Thoughts On A Sunday – 2/5/12

I’m in London this week. I had a wonderful play on literature this week on Twitter with my pictures for “My Tale of Two Cities”. SF was gorgeous and sunny and warm and then I landed in London on Sunday that had just experienced 4-6 inches of snow.

I had plenty of time to have a few thoughts twirl around so let’s get on it.

#1 – Facebook, FBook, $FB.
Thank god they finally filed their S-1. Tons of side stories around it, but the tidbit I found interesting was Zuck’s upcoming tax bill from options he will exercise. First off, it seems pretty unusual to me that a founder would be granted such an enormous option. I know absolutely nothing of the backstory on this situation, but if I had to guess I would say that the investors and Mr. Z were trying to ex-post facto get him ownership at the expense of prior common shareholders (i.e. Early shareholders and other founders). The movie ‘The Social Network’ touched on some issues around founder ownership, but I’m not sure I would trust a movie for fact checking.

#2 – Stock Options
Mark Zuckerberg’s $1.5 Billion tax bill is the headline, but there is a real story here about how screwed up our tax system is when it comes to stock options.

Zuck is going to exercise his option grant which means to say that he is going to write a check to Facebook to become the legal owner of those shares. He is going to pay a small amount relative to value, but realize that the only act he is taking is to purchase the stock.

The IRS, however, sees it a little differently. If an option holder exercises their right to acquire the underlying common stock, then a tax calculation kicks in that says the differential b/t the exercise price and the then current Fair Market Value is 100% taxable income (short term capital gains, I believe).

In the case of stock options, purchasing the underlying stock triggers a tax due AS IF you had sold the shares, not bought them. Down is Up, Right is Wrong, and Buying is Selling.

The effect of this tax ruling is that people are forced to do a ‘same day sale and exercise’ or they take on debt to pay the tax. One can do a same day sale only if there is someone to buy your stock. Zuck will be just fine because of the IPO, but note that he is waiting till the very end of the IPO process to exercise (he can’t afford to exercise and not sell a portion of his stock). What of the tens of thousands of option holders who are being denied the opportunity to be a stakeholder in their company because they do not wish to or can not go into debt to pay a tax bill. The benefits of the ‘Ownership Society’ require you to own the underlying asset. Unfortunately, I see this dynamic all too often in our underlying portfolio companies.

So, ‘What Do I Want’?
This post is not the equivalent of a Tea Party Rant against taxes. I want what is Fair. Exercising your option to purchase common stock is NOT the same as selling a security that you own. When a person sells stock for a gain and receives the cash, then a taxable event has occurred.

That is what I want.

Author: Phil Black

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: