The Skype Option Dilemma – Is There an “Industry Standard” for Treatment of Options?

There has been a lot of talk in the deal press recently about the treatment of former employees’ vested options in the wake of Silver Lake’s sale of Skype to Microsoft.  Former Skype employees, including Yee Lee, cried foul at Silver Lake’s clawing back of their vested options, saying that they were not aware of the clawback right and that such right was not consistent with “industry standards.”

 The questions of whether there is an industry standard for treatment of options for former employees and, if so, does it differ from the provisions included in the Skype option plan have been the subject of much debate recently?  It is clear that many venture capital analysts believe that the clawback provision was not in keeping with the “industry standard” and, some have argued that the provision amounted to an intentional trick aimed at preventing departing employees from sharing the benefits of any exit event.  Others in the private equity press have argued that for private equity deals a clawback provision in the event that an employee voluntarily terminates his or her employment is not an unusual provision.

These differing reactions seem to point to a distinction between the nature of venture capital  investing and private equity investing.  Venture capital investments involve earlier stage investments that are inherently more speculative and have a longer path to liquidity  Additionally, employees of early stage (particularly pre-profitability and/or pre-revenue) companies often work for reduced compensation relative to the employees of later stage profitable companies.  Given these risks and sacrifices, the predominant view in the venture capital community appears to be that existing employees should be able to retain the equity they have vested in by exercising their options, even if they depart their company prior to an exit event.  As these risks and sacrifices tend to be less prevalent for later stage companies, the predominant view in the private equity community appears to be that features such a clawback of vested shares for former employees are more appropriate and serve as an incentive to encourage retention of employees through an exit event. 

The take away for employees of venture and private equity backed companies is that they should fully understand the terms of their equity awards before joining their company.  They should make sure they review all documents related to these awards  - typically, an option plan and an option agreement, but there may be other agreements such as a right or first refusal or shareholders agreement.  And, if in doubt as to what the documents say, have a lawyer review them.

This post on Employee Equity was authored by Caitlin Vaughn.

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