Skype's stock situation: All about the disconnect

A controversy about Skype's stock options policy reflects a deep gulf between the types of private investment firms operating in Silicon Valley.

On Friday, I blogged about Yee Lee, a former Skype employee who is claiming he was swindled out of vested options by both Skype and its private equity sponsors (namely, Silver Lake Partners). To be clear, this is not a legal claim. Upon initial employment, Lee signed an agreement that gave Skype the right to repurchase vested options at effectively no cost, were Lee to voluntarily resign (which he did) or be terminated for cause (which he was not).

I encourage you to read the entire piece, both because it's far more detailed and because page views make my world go round. But for those who have better things to do, my quick takeaways were:

1. The "you've got to be in it to win it" arrangement is fairly common among private equity-backed companies, but foreign to startups (particularly in Silicon Valley). Skype is the former, while Lee is a veteran of the latter.
2. The contract Lee signed is incomprehensible. Seriously. It makes federal legislation read like a Dick and Jane book.
3. Lee was careless in not having a lawyer read over his contract before quitting. At the same time, however, his contract seems intentionally opaque. Moreover, by clawing back Lee's vested options, the company comes off as petty and vindictive.

I spent part of the weekend reflecting on my post, responding to related emails and reading related blog posts by Felix Salmon, Henry Blodget and Sarah Lacy. To me, the fundamental problem seems is that too large a disconnect remains between venture capital and private equity.

For several years, I've felt that these two distinct asset classes are getting closer to one another. Both venture and buyout funds have increased "growth equity" activities. Both now regularly engage in sponsor-to-sponsor transactions (via the growth of VC secondary sales). Fund sizes for top-tier VCs are growing, while fund sizes for top-tier buyout firms are shrinking (not close to parity, but the gap has lessened). Buyout firms understand tech. VC firms understand cash-flow positive businesses. And, as always, they both get fund commitments from the same people at the same institutions.

But a situation like Lee/Skype reminds me that the mentality of both groups remains miles apart. Just because a firm like Silver Lake is based in Silicon Valley and focuses on technology, that doesn't mean it's just a larger version of Kleiner Perkins. And just because Andreessen Horowitz is one of the hottest VC firms in the Valley, its investment in Skype doesn't mean the company will be run like a startup.

That said, both sides must do a better job recognizing the other's point of view.

Private equity has a model that has worked for decades, and there is a legitimate logic to its typical employee compensation guidelines (which were mostly followed in the Skype situation, albeit not entirely). Here is how one reader put it in an email:

"PE firms typically invest in mature companies with steady revenue streams and a plan to pay down the heavy leverage... Options in a PE investment are not lottery tickets -- they are long-term investments in a class of companies with a track record of paying off very well. So why should we let someone who isn't a long-term player in the company share in that long-term value creation?"

At the same time, however, private equity should adapt to its environment. Would it pay two employees doing a similar job the same amount if one was based in New York City and the other in Little Rock? Probably not. If you are running a Silicon Valley tech company, then you either should follow local custom or make painstakingly clear that you are not doing so (and why). After all, Skype is competing for talent with VC-backed startups (which is what Lee left for).

I don't believe anyone in this saga was evil. But I do believe there was a tone-deafness that continues with the refusal of any Skype investor to address this matter on-the-record. Pushing it all off onto a Skype spokesman is disingenuous, since these comp rules were prompted by the investors, not the company.

Actually, that leads to one final difference: Private equity firms do not quite understand digital media the way Silicon Valley understands it. Right now, Silver Lake is getting pounded for this situation -- and it will reverberate when it looks to hire for other portfolio companies (GoDaddy HR execs cannot be happy right now). It has allowed itself to fall behind the story. If you're going to invest in the Valley, you've got to be cognizant of its news cycles. This should already be yesterday's news.