You Got To Be In It To Win It

Comments (Archived):

1. One alternative is restricted stock with a vesting period – doesn’t have the same leverage as options and I’m not current enough to know the tax implications. Ownership in restricted stock avoids the need for the employee to sell some stock on leaving to finance the expense and taxes of option exercise, so the company avoids being saddled with strangers as shareholders.Restricted stock also has the advantage of letting the employees build equity even in times when the stock is moving down or sideways; this can be in long-term shareholder interest because employee pressure to keep the stock on an always upwards path leads to short-term decision making (been there, done that).

   1. if we could get the IRS to allow the issuance of restricted stock toemployees with a deferred tax payment until the stock is sold, then we’d begolden

      1. That’s the way it works in Israel. Employees here generally have their stock held by a trustee until a liquidity event. The trustee is authorized to vote on behalf of the employee per the company’s instructions.Governance here is very friendly towards start-ups. I’m surprised this is not the case in the US. 

      2. How about forward exercising your options? That would convert them to restricted stock that vests with the same schedule. Assuming you filed the right IRS forms (83-b), the tax obligations would be minimal. At least that’s what this article suggests: http://gigaom.com/2011/06/0…Main downside here is for the startup, not the employee, as it would increase the number of shareholders on the books once the restricted stock vest into common stock

         1. I will take a look. Never heard of that approach

         2. You can always exercise options even when they are not in the money or fully vested.  If you do, then instead of having an option grant at risk, you have stock at risk.The 83(b) election is quite straightforward and has been used for everything from real estate partnership carried interests to hedge fund sponsor interests to restricted stock.The benefits are the future tax treatment and the risks are a falling stock price or some other forfeiture mechanism in the plan.Get a lawyer to look at it for you but it is pretty straightforward.  There is a 30-day window in time to make the election after receipt of the interest which gives rise to the election.

            1. JLM, how can you exercise an unvested option?Technically it’s not yours yet…

            2. The option is yours subject to the appropriate restrictions including the vesting period and if you exercise the option the stock is yours.The stock is now subject to the same vesting period and performance obligations, if any, as the underlying option meaning it is subject to forfeiture becoming for all intents and purposes — restricted stock.Often stock options are not transferable and restricted stock may be transferable.This often comes up in estate situations wherein options expire in a short period after the death of an employee and thus are forfeitable while the restricted stock would otherwise not be forfeitable.

      3. The recipient of restricted stock does not incur any tax liability until the restrictions (typically a vesting period) burn off unless the recipient makes an 83(b) election thereby declaring the fair market value of the stock received at the time of receipt and paying tax at ordinary income rates.A thoughtful employer can craft restrictions that serve the employee’s interest as it relates to the burn off of restrictions.The 83(b) election has the benefit of establishing a basis for future capital gains tax treatment while subjecting the recipient to the risk of falling stock price and potential forfeiture.If the recipient does not make an 83(b) election, then everything is taxed as ordinary income at the time of vesting and this can then begin the holding period for future capital gains treatment of the subsequent increase in value thereafter.

         1. Hate to go on a side tangent to a great comment thread…but I had some trouble with an 83(b) election and have had a hard time finding info about it.  Pretty predictable story: filed the 83(b) election, then left the company and am now taking a short-term tax hit with the long-term benefit in serious question.   I have questions about 83(b) ramifications.  Can anyone point to a great info source on the web?

2. My view is that you can’t take away what you’ve already given.Simple as that.

   1. right. but what if you have given an option that has to be exercised to have value?

      1. At the heart of the Skype story are people who either resigned or were fired shortly before the deal closed.In both cases their already vested options were taken away from them.Whether 60 or 90 days is too short a period to excercise, or whether the excercise process itself is too financially onerous is a more shaded issue.However, taking back what you’ve already given is not so nuanced – it’s just plain wrong.

         1. Have to know more about the firings, but anyone who quit before they had cash in their pocket, without being absolutely crystal clear about the implications of doing so…well….sorry it didn’t work out for you, but you really, really, really screwed up.   And it’s nobody’s fault but your own.

            1. Not if it works that way in 99.9% of situations.This is the basis for Arrington’s argument that there may be a case for fraud against the company.

            2. Arrington’s the lawyer, not me.But I’d think the fact that you signed a, you know, contract, would be deeply problematic. Because that’s the point of a contract, yes?  To lay out the terms so that they are clear to all involved?  Unless the contract was actively misleading, of course.And the fact that this is getting tried in the court of public opinion leads me to think that, in at least some of these cases, there is no actual legal recourse.

      2. The options have value before it’s exercised.  If they don’t, then they aren’t a good incentive to employees.The options vesting schedule should be setup such that the employee has earned the value of that option at the time it vests.   There is then no need to try and take it back as a way to keep the employee longer. If you want to keep the employee after the vesting period of the options they earn, give them a new chunk of options with a new vesting schedule.  That’s how it worked at Microsoft in the mid & late 80’s.   “Golden Handcuffs” were awarded every 3 o4 4 years and vested over 4 years.  You always had some unvested ones you’d have to walk away from if you left. It was very effective as long as the stock price was going up and up and up. Salaries were also well below market but people didn’t care, the stock was what was going to make you rich.

3. The 90-day period has its own big downside — assuming that your exit is well before the company’s, you’re not able to use the cashless purchase option which is there for those who are “in it to win it,” so to speak, or at least not to the full degree. If your company’s FMV is 2x or less than the strike price, you are potentially throwing good money after bad, too.

4. One thing I’ve been considering for later-stage employees, which are the principal recipients in this Skype case as far as I can tell, is to give them vertical option spreads that effectively unlock a capped cash bonus once the company’s valuation rises beyond a certain point, it takes away from the open-ended sense of investment but I suspect most people care more about tangible numbers they can taste.

5. If the desire that motivates the repurchase rights is to control the cap table, then the repurchase should be at current fair value. That’s not been the case with Skype. They repurchased at the grant price. They were not just controlling who owns stock.If secondary markets exist to help employees exercise, why not include a provision for the company to repurchase exercised stock at fair value to assist employees with exercise and associated tax costs? Seems like a very useful thing to include in equity compensation contracts to me.This incident will only drive lawyers’ fees and engender mistrust between employers and employees. Thanks, Skype.

   1. The idea of the repurchase being at the current fair value (perhaps via the most recent 409a analysis) strikes me as being fair:- the employee *was* in it to win it and would be able to walk away with the amount of win that accrued while they worked at the firm- the company retrieves the wayward stock to keep the cap table cleanThe tricky issue is which valuation to use in lieu of a secondary market.

      1. i’m not sure that is fair. when there is upside in a venture deal, there is often a lot of upside

6. In the older wall street partnerships like GS, partners capital and bonuses, their options, remained with the company in most part. At AIG, if you left the company the bonus stock was worthless and if you stayed it could only be redeemed at age 65.There’s always been corporate hardball with bonuses and options.  I’m not saying that it was good but only that there is more options today with Second Market.  MSFT should cover these options for the PR value alone.

   1. You know who should do it for PR value?Andreessen-Horowitz.An absolute gold mine for them.

      1. Hard to do that when their LPs have already done the math on the deal. Thisshould have been worked our pre announcement

   2. I agree with you more than you agree with yourself.When you shoplift a man’s work, the bad karma will revisit you multi-fold in the future.

7. What you describe combined with the typical lack of transparency and understanding really devalue stock options for employees. I’m almost at a point where I don’t think they’re worth the hassle.

   1. Yup. That’s a big problem for startups because we need equity to competewith big companies for talent

      1. You know, if a reasonable prospective employee took a good hard look at the previous posts about expected exit values, things could get problematic.If 85-95% of your companies are going to exit at <$100MM, and the employee is smart about preference and that sort of thing, it’s going to get clear right off that the expected value of startup options is really quite low – and that if you are not in (very) early, the NPV of those options is quite possibly negative when compared to the additional salary and bonus at the “safe” job at a bank, say.Which is to say, you really need to compete on more than options.

         1. I can definitely relate to this.

         2. No one classifies themselves in the bottom 50% 🙂 Maybe not even the bottom 80%. I’ve never gone to a startup for equity so I can’t say exactly what someone is thinking when they do that, but in every corner of the investment world (not to mention outright gambling) there are plenty of people ready to take a risky deal they don’t understand because they think they’ll be one of the lucky ones. I wouldn’t say they’re the less intelligent ones either since investment skill seems to be distinct from other forms of intelligence. Since working in a startup does require some ability to overcome risk with creative solutions you might even say that the willingness to do this even when it’s not properly compensated is positively correlated with the type of people you want.

            1. “…the willingness to do this even when it’s not properly compensated is positively correlated with the type of people you want.”That’s actually my point.   Pushing option compensation is probably not a great way to hire startup employees, outside of your founding group.  It’s also, at the very least, morally troubling.The ones that can do the math are likely to call bullshit and the ones that cannot probably care about other things.And if it is your plan, better make sure you keep the options refreshed on a constant basis…

            2. It might not just be about doing the math. My guess would be that a lot of people don’t use do an expected value calculation and add that to their regular compensation. For some it might be more like “I get to work on interesting things, get some great resume material, and if there is a large exit it will help me out”. That might change if few startups reach the point of a large exit but that might be closer to a 10x difference rather than a 2x difference before it affects the decisions.

         3. Honestly, I wish people would compete more on network, or lifestyle….

            1. thats a really good point Shana …i thinks its happening more and more often ..especially results only work environments + work frome home vs 8-5 + commuite to cubicle.ive worked at 3 startups and 2 bigco’s now ..and exciting work and lifestyle are worth $$$$ salary against bigco.

      2. I’d think scandals like this are terrible for the start-up ecosystem at large.  If the pple you are trying to attract now feel they have to go into legalese back and forth costing thousands of dollars to protect their rights, they may not bother.  Or worse yet, if they hear about this type of thing, then the cost/benefit analysis won’t make it worth their while to take a chance that their lawyer did a good enough job to protect them.  just bad bad bad all the way around.  

         1. yup

   2. They are not and rarely have they been.

8. To be honest, I’ve never understood the requirement to exercise after you leave. If we are truly replacing higher salaries and compensating risk with options, then the employee has earned the option and it belongs to them until expiration once vested. (We always did quarterly vesting and 10 year expiration.)

   1. Nice terms Aaron, chapeau!The problems appears to be that these guys didn’t even get the opportunity to excercise.The vested options just vanished.

      1. I’m not trying to sound holier than thou (or actually, holier than Skype),but it just seems like anything but those terms is unfair to the employee ifhigher risk and lower salary are the reasons we give options.And like Fred said, perverse incentives get created if you do itotherwise…

   2. I think the reason is they do that is to try and keep you loyal.  I’m not sure how well it works….

      1. I’ve never found adverse contract terms to be helpful to inspire teamloyalty. Fair generosity, on the other hand…

         1. Theory, not practice 🙂

   3. This is a key comment! First time I see this addressed this way.Once an employee has vested an option, such option has monetary value. It can be calculated via option pricing methods.What if the employee is laid off? She now has say 90 days to exercise. But what if the option is underwater at that time? The option still has monetary value that has been earned but now the employee must relinquish its value since it is not rational to exercise an option which is under water. Most employees are not aware of this pitfall…….

9. Is the main issue here on the time frame for purchasing the stock options?I’m a little confused as I thought in the Skype scenario they were vested shares…If I leave with the vested shares I’ve already earned, can’t I do what I want with them when?

10. I think it’s worth noting the difference between “termination with cause” vs. “termination without cause”. As I understand, these definitions are pretty clear (employers can usually be forced to pay unemployment benefits for employees “terminated without cause”).The idea is that if I fire you because you lied on your resume about your qualifications, you get no stock, but I can’t fire you to take away your stock because the company is getting acquired and I don’t want to have to pay you.Is inserting these into stock option agreements no longer “market”?

    1. Any stock option plan without these provisions would be derelict.Hers is an interesting brain teaser and problem — how about if the guy who lied on his resume is your BEST PERFORMER, was his resume relevant to his performance?Can you really fire him for cause?

       1. Why would you want to fire him/her?Whilst I’m all for honesty, I’m more interested in an employee’s ability to create value than what they did before.A strong reprimand, and perhaps some sort of a financial penalty should suffice to balance the moral books…

          1. And therein lies the dilemma.On one hand, I am an absolute believer in honesty and integrity.On the other hand, I am also a believer in confession, forgiveness and redemption.On the other hand (three handed mind you), my only duty to the shareholders is to make a profit for them.An interesting problem to be sure.

             1. Indeed.

11. Some people are critical to the early success of a company, but then don’t have a clear role as the company gets bigger — it makes sense for both sides if they move on to something else. The option plan needs to recognize this reality.

12. A good formula may be to issue a lesser amount of shares in the beginning but then tell the employee if they stay until the liquidity event they will be issued x amount of more shares. This would be a good way to have all employees stay focused on the company.

13. I have always worked under the “don’t look at the other side of the table” mantra.  If I believe the deal is fair for me, it shouldn’t matter what the other guy is getting and whether he deserves it or not.At the end of the day, there will always be employees who walk when the company needs them, cash out for more than they deserve, etc.  Luckily, for this to be a big issue, we are usually talking about major stock appreciation for everyone involved.The solution really has to come in the initial hiring and is not a matter of negotiation but character.  Hire people who are in it to win it and not opportunists from the get-go, and then treat them as if they really matter, and it will minimize the issue as much as possible.

    1. Bravo, you are apparently a full grown, fully developed adult with a recognition that character is more important than any other aspect of a man’s personality.It is rarer than unicorns these days.Brilliantly played!  Don’t change.

14. I am glad things are up in the air. This whole thing has to morph. 

15. I agree as to what is market in VC-backed startups.  It’s worth reminding everyone (or, letting you know if it’s new) how private businesses with business models geared toward making money from operations (as opposed to a capital “exit”) have handled this forever.  Employees who get stock, whether from stock grants, stock purchases or the exercise of stock options, have to agree to sell the shares back to the company if they leave a price determined by some formula.  Sometimes that sale is at the option of either side, sometimes just at the employer’s option, but private businesses generally exercise the option if they possibly can because they don’t want non-employee, non-owner shareholders hanging around making trouble.  The formulas run the gambit.  If the stock is intended to produce regular dividends while held (i.e. basically a profit sharing mechanism), the buyback is often at cost or book.  If the stock is intended to appreciate in value (i.e. basically a kind of savings plan),the buyback is price is often determined by a periodic appraisal or a formula based on some measure of earnings, revenues or cash flow.  The problem with what Skype did is that it used a mechanism designed for an income-producing stock with respect to a capital-exit producing stock.  So employees got nothing.As far as fixing the problem, now that everyone needs to commission a 409A valuation every 12 months, a capital-value-based buyback right is much more realistic.  You’ll still get into fights over the 409A valuation.  Yes, I know you can make those come out wherever you want, within a pretty broad range and the general imperative is to push for the lowest possible valuation.  But it’s something to start with.  You could apply a multiple to it.  You could substitute the private secondary market price if it exists.  You could add safeguards to get people the benefit of deals that sign/close within some period after termination (lots of variations are possible there).

    1. Perfect analysis.  Well played.The methodology by which old line income producing companies compensate long term employees with stock with an obligation to sell the stock back based upon an agreed upon cash flow multiple valuation technique is as old as the hills.

    2. if i was working in a startup, i would not want to cap my upside any more than the investors are capping theirs

16. The whole point of stock options is to reward employees for building value while they’re at the company. Making them purchase when they leave avoids the scenario where people bail because things aren’t going well and then get rewarded for value which their former coworkers created after they left.

    1. that’s well said bram. i do feel that employees who stay should get some benefit for doing so. the rub is how you structure that benefit.

17. Actually, this points to a new problem: We should have standardized hiring docs.  There are copies of the relevant portions of the hiring documents/equity granting documents. If there were standardized documents, people probably would be more likely to take non-standard with a grain of salt, and be more likely to a) read over the thing and b) negotiate.

18. If I remember correctly, Omniture had options that were 4 year vesting with a 4 year cliff. Kept emloyees there and loyal.

    1. wowi bet it was hard to hire on that basis

19. This is easy: the “in it to win it” clause in employee incentives should be exit and IPO based bonuses. Everyone wins: the employees stay in it because they want the exit bonus, the company retains the employees, everyone’s incentives are aligned. 

20. “Companies feel that employees who stay and work to create ongoing value should have a better deal on their vested options than employees who leave and go to work elsewhere.”There are numerous ways to structure this incentive in an option plan other than a re-purchase clause. For instance, vesting does not have to be linear (ie. vest 10%, 20%, 30%, 40% over four years), the cliff can be extended to two years, and vesting can be accelerated on change of control (acquisition). You could also not allow any employee to exercise their options until change of control (ie. employees who leave can only exercise and cash out on their vested portion at the same time as the people who stayed) That would mean that you can proportionately reward employees who worked longer and through to an exit, while incentivizing those who may think about jumping to a different opportunity.The re-purchase clause is a rough and frightening way to solve a simple problem (that is, if employee motivation is the problem they were attempting to solve).

21. If Silver Lake or anyone else thinks they can acquire and motivate talent with clawbacks and other riders then more power to them. I may disagree with this approach but it doesn’t affect me. What is troubling however is that it appears that obfuscation of details and outlawyering less savvy individuals was central to the strategy. At a minimum they should have better explained their approach to prospective employees so that they had the chance to make an informed decision on the offer.

    1. I’d like to see more money flow into this late-stage PE market so that we have more investors competing with Silver Lake based on their reputation for fair-dealing and trustworthiness. Staying private would then be less risky if you can deal with investors who are better than these guys. I wonder if this mess will inspire more investment pros to enter this segment, aiming to do better than Silver Lake, or if it will just scare people away from dealing with PE.

22. Not sure how you can solve it other than market competition, company A does right and company B does not then A experiences a talent drain.  Shaming the companies that attempt to do it is about the only thing that seems to work  Before that can happen you need to educate employees about due diligence.  Contract reviews by a competent attorney, and an understanding of total percent ownership goes a long way to putting the brakes on this.The problem is that most job offers make people feel like they need to hurry through the process and “Just sign” which is never true.  

23. Fred, the solution to this may be more in how performance is rewarded along the way as opposed to “what happens with options when employees leave?””You want differentiation among options, among bonuses, and  among salary increases.  Differentiation is the mother’s milk of building a performance culture.  For the top 250 people, I use stock options.  We stay competitive on base salaries, but anybody who wants to make a lot of money at Honeywell has got to make it on options.  Here again, they’re not an entitlement.  For example, I’ve got a seasoned professional who’s good at his job but doesn’t exhibit further potential.  I’m going to pay him a tidy cash bonus but give him a lower allocation of stock options and maybe none in stock grants.  One the other hand, someone else seems to have a lot of potential, but if she didn’t do as good a job in one year as I would have liked, I’m going to give her less cash, but I’m going to continue to motivate her with options because I think she’s an asset to the company’s future.”–Larry Bossidy, Chairman & CEO Honeywell 91′ -99′”Execution: The Discipline of Getting Things Done” 2002Maybe this could be scaled down to work for a start up, and exercising could be taken out of the picture as Aaron Klein mentions in his remarks.

    1. Well played, great quote.  Sometimes it is difficult to remember that most of these issues are ancient.

    2. options are typically granted at the start of employment so it is hard to use them to reward performance unless you do another grant, which is something i encourage all of our portfolio companies to do

24.  Brian O’Shaughnessy is pretty damn clear when asked about Lee’s situation.  You’ve ‘got to be in it, to win it.’  If that is in fact the companies and Silver Lake’s position – why haven’t they chosen to write the employee contracts in a clear manner?  Legal contracts and how you chose to clearly or not clearly state things is a choice.  I’ll go with Felix Salmon on this one —  “I think, although anybody else owned by Silver Lake should be taking a long cold look at their option grants right now “

    1. This is exactly my take, too — and I think the letter from the General Counsel seals it.  If Silver Lake’s position was “you have to be in it to win it,” so to speak, then:1) the option grant contract should have clearly stated that;2) it should have been/become common knowledge at Skype (and pretty quickly) that you lose your options/shares upon resignation;3) HR would inform you of this on hire and, certainly, upon your exit;4) there would be no need for the GC to write to you because, well, it’d be obvious.Everything points to Silver Lake trying to hide the ball, which is probably what will bury them in the end.

       1. Dan…totally tangent off topic, but you know Elmo?  omg.  I’m seething in jealousy.  Just so you know, it was my dream to meet Kermit when I was a kid.  I have only cried when two famous people died.  Yitzhak Rabin and Jim Henson.  My 15 yr old couldn’t have cared less for Sesame street, and i sometimes think i had another child twelve years later in order to ensure Sesame street indoctrination (which is going quite well by the way)….Ok.  I’ll stop now. 🙂

    2. or worse, finding a new equity partner

25. So what explanation does Skype offer for sacking a goodly number of senior level management employees?  There has to be some reason and if this deal will ultimately require regulatory approval, the reason will be explored in great detail.If this is, in fact, simply driven by the impending sale, then the issue of severance is quite straightforward and while perhaps painful is just administrative.It seems much more sinister than that to me.

    1. There was an article not long ago abut the ownership distribution of Skype shares.  Outside of investors, 2% were left for employees and others.  At 3000 employees, there is not much money to go around and share the wealth.  It is a bit discouraging for any employee thinking about joining “start-up” world…

       1. Simple, Skype wasn’t a startup. It was a private equity investment. Two very different things. Silver Lake and others put in $1.9 billion in real cash to buy their interest, eBay retained a 35% stake. That sort of equity stake is normal in a PE world.  Think of how many VC backed startups have received $1.9 billion. Not even a valuation of $1.9 billion, $1.9 billion in actual cash. 

26. Anyone know if there’s a secondary market in Current TV option (the Al Gore cable channel)?  I’m about to leave and need to raise $70K to pay the tax.  

27. Fred, you and some other VCs have made the case for standard docs in seed and Series A financings. Isn’t there an even stronger argument to be made for standardized option agreements?In a financing, both sides typically have legal representation. (Woe unto the founders if they think their company’s lawyers are their personal lawyers, but that’s another issue.) In a board-executive negotiation, both sides should have counsel.But a junior employee shouldn’t have to hire an attorney to review their agreement, and almost certainly couldn’t afford one who knew what he was doing. It’s very one-sided.Option agreements differ in vesting terms, repurchase rights, and what happens in the event of an acquisition or IPO. Worst of all, a lot of companies refuse to tell employees how many shares are outstanding (and therefore what percentage of the company their options represent) which makes it impossible to weigh the grant against the salary you might get at a larger company.With no way to gauge their value, a lot of engineers treat options like a lottery ticket and demand the same salary they’d get at Microsoft – especially if they’ve been burnt before. For startups and their investors, this defeats the purpose of options.Get together with some other VCs. Create a standard form option agreement. Publish it on the web with detailed commentary. Use it for all your portfolio companies. Companies can depart from that, but new hires will be able to hone in on the non-standard language and request an explanation.Self-regulation. It’s better than (1) government regulation, (2) seeing your agreements tossed out in court as contracts of adhesion, or (3) employees valuing option grants at zero.

    1. Well played.  Great insight and advice.  Standardize everything but make it user friendly and kind.  Let a guy make a damn buck.

    2. great suggestion Jason. we actually need to get together with some lawyers to do this, not other VCsand what we have accomplished with funding docs is a standard set of docs for every venture law firm. fenwick’s docs, gunderson’s docs, cooley’s docs. etc, etc.there is no standardization as long as there are various law firms out there.but i like your suggestion and will see if we can make some progress on it

28. Stock options are just a part of a well designed compensation plan.A well designed compensation plan should include:Salary;Benefits;Performance bonus;Short term incentive compensation;Long term incentive compensation; and,Something special.Many well designed plans mingle bonus and short term incentive compensation and use stock options or restricted stock for long term compensation (I think they are different and accomplish different objectives).If you want a non-compete, then you better be able to show what you offered in consideration for that promise and it cannot be a job or other form of compensation related to the job.It has to be “independent” consideration for a separate and specific promise pertinent to competition or the safeguarding of proprietary or trade secret information.When you look at compensation this way, stock options begin to recede into their correct perspective — simply a component but not the core of compensation.I think that options are earned when granted and that the restrictions are simply golden handcuffs — a very good idea.  Once given, forget about them.  Let the recipient think about them.Don’t place too much emphasis on stock options.  Make sure they are only a part — an important part — of a well designed plan.

    1. JLM, I am always thoroughly impressed with your contributions on AVC. Your contributions are intelligent, well-thought-out, concise and simple to understand!I just wanted to take a moment to say thanks.- Mike, Internet CEO 

       1. Thanks, Mike.  I have an affinity for business as a system and have thought that CEOs in particular have to become 360 degree business persons.The days of being able to just be the chief and have experts around you — particularly for small businesses that cannot afford experts — is done.I have made it a practice to try to create “processes” that are simple and work for me.It is an endless task but sometimes, just sometimes, I think I am making a bit of progress.Of course, I have been a CEO for almost a third of a century, so you would think I would be finally figuring it out.Thanks, again.

    2. this is sage advice.here is the rub – the recipient of said options packages historically is less well informed than the savvy investor granting the allocation.Options have been dressed up and served out as the be all and end all.And like anything there have been predatory investors in the past that have seen an opportunity from ignorance.With the unbundling of these types of tactics thanks in large part to better informed entrepreneurs – we are moving back towards:invest in me – and let me try and make the both of us a ton of cash.Its fine for investors to get downside protection appropriately – as an entrepreneur i think thats fair – but wo behold anyone who tries sneeking around nickle and diming.lets make money together – not one at the cost of the other per se.I’ve always felt Fred takes this approach. He unbundles term sheets, opens up discussions on options etc and is generally very transparent around his activities and goals for investing.there are many others out there in his asset class that have the opposite approach. No bueno.

       1. In some ways this is most fundamental challenge in business — do business with “good” people.Company leaders have a responsibility — perhaps even a fiduciary obligation, I will have to noodle on that a bit — to make damn sure that everyone knows what they are getting and entitled to.I make it a point to sit down w/ my folks and ensure they understand the Company’s future and our benefits and the options.  I am not afraid to go through the Plan paragraph by paragraph.  Nobody really understands those plans, including me.Some time ago I made the fateful decision that I would never, ever be associated with an Option Plan in which I was not the Administrator — because the Administrator can waive anything in the Plan.As a result I have done cashless exercises for departing employees and have made extraordinary changes for key employees as part of a severance package.  It has left everyone w/ a smile on their face.  And it has served the company well.I have also used the Option Plan to create the strongest Golden Handcuffs possible but with the full knowledge that if you have a kid going to college I am likely to do whatever I can to help.In my business career, I have only lost 2 persons about whom I have shed a tear and one wanted to return.We should all view options as our way to make a great employee rich.  Make them rich and you are likely to do OK.

    3. JLM,  I second Mike’s comments.  Thanks for the valuable posts and comments yesterday.  Robert

29. “But in practice, once employees realized that was the deal, they were actually incented to leave …”Another angle of the Skype story is how the clawback was obfuscated. There was no way an employee could realize the conditions unless they consulted with a lawyer before they signed the contract.

    1. Imagine being the guy whose main job skill is writing these misleading contracts and tricking people out of compensation that they expected. The tech community should tell us what they think of such business partners by voting with their feet.

30. Interesting – It has been 10 years since I ran my company (Ganymede Software, purchased by NetIQ), but almost all of my folks purchased their options the day they vested (4 year grants, quarterly vesting) as they wanted to start the clock on capital gains treatment.

31. It’s true.. the best way to find our about a person and what bad they can do is to give them power. I read that line in the options contract and cannot understand what the hell it means. And I doubt anyone who’s not a lawyer would know either. And these idiots spouting about how he should have hired a lawyer, blah blah blah. Who the hell would hire a lawyer to sign a standard options contract unless you are a CEO or executive.Whoever was involved in writing this contract and doing this are scums of the earth.

32. Skype was not a VC investment and analogizing Skype to startup land is misplaced. It was a PE investment that happened to have a few VC’s along for the ride. $1.9 billion in cash investment for a controlling stake in a business that should not require future equity is a different thing than VC backed companies.  PE investors work differently and in it to win it is not something they hide in my experience.  Buyout funds, generally called private equity sponsors, have put a lot of thought into their incentive structures and have something that works well for their investing model which is a different model than VC funds in many respects. It also seems to work as private equity as an asset class has done markedly better than VC overall.I’ve been with multiple PE companies and they do work differently than VC companies. In the PE world, repurchase rights are absolutely common and are designed to make sure that people are not participating in the creation of equity value after they leave. Each company I know of has been very open with candidates who get equity, and has taken great pains to ensure that it is clear on what the differences with respect to equity are relative to VC backed or public companies. If Skype wasn’t transparent about this, then shame on them. But I’ve never seen the repurchase rights and terms hidden, in fact I’ve always seen it called out and clearly communicated whether in writing or in conversations with people who explain the option documents. PE sponsors want employees to be at a company through the end. They are upfront about it and view it as part of their business. PE investors are not about facilitating a job hopping ecosystem.However, it is worth noting that the terms of the repurchase right must be carefully negotiated, typically by the CEO with counsel, when setting up the initial stockholders agreement. The first PE sponsor ask is always that it is a repurchase at exercise price guaranteeing no gain, but most PE sponsors will take push back to have the repurchase be at fair market value on the repurchase date so the exercising former employee gets the gain up to the repurchase date. This is fair, the employee gets value up to the point they leave but not increases afterwards unless the company does not repurchase the stock. If the CEO doesn’t do a good job of hiring counsel and doesn’t negotiate well, the employees can get jammed on this point but I’ve seen it be fully disclosed regardless of which way it goes.I have no idea what Skype’s equity structure looked like and I assume it is more complicated than most, but it is worth noting that most of the PE equity structures I have seen are much simpler than VC backed structures. Many large PE sponsors stay away from the multiple classes of preferred with varying liquidation preference model that is common in the VC world because of the need to raise multiple VC rounds from different VCs which is not generally the case for PE sponsors. PE structures are typically much simpler and the numbers are easier to figure out, often with common stock only. I’ve seen many more people misunderstand VC structures and economic impacts, particularly when you add in the impact of participating liquidation preferences, than I have seen people misunderstand PE structures.

    1. and sorry for the lack of spacing. Something went wrong.

       1. Go back and EDIT and reinsert the paragraphs.

    2. Great points Dave.It’s only emerging now that this was more of a PE than a VC deal.In past news reports it was presented squarely as a VC deal.

       1. My read says it was presented as a VC deal by technology columnists who didn’t understand or focus on the differences between PE and VC and who noted the Andreesen Horowitz involvement must make it a VC deal. The broader financial press seemed to always present it as a PE deal because Silver Lake was involved. This was a spinout of a large division from a public company parent where the division no longer fit. A classic PE investment except is was in a technology space and has a brand name we all know. 

    3. just because it is the way it is done in PE doesn’t mean it is righti have spent my career resisting “that is the way it is done in VC”VC has changedPE should toofucking over employees is not right no matter what asset class you are in

       1. Great info in Dave’s comment, crowd pleaser points for your reply 🙂

       2. If a repurchase right is at the fair market value on the date the right is exercised, I don’t think it is screwing over employees. Employees exercise their options and then participate in value creation through the date the right is exercised, not value creation over the full term of the investment. Plus employees get liquidity. 

          1. It certainly gets closer to the concept of fairness to be sure but the suggestion that one MUST sell seems more than a bit heavy handed.When one invests their blood, sweat and tears it is the equivalent of real capital — maybe even more so.The notion that that sweat equity cannot ride the same rails as the cash equity seems patently unfair to me.

             1. @Dan–Fred’s generalization of all PE should change overlooks the fact that all PE is not the same, anymore than all VCs are. Some VCs still try to have ridiculous participating preferred liquidation preferences with no caps. That doesn’t mean all VCs are bad, just som@119d177d51d62dbce803ec53876e4468:disqus @JLM–The most significant concern of most employees exercising options is actually that the repurchase right will NOT be exercised. Employees fear paying cash to exercise options, then being forced to hold the asset for many years.@JLM:twitter PE is much more up front about “in it to win it” than most VCs are about liquidation preferfences and capital structure impact overall. It is also consistent with PE terms overall which, among other things, include significant cash investment by senior management most of the time. I’d encourage all the VCs who believe Skype/Silver Lake were not tranparent to think about whether they provide a liquidation preference model to all employees that allows employees to understand proceeds allocations to common and preferred at various sale values.

          2. That wasn’t what happened in this case, though.

          3. Of course you don’t think it’s screwing them over. It’s always more convenient to convince yourself you’re being fair than accept the possibility that you’re being unethical. You can tell yourself this 1000x over and even believe it but everyone who’s grabbing their ankles won’t agree with you.Making the distinction between VC and PE in the case of Skype is really besides the point.Using a platitude like “in it to win it” is really vague and could be used as an excuse to do all kinds of evil. Why stop at buying back unvested shares? Create a clause that says anyone who quits loses ALL their shares? When it comes down to it, they are outside the norm for the industry in how they are handling vested shares.

          4. that might be fair in PEbut in VC, you need to capture all the upside to compensate for the risk offailure

       3. right said fred 😉  well put Fred.

    4. Good read, thanks for the insights.I must say I continue to be troubled by the prospect that the vesting requirements of an option grant are not sufficient to deliver the continuity and golden handcuffs objectives of an investor.If the vesting rights are not equivalent to “freeing the serfs” then what real purpose do they achieve or seek to achieve?There is something inherently unfair and unconscionable about the unjust enrichment and value confiscation created by the unilateral repurchase option mechanism.Options are securities and they should be universally recognizable and used consistently across the entire securities industry.The PE guys are just greedy.  And, in this instance, greed is not good!

    5. The big evil here is not whether “in it to win it” is right or wrong; it’s the absolutely obtuse legal syntax used to obfuscate it.  Silver Lake were not upfront with their employees about the terms they were working under, and that contract seems written more to intentionally hide the terms than to create a clear legal document.

33. I think all these comments are reflecting an over-complication of the situation. It’s really this simple: if SilverLake’s intentions are squarely that you must be ” in it to win it” then the vesting schedule should be just that. To have buyback rights at cost negates the vesting altogether.Secondly, the purpose of vesting is to bestow value on the employee for the contributions made during that particular vesting period. if your intention as an employer is to actually confiscate that value contribution upon the employee’s departure, then shame on you.

34. There are a lot of ways to skin the cat with options programs and my view is that there is no best approach, as there always tend to be mistakes of one kind or another in hindsight.  The Board and CEO can help a lot by making sure that they do the right thing with respect to each employee at the point that they leave the company or the company has a liquidity event, however.  These include allowing certain employees to stay on as consultants to allow them not to have to exercise and/or making true-up bonuses to certain employees.  If a company succeeds, the people who contributed to the success should succeed.Option plans will never be airtight for employees, so a better focus is on the CEO, board, and investors and making sure that they are the type of people that you want to be in business with.Scott Maxwell- OpenView Venture Partners.

35. Great post. 

36. 90 days is norm.  Once, had a year to exercise. That was a  dream from my perspective even though a year later there were still no proof points to help with the choice.

37. The details are pretty fuzzy. It’s hard to criticize a decision without knowing who made it and what their reasoning was. For all we know it was Microsoft who requested these actions.

38. The 90-days is driven by the accounting for stock options which is onerous for the company given the Black-Scholes valuation technique required.Otherwise I agree completely with your comment.A big secret about all of this baloney is that every Stock Option Plan has an Administrator who is often and usually empowered to waive any provision of the Plan.I have been the Administrator of numerous Plans and have routinely waived vesting periods without a second thought.I have always thought of stock options as an essential and integral part of compensation and thus consider it earned when granted.Most of the rest of the debate falls under the Golden Handcuffs theory — one I subscribe to.

39. Why would Microsoft care – purchase price remains the same, and it’s not like they can save transaction expenses by having fewer investors they are purchasing from, since there are going to be plenty of Skype employees who are able to exercise their options. I think it’s obvious who is responsible – the investor base who put in the repurchase right (if you read the Felix Salmon, the finger is pointed squarely at the Silver Lake consortium). And if you read the letter by Velez and comments by O’Shaughnessy, it is clear that it’s to ensure no ‘benefit’ leaves from the hands of the investors and to the hands of employees who resign / are terminated with cause.

40. It’s also perfectly reasonable for the employee to expect that the employer will be honest and straight-forward.  The contract here, as far as I’ve read, seems to be the opposite of this.  It makes clear statements about vesting and then, an obfuscated section, effectively redefines the term “vesting” such that it means the opposite of the commonly-accepted definition.  It is not okay for one party, especially one with more legal sophistication, to write a contract in such a way as to intentionally deceive the other party.

41. the problem in the skype case is that the option agreement referred to other documents that the employees did not have access to

42. This individual that you are speaking of aside that clause was for all employee’s not just the experienced ones.The fact that find no fault with playing these kind of games on says as much about you as it does Skype.  Please be sure to let us all know who you invest in and we will avoid them like the plague. 

43. As a former employment lawyer, I tend to agree that people should read and understand their employment contracts.  However, there’s another side to it.  Employers shouldn’t draft documents which require that would-be employees hire counsel to negotiate the deal.  It poisons the employer/employee relationship. My other concern is that if the employee is either incompetent or lazy, why did Silver Lake want him?  It cuts both ways: anyone who objected to the clause is the type of employee you’d want (not lazy, not incompetent) but not the type of employee you’d get (because of the clause).Also, you’re very wrong that this employee has no chance of winning the suit.  There are a few things he can allege.  Fraud.  If he was fired for cause (I realize this guy resigned, but others were), defamation.  Perhaps some sort of theft of services argument, fraudulent inducement, unjust enrichment, tortious interference with contract, and of course, he can sue on the contract itself.  Once he files — and filing is cheap — there’s a good chance he’ll get a settlement offer.  This is especially true because if a lot of people were harmed in this matter, there’s a chance that the suit could be brought as a putative class action… which would amplify the damages pretty quickly.

44. misleading a counterparty to the contents of a written agreement is fraud, which in the USA is a criminal offense (for most people)see all the mortgage brokers who were charged with criminal offenses. they showed up in court and said ‘judge, dude signed a contract!’ .. meant nothing

45. Fraud is both a criminal and a civil offense.  In this context, it is likely a civil offense.The signing of a contract is not a defense to fraud as the inducement to sign the contract is often the actual fraud that is perpetrated.”Fraud in the inducement” is probably the most common fraud complaint. This is a garden variety tort.A contract which was fraudulently induced is arguably not enforceable in whole or in part and perhaps voidable which then throws the entire matter into the realm of “equities” — simply asking the Court to do what is right absent the fraud.A contract is not a one way street and the requirements for fair dealing, full disclosure, plain writing and being construed against the author are important considerations.

46. I am a law and order kind of guy and truly sympathize with your view.But the harsh reality of the legal environment today is that if Tommy’s playmate has $25 for the filing fee, then Tommy is going to have to prove before 12 borderline idiots whether he does or does not play nice.And, if they decide they do not like guys who wear blue shirts with white French cuffs and drive a Maybach it can get costly for the PE boys.A complicated contract by its very nature is really not enforceable on its face until it is fully litigated because it is one of a kind.Throw in a non-compete and it is Alice in Wonderland.Employment arrangements in which part of the compensation is based on options are truly weird as one is dealing with employment law, securities law and contract law.This is some very complicated stuff and complications always favor plaintiffs when the defendant drew up the contract.I am not suggesting I agree with that eventuality but I am saying that that is the way it is for good or bad.

47. Sure and words written down in contracts have force and effect. But they also make other words said about stock options and compensation in salary negotiations worth jail time.That’s the issue here. Not the wording on the contract. It makes other claims about the worth of stock options a fraud especially if somebody claims stock options a reason to pay little lower salary than the employee could get somewhere else. Also you might consider what jury feels reasonable. I’m pretty certain that at least somebody in the jury will feel the same as I do about these things. 

48. All parties to any contract have a common law obligation and expectation of fair dealing.The contract language is always construed against the author of the contract unless specifically waived by the other party in writing as part of the contract.The author has a legal obligation to write in “plain English” and an ethical obligation to be clear.

49. The contract was likely drawn up by the Company’s or the Board’s Compensation Committee lawyer from an employment perspective with input pertinent to the securities aspects from the Company’s or Board’s SEC lawyer.Sure a wise Executive should have had his attorney and a good securities attorney look over the agreement but that will not carry much weight in front of a 12-man jury with about 2 semesters of education at a community college.This will become particularly dicey if there is a non-compete and if the Executive is able to argue that the options were an integral part of his compensation because now you wander into the arena of “theft of services” and other extraneous theories of unjust enrichment.The company is not going to be able to get services or work for free or at a reduced rate because they cleverly drew up a contract.Those provisions will simply be unenforceable or voided and the balance of the contract will be ruled enforceable.One of the most basic concepts of contract law is the severability of unenforceable provisions rather than voiding the entire contract.The plaintiff will simply argue that the appropriate provisions are voidable or unenforceable and the balance of the contract is valid.It would be interesting to hear the arguments as to WHY it is necessary to construct the agreement in this manner.Again, I am a guy in favor of the strict interpretation of contracts amongst the big boys, but that is not the current state of this black art.

50. There is also the possibility (cf TechCrunch post) that the vesting agreement made reference to another document that was not made available.It’s true that the employee should have requested the second document, but these guys aren’t lawyers….If you need to hire a lawyer to look over your employment contract, what does that tell you about the state of the market?Transparency wins in my book.

51. If I were signing any employment contract today with anyone, I would have each and every exhibit attached and have every page initialed.

52. That works in a frothy employment market, or if you’re rich (or in demand) enough to walk away.Most employees are glad to be made an offer, and thus try not to rock the boat.

53. We are a Nation of whiners and winners and sometimes we are both and neither.More cases have been tried in the Court of Public Opinion than all others combined.

54. If it’s standard — and I believe you when you say it is — why was the guy surprised at the letter?  Why’d he get the letter at all?That’s what I don’t get.  If most people knew that this would happen, then the first time someone else quit, people would have mentioned that the quitter just gave up his equity.  Pretty quickly, everyone would know that was the case.  And that being the case, why does the GC need to send the letter?  Wouldn’t they just buy back the stock and send the letter then?

55. If you’re applying as an employee of a tech company and have to be well-versed in PE contracts (regardless of how standard they are) to understand it then something is really, really wrong.Imagine if you had to be constitutional lawyer to know your basic rights? Or you needed a degree in finance to pay your bills?It sounds like an excuse to screw people over but play like you’re innocent.

56. Well, that’s the point.Based on what I’ve read (for the developer who chose to leave) we’re talking about $70k.You tell me…

57. I agree, but consult a lawyer even it’s only worth one million or maybe even less. 

58. “Employers shouldn’t draft documents which require that would-be employees hire counsel to negotiate the deal.  It poisons the employer/employee relationship. “that is great advice dan and i am going to ask our companies to try to live up to that rule going forward

59. PaulYou do realize that you are making an argument predicated onfacts that are not in evidence…?In many ways, the Skype/Lee situation is an example of they said/he said – none of us are obviously privy to the specific facts of who saw what when docs were signed, or privy to what was said at that time.  So while we may have opinions, few of them are informed as to the specific situation (or, indeed, relevant).  The more constructive outcome is the application of this news to other scenarios.  Are PE and VC reconcilable?  Is there a fair-dealing issue?  I think that’s where most of this conversation goes, rather than ad-hominem criticism of Yee Lee.The inarguable facts (IMO, are the documents).  And – having signed my share of docs and had good legal counsel on my side in them – having read the docs, I say “WTF???”  The language is clearly not transparent and could be viewed as intentionally confusing.  You may rationalize all you want about how Silver Lake was justified in exercising this clause, but I strongly disagree.  Even with the benefit of hindsight, they buried that clause deep, and they buried it on purpose.-Paul

60. great stuff…