Silicon Valley should wake up to clawback culture

Microsoft Skype Ballmer

There’s been a storm around Skype ever since former employee Yee Lee let rip and accused the company’s investors, Silver Lake, of screwing employees over in its $9 billion sale to Microsoft. Specifically, Lee was upset by the discovery that his stock options suddenly become subject to “clawback” deals that made his stake in the company (which he had left before the sale) worthless.

With Silver Lake on the ropes, everyone has been jumping in to get their punches in. Michael Arrington almost popped at the prospect of such sneaky clauses; Reuters super-blogger Felix Salmon got (rightly) angry about the way the fine print worked. All in all,this bare knuckle brawl sends a simple message: Clawbacks are bad, and they should be fought wherever possible.

A Silicon Valley state of mind

But is it possible to see this any other way? Is it possible that these arguments about clawbacks are just a remnant of Silicon Valley’s cash-rich, founder-happy culture? Evidence from elsewhere would suggest that, at the very least, the entrepreneurs just don’t know how good they’ve been getting it. Let me explain.

In the startup business, clawbacks are usually seen as a feature pushed by private equity, used by investors to exert pressure on staff and maximize returns. In fact, writing on the Financial Times techhub blog , Richard Waters characterizes it precisely this way — as a conflict between the culture of Silicon Valley venture capital and the clubby world of private equity:

If workers are tempted to cash in after a year or two to move on to the next opportunity – something more likely to happen when prices in the private market are rising quickly, as they are now – then options  contribute to an “exit strategy” culture, not one geared to building long-term value. There are always people who are tempted to “double dip”, says Christos Cotsakos, the founder of ETrade  and now chief executive of EndPlay.

Venture capitalists frown on this behaviour but haven’t tried to prevent it. But private equity firms like Silver Lake, which led the Skype buy-out, clearly feel differently – hence the unusual and controversial clawback that caught out Yee Lee.

The truth is, however, that clawbacks are much more common than the reporting may suggest.

Scenes from a European startup

For starters, it’s seen as fairly typical procedure in Europe (where venture capital has traditionally been thin on the ground) and there are a large number of European startups that have clawbacks written into their employment contracts. Of course, that doesn’t mean it’s right — in fact, the terms can often be onerous.

What is certainly very common across European businesses is the so-called “good leaver/bad leaver” provision, which ultimately values an employee’s rights against the reasons they left the company. In general terms, a “good leaver” is somebody who ceases employment because of death, disability or being unfairly dismissed; a “bad leaver” is somebody who chooses to quit of their own accord, breached their contract or was legally terminated.

Doug Monro, a serial entrepreneur in Britain who’s currently working on job site Adzuna, has experience with companies based on both sides of the Atlantic. He told me these provisions, which often amount to clawbacks, were a strong European phenomenon:

“In my experience more EU startups have clawback or ‘discretionary bad leaver’ than in [the] U.S.,” he said, adding that the details of such clauses can be a “big issue for hires to look at.”

They didn’t start the clawbacks

But it’s is not just in European businesses that clawbacks are common. According to a BusinessWeek report from last year, fully 70 percent of America’s largest companies say they have clawback provisions of some form. There are also plenty of examples of other restrictions on employees who leave the business — such as being forced to sell options within a few months of leaving. British computer researcher Lyndsay Williams, who spent 11 years working at Microsoft before being made redundant in 2007, says she was surprised when she realized she had to sell her options quickly.

“I had vested stock options that I was required to sell by Microsoft within three months of being made redundant,” she told me. It turned out well, she says, since the stock value was only getting worse and it gave her money to invest in her own company, Girton Labs. “Given the very disappointing performance of Microsoft share price [being forced to sell] was not really a hardship.”

And remember, too, that this isn’t just about investors vs staff; it can be founder against founder. As British law firm Taylor Wessing outlines the argument in a a briefing document on private equity deals, not having clawbacks or bad leaver provisions can leave those who stay behind irked: “From the continuing founders’ point of view, why should the departing founder get market value if he has left the company?”

And let’s not imagine this is brand new, either. Two years ago, Fred Destin, a partner at Atlas Venture who was based in Europe at the time (he’s now in Boston), highlighted such clauses as a potential minefield for startups and founders. Although he said he “would not do a deal without some form of reverse vesting,” he suggested the details are something founders should watch carefully, and be prepared to negotiate hard over.

“Make sure there is a good leaver/bad leaver clause,” he wrote. “You get fired for cause, you lose some. You decide to leave, you lose some. The company decides it does not want you around any more, you keep it.”

That’s just the way things are

So there you have it. Clawbacks are not new, not rare and not necessarily about screwing over founders. The real difference is that they are new to the Valley, so some people are being exposed to them for the first time.

Whether it’s restrictions on bonuses paid to executives at failed banks, or a stick that encourages employees to stick with a business, clawbacks are less unusual than you may have been led to believe. In fact, it’s worth considering that Silicon Valley is the exception rather than the norm — that its tendency towards founder-friendly terms means it has been largely insulated from what’s commonplace in the rest of the world. Are clawbacks right or not? That’s for entrepreneurs and investors to argue between them, but perhaps they should start by realizing it’s time to wake up to what’s really going on out there.

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