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Zynga: One innovation Silicon Valley doesn't need

COMMENTARY. One of the tenets I've come to live by is: "If it ain't broke, don't fix it." Said another way, when you find a winning formula, stick with it. Sure, things evolve over time, but don't lose the essence of what makes the formula work.

That simple philosophy is at the heart of some of the greatest corporate cultures of all time, enabling companies like Apple, Intel, and Texas Instruments to consistently out-innovate competitors. It's also how Silicon Valley became the innovation capital of the world.

You see, there are several factors at the core of the Silicon Valley formula, and one of them is using equity or stock option grants in lieu of fixed compensation. Since Intel started the practice of widely disseminating stock options to employees, it's become the cornerstone of how cash-strapped, high-risk startups hire and retain the talent they need to innovate.

Now Zynga -- an online gaming site that's preparing its initial public offering -- and a handful of other social media companies are threatening to undermine the integrity of the practice. If their actions become widespread, it could destroy a key underpinning of America's high technology industry.

There's something's rotten in ZyngaVille

According to the Wall Street Journal, Zynga CEO Mark Pincus has come up with a unique way of getting back stock options he's already granted. Last year, he started a systematic practice of evaluating employees and forcing some to forfeit a portion of their unvested stock options if they want to keep their jobs.

More coverage: Zynga to employees: Drop those stock shares

On the surface, that actually sounds reasonable. It's pay for performance, right? If an employee's responsibility and salary can be diminished, then why not unvested equity? In an email to employees, Pincus calls the company a "meritocracy," meaning employment and compensation is based on merit. Well, I'm all for that.

Except there's one big problem with that argument. Equity isn't like any other form of compensation because, in the vast majority of cases, it ends up being worthless. It's a high-risk bet that employees make and, if they didn't make it in droves, there would be no Silicon Valley, at least not as we know it today.

The way it works is, an employee joins a risky startup and accepts an option grant -- in lieu of higher compensation from a larger, more stable company -- on the outside chance that the company makes it, achieves a liquidity event like an IPO, and makes it big.

Unlike title and salary, a stock option grant is an actual contract between employee and corporation. And the contract essentially says that, in exchange for this grant of worthless stock, you get to work long, crazy hours and give up your personal life in the hope that someday you'll hit the motherload and it'll all have been worth it.

No, that's not really what the contract says, but it also doesn't say that, once the company achieves success and begins to plan its IPO -- based primarily on the efforts of its employees -- it may rescind all or part of the unvested portion of the grant if that's deemed to be in the best interest of the company at the time.

That's apparently what's been happening at Zynga. 

Greed disguised as meritocracy

According to most option agreements, if an employee is terminated, voluntarily or otherwise, his unvested shares are returned to the company. So in theory, Pincus can justify clawing back unvested shares by saying it's better than getting fired. But "taking back" equity under threat of termination "might be seen as breaking a contract," according to Jim Finberg, an employment attorney quoted in the article.

Indeed, every stock option agreement I've seen -- and I've seen a lot of them -- is written as a "grant" that vests more or less over four years, plain and simple. Of course, if you're not cutting it, the company can fire you at will and recover your unvested options. That's all fine and dandy, but that's not exactly what's happening at Zynga.

It's a relatively common scenario in the fast-paced world of high-tech startups: the executives you hire to run the company one day are no longer the executives you want to run the show two or three years later when the company is ten times bigger and growing like crazy.

To attract new leadership talent from the likes of Electronic Arts, Yahoo, and MySpace -- as Zynga has done -- you need a boatload of equity to offer them. Typically, the option pool is replenished from terminated executives, plus companies issue more options as needed from time to time. While that does dilute everyone's equity somewhat, it's a small price to pay for meeting contractual obligations and doing the right thing.

Instead, Pincus is attempting to partially replenish the equity pool with clawed back options from executives being pushed down in the organization under threat of losing their jobs. And that practice has shown up at other venture-backed social media companies as well, according to the Wall Street Journal.

Should the practice become widespread, it would likely have a chilling effect on the willingness of talented people to join venture-backed startups. Not only will employees be making a high-risk bet that their options may someday be worth something, but they can no longer bank on the integrity of the equity grants themselves. If Pincus can giveth and taketh away, then any entrepreneur can.      

One innovation that Silicon Valley doesn't need

From my perspective, this practice appears to be nothing more than greed, immaturity, and bad business disguised as meritocracy and doing what's best for the company. I think it demonstrates the downside of short-term thinking and a reckless disregard for the integrity of a practice that's critical to how American companies innovate. 

The way to do it right is to show some maturity and restraint when issuing options, and when it's time to hire more experienced executives, issue more shares. That simple practice has worked for decades at companies like Apple, Cisco, Google, Intel, Oracle, and thousands of others.

If it ain't broke, don't fix it. The high-tech industry is one of the best things America's got going for it. Let's not break it.

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