Who Got Rich When Goldman Sachs Went Public, and What Investors Can Learn From It Today

In the world of financial media, there are few things as irresponsible as hyping an initial public offering to the general public. If you come across an article or television segment doing so, move on to more productive activities like, say, relacing your tennis shoes.

"An elementary requirement for the intelligent investor is an ability to resist the blandishments of salesmen offering new common-stock issues during bull markets," wrote Benjamin Graham in The Intelligent Investor. "Even if one or two can be found that can pass severe tests of quality and value, it is probably bad policy to get mixed up in this sort of business."

The problem, according to Graham, is that most of the stock is usually sold "for the account of the controlling interests to enable them to cash in on a favorable market and to diversify their own finances."

I bring this up now for two reasons. First, thanks to the record level of the stock market, the number of companies going public is soaring. Thirty-one companies filed IPOs last month alone, making it the busiest September since at least 2003 -- I say "at least" because that's as far back as Renaissance Capital's public data goes.

And by the end of the third quarter, 152 of such offerings had priced thus far this year -- actually gone public, that is. This figure is also the highest it's been in at least a decade.

The second reason I bring this up now is because of a new book written about Goldman Sachs (GS 1.79%) by former partner Steven Mandis. The point of the book, What Happened to Goldman Sachs, is to explain why and how it abandoned the principles on which its reputation was built -- most notably, "our clients' interests always come first."

A critical inflection point -- if not the most important juncture, according to Mandis -- was the company's 1999 initial public offering. The reasons are too numerous to list here, but they include a change in business mix and risk tolerance toward trading activities, as well as a misalignment of its incentive structure.

In line with Graham's explanation for why companies go public, Mandis discussed one partner's reason for supporting the investment bank's decision to do so, explaining that "All his wealth from working at Goldman for more than twenty years was tied up in the firm, and the IPO offered a way to get it out." That is to say, he didn't support the plan in order to raise capital for the business, as most IPO filings proclaim, but rather to get rich personally.

To this end, Mandis included a list of the partners that received money from the offering and how much each of their stakes was worth at the time. I suspect you'll recognize many of the names in the following table, which lists the five biggest stakeholders. Needless to say, they did quite well for themselves.

Source: Steven Mandis, What Happened to Goldman Sachs.

Are there exceptions to the rule that companies only go public to make their current stakeholders wealthy beyond imagination? Perhaps. The first that comes to mind is Facebook (META 0.43%), which was purportedly forced to go public by regulations limiting the number of shareholders a private company can have. Though, my guess is that there's less truth to that narrative than investors were led to believe at the time.

Much more representative of the types of companies that go public today are those that are owned and then expelled by private equity companies after every last ounce of legitimate value has been extracted. Noodles & Company (NDLS -0.36%) is a prime example of this, as is Chuy's Holdings (CHUY 1.17%). Both are popular restaurant chains that were purchased by private equity companies, loaded full of debt, and then released onto the public markets much like the mob dumps radioactive waste into rivers.

Have their stocks gone up since their offering? Yes. But that has more to do with the overall market and the abilities of Chuy's, as it's far too early to draw any positive conclusions about Noodles & Company, to fight its way out of the hole that its private equity overlords dug for it.

At the end of the day, I'm not trying to criticize those individuals that get wealthy when a company goes public. In fact, I applaud them -- with the exception of private equity companies such as Blackstone (BX) and KKR, which I genuinely believe are bad for the American economy.

What I am trying to say, however, is that, like Graham exhorted more than 60 years ago, individual investors would be wise to steer clear of initial public offerings. The only thing your "investment" in one does is to line the pockets of the seller -- not your own.