Questions of Fairness in Silicon Valley Apply To Acquisitions as Well as Financing


Recently there have been a few articles published on the structure of Airbnb's latest financing round in TechCrunch, Kara Swisher as well as the excellent blog post by Felix Salmon, the premises of the articles focused on the fairness play between insiders that both option holders and share holders. The one thing that really stuck me with was when Chamath Palihapitiya said:

In contrast, if you are viewed as self-dealing and shady, it will only hurt your long term prospects

I see aspects of "self-dealing", the conduct a corporate officer that consists of taking advantage of his position in a transaction and acting for his own interests rather than for the interests of the corporate shareholders, as a recent phenomenon in the Silicon Valley. It's possible that this is exacerbated by the recent lack of IPO opportunities due to the current market conditions leading to more "creative" forms of achieving liquidity.

On May 26, 2011 My former Employer MerchantCircle was acquired by for $60 million. At the time of the acquisition, as an early employee, I held around 8% of the unconverted exercised common shares and 1% of the fully converted shares. Investors received a packet detailing the framework of the deal in a 1,200 page deal document (see image) and were give a week to review the documentation. I picked up the paperwork on June 6th and then sent this letter to the board on June 9th. There were some details of the deal that I missed but, the paperwork itself was, in my opinion, purposefully obfuscated. I never received any reply from the Board or the Company about my concerns even thought my questions are neither specious or rhetorical. The thing that stood out the most in the deal was the fact that the former CEO, Ben T. Smith IV:

"will have the opportunity to receive in the Merger an amount of cash per share of his Company Common Stock that is substantially larger than the amount of cash per share than the other holders of Company Common Stock"

The definition of "fair" when related to stock has taken on a whole new meaning in Silicon Valley.

Under the "terms of the deal" investors were allowed to sell up to 37.5% of shares, employees were also allowed to sell 37.5% of total options granted as long as this was not greater than their total vested options. Employees were able to "lever" unvested options to sell vested options. The structure of this deal actually punished the investors that owned their shares since they could only sell 37.5%. Employees potentially got to sell 100% of their vested options as long as 37.5% or less were vested. In this case, the CEO granted himself 2,000,000 shares of common less than 6 months before the deal closed and exploited this clause to cash out as many of his shares as possible. This resulted in a cash dilution to investors and the transfer's major benefactor was Ben T Smith, IV.

A usual rule of thumb is that the more risk you take, the more reward you receive. In this case unvested options were worth as much as an purchased share owned by a non-employee. In this case, zero risk returned outsized reward, especially in the case of the CEO.

Here is my letter to the CEO and the Board in it's entirety:

Subject: Open Letter To the MerchantCircle Board
Date: June 9, 2011 11:35:31 AM PDT
To: Ben Smith IV, Members of the MerchantCircle Board

Board Members,
Let me start by saying that I am happy the deal with was "done". For the employees, many of whom are my personal friends, I feel that the terms of the deal are very generous. Almost all of the employees who have worked at the company for more than one year are able to elect to sell 100% of their vested shares at a reasonable valuation. This is an excellent outcome.

The following facts regarding the deal give me concerns:

  • On December 22, 2010 the company decided to grant 2,144,000 shares to Ben Smith, under the terms of the Reply deal these shares allow him to earn an additional $924,520.
  • This grant was so large that it exceeded the amount of ISO options that are allowed to be granted in a single year, the ISO component alone was the single largest grant in value in the history of the company.
  • Some members of the Board, former employees, and myself invested money into the company yet we are only able to receive 37.5% of our common holding in cash. The impact of this transaction was to create an additional class of shares, unable to take advantage of the magical December 22, 2010 grants. The merger documents identify an additional class of shares as the Series C-3 Preferred.
  • The value of former non-founding employees' shares is almost equal the $920,000 that was transferred by the December 22, 2010 grant. Our common share holder value has been leveraged to pay for that grant.
  • The merger documents themselves identify Ben Smith as receiving a "Golden Parachute" and inform me that "there is a presumption that the options granted ... were granted in contemplation of the change of control" .

I am left with these unanswered questions:

  • Is there any concern that the the timeline in this deal may construe "Self-dealing" by a corporate officer?
  • When the Board approved these December 22, 2010 grants, were they aware that the amounts were structured to match the deal?
  • Were grants to Ben Smith abnormally favorable or a "sweetheart deal"?
  • Do these action somehow deny Common shareholders equal status?
  • Why would the investors leave all their money "on the table"?

The Valley is run on reputation. Do we all suffered a loss of reputation by our association with Ben Smith and the terms of this deal in regards to former employee Common shareholders?

I hope that we can work together to resolve these questions and concerns, feel free to contact me.


Jason Culverhouse

1,200 Pages Of Deal