Skype’s evil ways, cont.

By Felix Salmon
June 27, 2011
story is refusing to die, with Yun Lee's revelations bringing out the same anonymous investor-group sources defending Skype's actions.

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The Skype/Silver Lake story is refusing to die, with Yee Lee’s revelations bringing out the same anonymous investor-group sources defending Skype’s actions. But if the defenders are comfortable in their anonymity, it seems only fair for me to share an anonymous email I got this morning from “Skype Insider”.

Remember the history of what happened here. First it was alleged that Skype was firing senior executives just before the Microsoft deal closed, thereby ensuring they don’t get their full payout. Then Lee came along and said that employees who left voluntarily were denied their vested equity in the company — which, as Graef Crystal has noted, does grievous harm to the plain-English meaning of the word “vested”. Dan Primack explains how Skype pulled this stunt by changing its options agreement after it was acquired by Silver Lake:

A source familiar with the situation says that many former eBay employees who remained with Skype have options that more resemble typical Silicon Valley (i.e., vested=yours). Moreover, the majority of Skype employees are in Europe, where the structure also is different.

But for U.S.-based employees who joined after Silver Lake and crew took over, you had to “be in it to win it.” In other words, these particular Skype employees wouldn’t get paid until the private equity firms also got paid.

We’ll get to the attempted defenses of Skype’s actions in a minute. But up until now we’ve been dealing with two classes of screwed-over employees: executives who got most but not all of their payout because they were fired just before the deal closed; and people who were hired after Silver Lake bought the company and who found that their vested options were worthless.

But according to my source, it’s actually worse than that. There’s a third class of employees, who were treated particularly badly: executives who were fired for cause, “based upon various trumped up justifications”, in the words of my tipster, thereby losing all their vested equity.

This is a particularly nasty move for Skype to pull, because such executives are naturally going to be reluctant to go public with their story. Any journalist would immediately ask Skype for comment, and the company would quickly start explaining, either on or off the record, just how bad the executive in question was. And no one wants to be the subject of that kind of public debate.

Importantly, if you were a Skype employee fired for cause, your options could be clawed back even if you had the old-school options contract. Former eBay employees who had had vested equity for years could suddenly find themselves with nothing.

Do I know for a fact that Skype did this? No — but I’d certainly be interested in hearing from anybody this happened to, in strictest confidence. And it’s consistent not only with the Skype-is-evil meme, but also with the message that Skype’s defenders are pushing. Here’s Henry Blodget:

Private equity firms have a different view of option compensation than VC firms, the Skype investor said. Specifically, private-equity firms recruit executives with a very specific mission: To fix the company and then sell it, a process that often takes several years. In private-equity’s view, executives only deserve a piece of the equity pie if they see that mission through.

Essentially, only one group of employees matters in PE-backed deals, and that’s the ones still standing when the exit arrives. You’ve “got to be in it to win it”, which means that anybody who’s not “in it” is, by definition, a loser, to whom the company owes nothing.

And the investors are quick to blame the losers here. See for instance Sarah Lacy:

As standard as getting to keep vested options if you quit before an investment is closed is in the venture capital world, it’s equally as common that you have to stay through the close of acquisition to keep them in the private equity world. Indeed, our source says the Skype contract is a boilerplate agreement for all the companies Silver Lake invests in. And all of this was in the paperwork the employee signed. He just didn’t read it carefully, at his own admission, because he assumed it was like other option contracts of venture-backed companies. That’s not really Silver Lake’s fault.

Actually, as Mike Arrington and Dan Primack and I have all tried our best to point out, the notorious clawback was not something which Yun Lee or anybody else could find by reading paperwork carefully: it’s impossible to read the clause in question and understand what it’s saying, since it references “the repurchase and other provisions in the Management Partnership agreement” — a completely separate document which Lee might not even have been given access to. (Arrington reckons he probably wasn’t.)

As for this suddenly-important distinction between venture capital and private equity, has Lacy forgotten that the public face of the Skype acquisition was not anybody from Silver Lake at all, but rather Marc Andreessen, a venture capitalist? Indeed, Arrington’s coverage of the deal had Andreesen Horowitz leading it, with Silver Lake a mere tagalong participant. And Silver Lake is hardly KKR or TPG: if you pop along to the CrunchBase profile page for the firm, you’ll see its headquarters are on Sand Hill Road, the boulevard synonymous with venture capital. Yes, Silver Lake is technically private equity rather than VC — but it does its best to hang out with VCs, co-invest with VCs, and generally inveigle itself into the VC world as much as it possibly can. Lacy’s sources might be very keen right now on the idea that they have “a different mentality and a different culture” to VCs. But the average Silicon Valley employee can easily be forgiven for failing to grok this distinction.

And this just doesn’t withstand scrutiny at all:

If the amount is so small, why not just give him the vested shares? Because this is their standard contract, Silver Lake can’t without opening themselves up to lawsuits from all the other buyout deals where employees have to live by the same agreed-upon contract.

Er, no. Silver Lake had no obligation, under the terms of the contract, to claw back Lee’s shares. Remember the letter sent to Lee? It’s very explicit on this front:

Pursuant to Section 8.01 of the Partnership Agreement, Skype has the right (the “Call Right”), which it intends to exercise, to repurchase up to all vested shares underlying your Options at a per share price equal to the exercise price applicable to the shares being repurchased.

Skype had a right to claw back the options. It made a positive decision to exercise that right. It had no obligation whatsoever to exercise its Call Right, and everybody’s actions would have been perfectly consistent with the signed documents if Lee had held on to his vested equity.

The fact is that there’s no good reason at all for Skype to be behaving this way — and there’s also every reason to believe that Skype’s decision to turn evil was entirely a function of Silver Lake’s corporate culture.

In any case, all of Silicon Valley is now to understand that the relationship between Silver Lake and the employees of its portfolio companies is a fundamentally adversarial one, where incentives are actually opposed rather than aligned, and everybody needs to lawyer up before doing anything. That kind of attitude goes down badly everywhere, but especially in Northern California. And that’s the fundamental reason why this story is refusing to die.

Oh, and one last thing, from my tipster:

Employees did not actually receive stock options at all, but rather shares in a Cayman Limited Partnership, Skype Management Partnership, LP. This complex partnership arrangement was concocted solely to avoid the possible application of employee-favorable laws in California and Luxembourg.

You fancy a lawsuit against Skype and/or Silver Lake? You’ll have to show that California courts have jurisdiction first. Since Skype isn’t even an American company, and the shares were in the Caymans, that’s not going to be easy.

Comments
15 comments so far

The LP might be Cayman organized, but if the employees were located in Cali, it sure would appear likely the offering/grant of shares/LP units/etc. was made in Cali. One offers securities in the U.S., one is usually subject to U.S. state and federal securities laws for example. Accurate/adequate disclosure made in connection with such an offering? I wouldn’t be feeling quite so sanguine if I were the SilverLake/Skype honchos. It ain’t so easy to avoid California labor-employee laws vis-a-vis California employees. All this matter has done – and the two companies continual defensiveness about it and reluctance to step up and rectify the situation – has been to draw attention to these things.

Posted by GrapeBinding | Report as abusive

Has anyone asked the original founders what they intended / told their staff about options?

Posted by davidjwbailey | Report as abusive

“…explains how Skype pulled this stunt by changing its options agreement after it was acquired by Silver Lake”

Hey, could some attorney help me out here, but if an employee signs an option agreement (even if it references another document, like the partner agreement), can that agreement be unilaterally changed by one party after the fact? I would think not, even if the agreement referenced the partnership agreement that gives the company the right to take back vested shares, as the partnership agreement that would matter is the one that is in effect at the time the options were granted.

And would the clause of the options agreement that references the partnership agreement be valid if the employee was never given a copy of the partnership agreement? Wouldn’t that outside agreement have to be provided along with the document as proof that it even existed, or wasn’t changed after the fact?

Can’t the employees say that the copy of the partnership agreement they saw never had that clause in it, and the scumbags have no way to prove they showed the employee said partnership agreement?

Sounds like no case for Skype and their owners.

Posted by KenG_CA | Report as abusive

Where is Microsoft in all this? They supposedly paid $8.5 Billion for Skype. Skype would not have fired 8 top managers without Microsoft approval (or Microsoft request that they be fired so they could be replaced with Microsoft people). If this is true, then what did Microsoft get back? So far they look clean, but I’m guessing that’s what was intended.

Posted by zato | Report as abusive

It’s alright – I guess MSFT doesn’t care about Skype’s brand as an employer, presumably because they are planning on recruiting under the Microsoft brand in future. Meanwhile, everyone else there at Skype is no doubt going to be looking for a new job as soon as they can take their equity with them.

Posted by DrFuManchu | Report as abusive

Anyone who ends up working for a company that has a Private Equity partner needs to learn about what it means. There are plenty of tricks and trade secrets in private equity designed to reduce risk for the PE Firm and increase their upside. If you’ve worked in PE, these things are obvious, but even for very experienced business people, they aren’t so obvious.

If you want to know more of the tricks to how PE makes money, you should read Private Equity Secrets Revealed. It’s not just about employee contracts, but everything about PE tries to extract value as quickly as possible from investee companies. You’ll be interested to know that a PE Firm can make millions even when a company doesn’t grow. You can find the reading here:

http://www.theprivateequiteer.com/privat e-equity-secrets-revealed

Posted by PeterCartier | Report as abusive

Another case of “caveat fidelis” (faithful beware). The list is growing. If this story gets much worse it’ll make my next book (on citizenship)m but not as a good example to emulate.

@DanFarfan

Posted by DanFarfan | Report as abusive

I don’t know what the controversy is. The bolded paragraph is very explicit that the “vested” shares are only owned indirectly via a limited partnership and that the employee cannot possibly realize any of the value of the options or underlying shares if they resign.

I want to know what the tax angle of this is. Seems like this partnership is in the business of fleecing US employees of their options. At what point is this a taxable event for the Cayman partnership? Are the options treated as contributions? When are they exercised, if ever, by the partnership? When, if ever are they distributed? Is the partnership filing US tax returns, and if not, why not?

Posted by TimC | Report as abusive

“Hey, could some attorney help me out here, but if an employee signs an option agreement (even if it references another document, like the partner agreement), can that agreement be unilaterally changed by one party after the fact?”

It depends on the agreement. You can draft the contract so that it references the January 1, 2000 version of the partnership agreement, or you can draft the contract so that it “automatically updates” with each new partnership agreement.

“And would the clause of the options agreement that references the partnership agreement be valid if the employee was never given a copy of the partnership agreement?”

I’m not an employment lawyer, so there might be a special defense available if the contract wasn’t provided to the employee. But generally – and I think especially if these were high level executives who would have the ability to retain counsel – its your duty not to agree to something without reading it. (In practice, of course, most people move forward under an assumption of good faith – I’ve been to a medical clinic where I was the first person to ask for the privacy agreement we all agree we’ve read).

Posted by AnonymousChef | Report as abusive

Is it really true that PE firms will regularly not pay out vested options for firms they manage? Is there a source on this among Blodget or Lacy that isn’t from Silver Lake?

Posted by jmh530 | Report as abusive

I’m all for allowing different kinds of contracts to which parties voluntarily consent, and there’s a certain extent to which it’s the parties’ responsibility to read and understand the contract, but I’m kind of hung up on this use of the word “vested”. Ten pages of small type followed by “where by ‘cat’ I mean ‘dog’” may be logically and linguistically interpretable, but sure looks fraudulent in intent.

Posted by dWj | Report as abusive

Moral of the story:

If you are a Silicon Valley exec, avoid Silver Lake like the plague.

Posted by ChrisMaresca | Report as abusive

@KenG_CA

I’m not a lawyer, but I’ve put together a number of companies. Partnership agreements very often have share buyback provisions for outlier circumstances (death, divorce, etc) and are sometimes quite broad. You would not necessarily request to see the partnership agreement as part of your employment contract negotiations and you would normally assume that such provisions were a last resort in case of an extreme event or legal fight.

That said, I personally would have refused to sign such an agreement without tracing all the dependencies… The other odd thing about all this is that, at a certain executive level, you negotiate termination clauses specifically to prevent this sort of evil behavior…

Posted by ChrisMaresca | Report as abusive

Since Andressen Horowitz were part of this deal why did they not insist at a minimum on transparency for all employees? If they were unaware how do they expect employees to pony up for legal fees to read options agreements?

Posted by factual | Report as abusive

FRAUD IS FRAUD. THE EXERCISE OF A CONDITIONAL RIGHT MUST BE PREDICATED UPON THE ACTUAL EXISTENCE OF THE PREDICATE CONDITION. THE TAKING OF THE SHARES FROM THE EMPLOYEES BASED UPON FABRICATED WRONGDOING IS THE ACT OF SCOUNDRELS AND SCALAWAGS. IT DOES NOT MATTER WHERE THE PERPETRATORS OF THE FRAUD RESIDE OR WHERE THE ACTUAL PERPETRATION OCCURRED. THE COMMERCE CLAUSE OF THE U.S. CONSTITUTION GIVES JURISDICTION TO THE GOVERNMENT AND CRIMINAL PROSECUTION IS NOT ONLY PROBABLE, BUT ALSO LIKELY. THE HIGH ARE NEVER SO LOW AS WHEN THEY VICTIMIZE THE DEFENSELESS. MICROSOFT HAS BOUGHT A SHIP OF FOOLS WHO STUMBLED UPON A GREAT PRODUCT. IT IS MICROSOFT WHO WILL SUFFER FINANCIALLY WHEN IT PAYS OFF THE WRONGED EMPLOYEES. THE FOUNDERS OF SKYPE WILL TAKE THEIR ILL-GOTTEN GAINS TO THEIR NATIVE INDIA AND BE ABOVE EXTRADITION. SHORTLY THEREAFTER, THEY WILL OBTAIN NEW PASSPORTS WITH NEW NAMES AND PREAPRE FOR THEIR NEXT CRIME.

Posted by ROBERTCBIBBJR. | Report as abusive
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