Monday, October 29, 2007

Facebook: Options pricing is no hiring hurdle

The Wall Street Journal has a lurking-schadenfreude story which suggests that the imputed $15 billion valuation of Facebook after the Microsoft investment will cause them hiring problems. I think not.

Firstly, I'd be shocked if the clever guys at Facebook haven't structured this deal so that part of the money that Microsoft is paying doesn't accrete to an imputed valuation - instead, it's payment for ad rights, or something similar. If the accounting only puts half of the $240m against the stock purchase, then Facebook's value for options purposes is more like $7.5 billion.

Secondly, the rule of thumb in the Valley is to grant common options at a strike price of about 10% of the preferred, since these shares have less rights which can theoretically decrease their future value in many downside scenarios. That handily locks in a 10X gain in the all's-well-that-ends-well scenario.

Thirdly, most option-motivated employees are looking for a 10X gain in the enterprise value while they work there -- given the built-in 10X from the strike price rule of thumb, that nets out to about 100X in actual return on options for four years of sweat, toil, and tears. On the scale that FB is playing (high stakes, win or lose) that 100X translates to millions in any 'win' case. Can FB get to $75 billion in enterprise value over the next four years? It will be hard, but it's not impossible.

But there's another factor at work. Given the scale of what FB is trying to accomplish, they're looking to hire successful, smart people who have done it before. And it's in this context that the M$ money is a huge win. At this point in the evolution of the web, there's a very large class of professionals - engineers, product people, managers, BD and marketing people - who have mortgages, kids in school, and gold-plated resumes loaded with relevant experience for building great companies. People who, say, went from Netscape '95 to CommerceOne '98 to PayPal '01, just to make up one arc. Hiring those people is tough for an under-funded startup, because they're at a clearly different point on the options-vs-salary & benefits curve, favoring the latter. Google has accelerated its business by being able to pay top dollar for people at this stage of life -- the cream of the crop of HP, Sun, Oracle, and a dozen other companies -- and Facebook can now go toe to toe in compensation package for both upside-motivated and cashflow-driven superstars. As Google has demonstrated, when you join the young, hungry and brilliant with the wiser, experienced and brilliant, seismic events can happen.

The schadenfreude may yet play out, but not this time.

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