THE SKYPE SCANDAL

Here's How Big Bad Private-Equity Firm Silver Lake Sees The Situation
Henry Blodget

Over the past week, a minor scandal has emerged in Silicon Valley over the way a bunch of senior Skype executives were treated after the company agreed to be acquired by Microsoft for $9 billion.


The first report was that the executives had been fired before the deal closed to save a bit of payout money for Skype's investors, namely private equity firm Silver Lake.

This story was quickly debunked, or at least muted, when it emerged that the firings were part of a re-organization by Skype's relatively new CEO Tony Bates and that the fired executives had, in fact, received the stock and cash compensation they had earned to date (if not what they would have earned had they stayed on for several more years).

But then another ex-Skype executive, Yee Lee, wrote an essay about how he had been reamed by "a bunch of rat bastards" at Silver Lake. And the scandal caught fire again.

Lee's main complaint was that when he voluntarily resigned from Skype, he thought he had made some nice coin on his vested stock options--only to learn that Siliver Lake had a "clawback" provision that allowed them to get his vested options back without his seeing any of the gain.

The normal Silicon Valley venture-backed option deal, Lee pointed out, is a 4-year vesting schedule with no clawback--once you've earned a vested option, it's yours. At Skype, however, options vested on a 5-year schedule, not 4-years, and they were subject to the clawback provision that Lee says he was unaware of at the time he signed on.

If, indeed, Skype and Silver Lake did not alert employees like Lee to this clawback provision, they should have. It's different enough from the standard Valley option deal that it's not something that employees should have to suddenly discover later.

But the big difference between Skype and most Silicon Valley venture-backed companies--a difference that is inflaming this scandal--is that Skype is a private-equity deal, not a venture capital deal. And standard operating procedure (SOP) in private-equity deals is different than SOP in venture capital deals.

In the wake of the Lee revelations, we spoke to a Skype investor who is familiar with Silver Lake's view of the situation.

Here is that view:
In the rush to blast Silver Lake as greedy and evil, the investor said, two different issues are being conflated. The difference is between the Skype executives who were fired and those, like Lee, who left voluntarily. The executives who were fired were paid out (i.e., they got their vested stock options). It was only executives like Lee who quit the company who did not get their options.
Private equity firms have a different view of option compensation than VC firms, the Skype investor said. Specifically, private-equity firms recruit executives with a very specific mission: To fix the company and then sell it, a process that often takes several years. In private-equity's view, executives only deserve a piece of the equity pie if they see that mission through, not if they quit in the middle.
Lee, the investor pointed out, quit voluntarily 13 months after joining Skype. If he had remained at the company until the Microsoft deal closed, thus completing the mission he had been hired for, he would have gotten his options. But he didn't. He quit the team early--voluntarily. This quit-as-soon-as-some-of-your-options-vest, the investor said, would be an "eyebrow raiser" even in normal Silicon Valley VC deals. (Most VC-backed option plans have a one-year "cliff vest" in which you get 12 months of options after a year's employment. Employees who quit 366 days after joining a company--the day after the options vest--aren't viewed kindly.)
The total amount of money Lee and other executives left on the table by quitting early was small in private-equity terms (under ~$1 million), so why not pay it out to avoid criticism? Because Silver Lake is standing on principle, the investor said: The firm hired Lee to help Skype on its journey from purchase to sale, and he quit in the middle. So the heck with him.

More broadly, the Skype investor said, Silicon Valley compensation trends are changing fast, and not just in private equity deals.

Instead of the old "4-year options" that everyone is used to, many companies are moving to either Restricted Stock Units (RSUs) or cash compensation (especially at Google), each of which have very different tax and liquidity considerations than stock options.

So the investor's advice for tech executives is actually the same as Lee's: Don't assume anything--know what you're getting into and whether it works for you.