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Zynga Leans On Some Workers to Surrender Pre-IPO Shares

By JUSTIN SCHECK and SHAYNDI RAICE

SAN FRANCISCO Zynga Inc. Chief Executive Mark Pincus often gave shares rather than high salaries to his top talent as he built his online-game start-up.

But as Zynga grew into a multibillion-dollar company with hot games like "FarmVille" and "Mafia Wars," Mr. Pincus appears to have developed giver's remorse.

Zynga CEO Mark Pincus, at a company event last month, asked certain employees to surrender some restricted shares or face dismissal.
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Early last year, as Mr. Pincus began preparing to take Zynga public, he and several other executives decided the company had doled out too many stock rights to certain people in its early days, say people familiar with the matter. The executives chose an unusual solution: They began demanding that certain employees surrender some shares or be fired.

Those shares matter as Zynga approaches an initial public offering, expected this year, that could value it at close to $20 billion and make holders of large blocks of stock wealthy.

Zynga's demand for the return of shares could expose the company to employment litigation—and, were the practice to catch on and spread, would erode a central pillar of Silicon Valley culture, in which start-ups with limited cash and a risk of failure dangle the possibility of stock riches in order to lure talent.

Built into that arrangement is the chance that founders will later wish they hadn't given away so much stock, and also that some very early employees will end up with bigger windfalls than latecomers who contribute more to the company. Many in Silicon Valley cite an early-hired Google Inc. cook whose stock was worth $20 million after the firm's 2004 IPO.

Zynga attempted to avoid such pitfalls. In meetings last year, Zynga executives said they didn't want a "Google chef" situation, said a person with knowledge of the discussions.

The result was a list compiled by top Zynga executives of employees whose job performance might not justify their large grants of restricted shares, which are shares that are doled out free but don't immediately "vest" and become saleable. Some employees Zynga reviewed had total grants worth tens of millions of dollars. Demands to return stock, however, applied only to portions of not-yet-vested share grants.

One list that Mr. Pincus kept, said people familiar with it, was known as his MIA list, for executives who did so little he considered them "missing in action."

Zynga declined to make Mr. Pincus available for an interview.

Andrew Trader, one of the first people Mr. Pincus brought in when he decided to found Zynga in 2007, eventually ended up on a broader list of people the CEO felt might have too much restricted stock, according to a person with knowledge of the list.

Mr. Trader—whose early duties, paradoxically, had included handing out shares to employees—left in March 2010, leaving behind some unvested shares but receiving a settlement, said people familiar with his situation. Mr. Trader didn't respond to requests for comment.

A person knowledgeable about another early hire's case said that during the first half of 2010, Mr. Pincus told this employee he had too many unvested shares and had to return a portion of them or Mr. Pincus would fire him. If so, he would lose all of the unvested stock.

The executive was surprised and upset, said the person familiar with the matter, who added, "Nobody likes to be told 'you're getting this taken away.'"

This person said the executive in question hired an attorney, who negotiated a settlement in which he surrendered some of his unvested shares and continued working at Zynga, although he eventually left.

By no means has everyone at Zynga who holds a large stock grant of shares faced a demand to return some; the employees asked to return shares are a small minority.

For instance, Mr. Pincus decided against placing Zynga's chief technology officer, Cadir Lee, on the list of those who had a large equity grants that might not be justified, because he determined that Mr. Lee deserved that compensation. Zynga declined to make Mr. Lee available for comment.

Zynga software developer Davy Sulock, foreground, worked on the videogame Mafia Wars II last month.

Most of those aware of Zynga's demands for the return of stock said the effort was designed to replenish the pool of shares that could be awarded to attract new talent. One person called the effort part of Mr. Pincus's strategy to continually assess employees and create a meritocracy where the biggest rewards would go to biggest contributors, and nobody could just "rest and vest."

Compensation experts say it was once all but unheard-of for a company to demand back equity granted to employees. That is starting to change, some said, as fast-growing social-media start-ups, in particular, try to avoid equity compensation's pitfalls.

Facebook Inc. got into a dispute over equity with a founder whose ownership stake was reduced and ended up reaching a legal settlement, an incident fictionalized in the 2010 movie "The Social Network." Facebook declined to comment.

One lawyer said that over the past year, he has heard executives of three social-media sites discuss the possibility of clawing back equity from some employees.

Another lawyer, who has handled stock-compensation issues with technology companies for decades, said he never saw a company try to take equity from employees until about two years ago, but has since seen three such cases at start-ups.

The move carries legal risks. While it is legal to ask an employee to renegotiate pay, making such a request under threat of dismissal could be grounds for a successful lawsuit because an employer might be seen as breaking a contract, said Jim Finberg, a lawyer in San Francisco who represents workers in employment disputes and hasn't been involved in litigation with Zynga. An employee might claim "a breach of covenant of good faith and fair dealing," he said.

But several lawyers say the practice has been so rare it hasn't been tested in court.

Another risk is that "if word comes around that the company grants equity and takes it back…people may not want to go to work for you," said Durward Gehring, a lawyer who advises companies on pay, and who also hasn't dealt with Zynga.

Zynga has reached several settlements with workers who faced give-back demands, with the employees departing but allowed to keep some unvested shares or otherwise receiving some compensation, said people familiar with the matter.

Mr. Pincus started Zynga four years ago, capitalizing on Facebook's growth by creating social games that Facebook users play on the site. Zynga doesn't charge for its games but makes money when players buy "virtual goods," such as animals in the "FarmVille" game.

He had backing from venture-capital firms but, like other entrepreneurs, awarded lots of restricted shares to people who were willing to take the career risk of going to work for a start-up rather than an established tech company. Typically, 25% of new Zynga employees' restricted shares vest after a year at the company and the rest over the next three years, provided the employees stay. Early on, such shares were valued at $1 or less.

Mr. Pincus would often rent a theater for all-staff meetings, where he gave restricted shares and promotions to employees who had met their goals, say people familiar with the early days. Zynga tracks the popularity and financial success of each game in real time, and Mr. Pincus makes the data available to employees so they know if projects are succeeding or failing.

"I felt very well rewarded for delivering results," said Eric Tilenius, former general manager of the hit game Mafia Wars, who left Zynga this year. "I think there were some people who weren't delivering results that probably didn't last that long," he added.

As more people were hired, the restricted-share grants piled up. Zynga had only about 150 employees in 2008, according to regulatory filings, but more than 1,400 by the end of 2010 and now about 3,000. The employees hold a large portion of shares, though the company won't say how large. Mr. Pincus himself owns about 19% of Zynga's equity and controls more than 38% of voting rights through a special class for some of his shares.

As Zynga expanded, some high-ranking executives with big stock packages were pushed down the ranks when more-accomplished people were hired above them. Meanwhile, Zynga's valuation rose quickly, and early stock grants were suddenly valued at millions of dollars. Thus, some employees who didn't rank near the top of the hierarchy stood to own more than half a percent of Zynga's shares, worth tens of millions of dollars.

About two years ago, the trend began to worry executives.

Mr. Pincus, human-resources director Colleen McCreary and a board member met to develop an expansion plan, which would entail hiring experienced technology executives to manage what was becoming a larger enterprise. Attracting them would require large restricted-stock grants because Zynga was competing for talent with companies such as Facebook and LinkedIn.

Ms. McCreary and Mr. Pincus told others Zynga was short on equity to hire experienced executives, said people with knowledge of the discussions. The board increased the share pool but expanding it too much would dilute early investors' holdings.

Mr. Pincus and Ms. McCreary told others they would "take some equity away from people" they felt had too much and "reallocate" it among new, more deserving hires, said a person familiar with the discussions. In meetings, according to people familiar with them, Ms. McCreary referred to certain people seen as too highly compensated for their contributions as "broken toys." Zynga didn't make Ms. McCreary available for comment.

As Mr. Pincus in the 2010 first quarter began planning an IPO, he told others that Zynga needed to reduce the number of shares held by such employees, say people familiar with the talks.

His team, they add, set about identifying those with too many shares. "Some of these people were sitting on over $200 million and close to 1% of the company" when fully vested, said one person familiar with the list that was compiled. An electronic document that circulated among top executives listed close to 30 employees with performance questions and large amounts of restricted shares, the person said.

On an office whiteboard, Mr. Pincus kept a smaller tally, his MIA list, according to people familiar with it, usually with six or eight names. In early 2010, Mr. Pincus "was rotating the list frequently," said one person familiar with the situation, as people on it were reassigned, asked to leave or told they had to give up some unvested shares or face dismissal.

At least two of the those who were asked in the early-2010 time frame for an "equity reduction," under threat of dismissal, "renegotiated their employment contracts" and continue to work at Zynga, said one person familiar with their arrangements.

One of them consulted with a lawyer but decided to relinquish some shares rather than risk being fired, said a person familiar with this employee's situation.

Another employee, hired in 2009 to serve a nonsoftware-related position, left after facing a demand to surrender equity, giving up all unvested shares but gaining a portion of their value through a settlement, said a person familiar with that case. Zynga made several such settlements with departing workers.

The equity recouped has been valuable as Zynga recruits experienced executives. In mid-2010, Mr. Pincus hired a former MySpace CEO, Owen Van Natta, who now, according to Securities and Exchange filings, has unvested Zynga stock valued at more than $14 million.