Skype: See no vesting, hear no vesting

June 24, 2011, 11:49 PM UTC

Last week, Skype took heat for firing three executives just weeks before the company’s $8.5 billion acquisition by Microsoft (MSFT) is expected to close. That was bad, albeit more optical than unethical. What we learned today, however, might have crossed that line.

Yee Lee, a former Skype employee, charged the company and its private equity investors with effectively cheating him out of vested options. Not in court papers, but via his blog.

Lee says that he joined Skype in March 2010, shortly after the company was carved out of eBay (EBAY) by Silver Lake Partners, Andreessen Horowitz and the Canada Pension Plan Investment Board. His job was to help make the Skype app more “web-oriented,” and also to help shorten product development life-cycles (the latter of which has been cited by Skype investors as a key achievement during their tenure).

His compensation included options for 750 ordinary shares, which would vest after five years. When Lee voluntarily resigned on year later to join a startup called Katango, he assumed that he was entitled to the 20% of shares that had already vested. Skype, however, say it differently.

In a letter, the company argued that his vested shares were effectively worthless, because he had voluntarily resigned before the five years were up (or, in this particular case, before Microsoft had completed its acquisition). Skype tacitly acknowledged that some of Lee’s shares had already vested, but said that such vesting was irrelevant.

For evidence, Skype directed Lee back to his original stock option grant agreement. On the third of eleven pages is the following passage:

If, in connection with the termination of a Participant’s Employment, the Ordinary Shares issued to such Participant pursuant to the exercise of the Option or issuable to such Participant pursuant to any portion of the Option that is then vested are to be repurchased, the Participant shall be required to exercise his or her vested Option and any Ordinary Shares issued in connection with such exercise shall be subject to the repurchase and other provisions in the Management Partnership agreement.

Don’t bother reading it again for clarity. It is intentionally incomprehensible. It also was not something that applied to stock grants for all Skype employees. A source familiar with the situation says that many former eBay employees who remained with Skype have options that more resemble typical Silicon Valley (i.e., vested=yours). Moreover, the majority of Skype employees are in Europe, where the structure also is different.

But for U.S.-based employees who joined after Silver Lake and crew took over, you had to “be in it to win it.” In other words, these particular Skype employees wouldn’t get paid until the private equity firms also got paid. It’s kind of like a stock appreciation agreement in option form.

Skype and Silver Lake clearly see this as an alignment of interest issue, and two corporate lawyers I spoke with said that such structures are not uncommon in PE-backed employee contracts. The only peculiarities – although vesting periods usually last for just four years instead of five, and only apply to C-level executives. In fact, some structures put specific investment performance hurdles on executive pay. For example, options won’t vest unless the private equity sponsor generates a certain return multiple.

So the problem here is not that Lee was treated differently than other employees at private equity-backed companies. It’s that such treatment exists at all.

First, golden handcuffs are generally counterproductive. Sure it might keep some folks around a bit longer, but they’ll be bitter and such practices can dissuade. Moreover, why allow incremental vesting at all if what’s vested after one or two years has no tangible value? Couldn’t Skype have just used cliff vesting, given the company’s apparent “all or nothing” mission?

To be sure, Lee should have had a lawyer read over his contract before quitting. It’s not as if this is his first place of employment (he’s had nine since 1999, according to his LinkedIn profile).

But it looks to me as if he was almost intentionally tricked. Just read over that contract language again. Skype must know the commonly-understood meaning of option vesting in Silicon Valley, so it should have explicitly said that its arrangement was different. As I said before, Lee had experience leaving companies. His shock indicates just how opaque this particular agreement was.

In fact, it reads like punishment for someone who chose to leave — particularly given that Skype could have awarded value to the vested options, had it chosen to do so. Instead, it viewed Lee as disloyal, even though he was looking out for himself just like Skype was looking out itself in firing those three executives.

Lee was careless and perhaps a bit greedy. But Skype and Silver Lake were petty and vindictive, with far more to lose from such behavior in the long run.