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Zynga, Equity & Tough Decisions

A couple of days ago, a story broke in the Wall Street Journal about Zynga “leaning” on some early employees to surrender portions of their equity.  Not surprisingly, this blew up a bit in the press, leading to a wide number of articles talking about the potential threats to the Silicon Valley equity culture, employment litigation, and a number of fairly serious issues.

As Zynga has indicated that their IPO is imminent, no doubt a lot of this is fueled by the fact that Zynga is a hot company right now.  But some of the issues raised are very real, and I thought it might be interesting to lend a different perspective to the story as a opportunity to think more deeply about the challenges leaders face in hyper growth companies, even ones as successful as Zynga.

Executives are expensive

Marc Andreesen wrote a great blog post on some of the very real issues around hiring, managing and firing executives in hypergrowth technology start-ups.  It’s too long to capture everything here, but I do recommend reading it. Marc calls it the “executive firing paradox”:

It takes time to gather data to evaluate an executive’s performance. You can’t evaluate an executive based on her own output, like a normal employee — you have to evaluate her based on the output of her organization. It takes time for her to build and manage her organization to generate output. Therefore, it takes longer to evaluate the performance of an executive than a normal employee.

But, an executive can cause far more damage than a normal employee. A normal employee doesn’t work out, fine, replace him. An executive doesn’t work out, it can — worst case — permanently cripple her function and sometimes the entire company.Therefore, it is far more important to fire a bad executive as fast as possible, versus a normal employee.

Now, the facts of the Zynga story are a bit blurry in the press, but for the purposes of this blog post, I’m assuming the following:

  • This issue affected a relatively small number of people at Zynga, specifically executive-level hires
  • These people were identified, over time, as underperformers at the original role they filled
  • These people still had not vested their equity

Obviously, the above distinctions above matter greatly in terms of the tricky balance of issues around making a decision like this.

It’s worth noting, however, that executives are expensive hires.  If an executive is vesting 250K shares per year, and hiring a new engineer or designer costs 10K shares per year, then that person really has to deliver an incredible amount of value to justify their compensation.  After all, you could use the money to hire 25 additional engineers.  A great leader can easily justify that value (and more) in terms of their power to create long term value for the company, but it’s definitely a high bar to clear.

The Reason for Vesting

Not to be pedantic, but there is a very good reason why employees at tech companies are given equity.  Fundamentally, the best corporate cultures in Silicon Valley are based on people working together not to just build technology or products, but actively working to build a great company.  Stock ownership is an important part of that culture – when people have meaningful equity in a company, it cements the idea that everyone is a part-owner of the business.

Four years may not seem like a long time, but in truth, hypergrowth tech companies grow and change at rates that seem theoretically impossible.  Zynga had 150 employees in 2008.  LinkedIn had fewer than 400.  As a result, the responsibilities and requirements of almost any position at the company radically change in a year, let alone four years.  This is one of the great opportunities that high tech companies afford employees who take advantage of growth to stretch and grow quickly into new responsibilities and experiences.  But it’s extremely challenging, and fairly unforgiving as hypergrowth means that every person’s efforts potentially impact dozens of employees going forward and millions of users.

Vesting exists as an important reminder, however, that your share of the company is earned over time, not at signing.  You earn your share of the company – every day, every month, every year.  For most people, this isn’t an issue, because it is amazing how dedicated people are in Silicon Valley.  People are passionate about what they do and the teams they work with, and that passion translates into world-class dedication and effort.

Real Equity, Real Money, Really Tough Decisions

Back to Zynga.  Let’s assume, for a second, that you have the situation described in the Wall Street Journal.  You’ve identified a small number of relatively high level employees who, for whatever reason, you decide are underperforming their original roles.  Normally, there are a couple of options:

  1. Tolerate the under-performance, or compensate for it with additional hires, but let them “vest out” their stock grants despite the fact that they aren’t filling the role that the equity was predicated on.
  2. Fire them.

As per Marc Andreesen’s post, option (1) is toxic.  The equity, while material, isn’t the dominant issue.  The impact to the company culture can be devastating, and if a repeated pattern, permanently damaging to the ability of the company to attract and retain the best talent and have them do their best work.

Let’s not forget also that we ask our company leaders to be thoughtful of their responsibilities to shareholders as well, particularly in public companies.  Executives are expensive hires, and equity allocated to them could always be allocated to hiring other great people.  Human beings tend to suffer from “sunk cost fallacy”, and they hate to admit mistakes and take on difficult confrontation.  Option (1) swims in all of those issues.

But option (2) doesn’t always feel right in a hyper-growth company either.  What if the employee has a number of positive attributes and skills?  What if you would gladly hire them today, just in a different role?

From the press, it looks like Zynga tried to find a third way.  Rather than fire the employee, offer them the ability to stay at the company in a role that better suits their performance, with compensation to match.

You may not agree with that approach, and I think Semil Shah does a good job in TechCrunch talking about the cultural issues that this type of approach can cause.  But it would be foolish not to see that this is really a tough decision, and shouldn’t be trivialized or sensationalized.

Talking vs. Doing

There has never been a shortage of armchair quarterbacks and theorists debating the merits and demerits of different leadership actions and company cultures.  It’s part of an ecosystem that rewards thinking and learning.

It’s relatively simple to have a knee-jerk, emotional reaction to a piece like the one in the Wall Street Journal.  Let’s face it, that’s part of the reason they published it.  Companies like Zynga are amazing, and more importantly, they matter.  How they grow, navigate, succeed and fail is part of how we all learn to build better high tech companies.

It’s fairly easy, in fact, to demonize actions that you don’t agree with.  However, it’s often a much more productive intellectual path to ask yourself, “Why would good, smart, ethical people do this?”  Whether you agree or disagree with the actions taken by Zynga here, these are very hard decisions, and there is a lot for aspiring technology leaders to think about and learn from.

As Tom Hanks said in “A League of Their Own”:

If it wasn’t hard everyone would do it. The hard is what makes it great.

39 Comments Post a comment
  1. Chris Yeh #

    When I first heard about the Zynga story, some might think my reaction was pretty callous. “Why didn’t Zynga just fire the underperformers?”

    But in the end, I believe that firing can be kinder than the well-intentioned “third way” Zynga pursued.

    Imagine you’re a well-compensated exec who is now an “underperformer.” How does it feel to be at a company where you are considered unworthy of your compensation? How can you have the authority to continue working with others?

    Rip the bandage off quickly.

    November 11, 2011
    • I’m fairly biased to agree with you. However, imagine this situation: you are a startup of 50 people, and you hire a Director of Engineering with a significant equity component. The company is worth $100M at the time. The responsibilities of a Director at this time are to hire and manage a group of 4 people growing to 10 over the next 12 months. Two years later, the company is a 1000 people and the company is worth $5B, and a Director is expected to manage a layer of managers and a total org of over 50 people growing to 100. The truth is, in a hypergrowth situation, organizations can out grow good people, and that leaves a significant management challenge are equity and fairness.

      Without the full details, this is all theory, because every situation is different. But I empathize with the desire to “keep” someone who has contributed a lot to the company, but now may not now be putting 100% in at their current level. This is particularly true for executives, where the costs (and expectations) are high. Ironically, option 3 is an attempt to reward the employee for their contributions & value, rather than the brutal option 2, aka “it’s just business”.

      November 11, 2011
      • Chris Yeh #

        I agree that option 3 is kinder; I just have seldom seen it work.

        It’s human nature to resist a cramdown; we reject rational offers that we see as unfair.

        In startups, it’s even worse. Everyone knows exactly how many shares they have, and it’s a rare person who only counts the value of their vested shares.

        Even though Mark was trying to be kind, and was actually offering a better deal than simple termination, I expect he’ll receive a lot of (undeserved) heat which will discourage anyone else from trying this.

        November 13, 2011
      • Options are performance-based compensation only insofar as performance that increases shareholder value also increases employee compensation. They are the potential for great wealth, and not wealth themselves, especially at the time of grant.

        Outside of clear visionary leadership (Jobs) or obvious public mis-steps (Apotheker), it is more or less impossible to attribute gains in share price to the actions of individual executives, no matter how much they would like to think otherwise. That’s why options are structured to only be useful compensation in the event of a substantial increase in share price.

        In your scenario, the director has overseen the growth of a group of 4 people to an organization of 100, and the executive team of which this director has been a part has taken the company from $100M to $5B. As an aside, I’d love to have that on my resume. However, in your scenario, there are three possibilities, two of which reek of attribution bias. Let’s examine each:

        1) This growth took place in large part because of the director’s leadership, and the director is eminently suited to continue in a leadership position. In this situation, the value of the initial option grant is now woefully inadequate; yet I believe that the prevailing attitude among most would be that it’s the director’s fault for not negotiating a bigger payoff at the outset.

        2) This growth took place in spite of the director’s leadership, and the director is now even less suited to continue in a leadership position than she was originally. Here the director clearly needs to be replaced as soon as possible. Keeping her on board when she’s garnered ill will among her subordinates by being a drag on productivity is obviously not the right move. The director’s payout is minimized by termination, and the unvested shares return.

        3) The director performeded to initial expectation, but extreme growth took place for reasons unrelated to the director’s leadership, and she is no longer suited to the duties now required by her position. The right move is to put her back where she can again be effective, growing teams of 4 to the size of 10. However, just as in the first scenario, where the initial grant now looks woefully inadequate, in this situation it now appears overly generous.

        The reason people are outraged is because in the first scenario, the director has no recourse. If she asks for a greater grant, Zynga is free to refuse her, and she has no leverage because if she chooses to walk, she sacrifices all of her compensation. However, when the situation is reversed and Zynga’s the one who bet wrong, they are able to renege on their original promises, and the employee is once again powerless. She must accept reduced compensation or none at all.

        It is the one-sidedness of this that has people outraged, and I can’t think of any scenario in which it is ethically justifiable.

        November 14, 2011
      • Two points of clarification:

        First, as a reminder, this post isn’t about the Zynga situation per se. I don’t have sufficient information to evaluate what happened there, I use the topic as a catalyst to discuss a difficult management issue.

        Second, your first scenario seems like a bit of a red herring. In real life, that means the person is going to be highly valued by the company, and will likely get promoted or increased comp. Also, if the company has experienced hyper growth, their original grant is likely not “inadequate” – at least not by any standard definition of that word. They’ll probably either finish out their vesting and go to a new opportunity, or some other firm will snatch them up. Reputation is far more than what your current employer thinks of you, and long term compensation is highly correlated to your professional reputation.

        November 15, 2011
  2. Great post, Adam. Really puts the WSJ piece in perspective.

    November 12, 2011
  3. Thomas #

    This is absurd. You can’t go back and rewrite agreements you’ve made. You make the decisions you make with their attendant risks and consequences, to then go back and try to renege on a deal absurd. Maybe you granted that person the amount of stock because of a competitive offer they had and they chose you because the amount granted.
    This sounds like more typical, convoluted “I can rationalize this because I have no regard for people and its all about making this company be a successful IPO.”
    You make agreements, you stick with them. A few thousand shares immorally clawed-back will not make or break your company. It just exposes your company culture for the craven cheapness that it is.

    November 12, 2011
    • So, you are arguing for Option 2? Because the agreement they signed says they can be fired at any time, for any reason, and they have no claim to unvested shares. Is that somehow better for the employee in question?

      November 12, 2011
    • Chris Yeh #

      At will employment works both ways; your employer can terminate you at any time, but you also have the option to leave at any time.

      It’s a relationship both parties go into with open eyes.

      November 13, 2011
      • At will employment doesn’t have anything to do with taking away compensation that was given as an incentive to the employee to sign on or as a performance bonus during their tenure. There are plenty of other levers that can be pulled, like demotions, docking salary, etc.

        November 13, 2011
      • So you would argue for letting a Vice President vest out 250K shares per year, even though you’ve demoted them to an individual contributor position? That’s the Option (1) that I discuss in my post above. There are significant problems with that approach, but it is a common one because it requires the least effort and confrontation.

        November 13, 2011
      • Chris Yeh #

        It’s important to remember that unvested stock isn’t compensation. It only becomes valuable when vested.

        Vesting schedules exist for a reason; vesting rewards performance over time, rather than simply the good fortune of being in the right place at the right time.

        November 15, 2011
  4. The idea that options vest because they haven’t been earned yet is absurd. Options are given because it’s an incentive to attract talent. Compensation given for performance throughout the year is called a bonus. It’s a very different thing.

    Especially for a company like a startup, options are a great tool because the startup needs to have a way of attracting talent without forking over extra money for hires, and prospective hires know that there is a higher risk associated with working for them. The employee is agreeing to take some portion of their compensation in options because while there is a risk that they might be worthless, if the startup pans out they stand to make a decent sum of money. This also means that they are committing to staying on for a period of time.

    If companies start taking your advice and start treating the vesting of options as optional (pardon the pun) based off of performance, then it would be a monumental blunder. Now options have no power to attract talent, because the employee takes all of the risk.

    It may not be illegal to do this, but it’s certainly not in the spirit of the contract signed at hire, and is really no different than docking someone’s pay because in retrospect you think their hiring bonus was too generous.

    November 13, 2011
    • Your explanation of why startups use options for compensation makes perfect sense, but it doesn’t contradict the fact that options (and in this case, restricted stock) have vesting schedule because the employee earns their ownership stake over time. In fact, the “one year cliff” that is most common is to ensure that someone who doesn’t stay with the company for at least twelve months gets no ownership stake whatsoever. To be clear, employees do not make a commitment to stay on for a longer period of time. Instead, they receive increased ownership in the company the longer they stay.

      The employee doesn’t have rights to paychecks that they will receive in 2012, and they don’t have rights to stock that doesn’t vest until 2012. That’s not actually debatable. The real issue is what is the right way to deal with the problem outlined above. It sounds like you are arguing for Option (1).

      November 13, 2011
  5. Why do you claim this is about executives? Doesn’t this run contrary to reports about avoiding a “Google chef” situation. If it is about execs, Pincus would do well to say this will only effect CxOs and VPs. Otherwise, I really think he’s simply targeting some early employees who have done a fine job — but if you they have $50M in stock, you can obviouly find 100 people to pay with that money, rather than just one — regardless of how much they’ve done.

    November 13, 2011
    • I tried to explain in the blog post that the “facts” in this situation aren’t clear. So I make some assumptions for the purpose of a thought exercise. I’m not trying to cover the Zynga situation per-se, just using it as a catalyst for thinking and learning about the challenges around hypergrowth companies.

      November 13, 2011
  6. AS #

    Thank you Adam for a thoughtful, reasoned approach to the vitriol that has been tossed about. As you say, there is a worthwhile thought exercise in this story. You did a great job of surfacing it.

    November 13, 2011
  7. Vasilis #

    Your assumption that this is only about executives is not neutral. It colors the issue, and it runs contrary to a lot of information about the Zynga situation.

    You also claim this is about unvested options. We don’t know that either. If indeed it is about unvested options, then it’s pretty clear that the presented options are as follows: renegotiate or be fired. Regular employees face such a dilemma all the time in many industries. Even executives sometimes. Not much to see here, if that’s the case.

    November 13, 2011
    • As I mentioned in the blog post, I don’t have the information. In the end, my post is purely an effort to use the Zynga discussion to illuminate a potential management challenge, not to reflect the actual events at Zynga. That’s why I focused on executives. That being said, everything I’ve read says this is about unvested shares (restricted stock, not stock options).

      November 13, 2011
  8. CharlieLuvr #

    What the hell is wrong with a “Google Chef” situation? Charlie was awesome and in Google’s early days (2000-2001) was one of the essential glue components that held together the early team that made Search possible.

    November 13, 2011
    • I think you are commenting on another article, not my blog post. The “Google Chef” reference is from the WSJ piece, I believe. My blog post really focuses on the potential problem of under-performing executives in hypergrowth companies.

      November 13, 2011
  9. TokyoRD #

    In the case of Zynga, I believe employees were asked to give up unvested shares, and the vested shares were not affected if they accepted the proposed cramdown. (One thing I would be curious to know is whether Zynga’s employee options have accelerated vesting on an IPO, which would indicate a fast windfall for many employees. Hmm, maybe this is what gave Mark Pincus so much heartburn.) What bothers me is the timing of this. If Zynga had been following this cramdown strategy in the past, that is one thing. But if this is solely related to the IPO and the expected pricing range of the offering, shame on Zynga. It’s employment blackmail. If you made a deal with an employee, honor it. The employee probably had other options when they committed to the job, and Zynga might not have been a slamdunk at the time they accepted the position, so they took a risk in joining the company. If you don’t like an employee’s performance, deal with that issue when it arises, not when there is an equity-related event.

    On the broader question of how to deal with under-performing employees… for mid- and lower-level employees, the difference in the amount of options traded back for a demotion would likely be small (from a big picture perspective) so I wouldn’t want to risk messing with morale over a small option grant. A couple disgruntled employees can do a lot of damage at a startup. If the person is so bad that you need to move them out of their job, you should fire them and fill the job with a more capable employee.

    For a senior level exec, I agree with Andreesen. If the executive is not capable or performing to expectation, let them go. If the job has outgrown the executive and you want to keep the person, you can always install a more senior level manager (who will likely get a larger comp package than the original employee). In this case, I still think it is very dangerous to clawback options from the existing employee because you are sending a highly negative message to an someone that will still have significant responsibility in the business. Maybe you made a mistake and overpaid someone. But the company’s culture and employee trust are far more important to the future success of the business than a few equity options.

    November 14, 2011
  10. This is an interesting strategy to evaluate, I tend to agree with Chris Yeh (above) — Executives should resist this on principle (it’s effectively having your power neutered, making you ineffective in your role) and all employees are likely to resist this strongly based on human nature (from Chris’s comment: “it’s human nature to resist a cram down”).

    As this all relates to Zynga, I think the key assumption you’ve made is #1 “This issue affected a relatively small number of people at Zynga, specifically executive-level hires.”

    I haven’t seen enough information to prove or disprove that, so I’m withholding personal judgement until that’s clear. If the target here was underperforming exec’s, I think the actions are potentially moral – if the target was people with > XXX,000 unvested shares, the actions are likely immoral.

    November 14, 2011
  11. Most stock options are worthless. I have been offered stock options many times and they have never paid off. The fact that the company changed does not change the point that the employee took the stock that was offered even though most of these offers are worthless. The Monday morning quarterbacking is being done by the company trying to fix decisions they made previously. The employees deserve to get what they were promised. The executives need to figure out how to live up to their obligations. Is it fair? No. It is business. Business is never fair.

    November 14, 2011
  12. Making excuses for Zynga is to put it mildly hideous. They are not just dumping “under performers” They are dumping those employees that have been around long enough to have stock options that when they go public will actually be worth something. Take those away or better yet use the Zynga plan of give them back or lose your job……..is an insult to those employees that took the chance on a start up company and have helped to make it what it is but when it finally comes down to the pay off Zynga wants to be selfish and greedy. Ask those of us that play their games. It doesn’t surprise any of us.

    November 14, 2011
    • As a reminder, the post above is not about the specifics of the Zynga situation. I don’t have enough information there. This is intended to be a thoughtful discussion around compensation issues that can come from hypergrowth, with the strong opinion that they are not trivial.

      November 15, 2011
  13. I would sue for damages if Zynga reneged on their contract.

    Having said that, I think Silicon Valley will look at an upper cap on salary and/or bonuses. We will give you this many shares, but if the valuation goes beyond a certain value, we will pay you a lump sum. Write in the contract and I think many employees will still sign assuming the lump sum is still a greedy amount with COLA.

    The other issue is that executives are paid far more than they worth. The problem, as it is with academic boards, is that board of a corporation is a group of other CEOs. If the board votes for a pay hike of an executive, the next time a board member needs to find a job, they are guaranteed a pay raise to be in line with “market rate”. The market rate is a scam and is based on what the board decides. Its greed pure and simple. Change how salary is determined and you don’t have these self-important ridiculously high CEO wages. Its gotten so ridiculous that even when you fail as a CEO (e.g. former HP), you still get a bonus. Seriously?

    November 14, 2011
  14. Pc #

    If cost v. performance were the true metric being used for compensation then half the founders out there need to give up a large share of equity.

    Using cost as an excuse to do something unethical sounds like founder apologism. If those people aren’t performing, let them go. It really is that simple. Trying to keep them for cheaper is unethical in the sense that a business agreement was made when they were hired. To go back on that is pure bait and switch.

    Even if this is isolated, if they are successful you can bet that every other company out there is going to adopt these tactics as a new “profit-maximizing” tactic.

    To give Zynga a pass here sets a dangerous precedent for all non-founders in Silicon Valley (99% of the people).

    November 15, 2011
  15. ech #

    One interesting fact about early options in a fast-growing company is that the unvested options can easily be worth ridiculously more than the employee. Say you’re an IC software eng. If, after year 3 of employment, your 4th year of expected options looks like it’s going to be worth, say, $20 million, then it makes no financial sense for the company to keep you, good performer or no.

    Is it “ok” for the company to fire the employee for this reason alone?

    November 15, 2011
  16. Andrew S #

    The main reason this is a bad thing is that no one else does this.

    Companies which are known to do this will find it more expensive to hire executives in the future. Execs will demand larger compensation (esp parachute) because they see the possibility of being demoted out of the options they signed up for.

    I think it’s a bad move, especially for a company which is cash rich. If the employee is a net negative, fire them. If you made a mistake hiring them for too much but they’re still useful contributors, take the hit. It’s your fault.

    If this is being done for cash/investment reasons, then dilution is the way to go. Everyone should take a hit…then give the top performers bonuses.

    November 16, 2011
  17. Andy G #

    No one seems to mention that Pincus will be a billionaire at IPO. Is that justified? Let him allocate some of his shares to deserving employees or put them back in the pool for future grants.

    November 23, 2011
  18. David L. #

    As a child, I was taught a very simple ethic in business. “A deal’s a deal!” It’s uncomplicated and to the point. It is, in a nutshell, what is wrong with what Zynga is doing. They made a deal. They must live with it, same as the people they made the deal with.

    November 28, 2011
    • To be clear, in this theoretical situation, the deal is that the employee can quit at any time, and the company can fire them at any time. None of the options involve breaking any deal. It sounds like you are advocating that the company go with option 1, which has a large number of negative consequences, but allows for “vesting in peace”.

      November 28, 2011
      • David L. #

        Unless you are in an “at will employment” state, such as AZ where I live, that simply isn’t the case. In most states you must show cause prior to terminating an employee. If the only cause you have is that you don’t like the deal under which you hired the employee… too bad. Terminating the employee in that case will probably result in a settlement or judgement of compensation equal to what was promised when they were hired. Rightly so in my opinion.

        November 28, 2011
      • My blog post is clearly biased towards California, which is an at-will employment state. According to Wikipedia, technically all states are at-will employment (as of 1959), although some states have exemptions for specific cases. The key exception to at will employment is anti-discrimination law.

        http://en.wikipedia.org/wiki/At-will_employment

        November 28, 2011

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