Goldman Sachs IPOCase Analysis

Presented by:

Group-7

Why Goldman Sachs has enjoyed the greatest reputation among its peers?

• Quality talent acquisition and retention: Personal sense of excellence, ownership and the urge to go that extra mile

• Refusal to pursue hostile deals

• The firm’s ability to cultivate a first-rate client list, composed of the top corporations in the US

• Living by the “Fourteen Commandments”. Goldman’s Values: teamwork, long term client relationships, integrity, honesty and reputation

• Long term relationships are valued more than short term profits

• Less tolerance for nonconformist behavior

Why it took so long to decide on the IPO issue?

• Lack of consensus among partners and various committees that were formed to oversee the company’s operations

• Agency problem – Partners not willing to let go of annual profit sharing on pretext of preserving organizational culture

• Dilution of voting rights of partners

• Increased regulatory scrutiny

• Different risk preference of partners and public shareholders.

• Doubt that going public will dilute the company’s culture and diminish the firms employee retention power

• An irreversible process

Did Goldman Sachs had enough capital to grow? Can it grow faster enough to retain its position?

• Borrowing from Sumitomo Bank and Bernice Pauahi Bishop Estate every few years to sustain their current growth rate which led to shrinking of Goldman’s Equity.

Did Goldman Sachs had enough capital to grow? Can it grow faster enough to retain its position?

• Investment Banking business was moving towards Asset Management and it was the only business where Goldman Sachs was not in top 3 and to expand it had to grow its capital for geographic and customer base expansion.

CompanyJanuary 1, 1997

Capital ($ billion)January 1, 1998

Capital ($ billion)

% Change in Capital from

'97 to '98

Number of LocationCostomer Accounts

(000s)Domestic ForeignMerrill Lynch & Co Inc 33 51.4 56% 695 50 9,000 Morgan Stanly Dean Witer & Co 21.9 39.7 81% 420 28 3,600 Salomo Smith Barney Hoding Inc 19 27.6 45% 442 41 5,000 Lehman Brothers Holdings Inc 19.8 24.8 25% 16 24 NA

Goldman Sachs Group L.P. 17.7 21.8 23% 15 33

267

Could they retain their capital base?

• No they cannot.

• Partners have 75% of capital (Figure A).

• Low barrier to exit.

• Unlimited liability provoked partners to withdraw their equity on losses

• Effect on Ownership Structure and contract design aka Private Partnership.

Would M&A be a better route?

• M & A might change the cultural character of the firm. Difference in ideology of two companies

• Issues in Structural Integration

• High Search Cost to find a compatible firm might outweigh the benefits of M&A

• M&A can grow only up to limited size. In case of IPO, company valuation may grow multiple times

Would increased scurrility in going public damage Goldman Sachs?

Short Term• Reduced aspirational value: dissolved hopes of partnership• Some loss of aura: as the company’s unique partnership structure

would be dissolved

Long Term• The company can draw upon leadership to carry the culture along to

the public firm• Access to US equity markets for future capital requirements• Increased size of the company• Improved presence in Asset Management space

What will be impact IPO on senior partners, non partner employees Sumitomoto & Bernice, Limited partners, shareholders, customer, competitors?

Partners • Wealth increase by $50 million +

Sr. Partners • Wealth increase by $100 million +

Non-partner Employees

• 50% of their 1997 and 1998 compensation plus bonus/year• They may get more attractive offers from competitors• The employees will feel more secure

Limited Partners

• Premium over the book value of their investment – between 25% and 55% depending on whether they choose cash or stock

Shareholders• They will be get a good return on equity which is expected to be

higher than the industry average. Will receive premiums and dividends as declared by the company.

Customers• Increased transparency • More information about the firm available in public domain

Competitors

• Increased competition as the firm expands and improves its market position across segments, even in asset management

• Competitors can gain because of customer attrition due to dilution of aura/Company Image

Would the agency problems increase or decrease after IPO? How moral hazard & selection (ESOPs) might arise?

Agency problems will increase

• Agents will be the Board of Directors appointed by investors after the IPO. With only 14% of Equity Dilution given to shareholders, partner representation will be high on Board of Directors, leading to Information Asymmetry between investors and Partners.

• Conflicts in shareholders and partners objectives leads to delay in reaching consensus on critical decision making. Shareholders will look towards short term gains whereas company management will work towards long term growth and sustainability.

Moral hazards:

• Lack of effort and motivation on the part of the agents as reward of partnership would not exist post IPO

• With extensive monitoring and regulations, the managing directors and employees may put in their best efforts or their best foot forward as their compensation post IPO will be outcome based

ESOPs Selection

• To curb moral hazard, employees should be rewarded with ESOP options.

Would the contract monitoring be based on outcome or behavior based (before and after the IPO)?

Pre-IPO• Principal: Company• Agent: Partners• Appropriate Contract : Behavior Based contract

Post IPO• Principal: Shareholders/Company (14% Equity dilution)• Agent: Managing Directors/Partners• Appropriate Contract : Outcome Based contract.

• Stronger form of monitoring systems (capital market, regulatory bodies),

• Degree of measurability was high.

Thank You