Skype and Employee Stock Option Plans

Technology blogs are busy right now discussing the affront to employees that was the Skype Employee Stock Option Plan.  Skype is currently in the process of being sold to Microsoft.  It appears that, in anticipation of the sale, Skype laid off a number of employees, claiming that they were ridding themselves of underperformers.  That process isn’t unusual, but it certainly does not engender a positive work environment and can lead to an exodus of top performers, especially if the job market is favourable to lateral movements.

The fallout from this process is that Skype’s Employee Stock Option Plan has been made public, along with it’s investor-friendly share claw-back clause.  The clause works as follows:  when an employee’s employment is terminated not only do non-vested options get cancelled, but vested options also get cancelled and shares bought through the exercise of options must be sold back to the company at the exercise price.

There are a number of variations on this type of clause, but the basic goal is the same: to retain equity in the hands of those involved with the company.  From a human resources perspective, the message is that only those people continuing to grow the company can participate in the growth in value of the company.  From a management perspective, the company retains control of the company with those actively involved and it allows for control over the employee option pool.

The following Techcrunch article does a good job of discussing the company perspective:

http://techcrunch.com/2011/06/26/skypes-worthless-employee-stock-option-plan-heres-why-they-did-it/

For a more passionate review of Skype and their HR practices, see the personal blog of the terminated employee, Kuo-Yee Lee, making the waves:

http://framethink.wordpress.com/2011/06/24/how-employees-get-screwed-in-private-equity-deals/

We are seeing an increasing number of these types of clauses for technology companies.  The clauses in and of themselves aren’t inherently “wrong”, but they do need to be clearly bargained for.  The risk, as seems to be brewing with the Skype file, is that an employee or group of employees will bring a legal claim that the options formed part of their overall compensation: particularly the potential growth in value of the shares. They could claim that they were not aware of the clawback clause and did not bargain for it.  The negative HR environment which such a situation could create would of course also not be welcome.

If the true intent of the buy back is retention of control within the company, a few different approaches could be taken.  A voting trust could be set up for all employee owned shares or a class of shares with limited voting rights could be issued to employees.  If a buy back of shares upon termination of employment is desired, actual or projected value could be exchanged rather than exercise price.  The value could be determined by a pre-set formula.

If a company or it’s investors decide to pursue a strategy such as the one used by Skype, a way to ensure that an employee is fully aware of the terms of the option grant would be to have them sign an acknowledgment, consenting to the terms with each and every grant. This can be done through a Stock Option Agreement which is executed with each grant (along with the Plan itself) or in a separate, stand alone acknowledgment.  The terms should be clearly laid out.  An independent legal advice acknowledgment should be included and steps taken to establish that employees know of their right to obtain legal advice prior to signing.  If it fits within the financial framework of the company as well as the HR strategy, the employee could be given the option of cash incentive or the options on the terms provided.

Courts in Ontario generally approach employment issues with the assumption that the employee is in a weaker bargaining position than the employer and there is a tendency to interpret contractual obligations in favour of the employee.  Particularly in the case of non-executive employees, there could be considerable exposure for companies who utilize ESOPs with these types of clauses.  If a company faced litigation on the clause just as they were entering an acquisition or other liquidity event it could prove particularly problematic.  If a company wishes to include a claw back clause it should be transparent and clear to employees.