Silicon Valley, Startups, and Labor Pricing

Looking back over the past twenty years here in Silicon Valley there have been some remarkable transformations in how knowledge worker labor has been priced.

Back in the mid 90’s, a CS grad fresh out of school would earn typically something like ~$60k/year. Founding teams were funded quickly with a Series A, half-jokingly valued by adding $2m per engineer and subtracting $500k for every MBA. Clever founders realized the value of labor; just pulling together a team of 20 engineers was “worth” $40m and you’d only have to pay them collectively $1.2m/year; easily enough done with, say, a $10m on $40m round. If the actually happened to create anything of value, so much the better. VCs and founders alike effectively conspired against early employees, hoping that they wouldn’t ask too many questions about “what are 20,000 options worth?” and would just hope that the lottery ticket would pay off. And it did, for some, with enormous IPOs — but generally if you were employee #12, it was unlikely that either you were being paid market rate or that your options would ever amount to much.

After the dot-com crash, 2001–2010, IPOs were no longer an effective liquidity path for many startups, but the public megacorps that survived offered an exit path via M&A, buying out whole operating companies. Over time it became clear that acquisitions are a complex game and a precious few companies actually had the competence to execute them; those that had botched continued growth of acquired companies found themselves mainly valuing the talent they had acquired. If acquiring companies was challenging, acquiring talent might be less so; purchase teams whole cloth and early in their development so as not to have to “pay off” large VC funds.

So from 2010–2015 we saw an era of “acquihires”: big companies buying out talent at early to mid-stage firms and shuttering the startup’s ostensible product. Even this was a little pricey as they ended up still having to “pay off” the seed and angel investors, etc. If what you’re after is the talent, why not just cut out the middlemen altogether?

The result has been a much more direct approach where large firms now offer incredibly generous compensation packages to new grads, especially when coupled with aggressive internship program engagement. The latter is key since the company will have already nearly wholly de-risked the individual’s culture fit and productivity, having had a well-documented quarter of direct observation. Consequently, the company can afford to pay top dollar for such talent. And companies are doing so.

Take a peek at pay for new grads today, nearly a quarter million a year!

The increased direct payments from companies coupled with greater sophistication around valuing options jointly lead to a dramatically changed calculus for startup employees.

IPOs remain few and far between, taking over a decade even at the successful companies — the odds that your startup options will be worth anything finite time (or in time for you to make a down payment on a home in Silicon Valley) are very low. But the cash and direct stock grants you can garner at a big company can be realized today with certainty.

From a certain perspective, this is actually really good as it reflects the correct pricing of labor. The risk-adjusted returns for a new computer science graduate are higher than they’ve ever been.

But startups are having a harder time competing for talent, especially for “employee #12”; they either need to raise large sums of money to pay market rate much more quickly or they need to offer a lifestyle different from that afforded by a large company (ability to work from home, offices in an exciting place like Telluride, flex employment, etc).

As knowledge worker compensation continues to accelerate, there are obvious impacts, like an increase in Bay Area housing prices, but there may be less obvious impacts as well. A typical CS grad may only three years out of college qualify as an accredited investor and begin participating in startup financing. Additionally as people mid-career hit sufficient personal cash reserves, we may see an increasing number of “F.U.” startups with founders & employees who have already made enough money to be more focused on the joy of creation than maximizing revenues. These startups can afford the luxury of time to explore product/market fit in complex markets and given the attention to culture and founder-first structure I would expect these startups to be generally disproportionately successful over the long run.