Clawbacks and Startups Don’t Mix

This post originally appeared in TechCrunch in 2011.

The story emanating from the Zynga is a wake-up call for startups.

Reports allege the company threatened to reclaim stock options originally granted to employees who, in the eyes of the company, were not performing to levels on par with their equity holdings. I don’t know what’s true and what’s not about the Zynga news. Therefore, I’m not going to comment on the particulars of those specific allegations in this post. That said, however, something is clearly going on and spreading around the developer community, and if the Hacker News community is any indicator, this earthquake could have powerful, plate-shifting aftershocks.

Last year, one of our family friends was let go from a job at a small but successful hedge fund in New York City. His path to the fund was not rosy. He struggled to get into and out of college. He scraped by to get his accounting license. He worked at a big accounting company for a decade and, it turns out, happened to be so good at his craft that he randomly caught the eye of one of New York’s most powerful financiers. He was recruited, offered a plum gig (with grueling hours), jumped ship, let go of his consistent paychecks, and took on considerable risk with a small team to help build a new hedge fund in the middle of the 2008 collapse. Then, a few weeks before his carry in the fund was to be paid out, he was approached by Mr. Number Two, plainly told he’d be fired with a year’s severance, and told to grab his belongings. “It’s just business.”

He was crushed. The dollar amount aside, he couldn’t understand why this would happen. He sought the advice of all of his mentors, most of whom shook their head in disbelief, dismay, and disgust, all saying some variation of, “it’s just business.” The opening scene in The Dark Knight depicts a bank robbery pulled off by a group of men, each of whom kill each other, one-by-one during the heist, until the only person standing is the Joker, the mastermind of the scheme. As one of the robbers says, “One less share.”

Startups are supposed to be different, right?

Startups are when people get together to build something new, to form new cultures, to help define a new type of workplace while collectively trying to solve a problem. In the riskiest part of these ventures — company formation and the early stage — startups and their shareholders recruit extremely talented people, mostly technical and some non-technical, on the promise of a potential deferred payoff through realized equity in exchange for a lower monthly salary and oftentimes insane work hours and demands. Yet, so many extremely qualified, passionate people are willing to forgo the safety of a consistent paycheck and defined-contribution retirement program to get into the game. When you step back and think about the dynamics, it’s pretty damn inspiring and what makes entrepreneurial ecosystems so exceptional.

The reality, however, is that startups are not immune to the Joker’s “one less share.”

In the world of non-unionized, at-will employment, shareholders and managers can terminate employment when they see fit, even at times when a significant payout looms. Sure, once a cliff is reached with respect to vesting of shares, an employee will accrue equity that is rightfully theirs. In some cases, there could be sensitive company intelligence that only the founders, executive management, and board members are aware of, such as a potential acquisition, merger, or details around a public offering. With that information, management could, hypothetically, have an incentive to look over the ledger and ponder a re-splitting the pie.

If the story from Zynga is true, and if equity “clawbacks” and attempts to reclaim shares (against threats of termination) are used as tactics to manage option pools and optimize for a policy of “one less share,” the repercussions from this could spread. It could be the line in the sand. Should any early-stage employee truly put their trust in an equity agreement or option grant issued by their new employer? Who will back them up when legal fees may be too daunting? Will management seek to retain talent with promises of equity instead of just hiring and firing the right people, in the best interest of the company?

These ideas dominated Hacker News and one story posted today had, on its own, close to 300 comments. In my four separate interactions with engineers today, the topic came up, and their reactions were not muted. They are paying attention to every potential actor in this story and what it could mean for their future gigs or when they start their own companies. While clawbacks seem to be known dangers in the world of finance, I’d like to believe that this ethos won’t creep into the startup world, an ecosystem that is certainly not perfect but is decidedly far too passionate to say “it’s just business.”