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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