Some Google engineer gets paid $3.5 million to not leave, and finally people notice: Irrationality seems to be escalating in Silicon Valley, a place that, for some odd reason, is detached from the global economic reality. This is not going to be good for startups.

Predictably irrational

Predictably irrationalWow, finally people noticed.

All it took was Google to supposedly offer $3.5 million to an engineer to not go to Facebook. Now, that is what rational people would call cutting off the nose to spite the face. But these are not rational times. I have been writing about the escalating irrationality in Silicon Valley, which for some odd reason exists detached from the global economic reality.

In past few months, I wrote about three major and potentially troubling signs.

There are some excerpts from Fred Wilson’s post I think are worth highlighting.

I think the competition for “hot” deals is making people crazy and I am seeing many more unnatural acts from investors happening. If it were just valuations rising quickly, I’d be a bit less concerned. But we are also seeing large deals ($5mm to $15mm) getting done in a few days with little or no due diligence. Investors are showing up at the first meeting with term sheets. I have never seen phases like this end nicely.

Irrationality often doesn’t seem irrational because it is often labeled as conventional or fashionable thinking. Let’s step back for a minute: if you take what Michael Arrington wrote or what Fred Wilson has to say or my own reporting, we are beginning to see signs of hyper-inflation in the web and startup landscape.

Fred doesn’t want to call it a bubble and he is right, mostly because it is not a classic case of mass hysteria, and instead it is a madness that impacts only a certain genus, the professional investor. The implications of this early stage investment hysteria are going to be felt across the ecosystem.

Let me explain.

Google, worried and perhaps tired of losing its great engineers and talented people to other companies including Facebook, decided to fight back with a weapon it knows can be effective in the short term: money. A ten percent across the board pay hike and generous offers to exceptional and standout employees are a good way to stem the flow of talent. Facebook and others, if they do indeed want these people, now have to spend cold-hard cash to lure people out of their cushy Google gig.

Of course, one could argue that what is good for the goose is good for the gander. The more cash big web companies offer as salaries, the more startups and others are pressed to offer higher salaries to their recruits, which in turn means that startups are going to need more money. More money means that tide might turn against the angels in favor of larger Sand Hill Road firms. A million-dollar angel round isn’t enough when you have to pay $100,000 or more in engineer salaries! In other words, the startup economics are going to change.

This is not good for startup founders either. Inflation means they need to raise more money, which will come at a cost: They will be giving up a bigger portion of their business to investors. Of course, higher valuations would make exits –- still few and far between –- tougher.

I think Wilson’s comment about “investors are showing up at the first meeting with term sheets” is particularly telling and indicative of the irrationality in the market. And the sad part –- it is only going to get worse.

Image courtesy of Flickr user joelogon

Related posts from GigaOM Pro (sub req’d):

You’re subscribed! If you like, you can update your settings

  1. omis.me » Weekly Rewind: Five Posts I Wrote Friday, November 12, 2010

    [...] Irrationality, welcome back to Silicon Valley [...]

  2. sucks when you have to pay the talent market rates!

    1. Actually not at all. I think the whole cost structure today is getting irrational. If folks can get more money for their engineering skills, more power to them. I am just pointing out that the whole economics of a startup is going to change.

  3. Graeme Thickins Friday, November 12, 2010

    Hi, Om. Sounds bad. It’s not like that here in the Twin Cities. Nor is it, I suspect, in other tech centers between the two coasts. (Except maybe Groupon’s Chicago, an aberration.) But then, people on the coasts think we’re a bunch of rubes here, standing in the middle of a cornfield. (That would be a snowy cornfield right now, btw.)

  4. Do people really believe that there is too much money chasing not enough start ups? It is more the “French Laundry Syndrome.” Investors are looking at the same sources (e.g. Y Combinator). So they end up paying top dollar, and complaining about the price. But they keep making reservations.

    1. Rob, I completely agree. Maybe I’m not mingling with the elite class of entrepreneurs, but I haven’t witnessed the phenomenon Fred Wilson describes of investors showing up at first meetings with term sheets. If they’re really doing that, my guess is it’s with serial entrepreneurs with proven track records of exits at hefty valuations — the “celebrity chefs” who open a new restaurant, to follow your French Laundry analogy.

  5. Ryan in Atlanta Friday, November 12, 2010

    If Companies want to pay their employees that way then one of 2 things ultimately happens; they remain on top and it was a good choice or the money should have been spent elsewhere.

    I suppose another, perhaps positive angle, might be that it’s nice to see that people are willing to spend money at a time when the economy is keeping many people from doing the same thing…

  6. TropicalGringo Friday, November 12, 2010

    Man, if I ever needed confirmation that my idea to offer up “startup worthy” developers from Latam had legs, this was it ($200k/year for a star engineer makes this a worthwhile venture) :) http://ow.ly/399qw

  7. Clearly a VC bubble. Arrington crashes that VC “collusion” party a while back with all those guys crying in their beer about not getting good deals. That screams, “too much $ chasing” to me. If that’s not a bubble, then what is?

  8. Interesting Post. Just wondering if the Lean Start up approach will solve the issue related to Start Up Economics!


  9. Knowledge economy…. It’s great to see that companies are having to spread the wealth. The way the technology evolves what r the odds that what you know today will be worth so much tomorrow. Besides… If you subscribe to the thesis that in general tech has oversubscribed consumer needs… I.e. The startups will make money via mktg innovation not technological. And that’s where I’d expect the mkt to go. Nothing is bad for startups except lack of social fabric such as food, healthcare and accomodation that prevents any risk taking.

  10. Tea with the guy who stole a big fish from Facebook — Scobleizer Saturday, November 13, 2010

    [...] After all, we’ve all noticed that things are getting a little heated again. Om Malik wrote yesterday “Irrationality, Welcome Back to Silicon Valley.” [...]

Comments have been disabled for this post