
Skype’s Worthless Employee Stock Option Plan: Here’s Why They Did It - tilt
http://techcrunch.com/2011/06/26/skypes-worthless-employee-stock-option-plan-heres-why-they-did-it/
======
grellas
Options can be tricky enough for employees to handle even in standard startup
scenarios (see recent thread here:
<http://news.ycombinator.com/item?id=2623182>).

You have to earn them out over time before they might have any value at all.
You have to pay real money to get illiquid stock in a company that might
easily fail. If the paper value of the stock is high, owing to recent funding
rounds, you will have to pay ordinary income tax on the spread between your
exercise price and the then fair market value. If you have ISOs, you may avoid
ordinary income tax but may easily get hit with AMT. After you pay for the
stock, and any associated taxes, you hold common shares that stand in the back
of the line on any liquidity event, meaning that you might get nothing even in
a liquidity event should the proceeds not exceed the value of the liquidation
preferences held by preferred stockholders or should the acquisition be
structured in a way that primarily rewards those who get bonus/retention
packages with the acquirer and leaves others with essentially nothing.

As if this all were not risk enough, Skype now comes along with a vehicle by
which you lose the value even of that illiquid stock you thought you had
bought - and paid for, and paid tax on, and whose value you ran the risk of
losing in case the company went nowhere - at the very time when the wild
success case strikes. This is the essence of a rigged game. The company fails
or plods along uneventfully: it has no obligation to buy back anything from
you; you took the risk and lost. The company succeeds: it has the option to
rob you of your equity value by getting it all back at a strike-price cost
that is a tiny fraction of its now vastly appreciated market value. This is
what they call "heads I win, tails you lose."

This is not equity ownership. It is merely the illusion of ownership - an
ownership that comes with all the risks of buying stock (the cost, the tax
risk, the economic risk) and none of its benefits. As this piece points out,
legally, you might be able to frame things this way and maybe this is the
custom and practice in private equity deals (it can even make sense in an
individually-negotiated deal with a senior executive who knowingly accepted
the risks involved). But it is not legal to offer it up in materially
misleading terms, which seems to have happened here. And, whether technically
legal or not, no one wants to play a fool's game - once exposed as the stink
bomb that it is, this particular PE ploy should hereafter die the death that
it richly deserves.

~~~
brudgers
Having been a minority shareholder employee in small businesses and spent
extensive time around limited partnerships formed for real-estate development,
there is nothing unusual in the buyback provisions of the Skype agreement. The
principles underlying it are quite common even if such terms would not be
palatable or useful for a startup - which of course Skype is not.

Skype run by private equity is more akin to a Big Dumb Company. Those who
survive the politics and decisions of the bean counters will make money, those
who fill the cubicles for but a short time will experience just another job
with a paycheck. What is unusual at Skype is that those who survive to a
liquidity event will be able to cash out when Silverlake liquidates which
triggers the vesting of stock ownership rather than the vesting of stock
options. Private equity works by incentivizing staff to put up with the misery
which often accompanies a turnaround.

~~~
caf
The unusual part is being able to buy the stock back at the Exercise Price,
not the fair market value at the time.

The way it's structured, it's essentially an interest-free no-recourse loan
from their employees.

~~~
brudgers
Not exactly. First what has been granted is the option to purchase stock, the
employee need not do so if they feel it is a bad investment under the terms of
the stockholder agreement.

Second, the stockholder employee will receive any dividends paid by the
company and in most cases this is the primary value of stock held in non-
growth oriented privately held companies - keep in mind that the strike price
for the options typically no more reflects market value of the stock than the
repurchase price will; Both are typically fixed at a low value because this is
in the company's interest because the departure of a large share holder at a
time of low cashflow could easily put the company under (not to mention that
stock options in a private company are primarily a tool for attracting and
retaining employees not an attempt at raising cash (that's what investors and
banks are for) from those who do not have it.

Finally, the repurchase is only triggered by an employee leaving the company,
those who survive corporate restructuring will see the benefit of the higher
stock price if the company is sold.

------
patio11
I once heard some advice worth remembering from a lawyer: do not sign
contracts on the basis of trust for the counter party, because they are your
counter party _today_. For long-term contracts, when you actually have a
dispute several years down the road, you may be dealing with a totally
different set of actual people. People change jobs. Companies get bought.
Cultures and personalities drift over time.

Your contract will not, ordinarily, adjust itself just because the guy who
promised that Odious Clause X was boilerplate that would never be held against
you has left the company and been replaced by Scrooge McStealYourEquity. Don't
give Scrooge the opportunity. Get exactly what you expect to have happen to
you written in the contract.

P.S. Relatedly, your discount rate is probably too low, and you probably
overestimate your odds of a liquidity event _and_ the upside potential. Your
employers will act to encourage this. Get paid in cash as much as possible.

~~~
DanLivesHere
Agreed, with an addition:

Contracts exist for _when things go wrong._

When you sign a contract, things are going right. You and the other party are
friends, everyone loves each other, etc. The day you sign the contract, you
don't need it. The temptation to not worry about it is huge.

But the day you need the contract, you'll wish you had worried about it.

~~~
damoncali
I disagree. Contracts are there to make sure that minds meet in as clear a
fashion as possible, hopefully preventing things from going wrong. Contracts
are often totally inadequate when things do actually go wrong.

~~~
floppydisk
I think you're both right (parent + grandparent). Contracts are where both
parties hammer out the exact nature of the relationship. Responsibilities,
compensation, duties, etc. with the goal being everyone having a clear
understanding of how things will work. That being said, when/if things go bad,
the contract then becomes the document you use to guide the resolution if it
relates to employment. For instance "my manager ordered me to work X hours of
unpaid overtime or be fired when my contract says any overtime work means 1.5x
base compensation." Silly example, but the contract gives the employee (or the
employer if the employee does something incredibly stupid) some measure of
legal protection and recourse including suing the other party.

In the instance of the Skype people, if they weren't given the MPA document
and the clawback clause explicitly refers to policies in that document as the
basis for clawback, then I think they have a case for fraud on the grounds of
dishonesty (disclaimer: IANAL) and at a minimum have skype refund them all the
taxes they paid (if any) on the stock options.

------
wccrawford
We know why they did it. They're greedy jerks. They weren't thinking of the
'company', they were thinking of themselves and thought they could fool hard-
working people into a con.

And that much of the plan worked.

What they didn't expect was that those hard-working people would fight back,
tell the entire internet, and (I expect) engage in a legal battle that could
possibly damage the company irreparably.

And on top of that, any employee that understands the contract would be a bad
one. You don't keep hard-working people by locking them in like that. But you
CAN keep lazy jerks that way. They'll simply sit and do a half-arsed job and
wait for a downsizing to get rid of them and collect their shares then.
Because that's the ONLY way to collect your shares! You can't quit or be fired
for cause and still collect them. They have to fire you without cause.

~~~
joe_the_user
I'd be interested in any lawyer's take on this.

IANAL but I know that it is possible in some instances to challenge a contract
which is written to seem to give you X but really gives you nothing.

My non-lawyer-y understanding of the situation would be that a lawsuit would
turn on the fact that the employees weren't made aware that "vested" didn't
mean vested in the contract.

~~~
wglb
Grellas is a lawyer in this space and he has offered a comment, which as I
write this is at the top.

------
amesign
I like this comment:

    
    
      "Based on your last paragraph I just sent a note to my lawyer to make sure we do NOT do that."
        -- Scott Yates, CEO of BlogMutt
    

I hope that companies interested in attracting top talent and creating a great
company culture follow suit. It just doesn't make sense in the long term to
try to squeeze out every last drop of equity from your own (ex-)employees.

~~~
spaghetti
My thoughts exactly. This nasty Skype incident is an opportunity for the great
CEOs and company leaders to differentiate themselves. Just spend some extra
money on easily comprehensible contracts that explicitly avoid the "clawback"
clause.

------
ctide
Why even have a vesting structure in this case? Why not just vest all shares
on day 1 with the expectation that the company will just take them all back if
you quit?

Is the vesting structure strictly in place to disguise the fact that the
company plans on buying back all shares in the case of you quitting anyways?

------
brudgers
>" _The vast majority of stock options granted to startups have a vesting
period, typically four years, with chunks of those options becoming vested
during that four year (or whatever) period._ "

This is irrelevant because Skype is not a startup. It is an established
company. In addition it is a private company not a publicly traded one and a
company with no intention of becoming a public company (indeed it never was a
public company - though it has been part during eBay's ownership).

The techpress keeps spinning this as a story about startups while ignoring the
difference between Private Equity firms which invest in mature companies which
are distressed and Venture Capital firms which invest in small companies with
a high potential for growth.

The techpress would do well to get outside the Silicon Valley echo chamber
once in a while.

As is the case with Skype and Silverlake, private equity firms tend to be
focused on flipping companies. Like people flipping houses on cable network
reality shows, they don't establish the sort of personal attachment which
investors in a startup need because at the point private equity becomes
involved founders don't have much power and the owners (i.e. shareholders) are
looking to liquidate their investment not dilute it on the expectation of
future company growth.

In the vast majority of privately held companies, the practical effect of
stock ownership is the receipt of dividends because most closely held
companies are not focused on growth in the manner that startups are. Buy-sell
such as those at Skype are typical - share price escalation is typically
undesirable because of potential tax implications and liquidity issues.
Therefore, buy-sell agreements usually require selling shares back upon the
end of employment. The greater flexibility private companies enjoy when
compared to public companies in negotiating the terms of employment often are
used to mitigate the effect when employees with large numbers of shares leave.
When a low level employee leaves, however, the break is clean and complete in
a way which keeps disgruntled ex-employees out of shareholder meetings.

Sure the former shareholders can sue Skype, anyone can sue anyone in the US.
But it's hard to see how they will substantial precedent given that a huge
amount of employee owned stock in the US is subject to provisions similar to
those in the Skype agreement.

~~~
pbreit
"a huge amount of employee owned stock in the US is subject to similar
provisions"

Are you sure about this? Most folks are saying this is quite rare, startup or
large co, public or private. I, myself, have never seen such terms.

~~~
brudgers
It's extremely common in small business because they are privately held with
no intention of ever going public (and therefore often closely held as well).

Big companies usually are publicly traded and startups are usually structured
to allow becoming publicly traded. <IANAL> Therefore such restrictions on
common stock are not practical <IANAL>.

Privately held companies don't operate with the same logic as startups or
publicly traded corporations, and private equity operates in a way that is
even more radically different because they often seek to dismantle a company
by selling off its assets often to the point of complete liquidation.

------
jjm
This is what the golden handcuffs are[1]. This has traditionally not worked in
the tech industry with the talented.

Here are some case study[2] in fighting a Forfeiture provisions. One good
point is that the clauses must be clear.

[1] <http://en.m.wikipedia.org/wiki/Golden_handcuffs>

[2] <http://www.weil.com/news/pubdetail.aspx?pub=3428>

------
brown9-2
Skype isn't really a startup though, is it? Kind of odd to see them
characterized as one.

~~~
code_duck
The word is used to put size in perspective relative to goals: if their goal
is to replace AT&T and Verizon, by that measure Skype is still a startup. I've
even heard people refer to Google as a startup within the past couple of
years.

Sometimes companies apply this label to themselves, seemingly to attempt to
excuse issues like lack of profitability or shoddy organization ("we're new
and still learning, started in my living room" etc.). The claim is that if the
business is still taking VC funding, it is a startup, regardless of
profitability or establishment in the market. My belief is that when a company
has been around for more than 3 years, has a multitude of customers, well over
10-20 employees and collects corporate-sized (millions in) revenues, it's a
regular business and the startup label should not be used. The line used for
'small businesses' in the US is something like 100 employees, which seems huge
compared to the businesses I've worked in with 1-5. If the company isn't even
a small business by those standards, it's a stretch to say it's a startup. But
it can still feel like one compared to IBM.

~~~
burgerbrain
I think it's really just as simple as "startup" is something hip to be. It's
like bands signed to major record labels pretending that they're "indie".

~~~
code_duck
That's quite true for some companies. My own view of the word is flexible,
though so I'm trying to figure out the bounds.

------
rdl
All they had to do to not be deceptive, subhuman assholes would be to
repurchase vested options at market value vs. at initial value.

It's reasonable (sort of) to not want former employees to retain an ownership
interest in a private firm, especially one with no intent to exit.

It's not reasonable to have equity which "vests" and then can be repurchased
at the initial buy-in price at any point in the future.

By handling the repurchase at market price (which is difficult to determine in
some cases, but in an M&A or IPO is fairly transparent), you give the former
employee the economic upside he has earned, but don't have to deal with a
former employee as shareholder.

------
felipemnoa
I hope those that are being taken advantage of sue. Why wouldn't they? At this
point it seems that those who have been fired have nothing to loose. At least
it will set a precedent of what will happen when companies try to be sleazy
with their employees. Hopefully other companies will see this and not try to
add secret exploding clauses.

~~~
ecopoesis
Who are they going to sue? Themselves from 5 years ago for not reading the
contract they signed? Skype doesn't seem to be an option as they explicitly
wrote out in their contracts what they were going to do.

It's hard to feel bad for the folks getting their options canceled: this
eventuality was right there in black and white. It like people with ARMs that
adjust after 5 years suddenly not being able to pay they mortgage, and not
being able to sell their house because it's underwater. It's clear from the
day you sign the contact that this could happen, yet they only thought about
the futures where everything went their way and they made millions on options
/ flipped their house for millions.

Contracts are easy: don't sign if you don't understand it, and if you don't
understand it find someone who does and make them explain it to you until you
understand it.

~~~
pbreit
Did you read the article? It was _not_ there in black and white. If there are
grounds to sue, and it appears there are, there are obvious defendants.

~~~
ecopoesis
But it is black and white. If employees didn't like they contact, or weren't
able to see part of it, they didn't have to sign it. Choosing to not read the
Management Partnership agreement or even investigate it at contract signing
time is negligence by the employee. They can whine about not being told as
much as they want, be it is there and written down.

------
va_coder
I'm trying to figure out if there's a way to write software to parse legal
documents and find crap like this.

~~~
felipemnoa
Probably need something very close to strong AI.

~~~
dctoedt
1\. The problem is that contract language, like Perl, is very much TMTOWTDI or
"Tim Toady": _There's More Than One Way To Do It._

2\. Exacerbating the problem, a lawyer drafting a contract (like most
programmers I've known) often can't resist the urge to "improve" specific
provisions, sometimes for style but more often to try to subtly micro-optimize
his client's future position, to the disadvantage of the other side.

3\. All this means that the other side's contract reviewer has to read the
entire contract every time, looking for "improvements" by the drafter that
might not be in the best interests of the reviewer's client.

4\. Strong AI wouldn't be needed if clients would push for Perl's
TMTOWTDIBSCINABTE or "Tim Toady Bicarbonate" attitude about contract language:
_There Is More Than One Way To Do It, But Sometimes Consistency Is Not A Bad
Thing Either._

5\. In an ideal world, there'd be:

a) a Creative Commons repository of benchmark language for various flavors of
different types of contract provisions, and

b) _client- and market pressure_ for lawyers to edit the benchmark language
when drafting a contract. That would allow the other side to run a quick diff,
_e.g.,_ using Compare Documents in Microsoft Word, to see which benchmark
provisions were used as-is, which were modified, and which were omitted
altogether.

6\. Contract reviewers could maintain private copies of the benchmark language
repository, annotated with tags such as, for example, "FAVORS EMPLOYER" and/or
"HEADS-UP" and/or "ALWAYS ASK FOR THIS." These annotations would show up in
the Compare Documents results, for free, canned "legal advice."

7\. The foregoing could greatly reduce the cost and delays associated with
contract legal review. But lawyers (and many clients) will almost never do so
voluntarily, because they hate the idea of giving the other side's contract
reviewer any help -- even though doing so might help their clients get to
signature more quickly.

8\. I've been experimenting with something like the foregoing as a side
project; I'll post an announcement if and when I get an MVP.

------
daimyoyo
Google should use this as an opportunity to destroy skypes business. They
should plaster ads in every medium out there saying what skype has done, and
then reminding people that google voice is a better alternative. They could
probably take half the market in the next 90 days because everyone that I know
who uses skype doesn't like it. The latency is always horrible and the video
output seems to freeze at least once a call.

~~~
mahyarm
Google voice is similar, most video conferencing is similar. Customers are not
going to not buy something because of company shenanigans, most people
wouldn't buy most things if that was the case. (Nike, Monsanto, Dole,
Chiquita, etc)

------
sunstone
Seems like these two companies have found a true soulmate in each other. It
makes you want to cry.

~~~
gaius
Microsoft has traditionally been pretty generous with stock.

------
pdovy
It's unfortunate that this happened to these guys, but I'm glad it's been made
public. I'd like to think I'd _always_ carefully read a contract before
signing, but this is one gem we can all watch out for now in particular.

