David Sacks' Argument Is Rational, It's a Good Thing Silicon Valley Isn't

By Sarah Lacy , written on August 20, 2012

From The News Desk

David Sacks is a very smart, rational man.

While at PayPal, he was the architect of one of the most important things the company ever did: its policy of paying people $20 to refer a friend. It seemed wasteful, but for the late 1990s -- when people were spending massive amounts on branding campaigns -- it was actually a relatively cheap way to acquire customers. It was efficient too: Rather than give advertisers all this money, let's just give it to the customers we're trying to get.

When his next company, Geni, wasn't taking off, he pivoted to focus on Yammer -- an intra-company Twitter they'd developed in house. He had a hunch it could help other companies communicate, and he was right. Goodbye, Geni. Hello, company with a better shot at the big time.

And when Microsoft offered Yammer $1.2 billion -- an insane multiple on its revenues, Sacks said yes. As a Yammer user, I complained, but anyone rational would have done that deal. It would have been a challenge for Yammer to scale its sales force and fend off other enterprise social network players to claw its way to an exit that large on its own.

And this weekend when David Sacks accidentally unleashed a shitstorm on his Facebook page when he wrote that Silicon Valley as we knew it may be over, he was also being rational. His reasoning was this:

I think silicon valley as we know it may be coming to an end. In order to create a successful new company, you have to find an idea that (1) has escaped the attention of the major Internet companies, which are better run than ever before; (2) is capable of being launched and proven out for ~$5M, the typical seed plus series A investment; and (3) is protectable from the onslaught of those big companies once they figure out what you’re onto. How many ideas like that are left?
But here's the thing: What drives Silicon Valley are the huge home runs. We've all heard the stats: 95 percent of the returns come from 5 percent of the deals. And what has made Silicon Valley the place where those huge home runs occur, cycle after cycle, is a few, key entrepreneurs' inability to be rational.

Let's start with the very act of starting a company. The vast majority of them will fail. New companies do one of two things. They seek to disrupt an entrenched, deep pocketed giant or they seek to create a whole new category. Either requires an insane amount of arrogance and optimism. Neither are rational thoughts.

Nor is it rational for VC to fund a guy and an idea. Particularly if that guy is a 22-year-old kid with no track record.

What about the reason why legions of developers join these companies? Stock options. Everyone gets 'em. But the vast majority of people who join startups will never see a dime from their options. Even at companies that sell for hundreds of millions of dollars, the bulk of the staff may not make anything on the exit. It depends on how much money has been raised, the liquidation preferences, and the intricacies of the cap table. Only at those huge home run companies are hundreds of new millionaires created. The Valley is filled with people who spend their careers hopping from startup to startup still hoping for that golden option ticket. Why do they keep doing it? Out of an irrational hope that the next startup is the one.

Even less rational is that anyone turns down an acquisition offer. A company with momentum is frequently offered an amount of money that has nothing to do with what they've built so far -- but the promise of what they could build. And for all the reasons above, no matter how promising the odds are stacked against the company. And yet, in every cycle we see plenty of entrepreneurs turning down the safe money.

The archetypal example of the last wave of companies was Mark Zuckerberg -- a person who coolly turned down a $1 billion acquisition for a company that was still, at the time, second to MySpace -- a Facebook that was pre-platform and pre-newsfeed and pre-Sheryl Sandberg. It was a deal that would have netted him some $300 million -- personally. There was no logic in the world that could have defended that position. He just knew. And, fortunately for him, he didn't have to convince anyone, because he controlled the board.

For every Zuckerberg, there's an entrepreneur whose gut was wrong or whose execution fell short. It's easy to put Digg into that group, in hindsight. And, perhaps, Groupon should have sold to Google. But what makes it so irrational is that the bulk of the people who make that call, won't look back and securely know they did the right thing. They'll wince at how naive they were.

What makes the irrationality of Silicon Valley so powerful is that people in the thick of it have no concept that they're being irrational. Every entrepreneur thinks his startup will make it. The biggest risk takers actually don't see themselves as risk takers. They just clearly see an opening in the market and know they can fill it -- whether time proves them right or not. Over and over again you hear this from entrepreneurs: If we'd had any idea what we were taking on, we never would have started this company. 

So when David Sacks says the Valley is done, I'm not surprised. Because that's coming from a person who just did the rational thing and sold his company for $1.2 billion. He's been around long enough to see the people who didn't. He was clearly staring into a competitive and well-funded enterprise software landscape, and judged that selling for a huge amount was a safer bet than competing. He knows it was the rational thing to do, and probably, the responsible thing to do for his investors and employees.

But Silicon Valley doesn't function on rationality. Witness some of Yammer's competitors in the burgeoning enterprise world. At Box, CEO Aaron Levie has turned down at least half a Yammer from Citrix, and Asana's Dustin Moskovitz and Justin Rosenstein have intimated that to leave Facebook, work for years on a company, and sell for "a mere" $1 billion would be a disappointment.

Are they silly kids with no experience in enterprise who have no idea what lies in wait for them? Yep. And that's why they may just pull it off.

This is why the biggest home run hitters frequently are young entrepreneurs and pioneers of a new wave. People who don't get all the reasons they'll probably fail. People who don't realize how many mortgage payments and years of private school $300 million could buy. People who don't realize how almost impossible it is to build a company that is still relevant in five years, let alone 10, or even 30.

Or they are just plain crazy. Consider Elon Musk. No one rational decides he'll take on the auto industry and space and invest his entire fortune in doing both at the same time. There's a very fine line between delusional and confident, and it's usually drawn with the benefit of hindsight.

The Valley has always excelled when it exploits that difference between how things should work on paper, and how they do when you factor in intense talent and determination, market timing, luck, and the staggering ineptitude of incumbent players. Because most of them are staggeringly inept. Money and manpower can't solve every problem in the world. Innovation isn't just a buzzword consultants use; it's a way of looking at a problem from a new and frequently destructive different angle.

And when I look around the Valley today, I see plenty of examples of that. Square is a radically bold company that some of the biggest investors in the Valley keep passing on and then regretting they passed on. Uber has fundamentally changed how transportation works in the largest cities -- knocking a protected age-old industry back on its heels, legal challenges be damned. The experience is so much better than what's out there, people are happy to pay through the nose for it. Airbnb took a concept that many investors found totally repugnant -- letting people you don't know stay in your house -- and made it a new way to travel.

Sure there are tons of lame companies that will go nowhere. Many more who dream of a $50 million flip. But that's not everything. We're not seeing an end to opportunity in the Valley. Not even slightly. We're seeing the Web just now crawling out of the computer screen to disrupt everything that is unsatisfying about real life. Now-- when we carry powerful computers in our pockets-- is when the power of the Internet gets interesting.

As for Sacks's claim that big Internet companies are better managed than before, I have four words: Really? Yahoo? HP? eBay? Even if you agree with Sacks and believe incumbents could innovate on these things, they won't for one simple reason: It's not in their best interest. Unlike entrepreneurs, we can count on big companies to be rational -- if they don't, their shareholders sue. (Just ask Jerry Yang.) And ripping apart your whole industry is not rational.

I first moved to Silicon Valley in 1999, and in the aftermath of the NASDAQ crash, there were far more persuasive arguments on why the Valley was done. There are at any inflection point in the economic cycle, as the people who made money a certain way in a certain cycle, see that cycle end.

Lucky for the world, no wave of talent stays at the forefront of innovation forever.

[Illustration by Hallie Bateman]