Skype’s options plan and Silicon Valley norms

By Felix Salmon
July 7, 2011

Steven Davidoff has published two recent columns on l’affaire Skype. The first takes a familiar position: that Silver Lake isn’t evil, it’s just a private-equity shop. I would however take issue with this:

The easy lesson here is the need to carefully read contracts before you agree to them and hire a lawyer if you don’t understand them. The language Mr. Lee complains about was certainly legalese but heralded caution.

Remember the language he’s talking about here. It’s one sentence of an 11-page stock option grant agreement, buried in a paragraph about IPOs:

If, in connection with the termination of a Participant’s Employment, the Ordinary Shares issued to such Participant pursuant to the exercise of the Option or issuable to such Participant pursuant to any portion of the Option that is then vested are to be repurchased, the Participant shall be required to exercise his or her vested Option and any Ordinary Shares issued in connection with such exercise shall be subject to the repurchase and other provisions in the Management Partnership agreement.

Yes, this is legalese. And what’s more, it doesn’t actually explain what Skype is doing; it just refers to some other, presumably equally unreadable, agreement. But here’s the thing: if you did read this sentence carefully, it still wouldn’t raise any red flags. Because it looks very much like something which is standard practice in Silicon Valley: when you leave a company, you need to exercise your vested options very quickly — normally within three months. If you don’t, then the company can claw them back.

So when Davidoff says that Lee’s failure to carefully read his contract is “baffling,” he’s being too harsh. Even a careful reader would have missed this one. And that’s why Skype was evil. If they’re going to have aggressive clawback provisions in their contract, they shouldn’t bury them in incomprehensible legalese: they should be open about what they’re doing.

Davidoff followed up his first column with a second one which only served to make everything worse. The headline: “Skype Not Alone When It Comes to Options.” And here’s the little summary you get in your RSS feed:

Silver Lake may have imposed a greater penalty, but LinkedIn, Google and others in Silicon Valley have similar requirements for vested options.

Um, what? This is simply not true. Silicon Valley standard practice is clear: you have every opportunity to exercise your vested options when you leave a company. Skype took that opportunity away. That’s not “similar” at all. Being able to exercise your options when you leave is always better than not being able to exercise your options when you leave. It has, if you’ll excuse me, option value. But Davidoff contrives to believe that standard Silicon Valley options language “is no worse than the legalese in the Skype documents that Mr. Lee complained about”.

He’s doubly wrong here. For one thing, standard Silicon Valley options language, while not exactly plain English, is still vaguely comprehensible. It gives a clear deadline of three months after you stop being employed at a company, and says that options expire at that point. On the saying-what-they-mean front alone, Silicon Valley companies win here.

And more substantively, those companies are giving exiting employees the opportunity to share in some of the growth they’ve helped to achieve.

Davidoff is underwhelmed:

This provision forces former employees to exercise their options while the company is still private and the true value unknown. In addition, the fair market value of the option may be very low and at or near the exercise price. It certainly isn’t at the initial public offering price.

Given the risks involved, employees are likely not to want to pay the exercise price out of their own pocket.

It’s hard to know where to start here. Silicon Valley companies might be private, but that doesn’t mean they’re unvalued. They tend to raise multiple rounds of capital at steadily increasing valuations; if you’ve stayed at the company long enough to see a new fundraising round, then automatically your options are in the money. And increasingly equity in these companies is priced on private markets like SecondMarket and SharesPost. It’s true that the price of the equity isn’t the IPO price, but then again the price of a company’s equity is almost never the IPO price. (Employees in Pandora, for instance, are unlikely to get the IPO price for their options, even after it has gone public.)

And certainly options are risky assets. Everybody in Silicon Valley knows that. When you leave a company, you have a 3-month-long opportunity to buy stock in a private company at a level which is probably a very good price. Many people in Silicon Valley would jump at that opportunity, especially if they’re senior enough that they have a bunch of cash lying around. Certainly some employees will pass. But that’s the employee’s choice. It’s clearly better to have the choice than to not have the choice.

Yee Lee thought he had the choice — and decided he wanted to exercise his options. He knew the rules, knew he had to make his choice quickly, and made that choice. He informed Skype’s HR department of what he wanted to do, in a more than timely manner — and then spent a month going back and forth with them, before learning that Skype was refusing to let him exercise his options at all.

Davidoff’s second column seems to be aimed at unnamed “commentators” who don’t understand Silicon Valley standard practice, and who think that vested options can be held in perpetuity after you’ve left the company. That’s not the case. But that hardly makes Google as bad as Skype. Not even close.

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Comments
6 comments so far

The legalese separated two classes of people: those who were fired and in good standing, and everyone else. In the everyone else class, Skype was to buy back your options at the lesser of two valuation methods.

So if you follow the response from legal to Mr. Lee, Skype assigned his options at $0.00, which is extremely dubious of a valuation. Which is why, if Silver Lake Partners and Skype weren’t full of BS, they’d release the Partnership Agreement to the public, so that we could judge what was IN that, allowing them to assign a net value of $0.00.

THAT is where you should be pushing, IMHO.

Posted by GRRR | Report as abusive

I’d still like to know what Mr. Lee’s lawyer said to him about the documents, but that doesn’t diminish the evilness of Skype and Silver Lake.

It’s also worth noting that repurchase agreements are pretty much always at FMV, not exercise price, as the Skype agreement supposedly was. I expect the “they simply exercised their repurchase rights like everyone can” arguments to start soon.

Posted by AngryInCali | Report as abusive

Very good point GRRR.

Given the Skype/Facebook deal it seems there were some people who wanted to keep it all to themselves, knowing this was in the works. It all sounds too familiar…

The options are dangled as a incentive to hire and also keep an employee “vested” in the company and its future. Therefore, aren’t options are the reward for having been a loyal employee? As you said, other “companies are giving exiting employees the opportunity to share in some of the growth they’ve helped to achieve.”

But Davidoff says Venture Capitalists are not saints, so it’s OK. I guess in these economic times, where people are looking for jobs, clawbacks are the norm, not treating employees with respect and valuing their contributions.

Placing really bad legalese gobbledygook in that run on sentence is trickery and thus evil. So along with the terminology of bad leaver/good leaver that has found its way into stockholder agreements, being ‘skyped’ can now be added for those about to be shafted. No more long, legalese sentences required …

Posted by hsvkitty | Report as abusive

The posts that I’ve seen say that there was an employee presentation accompanying the agreement that made it clear that their options would be repurchased if they left Skype voluntarily pre-IPO.

Ah, here it is. Slide 8: http://www.docstoc.com/docs/83058145/Sky pe—Employee-Presentation

No idea whether everyone saw this, though.

Posted by waynnlue | Report as abusive

I’ve been subject to repurchase agreements in at least two startups, and I’ve always had to either sign a separate repurchase agreement, or the repurchase language was included in the stock grant documents.

In the Skype case, it *appears* as if the only details on repurchases are in the management partnership agreement. If the employee was also given a copy of that agreement, then perhaps you could argue that he should have understood it. Otherwise, I’d agree that the whole thing is very deceptive.

Realistically, for documents this complex, employees should have been given a summary as well.

BTW, repurchases are not always at FMV. The agreements I participated in were at the exercise price, not FMV. They existed because I was granted shares, not options, and the repurchase agreement effectively implemented standard vesting by granting repurchase rights at the initial price over shares that hadn’t vested.

In any event, I’d agree with Mr Salmon that Skype is being outrageous here, and that its behavior and terms are well outside of SV norms.

And for $1M? Skype’s new owners are crazy. They’ve basically labeled themselves as dishonest, and it will definitely cause them recruitment problems going forward, at least among those not desperate for a job.

Posted by PghMike4 | Report as abusive

I’ve been subject to repurchase agreements in at least two startups, and I’ve always had to either sign a separate repurchase agreement, or the repurchase language was included in the stock grant documents.

In the Skype case, it *appears* as if the only details on repurchases are in the management partnership agreement. If the employee was also given a copy of that agreement, then perhaps you could argue that he should have understood it. Otherwise, I’d agree that the whole thing is very deceptive.

Realistically, for documents this complex, employees should have been given a summary as well.

BTW, repurchases are not always at FMV. The agreements I participated in were at the exercise price, not FMV. They existed because I was granted shares, not options, and the repurchase agreement effectively implemented standard vesting by granting repurchase rights at the initial price over shares that hadn’t vested.

In any event, I’d agree with Mr Salmon that Skype is being outrageous here, and that its behavior and terms are well outside of SV norms.

And for $1M? Skype’s new owners are crazy. They’ve basically labeled themselves as dishonest, and it will definitely cause them recruitment problems going forward, at least among those not desperate for a job.

Posted by PghMike4 | Report as abusive
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