Startup Moneyball

Instagram’s CEO Kevin Systrom received almost $400M from his company’s $1B acquisition by Facebook. Snapchat CEO Evan Spiegel could’ve received even more for the $3B that Facebook offered for his company. The CEO’s of WhatsApp is likely a billionaire from the $19B that his company was purchased for. These amounts of money are mind-boggling to people outside of the top 0.01%, but it seems like hardly a week can go by in the news in which there isn’t an announcement about a startup founder (typically a CEO or executive) that received a payout in the millions or tens of millions of dollars, or more. While I often hear the argument that these payouts are unfair, egregious, etc, my problem with them is much mundane: the people who get them are usually not worth the amount of money that they receive.

“Worth”, of course, is a very subjective term. If you are a pure free-market conservative, then worth is whatever someone can legally get paid (unless you’re a Wall St executive, in which case legal should be replaced with “legal”). But when I think of the concept of worth as it pertains to startup founders, I think of it in terms of the value provided by one individual vs another, given those individuals’ and companies’ professional environment. As I’m sure you guessed from the title of this blog, I’d like to draw a parallel with a recent sports example: Moneyball. For those of you that haven’t read the book or seen the movie (in which case, drop what you’re doing and order it now - Jonah Hill not playing a funny fat guy stoner is worth the price of admission), the concept is this: for decades, baseball executives had been measuring prospects on things that were at best of debatable importance to winning, and at worst completely subjective/absurd - listen for yourself. In order to compete in a sport where (unlike football) there was no limit to how much money a team could spend on players, the poorer small-market teams (i.e. Oakland A’s) were at a significant disadvantage to the money-laden big market teams (e.g. New York Yankees). Alongside Assistant GM Paul DePodesta, and utilizing the research of baseball writer Bill James, Oakland GM Billy Beane built a team of players who didn’t fit into the traditional metrics of success (but who, according to the “Moneyball” metrics, would actually help the team win more games), and thus were undervalued (read: cheap) and ignored by other teams. One of the basic metrics is called Wins Above Replacement (WAR), and indicates how many additional wins a player will add to a team compared to the average, or replacement, player at his position, and considers things like differences in eras (e.g. whether everyone was on steroids) and parks (since some are bigger than others and thus result in fewer home runs). While chided at first, Moneyball principles have now been adopted by the vast majority of MLB executives and coaches, as well as across other sports (more recently the NBA).

So how does Moneyball apply to founder compensation? Easy (in theory, anyway): figure out better ways to accurately measure founder value (or founder WAR, if you will), and align compensation (in startups, this will usually mean stock options) to it. But how do you determine founder WAR, especially in an environment as dynamic as Silicon Valley? After all, by definition a founder has to come up with an idea as well as run the subsequent company effectively for a period of time (to receive a massive payout, anyway). I agree, that the idea and initial risk is worth something. But it’s not worth 20x+ what other other employees receive. Consider that if you founded a Silicon Valley technology company during the tech boom or the late 1990’s, then you likely could’ve been a pretty mediocre executive and still done well by traditional measures. If you founded or ran that same company after the bubble burst in the early 2000’s, it’s unlikely that you would’ve been successful by those very same measures, no matter your ability. Exhibit A: pets.com. And that divergence is exactly the point: founders significantly affect the trajectory of a company, but current compensation methods don’t take into account everything that they don’t (or can’t) affect.

There’s also another area where this phenomenon takes place, and it’s a far cry from the technophiles of Silicon Valley: Washington, DC. Politicians and startup founders may seem to be on opposite ends of the spectrum in many ways, but they both bear the brunt of unrealistic expectations, often exacerbated by personal decisions. In politics, there is something called the Presidential Green Lantern Theory. The gist of this theory is that the president is all-powerful and thus is responsible for the determining the policies and outcomes of US society. Why this theory still exists is beyond me (though this is a country where 20% of people still don’t believe that smoking causes cancer, so I guess I shouldn’t be too surprised), but its persistence becomes immediately apparent when we all buy into the hype and promises that any politician, but particularly the president, make and then inevitably fail to fulfill. In reality, there are many checks and balances, some helpful and some immensely frustrating, that keep a President from being able to make the impact he promises to make. That’s not to say that he can’t affect change - he can, and does - but it’s never to the extent originally promised to the people.

Likewise, in startups, traditional measures of success often ignore powerful external factors (e.g. market and industry conditions, as outlined above) that can affect return and mask or negate the actual ability-driven contributions of a founder. Disproportionate founder compensation also ignores non-monetary factors (ability to manage, ethics, corporate wellness) that contribute strongly to the success of an organization, and which can dramatically impact a startup. It seems like every conversation I have with a startup founder involves a breakup or mismatch with another founder at either his/her current or previous company, a mismatch which inevitably had financial consequences. The same goes for the consequences of execution: the executives set the strategy but the rest of the team has to execute. A good founder should also be able to attract and hire good talent, but once a company gets beyond a certain size (in my admittedly limited experience, ~30-40 employees) it becomes much more difficult for the founders to keep a hold on the hiring and personnel growth. But potential equity is doled out well before any of this happens, and in massive disproportion to every other team member. Sam Altman, founder of Y Combinator, wrote about this very issue. Most importantly, founder success often compares a founder to…him/herself! Or another founder in a completely different area of the business. But no one ever thinks that’s a good idea with lower-level employees.

Let me state unequivocally that I believe that some founders are worth the money. And that the initial risk and idea are certainly worth additional compensation. And that great founders can impact an organization’s success in ways that may make or break the business. Those seem obvious to me. But the impact that founders have and the way that they are compensated should be examined within the environment in which they exist (i.e. external influences, industry, etc), against other similar people in their own ecosystem (not against the impact of other employees to the organization - most of whom by design cannot impact an organization in the same way that a founder can), and should be weighted against you know, actual performance, and not just being one of the first people in an organization. The subtle consequence of this shift will also be to incentivize smart risks, and not just decisions with good results - good ideas fail for a lot of reasons, and bad ones can succeed despite the odds against them.That’s the basis of founder WAR, and in my opinion a much more appropriate way to distribute equity and other compensation amongst startup founders. Or you can keep judging a founder by whether his/her spouse is a 6 at best - and risk paying for it later.