Facebook’s first employees to share $23bn

Given the scale of the company’s success, almost everything about the impending Facebook stock market listing is couched in superlatives.

So it is no surprise that the personal wealth about to be showered on its army of 20-something engineers and other employees will outshine anything seen since the days of the dotcom bubble.

The consequences of these instant stock profits though, are likely to prove controversial, triggering a debate about the impact of the lottery-like winnings on the companies where they are made and the culture of Silicon Valley at large.

The financial implications will also have unexpected effects on Facebook’s tax bill and its accounting after it becomes a public company. Among the most surprising: a $500m US tax refund to the company early next year. It is a payment that is likely to be controversial given the state of the US fiscal position and Facebook’s own conspicuous success.

The employee wealth generated by the company has largely been overlooked amid the attention focused on the large profits for Mark Zuckerberg and some of the company’s other founders and early shareholders – not to mention the $200m that the graffiti artist who fashioned murals in the company’s first HQ stands to make, if he still holds the shares.

At an estimated $23bn, the 3,000-odd employees stand to collect an average of more than $7m each. Those gains, though, will be very unequally shared, with it will be the first employees taking the bulk of the money. Young start-ups greatly reduce stock awards for new hires once their success seems assured – as Google did in 2002.

“It will create all sorts of internal equity problems for Facebook,” said Kevin Murphy, professor of finance at the USC Marshall School of Business. The “first-mover advantage” of the workers who came in first will make them a privileged – and very wealthy – class inside the company, he added.

Some of the immediate financial implications of this staff bonanza can be traced in filings Facebook has made with the Securities and Exchange Commission ahead of its IPO.

In tax terms, the company will pay some $5bn to cover its employees’ personal tax bills six months after its IPO, on top of the $1.5bn-$2bn tax liability that Mr Zuckerberg himself is expected to face. That is based on the 224m restricted stock units that will vest in November, along with a portion of a remaining block of 102m that has yet to vest.

Under US tax rules, Facebook will then be able to offset those amounts against its own profits – effectively erasing its own US tax bill this year.

Also, since the company can carry these “losses” back two years, Washington will actually give Facebook a $500m refund in 2013, according to the company.

Given the scale of the employee taxes already expected this year, as well as taxes on future profits from other stock benefits, that makes it unlikely that Facebook will pay any US taxes for some time.

In accounting terms, meanwhile, the employee windfall will result in a one-off charge to Facebook’s profits of almost $1bn at the time of the IPO, with total charges of $2.5bn expected over two years. With the company’s totalled reported profits last year reaching $1bn, those costs will loom large – though Wall Street largely discounts such charges when assessing the profits of tech companies.

Not all Facebook employees will share in the wealth. Some early employees, who were handed options, ended up with nothing: faced with paying tax on any options they exercised when they left the company, some let their options lapse rather than face a bill on shares whose value was uncertain.

In all, some 427m options have already been exercised, according to Facebook’s regulatory filings. Those shares would be worth an additional $19bn at today’s notional private market value, though many were sold early by departing employees, taking advantage of the new private markets that have sprung up for young tech start-ups.

Like many tech companies, Facebook turned away from stock options after a change in US accounting rules in 2006 that forced companies to treat them as an expense against their profits – a rule that did away with one of the main attractions for issuing options rather than stock.

As a result, much of the employee wealth will come from restricted stock, which becomes available for sale four years after being granted. Four senior executives, including chief operating officer Sheryl Sandberg, stand to make $2.5bn between them from such awards, according to filings with the SEC.

How many will take the money and run will now become a question uppermost in the minds of Facebook’s top executives, as well as the many other Silicon Valley companies hungry to hire talented staff. Much will depend on whether the company can convince its workers that it will remain one of the Valley’s coolest places to work, and whether its value continues to rise.

“If Facebook executes its strategy, the stock will eventually be worth far more than the IPO price,” said one Silicon Valley financier with close ties to the company. “Some employees will cash in and move. Most will stay.”

For those that follow, though, the rewards will never again be as good.