Wednesday, February 23, 2005

Stock Loan Issues Refuse to Die

One of the little-known dark secrets of the telecommunications industry crash is that many employees were left with Promissory Notes (loans) for stock that they never really owned. My experience with this problem comes from a startup that I worked for in the early 2000s (when every company in telecom was going public and making gobs of money for their lowly workers).

We were all encouraged to sign notes for our stock options the moment that they were granted - even before they were vested - to avoid onerous taxation via the Alternative Minimum Tax. That is a ridiculous and outdated law that says, for example, if you are granted stock options at $1 and you exercise them when the stock is trading at $5, you owe tax on the $4 difference even if you don't sell them. (Many employeed didn't or couldn't sell in time and ended up owing more in tax than the stock was worth.) So, we all signed notes for the value of the stock so that the IRS would consider that we purchased them at the $1 level. And the interest started running.

Fast forward to the crash, and those options are now worthless. However, the notes are full recourse and the bankruptcy lawyers have no souls. There are a few options. First, the loan can be forgiven. In that case, the employee owes regular income tax on the loan amount. For a $40k a year installer with a $100k loan, that's about $30k in income taxes on money that he never saw in his bank account. Not a pretty outcome. Another option is to devalue the loans (pay 10 cents on the dollar) and write off the capital loss at $3k a year for the rest of your life - plus pay taxes. Also not good.

So, some enterprising ex-employees of my little startup experience banded together and purchased the loans outright. The plan is to stick them in an Al Gore approved lockbox where they will never hurt anyone again. As posted on the bulletin board:
The MIGA (Make it Go Away) Group has recently negotiated a deal to buyout the remaining [company] Stockholder loans. MIGA is a group of 36 loan holders, whose loans range from $8.3 to $95K, that represent close to $1.4M of the outstanding $2.5 M loans (including interest). Over the past three years, MIGA defended against the collection of the [company] Stockholder loans and developed arguments on why the
stock was overvalued (for negotiation and tax arguments).

Employee stock loans and [founder]'s personal loan are the only issues remaining that are keeping the Company from shutting down. The Company still has around $200K in the bank in September 2004 when last reported, plus prepaid legal fees. Just enough money to forgive the stockholder loans, file the necessary 1099s, and pay FICA (7.65%)taxes on the loans. This would of course subject loan holders to taxation for loan forgiveness.

In November 2004, [company] was talking about dragging this out further in court or forgiving the loans. MIGA negotiated a deal to buy all the loans because [company] refused to sell only MIGA member loans. This allows [company] to sell off the loans without paying FICA taxes and filing 1099s. MIGA will own the loans indefinitely as a group.

To reduce the burden on MIGA members, we are asking all current loan holders outside of MIGA if they would contribute 3.5% of their [company]-reported loan amount to assist with our effort, as we all benefit from this settlement. Some of MIGA members have contributed during many months of unemployment. Some are recently unemployed and unable to contribute now. MIGA group's burden without your participation will average close to 5% of their loan amounts or over $65K to cover:
  • $35K for the loan buyout
  • >$30K for 3 years of legal fees for fighting the collection of the loans, establishing our claims for low stock valuation, and negotiation.
Please notify me ... immediately if you can participate and I will send you details on the amount you owe, how and where to contribute. We need to collect the funds in the next 3-4 weeks to close this deal.

Someday this will all make a great book. Or perhaps short story. It has a good moral, interesting characters, and what appears to be (finally) a relatively acceptable ending. Now I just need to find the money to contribute ....

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