Buffett a key to Goldman's Tarp payback

(breakingviews.com) -- Goldman Sachs executives made clear they want to pay back government funds weeks ago. Congress's flirtations with a 90% bonus tax just reinforce their desire. So let's assume that regulators give them the go-ahead.

All the Wall Street firm needs to do is replenish some of the funds by selling new stock, right? Not so fast. Goldman (GS, Fortune 500) still needs to reckon with Warren Buffett.

The septuagenarian's conglomerate, Berkshire Hathaway (BERK.A), injected $5 billion into Goldman last September in return for preferred stock. That, combined with an almost $6 billion common stock offering, helped bolster Goldman's capital in the wake of Lehman Brothers' bankruptcy. But Buffett's involvement came with a condition that could qualify him for a top-up.

That sounds ominously similar to the so-called ratchets granted to those who invested in Merrill Lynch and Washington Mutual during the credit crisis. A ratchet is a feature that allows those investors' stakes to be recalculated should the company raise more capital at a lower price. They might like the protection it offers, but it's often bad news for the recipient and its shareholders.

The rights WaMu handed to private equity firm TPG arguably scared off other potential new investors before the bank folded and was handed by regulators to JPMorgan (JPM, Fortune 500). Meanwhile Merrill had to hand over almost a third of the $8.5 billion it raised last summer to cover the ratchet Singapore's Temasek had negotiated with its previous investment.

Thankfully, the deal Goldman struck with the Oracle of Omaha is nowhere near as onerous. Unlike others, the top-up isn't linked to the price Berkshire negotiated for its preferred stock and warrants. Instead, it requires two triggers.

First, Goldman would have to sell new shares at a discount of 5% or more to where its stock trades at the time. That's certainly possible - it offered an 8% discount last September during one of the most volatile weeks of the year. The average secondary share sale dangled just less than a 5% discount in 2008 and only just breached that in the first three months of this year, according to Dealogic.

But the discount boosts Buffett only if Goldman sells stock to a small group of select investors. A broader sale - perhaps even a rights offering to all its shareholders - wouldn't set off the ratchet. That gives Goldman a good deal of leeway. It's not as clean a deal as Morgan Stanley's (MS, Fortune 500) ratchet-free $9 billion investment from Japan's MUFJ. Still, in this market, the fewer shackles, the better.