There’s no shortage of losers in the Facebook IPO: Mutual funds that didn’t get the insider tip about the company’s sliding prospects; starry-eyed individual investors who jumped at the chance to buy shares above $40 in the first few frothy hours of trading; and the reputation of the investment banking industry, which gave the general public one more reason to believe the stock market is nothing more than a rigged casino favoring the house – their house.
But after searching high and low, we’ve finally turned up two big winners from Facebook going public: the U.S. Treasury and the state where Facebook executives and key employees reside – California. Those governments will reap an estimated $4.6 billion in income taxes due from insiders who received over 400 million shares of stock as part of Facebook’s 2005 equity compensation plan. Stock distributed under such plans is taxed as ordinary income.
Now comes more bad news for customers of Morgan Stanley and the other investment banking firms that encouraged their customers to cough up $38 a share for Facebook, which is more than 70 times last year’s earnings. The company treasury will pay those taxes to Uncle Sam and the states on behalf of the stock-compensated employees, including Mark Zuckerberg, who reaped over $1 billion by selling 30 million shares in the offering and still holds over 27 percent, or about a half billion shares of the company (making him worth – at Thursday’s $32-a-share price – about $17 billion).
And where will Facebook, which only had $3.9 billion in cash and marketable securities on hand at the time of the IPO, get the $4.6 billion necessary to pay those taxes? The prospectus stated it plainly: “We anticipate that we will expend substantial funds (from the stock offering) in connection with tax withholding and remittance obligations related to the initial settlement of our restricted stock units” (the stock tied to the 2005 executive compensation plan).
In other words, Facebook raised $6.8 billion from the 180 million shares it sold to the general public in the IPO, and will spend more than two-thirds of that cash, much of it from the retirement savings of middle class Americans, on its wealthiest employees’ tax withholding. “That level (raised for taxes) is unusual,” said Michael Maryn, a partner at SNR Denton and an expert on executive compensation. “The real purpose of this IPO was to allow Zuckerberg and early shareholders to cash in on the value of Facebook. They’re cashing in their chips, so to speak.”
To be fair, the number of shares distributed under the stock compensation plan will be reduced by about 45 percent to offset the payments made to the Internal Revenue Service (35 percent high-end tax rate) and California (10 percent high-end tax rate). But the company still has to come up with the cash to pay the withholding: about $3.6 billion to the U.S. and $1 billion to California. It did so by selling shares to the public.
“It’s an unusual use (of capital raised through an IPO), but it is permitted,” said Walter van Dorn, also a partner at SNR Denton, who specializes in Securities and Exchange Commission law after working there as a regulator. “They have leeway to do what they want.”
The company admitted in its prospectus that it has no other real use for the money other than adding to its treasury for general purposes or to make acquisitions, none of which were tied to the offering.
The amount paid in taxes could go down, of course, which would leave more of the money raised from the public in Facebook’s hands. It will wait 151 to 180 days before paying the governments.
Though the shares were distributed immediately, the company will set their value and estimated taxes based on the share price after the lock-up period ends. If it’s below $38, the $4.6 billion liability will go down. If it’s higher, “we may need additional financing,” the prospectus warned.