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Skype’s Worthless Employee Stock Option Plan: Here’s Why They Did It (techcrunch.com)
177 points by tilt on June 26, 2011 | hide | past | favorite | 57 comments

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.

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.

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.

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.

isint that what the vesting is for, you can buy back everything unvested, so worst case the employee does not walk away with a chunk of the company.

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.

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.

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.

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.

The problem with that theory, is that no employee below a senior CXO position will ever get an employee contract that provides them _any_ level of protection. If you can't trust your potential employer, that employee contract doesn't give you, or your so called equity, a spit of protection. In a Private Equity, you can, at the drop of a hat, be diluted to nothing. A new round of funding can come in at a 2X, 3X, or, in some vulture rounds, 5X liquidation preference - effectively wiping out any value your common has.

Employees get no almost no protection from their employee contracts - 99.9% of the signing employees didn't write them, the company's who are hiring them did. 99% of those employees don't negotiate terms to their benefit based on that contract. Other than the Founders and other groups with controlling shares, most of the common is worthless while the venture is private, subject only to the good graces and manners of Sr. Management.

So, respectfully, I'll have to disagree with patio11 - when signing an employee contract in the valley, it's all about trusting the founders, and controlling parties - your contract isn't going to do anything whatsoever for you should Scrooge McStealYourEquity take over.

I disagree - at the end of the day, it comes down to if I trust the people in charge (board/founders/investors) since there is basically nothing an employee at a startup can do to protect themselves from those people.

I could be diluted to practically nothing, there can be a 'sale' where only 'chosen' people make real cash via golden handcuffs/consulting agreements/signing bonuses, IP can be licensed into a new company, etc.

Depending on the details, some of those things might provide a cause of action for a civil suit but, in practice, I'm not going to get into a protracted court case over, at most, a few hundred thousand. It isn't enough money for a lawyer to take the case on contingency, and I wouldn't want to spend $(X)XX,000 out of pocket or gain a reputation for being litigious. (Of course, the calculus changes if the company is the next Google or FB - but 1000x+ returns are exceedingly rare).

The other side of the coin is that "you can't build a cage to hold a snake", so trust is really all you have.

The real sadness in all this is that this sort of behavior greatly devalues stock options for employees of every company.

I doubt that you could be an employee of a startup with that approach. But you could still be right about this...

I agree in principle, but the reality is that the majority shareholder in a private corporation, from what I understand, can nearly always screw minority shareholders.

My understanding is that nothing is stopping the majority shareholder from simply issuing more shares to themselves and diluting you out.

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.

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.

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

Arrington is a lawyer.

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.

I've read some of the contract clauses and would love to know if that kind of obscurant legalese is common. I know that legal documents often use very specific language in order to express very particular claims and conditions, but this looked to be deliberately confusing, like some kind of Dada-infused Post-modernist Johnnie Cochran.

Well, as bad as this is, it is probably the best that it happens a few more times very visibly. Until people are aware of the dangers and do something to fix it.

Best case scenario: we start calling contracts like this the "Skype Option Plan" and it forever carries a negative stigma.

We know why they did it. They're greedy jerks

The PE firm, for sure. What about the VCs? Why didn't they say anything? Ignorance, or complicity?

I would be very suprised if Andreesen Horowitz would be ingnorant of this - most likely that would indicate that they're inept in some way.

That leaves complicity. They did make millions (50M?) in a very short period.

The cool thing to do would be for AH to step in and tell the engineer that they'll pay him for what his stock should have been worth, taking it out of their payout.

That would be a classy move.

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.

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.

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?

>"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.

All well and good, if they made this clear to the employees who were fired when they were hired. "Oh, and I'd like to point out that if you're terminated before a liquidity event, we can purchase all your stock back, even the shares you purchased. You know, this isn't a startup. We're in this to flip this sucker over and make a ton. If you're with us at the end, then you'll benefit, otherwise you won't."

"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.

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.

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

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

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.

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".

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.

Not in the sense that it was started recently. But it was a high growth tech company aiming to IPO. What would you call it? And do you think this voids the controversy?

>"But it was a high growth tech company aiming to IPO"

It was a high growth company. Given Skype's European and post bubble heritage, an intent to seek an IPO is pure speculation. The evidence is that they were seeking to be acquired, which they were in 2005 by eBay. The $7-8 billion involved in Microsoft's acquisition would make Skype a large Midcap or a small Largecap company.

At this point, the main thing it has in common with startups is that it is in the tech-industry. Then again, so is Pittney-Bowles.

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.

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.

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.

It's unclear whether the employees were given the Management Partnership Agreement for review. If not, they were induced to enter the stock option grant agreement with material terms not being "explicitly [written] out" and disclosed to them.

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.

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.

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

These guys are taking a shot at it although they are targeting lawyers rather than laypeople: http://www.greenlinelegal.com/

Probably need something very close to strong AI.

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.

It'd end up looking like the Gmail spam box for a popular account. Tons and tons of jibberish trying to sneak past the filter.

It's called hiring a lawyer to look over it for you.

What does it typically cost to have a lawyer go over the contract?

I'm pretty sure it's dependent on the a) lawyer's rate and b) complexity of the contract.

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.

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)

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

Microsoft has traditionally been pretty generous with stock.

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.

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