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Silicon Valley Wakes Up to Clawback Culture

There’s been a storm over Skype ever since former employee Yee Lee let rip accusations that company investor Silver Lake Partners had screwed employees over in Skype’s $9 billion sale to Microsoft (MSFT). Specifically, Lee was upset to discover that his stock options were subject to "clawback" provisions that made his stake in the company (which he had left before the sale) worthless.

With Silver Lake under fire, everyone has been jumping in to take shots. Michael Arrington virtually exploded 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, the bare-knuckle brawl sends a simple message: Clawbacks are bad and should be fought wherever possible.

Is it possible to see this any other way? Could these arguments about clawbacks be 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 having 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 thereby maximize returns. In fact, writing on the Financial Times‘s techhub blog, Richard Waters characterizes it precisely as a conflict between the culture of Silicon Valley venture capital and the clubby world of private equity.

An "Exit Strategy" Culture

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, founder of ETrade and now chief executive of EndPlay.

Venture capitalists frown on this behavior but haven’t tried to prevent it. Private equity firms such as Silver Lake, which led the Skype buy-out, clearly feel differently—hence the unusual and controversial clawback that snagged Yee Lee.

In truth, clawbacks are much more common than the reporting may suggest. The procedure is seen as fairly typical in Europe (where venture capital has traditionally been thin on the ground). A lot of European startups write clawbacks into employment contracts. This doesn’t make it right. The terms are often onerous.

Common across European business is the so-called good leaver/bad leaver provision, which measures employee rights against the reasons they left the company. In general terms, "good leavers" depart because of death, disability, or because they were unfairly dismissed; "bad leavers" are those who choose to quit of their own accord, breach their contract, or were legally terminated.

A "Big Issue for Hires to Look at"

Doug Monro, a serial entrepreneur in Britain who is currently working on job site Adzuna, has experience with companies based on both sides of the Atlantic. He told me that 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 tweeted, adding that the details of such clauses can be a "big issue for hires to look at."

Clawbacks aren’t common only to European businesses. According to a Bloomberg Businessweek report last year, fully 70 percent of America’s largest companies say they employ some form of clawback provisions. There are plenty of examples of further restrictions on employees who leave a company, such as forcing them to sell options within a few months. British computer researcher Lyndsay Williams, who spent 11 years working at Microsoft before being laid off in 2007, says she was surprised to realize 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 declining and the transaction gave her money to invest in her own company, Girton Labs. "Given the very disappointing performance of Microsoft’s share price, [being forced to sell] was not really a hardship," Williams says.

Remember, too, that this isn’t just about investors vs. staff. It can pit founder against founder. As British law firm Taylor Wessing outlines the argument in a briefing document on private equity deals, not having clawbacks or "bad leaver" provisions can irk loyalists who stay behind. "From the continuing founders’ point of view, why should the departing founder get market value if he has left the company?" asks Wessing.

Founders Should Negotiate Clawbacks

Let’s not imagine that this is a new phenomenon, 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 Destin said he "would not do a deal without some form of reverse vesting," he suggested that the details are something founders should watch carefully—and be prepared to negotiate vigorously.

"Make sure there is a ‘good leaver/bad leaver’ clause," Destin 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."

So clawbacks are not new, rare, or necessarily about screwing over founders. Whether they entail restrictions on bonuses paid to executives at failed banks or sticks that encourages employees to stay with a business, clawbacks are common. Because they are new to the Valley, some people are being exposed to them for the first time.

Silicon Valley is the exception rather than the norm, with a tendency toward founder-friendly terms that have insulated it. Are clawbacks right or not? That’s for entrepreneurs and investors to argue about. Perhaps they should start by realizing that it’s time to wake up to what’s really going on out there.

Also from GigaOM:

The Case for Increased M&A in 2011: Actions and Outlooks (subscription required)

Skype Adds XMPP Support; Interoperability Coming Next?

How Gaudy Do You Need to Be to Own One of These Android Phones?

Facebook’s Open Compute Project Both Friended and Poked

Four Things the Last Four Years of IPhone Tell Us About Its Future

Johnson is a writer for the GigaOm Network

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