Skype mess: How far will this go?

Wow…. the ugliness around Skype keeps getting bigger and bigger. The Internet telephony company which is in the process of being sold to Microsoft for $8.5 billion is fast becoming a poster child of investor greed and corporate mistreatment of it employees.

Earlier this month, Skype cut many key executives, a move that is said to have been inspired by investors who were looking to extract the maximum value from the deal. Investors in Skype include Silver Lake Partners, Andreessen Horowitz and the Canadian Pension Board.

A company spokesperson absolved the investors of any misdoing and said that the executive cuts were part of a long drawn-out decision-making process under the aegis of CEO Tony Bates. An investor in the company argued that the money saved would be negligible and not worth the trouble.

Well, that doesn’t appear to be the case and this morning Business Week reported that things are not as sanguine as the company makes it seem.

Normally options give employees the right to buy shares at the price on the grant date, once they have worked at the company for a time. After a month of back-and-forth with Skype’s human resources department, [former Skype employee Yee] Lee learned that even his “vested” options were worthless. It turns out the investor group, led by private equity firm Silver Lake Partners that bought Skype from EBay (EBAY) in 2009, had secured a so-called repurchase right that gave them authority to buy back the shares at the grant price.

Today, Yee Lee, a former employee shared his side of the story on his personal blog, giving more details on his predicament.

The most important lesson I learned from Skype was that compensation and stock policies in PE-owned firms can be very heavily tilted in the owners’ favor and against the employees. Skype employees have 5-year vesting of stock options, for example, not the usual 4 year schedule that most Valley firms have. Even worse, Skype’s stock option agreement had special clauses that the Board had slipped in that gives them the right to “repurchase” any vested shares for anyone who leaves the company voluntarily or is terminated with cause — effectively taking “vested” shares and making them worthless.  Here’s a nice letter I got from the Associate General Counsel of Skype that points out exactly how my stock options have “no financial value.”

Skype obviously feels otherwise. Fortune’s Dan Primack points out

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.

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. 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.

Lee’s allegations and a prior Bloomberg story points to what might have been a systematic issue. The key thing here is that Microsoft is going to be the company that is left holding the bag. Scott Rafer, a veteran entrepreneur with deep roots in Silicon Valley had this to say on his blog, which kind of makes Microsoft responsible.

It’s hearsay (though very intimate hearsay), but the executive cuts were definitely made in order to save on bonuses and put incrementally more cash in the PE investors’ pockets. However, it’s going to backfire.

In all these transactions, there’s an allowance for a ‘basket’ of liabilities in which the Seller (i.e. Skype shareholders) take economic responsibility for unknown liabilities that come up after the deal closes. It is FREE for Microsoft to pay out the amount of money in the basket to whoever sues them on a Skype-specific issue. If the people who were fired have a decent attorney, they’ll sue the successor entity to Skype (i.e. Microsoft) after the deal closes. Microsoft’s attorneys won’t care about whether they win or lose up to the amount of the basket.

The drumbeat of bad news around the deal masks a bigger problem. At the time that Skype was spun out of eBay, I pointed out that with nearly 15 board members — all of them with strong personalities — it would become a problem. Well that is precisely what has been happening. Lee blames Silver Lake for many of the issues.

The firm inserted itself into every level of the company. At one point in my tenure at Skype, Silver Lake had representatives or consultants on the Board, in C-level executive roles, in technical leadership and operating roles, and all the way on thru the organization to the person actually running our software deployment schedule… So Silver Lake put its fingers really deeply into Skype’s pie and they started rearranging things.

You can agree or disagree with the practice of re-organization, but I personally had never been part of a restructuring that ran so deep in a company.  During the year I was at Skype, the company:

  • lost a CEO
  • hired and fired a CTO
  • hired and fired a CFO
  • gained a CEO, CMO, CIO, and CDO
  • created an entirely new product development org structure
  • eliminated every Project Manager role
  • fired, re-interviewed, and re-hired Product Managers
  • created two new business units
  • combined two business units into one
  • dissolved one business unit
  • opened a new office and hired several hundred people
  • the list goes on…

Nevertheless, the question here is — if Silver Lake was acting a certain way, what was rest of the board doing? Some former employees I spoke to said that there has been a wholesale interference from the board members, each one having some issue with some employee or the other. From hiring decisions to product directions and platform support, the pressure from the board was described as unusual and sometimes without rationale.

Don’t be surprised to see more details leak out.

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