Thursday, May 20, 2010

Compensation Thought Experiment

Pop Quiz to see if you've been paying attention to the past few blog posts (or better yet, read my book): Supposed you had a $250K equity offer from Google, and a $250K equity offer from Facebook, which one is more valuable? Under what circumstances would one offer be much better than the other? (These are purely hypothetical numbers and have no relation to offers being handed out at either companies today --- I just picked a nice round number out of thin air)

Both companies are handing out RSUs (Restricted Stock), so you can't play any of the tax planning games I discussed in my book. Facebook is currently valued at around $25B. Google is valued at $151B. If Facebook really succeeds in its quest to dominate social networking, monetizes it, and dominates the web, it's not inconceivable that it becomes worth $50B or $100B (which would make the final compensation $500K or $1M). What would Google have to do in order to double or quadruple? The largest market cap company in the US is Exxon Mobile at $283B. So if Google were to double it would be bigger than Exxon-Mobile. That sounds unlikely. It's not impossible, but it's unlikely. For instance, if YouTube were to dominate all of TV, we could model that by say, taking TV network market caps and adding that to Google. CBS is only worth $10B, so my guess is even if YouTube wiped out CBS/ABC/NBC, it would only add $50B to Google's market cap. This is the price of success: it takes a lot of dollars to move Google's market cap!

Now, Facebook is also much more likely to be worth $0 than Google is, so in market parlance, we say that Facebook is higher risk. Under what circumstance is the higher risk stock (represented by Facebook in this case) a better bet? Well, if you're a young engineer (fresh out of school, for instance), then you have plenty of time to recover from Facebook going to $0. If you're in your 50s or 60s and haven't saved enough to retire, you might as well roll the dice and shoot the moon, since the extra $250K wouldn't support your lifestyle anyway in retirement.

The person who should take the Google offer is someone right on the cusp of achieving his financial goals: that last $250K is much more valuable than rolling the dice and getting $2M or $0. Note that I'm making all this computation based on not knowing anything about Facebook's revenues or potential growth. In practice, the risk of taking the pre-IPO company's offer is much lower if you manage to deduce their revenue/profit/growth situation during the interview process, and the offers rarely end up being equal.

Now that you've had the chance to think about this, stories like these make a lot of sense, right? Or at least, I hope it does.
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