Mark presents some good points here. I like how he takes responsibility for his own trading losses and does the correct thing: he gets out when it doesn't do what he expects.
He's also correct that a company can reprice their options.
But all of that misses the point.
Later employees can have repriced options so they're no longer underwater but you have to remember that a lot of people went to Facebook in the latter days for a pre-IPO payoff that didn't eventuate. If their vesting options look little different to an RSU package they'd get from Google, there is no "golden handcuffs", which is what you really want for talent. If Facebook has to reprice their options to recreate that situation they may end up spending a lot of the cash they gained for the high IPO price.
Second, every company, every lawsuit, every war has a narrative. That narrative is important. If you're trying to get people on your side, the facts typically don't matter, the narrative does. Pre-IPO, Facebook's narrative was of going from strength to strength to the point where it had competitors scared that Facebook would be the Internet.
That is no longer the case. The spell is broken. Investors have realized this. No longer is Facebook the company with blue sky potential. It's (now) a company with a really high P/E ratio. Google, for example, peaked in 2007. Part of this was the highs of the market but part of it is also this shift from blue sky potential to viewing the company as a source of income. All this even though Google is making way more money than in 2007.
So Facebook may take years to regain the IPO price. Watch out for the pundits who see the $38 IPO price and consider $18 cheap. The first price we see for something tends to imprint strongly and we view all subsequent prices in those terms. It's a trap that could well lose a lot of people a lot of money.
Beyond employee and investor issues there is another problem here: companies tend to prefer to pay for acquisitions with stock rather than cash (eg Instagram was, at the time, $700M in stock and $300M in cash IIRC). If the narrative of your stock is one of it having consistently dropped since the IPO, it makes it harder to pay for acquisitions with stock as investors and founders have to price the stock based on expected losses rather than expected gains.
The key motivations in any market are fear and greed. If the stock has a history of going up (like Apple's in the last decade) then greed takes over and people want to get in. In Facebook's case, fear would be a significant factor now (given lock-ups of shares on acquisition, etc).
The problem with Facebook IMHO was that it waited too long to IPO. Of course as a colleague of mine likes to say, "that train has sailed" [sic].
One thing I that makes me chuckle is thinking back to the prices paid on secondary markets pre-IPO. Staunch FB defenders argued this was useful price discovery (one function of any market). Others (including me) argued that such markets were essentially echo chambers and the stock was too thinly traded to give meaningful price information. That view has turned out to be correct.
The best part of this whole story is that the wider market hasn't bought into the hype and has discounted Facebook stock accordingly. Any concern of us being in a bubble should go out the window.
to your points an interesting article from business insider
It's Becoming Clear That No One Actually Read Facebook's IPO Prospectus Or Mark Zuckerberg's Letter To Shareholders
Quick hits from the article
----------------------------
Didn't anyone even read Facebook's IPO prospectus? The answer, I can only assume, is "no." Because if anyone had read the Facebook IPO prospectus, they would have learned, among other things, the following:
Facebook's growth rate was decelerating rapidly.
Facebook's user-base was rapidly transitioning to mobile devices, which produce much less revenue.
Facebook's operating profit margin was already an astounding 50%, which suggested it had nowhere to go but down.
Facebook's CEO had a nearly unprecedented amount of control over the company.
Facebook's CEO had set up this astounding level of control intentionally. Mark Zuckerberg knew all about how impatient public-market shareholders are. And he set up the whole company so he would never have to pay attention to their whining.
In the 9 months following the IPO, insiders would be free to sell more than 2 billion shares of Facebook that they had been holding for years.
Facebook was going public at an astoundingly high price for a company with these characteristics—about 60-times the following year's projected earnings, in a market in which other hot tech companies like Apple and Google were trading at less than 15-times.
Facebook's CEO had a nearly unprecedented amount of
control over the company.
Is that a bad thing?
I was under the impression that Larry and Sergey did the same thing with Google. As I remember they always retained more than 50% of voting rights, and now there's a new special class of stock issued to shareholders with no voting rights.
Thing is, shareholders can be irrational, especially with companies that are working on the cutting edge, because shareholders are more interested in short-term gains. E.g. Shareholders and Wall Street were thrilled when Dell was outsourcing their core competencies to Asus, which in the end screwed them over. Dell is now just a shadow of what it used to be, with no bright future ahead.
Of course, if you view that as a warning sign, then simply don't buy. But there are other factors at play here. Do you trust the company? Do you trust the CEO? Do you understand the risks? If not, then maybe you shouldn't own stock in the first place.
Without any expectation of either control or dividends, shares don't represent ownership in any meaningful way. They're baseball cards, and the only reason to buy is to play hot potato with the other speculators.
Again, Mark Zuckerberg set up the entire structure of the company so he wouldn't be forced to make dumb short-term decisions by whining public-market shareholders.
And he TOLD them that he wasn't going to make those decisions.
They just didn't listen.
The article isn't an indictment of Facebook, its an indictment of investors who ignored the warning signs that this wasn't a stock designed for a short term position and are now complaining about it.
None of this matters if the market expects significant growth in profits. FB's customer growth rate can be zero, but still command a price premium based on expected future profit growth. Given Facebook's broad customer base, and perceived untapped revenue opportunities, it seems believable.
Many people bought into the idea that Facebook had yet to scratch the surface with revenue opportunities. Obviously, the market has not shared this view.
There are others who did not even need to read the prospectus to know the points you made. If you had been following the company closely enough, most of these points were fairly evident.
EDIT: I am wondering though, if the artificially high price was a ruse - a scam used by those who COULD sell at the overly inflated IPO price to cash out tons before it dropped to what they knew was the correct reflection of value.
As far as paying for acquisitions with stock, it'll mostly balance out.
The companies being acquired will do so at a lower valuation because their upsides aren't as stratospheric as they seemed a few months ago. "If Facebook isn't worth that much, how much are you worth?"
Today Instagram would take $300M cash and $350M stock and be happy with it.
Not to mention FB has been issuing RSUs (not options) for several years now, which means that 1) Later employees still get a payout, of course only half of what they were expecting
2) Anyone early enough to get in when they still were giving options has an good strike and is still gets off fine
Does anyone here know the tax situation on these RSUs that facebook gives?
If people do it through an 83(b) election, aren't these RSUs supposed to be taxed as cash at the second of grant? (but if forfeited, that tax is lost?) - That would be horrible.
If people don't do a 83(b), then it is taxed at vesting - so it's just equivalent to a cash bonus at exercise (and taxed the same) - but if that's the case, how has anyone ever thought it was anything other than a cash bonus (determined at bonus time by a constant C*company value for some C, which appears in your employment contract, but is otherwise arbitrary and can be changed arbitrarily at any point before grant by the company)
Wouldn't you want the clock to start at the second of grant so that appreciation would be long-term capital gains sooner? Although I can see how it would cause a cashflow problem in the short term.
If the shares are worth $38 at grant, you are paying taxes based on the $38 value if you do an 83b.
if the stock price goes up, you are golden, as you started your long-term capital gains clock earlier.
But what if the stock price goes down? Then you just paid taxes based on a $38 share price, and ended up with shares worth just $18. If the stock price goes down a lot, you may end up paying more in taxes than the value of the shares themselves
(b) sold all your shares (was practically impossible for FB employees before 2nd market and friends came along; still mostly impossible for employees in most companies until 6 months after IPO or acquisition)
(c) have realized capital gains in the year(s) following that loss (I don't recall the exact details, but you can net the full loss for 3 years, and then less and less until nothing at all in 7 years or so).
Now, let's look at a more typical case:
You start to work at facebook the day of the IPO; you are awarded 10,000 RSUs at $38 each. That's $380,000 right there; If you make an 83(b) election (to start the capital gains clock ticking), you just scored $380,000 in the "other income" (or even "salary") columns. If you're in high tax place, like NYC, that's 48% in marginal rate (which is not unlikely -- although, assuming you were unemployed, and this all happened on 31-dec, would "only" be 43% or so ....): 35% federal + 8% NY state + 5% NYC. So you just incurred a tax bill of $180,000 of money you never got.
Now, you can get fired the next day. The shares have been forfeited. You do not have a capital loss in that case. Just a $180,000 tax bill with NO income or credit to offset it, regardless of what happens to the stock.
But let's say you stay working for the whole vesting period. Except the whole time you can actually sell them, they are at $16. You're still $20K out of pocket at the end of the period, after selling everything. (And whatever the interest and opportunity costs for spending those $180K on taxes).
But in this case, if you make a huge capital gain profit sometime in the next three years, you'll be able to take credit for your losses - of having bought the RSUs at $38 and sold them at $16 - a loss of $220K.
Oh, and you often have to pay for RSUs, so your losses are larger (although unlike options, that's not mandated by law, and FB could give them to you "for free").
So, no, you don't want to turn the capital gain clock on RSUs unless the shares are essentially worthless at the time of the 83(b) election [or otherwise have no way of siginficantly losing value, and have a good probability of gaining value).
By all means, you should do an 83(b) election when founding the company (if it is needed and makes sense) - on week one, when the value of the company is $5000, it makes sense to pay taxes on your 25%=$1250. But a few months later, when you're raising money at a $1M valuation, that's the value the IRS will want to see on your 83(b) election.
> thinking back to the prices paid on secondary markets pre-IPO. Staunch FB defenders argued this was useful price discovery
I'm no FB defender, but doesn't the IPO placement of 421 million shares at $38 indicate that the secondary markets had it correct? The decline, albeit soon and somewhat swift, occurred afterwards.
He's also correct that a company can reprice their options.
But all of that misses the point.
Later employees can have repriced options so they're no longer underwater but you have to remember that a lot of people went to Facebook in the latter days for a pre-IPO payoff that didn't eventuate. If their vesting options look little different to an RSU package they'd get from Google, there is no "golden handcuffs", which is what you really want for talent. If Facebook has to reprice their options to recreate that situation they may end up spending a lot of the cash they gained for the high IPO price.
Second, every company, every lawsuit, every war has a narrative. That narrative is important. If you're trying to get people on your side, the facts typically don't matter, the narrative does. Pre-IPO, Facebook's narrative was of going from strength to strength to the point where it had competitors scared that Facebook would be the Internet.
That is no longer the case. The spell is broken. Investors have realized this. No longer is Facebook the company with blue sky potential. It's (now) a company with a really high P/E ratio. Google, for example, peaked in 2007. Part of this was the highs of the market but part of it is also this shift from blue sky potential to viewing the company as a source of income. All this even though Google is making way more money than in 2007.
So Facebook may take years to regain the IPO price. Watch out for the pundits who see the $38 IPO price and consider $18 cheap. The first price we see for something tends to imprint strongly and we view all subsequent prices in those terms. It's a trap that could well lose a lot of people a lot of money.
Beyond employee and investor issues there is another problem here: companies tend to prefer to pay for acquisitions with stock rather than cash (eg Instagram was, at the time, $700M in stock and $300M in cash IIRC). If the narrative of your stock is one of it having consistently dropped since the IPO, it makes it harder to pay for acquisitions with stock as investors and founders have to price the stock based on expected losses rather than expected gains.
The key motivations in any market are fear and greed. If the stock has a history of going up (like Apple's in the last decade) then greed takes over and people want to get in. In Facebook's case, fear would be a significant factor now (given lock-ups of shares on acquisition, etc).
The problem with Facebook IMHO was that it waited too long to IPO. Of course as a colleague of mine likes to say, "that train has sailed" [sic].
One thing I that makes me chuckle is thinking back to the prices paid on secondary markets pre-IPO. Staunch FB defenders argued this was useful price discovery (one function of any market). Others (including me) argued that such markets were essentially echo chambers and the stock was too thinly traded to give meaningful price information. That view has turned out to be correct.
The best part of this whole story is that the wider market hasn't bought into the hype and has discounted Facebook stock accordingly. Any concern of us being in a bubble should go out the window.