest, or even, perhaps, investing in a professional sports team and associated new facilities. And those aren't even the exotic ones.
Today, however, the sport is in watching the Facebook action and running the numbers. How high do you think it will go?