Uber owes some employees tax reimbursements on RSU share income

 
In May 2019 Uber Technologies, Inc. finally went public in an $8 billion initial public IPO. The $45 per share IPO price valued the company at $82.4 billion. Uber delivered its employees’ shares per their Restricted Stock Units (“RSUs”) at that $45 price even though its RSU agreements provided for Uber to deliver the stock six months later. The stock had declined to about $27 per share six months later when the 180-day “lock-up” period expired and employees could finally sell. So, employees owe income taxes based on a $45 IPO price that they couldn’t realize, and that hasn’t been seen again since opening day.

What does that really mean? Take the following illustrative example. A software engineer goes to work for Uber, receiving a grant of 40,000 Restricted Stock Units, vesting over four years, provided there’s a liquidity event. Suppose she stays the whole four years and then is there for the IPO, so all 40,000 shares fully vest. Seems like she should be rich now, perhaps. But here’s the math.

Uber issues her shares at the $45 IPO price, a face value of $1.8 million—enough for a modest retirement. But Uber’s actions made the tax consequences even worse than they were supposed to be. Because this is an outright grant, the entire proceeds are taxed as ordinary income. Applying a combined California and Federal tax rate of 52.65% (a likely marginal not average rate), she owes $947,700 in income tax. Uber withheld the minimum 37% of the shares against taxes, in effect selling those shares for her at the IPO price, so she received only 25,200 shares but the withholding covered $666,000 of her taxes, leaving her owing $281,700. By the time she could sell them six months post-IPO, however, her 25,200 shares were only worth $27 each.

If she sold her remaining 25,200 shares at that $27 price to cover her tax obligations and diversify her holdings (a sensible strategy), she would net $680,400. After paying the $281,700 in remaining tax, she would have just $398,700 of her $1.8 million left after taxes.

Is that something the affected employees have to live with? For lots of employees, the answer is no. Many Uber employees’ RSU agreements provided that Uber wasn’t supposed to deliver the RSU shares until six months post-IPO. The IPO caused the RSUs to vest—employees’ rights to those shares became definite—but those shares weren’t supposed to be delivered until the “settlement date” six months later. If Uber had settled six months later, per the RSU agreements, those employees would have been taxed on the $27 per share November 9, 2019 price, not the $45 per share IPO price on May 9, 2019.

How widespread is this? At the IPO, Uber employees received 47 million shares in “net settlement” of 76 million vested restricted stock units (“RSUs”). Uber withheld (netted out) 37% of these RSUs to cover withholding taxes—he minimum required by law, not the likely amount owed. This withholding helped. But Uber’s decision to deliver at the IPO rather than six months later likely imposed about $200 million in additional needless income tax liability on employees that was not covered by the withholding (at $45 a share) and therefore comes out of employees’ pockets.


Uber could have honored its agreements, but it didn’t. Uber could have avoided employees’ exposure to additional income tax resulting from this acceleration by increasing withholding, but it didn’t do that either—probably because Uber didn’t want to use more of its cash to pay withholding taxes than it had to. Uber also did nothing to remove or shorten the lock-up period so employees could sell at the IPO price to cover their tax liability.

Uber knew its decision imposed significant tax risk on the employees. If Uber’s share price increased between the IPO date and the expiration of the lock-up period, the employees would benefit from paying tax based on the lower IPO price. But if the price went down, as often happens and predictably happened here, the employees would still owe taxes based upon the IPO price.

A few days before the IPO, Uber delivered a memo to employees laying out its purported reasons for the acceleration.

First, Uber said it was required to withhold taxes when RSUs vest and are settled, so they elected to withhold shares (delivering a net number of shares to employees and paying the withholding taxes out of the IPO proceeds). This net settlement approach was chosen, according to Uber, to reduce the number of shares flowing into the market at the end of the lock-up, which could put downward pressure on the share price. Electing the net settlement option made sense. But Uber could have done a net settlement on the original settlement date (six months after the IPO), with the same net number of shares flowing into the market. The net settlement had nothing to do with the acceleration.

Second, Uber said it accelerated the settlement date to lock in the amount of tax it had to fund with cash from the IPO proceeds as withholding for employees. If Uber had delivered the net RSU shares on the contractually-specified settlement date six months later, the share price might have been higher than the IPO price, and the cash required to fund the withholding greater. Fixing that amount would eliminate the possibility that Uber would have to pay substantially more. And eliminating the uncertainty would probably increase the share price.

By delivering the shares on the IPO date, if the market price went up, both Uber and the employee would win. Uber would save cash and the employee’s ordinary income tax liability was locked in at the IPO price. The employee would be taxed at the lower capital gains rate on any increase over that price. If the market price went down, Uber still won—since the tax liability was locked in at $1.3 billion, the use of proceeds its IPO underwriters agreed upon and the market expected. But the employees lost—since their tax liability was locked in at the higher IPO price.

Third, Uber said that accelerated settlement could start the capital gains holding period earlier than if the company waited until the end of the lock-up period to settle the RSUs and issue shares. Whether this would be beneficial to the employees of Uber was speculative, depending on whether employees intended to keep their stock or sell it and diversify their assets—which of course is the prudent strategy for most employees, who shouldn’t have a substantial portion of their net worth invested in one stock, especially Uber.

Uber wasn’t helping anybody but itself. It was doing what was best for Uber, in breach of the RSU agreements, and betting on the future share price with the financial risk being borne by the employees.


 Did Uber know that it was exposing its employees to unreasonable risk, in fact a probability that they would be worse off? Consider the facts.

 As of the IPO, Uber already had raised $24.5 billion in a dozen rounds of private venture funding. Uber issued 180 million shares in the IPO, and post-IPO had 1.7 billion shares outstanding, with the substantial majority of shares becoming freely tradeable following the lock-up period (beginning November 9, 2019). That’s a lot of investor money tied up, some for more than 8 years, and most at valuations significantly less than the IPO price. So the market expected a lot of its investors to cash in by selling their shares, placing downward pressure on the share price, as soon as the lock-up expired.

 And Uber had other reasons to expect that its market price would decline. As of the IPO Uber allegedly knew of, and failed to disclose, adverse facts concerning the company’s business model, passenger safety, and financial condition. As these adverse facts came to light in the six months following the IPO, the price of Uber’s common stock declined about 40% from the $45 IPO price to $27.01 on November 9, 2019 (the original settlement date). Uber is currently defending a class action lawsuit on behalf of IPO investors making these allegations.

Uber also knew that its closest competitor, Lyft, which went public on March 26, 2019 (about six weeks before Uber), had experienced a 22% drop in value from its IPO price by mid-April. Uber and its advisors surely watched Lyft’s experience closely.

Finally, market statistics did not support the gamble that Uber took in unilaterally accelerating the settlement date. Between 2000 and 2017, market data shows that six-month returns on IPOs are negative as compared to the IPO price. This is consistent with the sell-off that is typical upon the expiration of an industry standard 180-day lock-up period. In other words, on average, the market price is lower than the IPO price at the six month mark.

 Given these facts, it was probable that Uber’s share price would be lower at the end of the lock-up period. And Uber knew it. Uber knew it was probably imposing substantial additional (needless) income tax liability on its employees and did it anyway.


So why did Uber decide to impose such a high degree of risk on its employees by accelerating the settlement date?

As suggested above, we think Uber probably determined it would benefit the post-IPO market price to fix its compensation expense concerning the RSU Shares. This removed significant uncertainty concerning 2019 net profits and losses, enabling the actual amount of the compensation expense to be built into the valuation of Uber as of the IPO date. The $3.6 billion in compensation expense that Uber incurred in the quarter ending June 30, 2019 was known to analysts at the time of the IPO, and thus was unlikely to significantly adversely impact the share price after that.  
Also, net settlement required Uber to use $1.3 billion, or 16.25% of the IPO proceeds to pay the withholding taxes for the employees’ RSUs. Uber’s decision to limit the net settlement withholding to the minimum 37% is telling. Uber knew many if not most RSU holding employees would be taxed at a higher rate. Uber wanted to avoid having to use a greater percentage of its IPO proceeds to cover tax withholding on RSUs. Uber avoided this use of funds by exposing its employees, not its IPO proceeds, to the risk of higher taxes that the employees were unable to mitigate because the lock up agreement prevented them from covering the entire tax liability by selling shares at any price on the downward path to $27 on November 9, 2019.

Uber’s acceleration of the settlement date not only fixed its compensation expense, creating the certainty that financial markets value, but further ensured that if the market price of the shares increased following the IPO, the resulting higher compensation expense associated with the original November 9, 2019 settlement date would not be higher, adversely affect Uber’s operating results by increasing its compensation expense.


We often represent employees in courts and arbitrations, including some “C” level folks at big companies you’ve heard of. We looked hard at this case to decide whether we think Uber is liable for the additional tax. We think so.

The above analysis shows that Uber knew it was probably significantly increasing RSU holders’ income tax liability by delivering their shares on the IPO date instead of six months later, but did it anyway, for its own benefit. And Uber probably was substantially enriched by that decision in that the $45 IPO share price was likely higher than it would have been had Uber not fixed its RSU compensation expense as of that date.

Did the contract allow Uber to make that change? We don’t think so. The RSU Agreements we’ve seen allowed Uber to make only limited adjustments. The most relevant one allowed changes to avoid adverse accounting consequences. But this is not about how a transaction is characterized on Uber’s books. It’s a dramatic change in the delivery date of billions of dollars of in common stock, with roughly $200 million in predictable adverse tax consequences for employees. We think a court or arbitrator will agree with us.


You should get what Uber promised you

Sophisticated business people don’t let themselves get ripped off. If this happened to you, you shouldn’t let yourself get ripped off. If you’re still working at Uber and worried about retaliation for asking Uber to honor its agreement with you, you should know that in California, any act of retaliation for seeking compensation from your employer is illegal, even if you lose you can recover damages. Many verdicts run to millions of dollars. So employers with competent lawyers and HR departments bend over backwards to avoid even the appearance of retaliation. There’s a detailed article about this that I posted on Medium (just search for Ray Gallo and retaliation).

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And don’t worry about fees. We’ll handle the case on contingency, and Uber will have to pay your fees if it loses. We (and Uber), not you, will be taking the financial risk.

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