Talent as leverage

10x engineers, tech bubbles, and the PayPal mafia

Check out my previous posts on scouting talent as buying options and some questions about great talent curation.

I. Leverage

The “10x” in “10x engineer” conveys leverage just as the “3x” in “3x S&P” does. As an investor, leverage can multiply the returns you receive from a great investment thesis. And similarly, if you’re a founder with a great vision, your superstar employees will help you realize it faster and better. However, if you put these A players to work on a misguided startup idea, then you’re paying for your gamble with a high six figure salary that doesn’t generate returns and crowds out other investments (offices, marketing, compute, etc).

This is not to mention the most significant risk of hiring extremely competent and ambitious people - you are training and spotlighting potential competitors. The governing body in France after the revolution and its terrors made a highly leveraged bet in the person of Napoleon Bonaparte. He delivered stupendous returns - Italy, parts of Austria, and even a serious shot at Egypt. But these gains came with an equally large risk premium - when he returned to Paris, he orchestrated a coup that made him ruler of France. What else did you expect from a man who could conquer half of Europe for you?

During a bust, a highly leveraged hedge fund can experience a death spiral, where people react to bad financial news by calling in their loans, which forces the fund to sell its positions in a weak market, causing lenders to pull back further, and so on. Something very similar happens when you hire superstar employees. By virtue of their talent, these people have lots of options. As soon as you run into trouble and stop being the best place in the world for them to work, some of these 10x’ers will leave (remember, one of the things that makes them 10x is their ambition). And once their peers leave, the remaining A players will scatter too

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. The leverage you get from hiring really talented people is a huge risk during rough times, because these people have lots of other options and the ambition to pursue them.

Leverage is also a serious risk during a boom. Hedge funds like Tiger Management saw the late 90s Dot-com crash coming. But when they tried to short the tech market, some of their investors asked for their money back, which forced the fund to liquidate its short in a bullish market, which caused even more lenders and investors to pull out, causing further losses.

PayPal was acquired by eBay for 1.5 billion dollars, which makes in only a mediocre success (especially if you consider how incredibly talented its founding team was). Many on the PayPal board, including Musk, thought that eBay’s offer undervalued them. But after three gruelling years, the company’s A players were just too tired to continue and wanted the exit that an eBay acquisition would provide. PayPal’s talent forced the company to sell its implicit short against the rest of the e-payments industry early, just as a hedge fund can be forced by its creditors to liquidate a wise short position prematurely. From Jimmy Soni’s excellent new book on PayPal’s early history, The Founders:

Ultimately, the deciding factor for [PayPal board members like] Malloy, Hurd, and Musk was the executive team’s insistence that they and their direct reports were at the end of their tether. “They did ask us whether or not we wanted to be acquired by eBay,” Skye Lee recalled. “And I was tired. I’m like, ‘I’m ready. I can’t do this anymore.

As an investor, if you’re certain about your positions, you ought to be more leveraged. For the same reason, when you have reached product market fit and are confident in your company’s trajectory, you should hire more superstar employees. When we see companies like Netflix only hire senior engineers, we should take that as a signal that they are sure of their strategy - a good omen if you think the belief is justified, but a sign of high fixed costs and fragility if you think they may need to pivot or reform in the future.

II. Bubbles

In The Alchemy of Finance, George Soros explains market bubbles with his theory of reflexivity. Bubbles shouldn’t exist in an efficient market, because speculators will bet against any asset whose price rises above its fundamental value. But bubbles are a common and recurring phenomenon in financial history.

Soros explains that the efficient markets hypothesis does not map onto actual markets, because it treats price simply as the output of market forces despite the fact that price also acts as an input. If a company’s stock quote increases, it will be able to raise more capital from investors, and on the basis of the money it just raised, its value will rise even further. Through this feedback loop, the prevailing bias is reinforced.

Reflexivity is at work in talent markets as well. Say that you manage to convince a few A players that your startup is extremely promising. Now, you can go to investors and say, “I’ve got the beginnings of an amazing startup - look at this awesome team I’m putting together.” And now you can hire even more 10x engineers by telling them, “Hey, we just raised our seed round on a 50 million dollar valuation. How can you not join this rocketship?”

But if this self-reinforcing cycle is not backed up by a legitimate and scalable vision which can make use of the influx of talent, then you have a bubble. Theranos founder Elizabeth Holmes recruited highly credentialed biotech talent, and then advertised this team to raise billions in capital, which helped her get more clout and attention, which she used to recruit even more superstars, and so on.

Leverage tends to accelerate bubbles, because it allows people to throw more money into an already inflated asset. Similarly, extremely talented people accelerate tech bubbles. No prospect is more attractive to a 10x engineer than working with other 10x engineers, and no opportunity is more irresistible to an investor than funding a team of 10x engineers. The positive spin on this is the Byrne Hobart view, that bubbles set a Schelling point for talent and capital

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. A founder quality person can quit his job and start a new company in Web3 or biotech because he think he’ll get funded, and investors are willing to fund him since they expect that he will be able to recruit 10x engineers, who are comfortable making a career pivot because they find the founder’s vision exciting.

If any of of the people in this chain stop believing the hype around which their project is organized, then the hype becomes unjustified. So the con view of tech bubbles is that the entire party crashes if one person leaves early. And once the bubble starts to wobble, 10x employees will move on to the next compelling tech vision, causing the leveraged death spiral mentioned in the last section. Leveraging your company with talent increases your volatility - either you orchestrate a revolution, or you implode.

Technology, more than any other sector, seems to have this strong pattern of producing bubbles, where one hype train follows another. Perhaps this is because the smartest, most talented people go to work in tech, and just as credit produces bubbles in financial markets, talent accelerates bubbles in technology

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III. Hedging

Hedge funds compensate for the extra risk they take on from being highly leveraged by hedging. They short a small amount of stocks they consider to be overvalued so that they can weather (or even benefit from) a general market downturn. By combining leverage and hedging, they can increase their expected returns without increasing their net exposure. From Sebastain Mallaby’s book on the history of hedge funds, More Money Than God:

the hedged fund does better in a bull market despite the lesser risk it has assumed; and the hedged fund does better in a bear market because of the lesser risk it has assumed.

Companies become highly leveraged when they hire lots of superstar talent. They can reduce the risk this creates by hedging against their business model. Basically, this involves asking, “In a world where our main product fails, what other products or services are likely to be successful?” and then building those themselves.

You can see this happen in the early history of a company like PayPal (again, I highly recommend Jimmy Soni’s The Founders for more on this topic). PayPal was the result of a merger between two different companies - Thiel and Levchin’s Confinity and Musk’s X.com. But neither company’s original vision involved the actual niche in which PayPal became successful - email payments. To put it in investment terms, Confinity was long on PalmPilot devices - they wanted to develop protocols for encrypting and exchanging data between these primeval smartphones. X.com was shorting the entire financial industry, as Musk’s characteristic ambition led him to believe that he could provide all the services banks and brokerages offered but cheaper and faster.

Confinity’s thesis was demonstrably wrong (the PalmPilot sold poorly and was eventually discontinued), and X.com’s was debatable at best (the finance industry is slow and expensive partly because of how highly regulated it is, and abiding by these regulations would slow X.com as well).

Both these companies were also famously talent leveraged. If you’ve used the internet, you’ve used a product that was founded by one of the people originally on the PayPal team (YouTube, Linkedin, Tesla, SpaceX, and Yelp, to name a few). But just putting the right talent to work on the wrong business model means shredding VC money faster. Thankfully, both companies had hedged against their main product thesis in the form of email payments. Initially, Elon thought that email payments were but an appendage of his grand plan to revolutionize banking, and Levchin thought that they were a distraction from the cryptographic protocols that he was implementing for PalmPilot money transfers.

It was this combination of leveraging talent and hedging vision that made PayPal successful

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. The hedge allowed the company to find product market fit, and the talent allowed it to dominate that market once it was found.

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Thanks to Rohit Krishnan, Basil Halperin, and Christian Holland for comments.

1. The converse of Max Levchin’s maxim for hiring at PayPal: A players hire A players, whereas B players hire C players. So the first B player you hire will destroy your company.

2. Byrne’s example is how Microsoft starts building software that is meant for the faster chips that it’s expecting Intel to release in a few years, and Intel invests in developing faster chips on the assumption that Microsoft will build software for them.

3. Though Rohit Krishnan offered another compelling explanation in response to a draft of this post. Technology is fundamentally about trying to realize high expected value + high risk plans, so it’s no wonder that it is also extremely speculative and bubbly.

4. PayPal almost hedged in a much more literal sense. Sonni discusses how Thiel wanted to use the 100 million they raised in their Series C to short the tech bubble at the height of the Dot-com bubble - a move that in retrospect would have made them way more that PayPal’s actual business, but one which the company’s board did not go for.