Winklevoss Twins Lose In Court, Forced to Accept Facebook’s Legal Settlement
In a court decision which further frees Facebook’s hand for an IPO in the near future, the 9th U.S. Circuit Court of Appeals has unanimously ruled that Cameron and Tyler Winklevoss, the Olympic-rowing twins who accused Mark Zuckerberg of stealing their idea for a social networking site, must accept the settlement they reached with Facebook in 2008. Their argument that Facebook had withheld relevant information from them during these negotiations has been rejected, and the settlement that the Winklevosses will have to take, which consists of $20 million in cash and a percentage of company ownership, has been previously valued at $65 million, but may presently be worth more than $100 million due to appreciation in Facebook stock’s value.
I note one irony in passing. The ratio of the stock value to cash payment that made up the original settlement was not coincidental. The $65 million value consisted of 1.2 million Facebook shares originally valued at $45 million plus $20 million in cash. Receipt of such stock is a taxable transaction and, indeed, would constitute ordinary income to the Winklevoss brothers. Thus, they were to have received $65 million in taxable income, including $20 million in cash to help cover the tax. But that was then. Having chosen to fight the issue, they would not have realized any form of taxable income on this deal until they actually received the stock. As a result, when they now receive the cash/stock package, they will realize an estimated $170 million in taxable income (the cash plus FB stock worth $150 million), with only $20 million to help defray taxes. That stock will not be immediately marketable, even on the secondary exchanges and will require FB’s permission to be sold there. The net result, unless I mis-analyze, is that the Winklevoss brothers have by their choosing to fight managed to convert over $100 million in stock value from what would have been a long-term capital gain into ordinary income, will have to pay much higher taxes accordingly, and will (I would assume) be faced with a serious logistical problem in the form of a short-term cash squeeze in raising funds to cover the taxes. I am not a tax specialist and may be wrong on this, but I don’t think so.
FB dodged a bullet on this one. Had the settlement been set aside, the liability overhang would very likely have messed up its IPO, among other serious consequences.