Are startup valuations and payouts too high?

Since I have jumped into the startup game, I’ve consistently heard people comment on the high startup valuations/acquisitions and the high payouts that successful founders and early employees get in liquidity events.

These comments/complaints sound something like:

  • Snapchat just turned down 3 billion. Is it really worth that?
  • Pinterest and Dropbox have valuations of 4+ billions. That’s crazy!
  • Twitter just raised close to 2 billion on a 14 billion valuation.. built on top of a table storing 140 character tweets!
  • Tumblr? 1 billion? Damn, that is a lot of money.

There are also similar comments about the money people end up with:

  • Snapchat just turned down 3 billion? Even with modest founder equity percentages, the founders would have banked. Is it fair that they make so much?
  • Instagram had twelve people and sold for a billion? That is a boatload of money for 10+ people.
  • etc., etc., etc.

People seem to have a hard time with these kinds of numbers. Are these high numbers alright? And are the high payouts for founders and early employees fair?

I believe that for the most part, the high valuations and payouts and 100% warranted. I’m no economist, finance wizard, or even that good with numbers, but I don’t think it is difficult to come to this conclusion.

High startup valuations.

As a quick exercise, check out the market caps of the Fortune 500 companies (and these are for 2012). You see that? Apple is at 568 billion! Microsoft is at 269 billion. Those are some big big numbers.

People squawk about startups valued at a few billion. Seriously? They don’t believe that a startup could speculatively be valued at 1% of Apple? At some point, the breakout unicorn startups will be surely be worth a few percent of Apple. And possibly more in the future if they do a great job.

Individual don’t usually deal with huge numbers in their bank accounts, but businesses do. You shouldn’t be stunned with you see billions in the business world. It is a regular thing for the real large successful companies out there.

 High founder and early employee payouts.

The real insight here is this: a person’s pay should be related to the value they bring to the market.

It can be easy for employees of large corporations to lose sight of this. Why? Because they go to work everyday, and collect a nice paycheck regardless of the value they bring to the market. The employee doesn’t directly bring value to the market. Instead, the business does. The business is a money making machine, and it pays employees to keep this money making machine sustainable.

Founders and early employees have a different job than employees. Their job is to figure out how to create value for the market, and then turn this value into a money making machine. Their job is to create the beast which, if successful, may one day have a market cap in the 10’s or 100’s of billions!

When you think this way, it surprising that founders and early employees of successful companies are well compensated? Not really.

A common dialogue.

I have many friends in the tech industry, and I have already repeated this conversation several times. In turns out, I have many friends in research, so it makes this conversation even easier. It goes something like this:

Friend: Dude, Snapchat just turned down 3 billion cash! The founders could have easily walked away with 100’s of millions cash, if not more. Isn’t that crazy?

Me: Well, it really isn’t that crazy. You’re a good software developer at Google/Facebook/etc. I bet your yearly compensation is somewhere between 150K and 200K right? Possibly more?

Friend: Yes.. that is in the right ball park.

Me: And I bet your boss makes more right? As does you’re boss’s boss. They must make 200K-1M a year depending on how big they are right?

Friend: Yes… probably.

Me: OK, well tell me: what happened to your project this last year or two?

Friend: Well we’ve been working on something, but the project just got cancelled and we’ve been put on something else. (Again, having friends in research makes this argument really easy.)

Me: Hmm.. OK. So you and your bosses are banking a cool fraction of a million per year without creating value in the world. Do you know what the Snapchat kids did? They have 30+ million active users and are sending 400+ million messages a day. It is quite a feat. That is real value, and it is real world impact. Are you telling me that they don’t deserve a payout that is orders of magnitude more than you and your boss?

Friend: Ummm….

Me: Oh yeah, and if you want another way to think about it, Paul Graham has this really good essay on how to make wealth. You should check it out.

P.S. This is post number #75 in a 100 day blogging challenge. See you tomorrow!

Follow me on Twitter @alexshye.

Or, check out my current project Soulmix.

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