The Power Law: Venture Capital and the Making of the New Future

Silicon Valley wasn’t created in the 1950s by government intervention — which favored neither California nor Massachusetts at the time. It wasn’t just northern California’s counterculture or Stanford. Its ability commercialize basic products was the interweaving of egalitarian openness and capitalistic competitiveness that venture capital created.

So argues The Power Law: Venture Capital and the Making of the New Future, a 2022 book by economics journalist Sebastian Mallaby. What early Silicon Valley culture did have was a true ecosystem of people gossiping and swapping ideas and sharing. It reminds me of why free speech emerged in Europe.

The book is a history of venture capital, though it adds nuance to another book I read that is a pure history. This book gets its title from the the power law concept, in which you lose only 1x your money but if you miss a deal you could lose out on 10x or 100x your money. That fuels big bets.

Mallaby’s book is exhaustive. I appreciated its deep history, others might not. The book does feel full of survivorship bias, of war stories from successful people (mostly men) describing why they were successful. Quirks of the writing come up — he uses the subjunctive a lot like “in 1986, he had offered,” and sprays the term “Presently” all over the place — but I mightily appreciated the book. Give it a try.

I share my notes below for future reference.

My notes:

Indian-American VC Vinod Khosla: “All progress, depends upon the unreasonable man” “ the creatively maladjusted”…. “ most people think improbable ideas are unimportant but the only thing that’s important is something that’s improbable.”
Horsely Bridge has stakes in firms that have backed 7k startups between 1985-2014. Just 5% of deals generated 60% returns. Compare to S&P in 2018 in which top 5% sub industries made 9% of performance
In 2012, Y Combinator said 3/4 of its gains came from 2 of 280 of its investments
“Now consider the returns in venture capital. Horsley Bridge is an investment company with stakes in venture funds that backed 7,000 startups between 1985 and 2014. A small subset of these deals, accounting for just 5 percent of the total capital deployed, generated fully 60 percent of all the Horsley Bridge returns during this period. (To put that in context, in 2018 the top-performing 5 percent of subindustries in the S&P 500 accounted for only 9 percent of the index’s total performance.) Other venture investors report even more skewed returns: Y Combinator, which backs fledgling tech startups, calculated in 2012 that three-quarters of its gains came from just 2 of the 280 outfits it had bet on. “The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund,” the venture capitalist Peter Thiel has written. “Venture capital is not even a home-run business,” Bill Gurley of Benchmark Capital once remarked. “It’s a grand-slam business.
Losses can only be 1 times money but the gains are exponential
“The more common error, the more human one, is to invest too timidly.”
Innovation power law
“if tomorrow will be a mirror extension of today, why bother forecasting?”
“The future can be discovered by means of iterative, venture-backed experiments. It cannot be predicted.”
“I can’t think of a single, major innovation coming from experts, in the last 30, 40 years.” Khosla the VC who made early bets on telecom needs before the internet even needed it. Musk and Bezos and Zuckerberg were outsiders to industries they changed
Ronald Coase: markets for price signal and contracts; and corporations for trends and efficiency. This author says VC sits between the two and deserve the same review; “distributed R&D”
VC is spreading in three ways: geographically; sectorially beyond software and web and beyond startup phase to build unicorns
“In a world of intensifying, geographic, economic competition, the countries with the most creative innovation hubs are likely to be the most prosperous and ultimately the most powerful. In a world of intensifying income inequality, the countries that can foster greater regional diversity in the locations of those hubs will be happier and more stable.”
When did Silicon Valley start? Fred Terman in 1951 started its research park; 1956 William Shockley moves silicon firm to his research park or 1957 with the traitorous 8, who couldn’t get bank funding but did get $1.4 m in venture financing
Despite military contracts being part of the Silicon Valley story, it’s not convincing since Vannevar Bush symbolized the 1950s, as dean of MIT engineering school, Raytheon founder and FDR military adviser. Boston/Cambridge had more than Stanford and silicon caller
Others point to the counter cultural vibe , but the Tech Model Railroad Club which shaped hacker code came from MIT and many other examples of the rest of the world
Tim Berners Lee and Linux were also anticapitalist and radical.
“The Valley’s distinguishing genius is that the patina of the counterculture combined with a frank lust for riches.” “It was this combination of laid-back creativity and driving commercial ambition that truly defined Silicon Valley.”
Silicon Valley is “the most durably, productive crucible of applied science anywhere, ever “
By 2014 an astonishing 70% of the publicly traded tech companies in Valley could trace their lineage to Fairchild
John Hay Whitney: his firm shortened “adventure capital” into venture capital, which was being used by 1947 in New York Times to reference risk for private business and distinguish from other investment banking, but the term was not widespread beyond this
Reid Dennis’s famous bet on Ampex tape recording (which made Bing Crosby an early fan) by going public in 1958 earned a 67x return and popularized a San Francisco lunch called The Group, where startups pitched primarily in plywood booths at Sam’s restaurant in financial district over sourdough bread. Founders would wait on the sidewalk to hear if they got funding and likely follow on. This group was later formalized into Western Association of Venture Capitalists
George’s Doriot and ARD had a large role in early private business investing: in 1957 his famous bet on Digital Equipment Corp which used TX-O to show transistors best vacuum tubes. That single deal accounted for up to 80% of all ARD gains in 25 years
Kleiner of the Traitorous 8 sends message to his father that ends up on Rock’s desk who calls June 20, 1957 and then travels from New York to meet them at a San Francisco restaurant told him to leave to start own company. It was internal science met with Wall Street capitalism and finance
But Rock struggled to raise the $1m he pledged. It was revolutionary. “why buy worker’s loyalty with stock options when the culture of the 1950s provided it for free?”
But Fairchild backed them with the help of a “call to greatness” speech from Noyce in Fairchild’s Manhattan town house
The Fairchild scientists would talk to customers like the military and IBM, not something that Bell Labs or Texas Instruments allowed. Customer research!
After the Bull market of 1950s, the 1960s finally saw Rock and Davis set up (investors wanted other places to put their money)
A time limited pool of capital partnership: They skipped the popular but constrained SBIC structure and raised from LPs
Rock: the only reason to invest is “intellectual book value” or the team behind the early-stage idea when nothing else to go on
Arthur Rock popularized people first investing: invested in SDS despite a rule against competing with IBM because he believed in the founder
Tom Wolfe’s 2018 Esquire piece on Robert Noyce
Atari was a business risk not a technology risk because it’s tech was simple but would a new model scale?
“If the 1950s had revealed the power of liberation capital and if the 1960s had brought the equity-only, time-limited venture fund, the advances of the 1970s would add hands-on, activism, and stage by stage finance”
Don valentine and Tom Perkins
Apple: Tom Perkins and Eugene Kleiner refused to meet Steve Jobs; Bill Draper sent a young associate; Jobs pitched Stan Veit to own 10% for $10k and Nolan Bushnell to own a third for $50k but both turned them down; finally Don Valentine of Sequoia who had backed Atari (Kleiner and Perkins preferred technical risks rather than business risks but Apple was a business risk) introduced them to Mike Marklula who could be called the Valley’s first angel investor
In 1978 Merrill Lynch forecast confidently that “future developers of promising technologies, new products in new services are likely to be well-financed divisions of major corporations.” They were wrong
AnnaLee Saxenian has argued that Silicon Valley outpaced Boston and Japan in tech because those two were dominated by large secretive firms: Digital Equipment and Data General; Toshiba And Sony, but Silicon Valley was “a bubbling cauldron of small firms” and it was porous with friendships and alliances (the ecosystem metaphor of today)
This information spillover and social network benefit is beyond the efficient productive matching of employers and employees, of companies and services, but argues the weak ties of many disruptive small firms helps more than many big ones (he cites Granovetter 1973 weak ties paper)
WHY did Silicon Valley develop a permissive porous culture? Commonly, California made non-competes illegal (unlike Massachusetts) and Stanford welcomed professor sabbaticals (more than Massachusetts, though graduate students do more startups than professor). But not whole story, he argued VC industry created this culture
1970s and 1980s was when Silicon Valley VC culture blossomed and when SV pulled ahead from Boston and japan
In Boston Greylock and Charles River and later Matrix Partners were less go-getting
Firing of Cisco founders is Silicon Valley mythology of when VC showed its ruthlessness
As late as 1990, women were only 9% of engineers in United States and rarer in valley startups (data)
Accel an industry focused fund, its specialization avoided fads: “every deal should lead to the next deal”
UUNET example of government science and vc commercializing (started in northern Virginia as a nonprofit)
Al Gore: information superhighway for fiber optics
Mosaic browser with graphics profiled by NYT in December 1993. Marc Andressen invented at University of Illinois, a taxpayer backed lab where he was paid $6.85 an hour; he was offered a permanent job but he had to give up on Mosaic. Instead he left for the Valley and with funding from Jim Clark, seven other Illinois lab employees were lured away with big salaries, making another Traitorous 8
Mike Moritz, a TIME journalist took a job at Sequoia and understood Yahoo’s irreverent founders and plans to not charge users. This may have been a first in VC but had precedent in general interest news orgs
Yahoo’s Yang said he picked Moritz as investor because he had “soul”
“The innovation of backing companies that charge little or nothing for products spread through the venture capital business like wildfire”
Tom Perkins’s dictum; because Yahoo had no real technology (much of its cataloging was manual) it wasn’t technical risk so it was all business risk. Yahoo had to show momentum and growth because it had no real technology. That set internet culture of growth
Son offered first $100m investment; it went to Yahoo
Kapor and Omidyar made VC wealth and later got into philanthropy
Omidyar built a community model for eBay and sought Benchmark Capital (a highly geographically focused VC) for governance help
In September 1998, eBay went public at $18 a share. By the end of November it soared to $200. In April 1999, it crossed $600.
When Google launched there was already at least 17 other internet search companies
Jeff Bezos sought John Doerr and Kleiner Perkins as first lead investor because of Doerr’s reputation
Eric Schmidt recruited as Google CEO, sign of governance via VC John Doerr
Google’s IPO with two class of shares which founders Brin and Page argued was like newspapers that has “responsibility to the world”, as their prospectus argued. They retained control to make tough decisions they argued and maintain trust
Paul Graham’s March 2005 unified theory of VC suckage
Don Valentine compared Zuckerberg’s Sequoia meeting in pajamas to Nolan Bushnell of Atari using a hot tub
Sequoia brokered PayPal and X.com merger , again vc as making it all happen
Andersson Horowitz investment in Instagram was a disaster: though its $250k became $78m when it was acquired by Facebook it needed to be far larger to power that fund
Alpha: returns based on insight; beta: returns for being in the market
Paul Graham and girlfriend Livingston’s Y Combinator built on thesis that software startups needed little cash to test an idea. $10k for 6% originally; Alexis Ohanian and Sam Altman were among the first. He felt he wasn’t just meeting entrepreneurs but creating them
VC: first generalists, then industry like Accel and then stages like seed via YCombinator
Gary Rieschel led a China VC push, so did Shirley Lin via Goldman Sachs; Neil Shen established Seqoiua China
Alibaba was no China government start and US finance support; Alibaba was to China what Fairchild was to US
Being too early can be the same as being wrong
Tiger Global pioneered “this of that” investing like Amazon of China and Google of Russia; Yuriy Milner brought that this of that model to US
“VCs, as individuals can stumble sideways in to lucky fortunes: Chance and serendipity in the mere fact of being in the venture game can matter more than diligence or foresight. At the same time, venture-capital, as the system is a formidable engine of progress – more so than is frequently acknowledged.”
The power law concept is that you lose only 1x your money but miss a deal and you could miss out on 10x or 100x
Facebook’s breakthrough was using college campuses to build up density and student email addresses to ensure quality
Accel used “prepared mind” exercises to recognize it had lost Web 2.0 deals like Skype and Flickr because it overlooked that founders of consumer brands were frequently unorthodox, but the data of scale is the signal regardless of governance quality
Accel outbid Washington Post for Facebook
VC is known for path dependency (success begets access and success) but the decline of Kleiner Perkins shows it can falter
Kleiner and John Doerr bet big from 2004 to 2007 and onward on cleantech that just didn’t emerge: large markets are not necessarily profitable ones; after 2008, they began to hit with Beyond Meat and QuantumScape and Nest. In 2001, John Doerr (Google and Amazon) was third on Forbes Midas list; in 2021, he was 77
Aileen Lee and Ellen Pao were among the women investors that John Doerr brought in the Kleiner Perkins, one small, bright light of doors, overbearing personality that is often also attributed to Kleiner Perkins over extension in the clean tech
Yuriy Milner bought $300m of Facebook ($200m of fresh equity and $100m buying employee shares) by declining a board seat to concentrate Zuckerberg’s control and with his international analysis showing Facebook could grow revenue both in United States and abroad; this big passive investment began the era of the Unicorn as Milner was ok to be passive because he treated it as passive
In 1995, Netscape showed a red hot internet company didn’t have to be profitable to go public; in 2009, Milner and Facebook showed a mature and profitable company had option of staying private
Incremental margins: with additional revenue, do costs grow less quickly?
A16z wanted to hire all entrepreneurs but eventually admitted that they found venture experience is a different skill (entrepreneurs only see inside 1-3 companies in a career)
Sequoia brought data focus, like part of effort to buy Golden State Warriors; they developed the investment scout model
Theranos, Uber and WeWork seen as natural extension of founder-first control (ie Benchmark Dunlevie). In 2012 WeWork was profitable. In 2015 sales doubled but expenses tripled. (Bad incremental margin) That same year, the mercurial founder Adam Nuemann sprayed one of his financiers with a fire extinguisher as part of an elaborate prank. The investor poured in money the next year, pushing WeWork’s valuation to $16b. In 2017, SoftBank invested $4.4b, more than WeWork’s previous lead investor Benchmark had raised in its entire 22-year history
“We saw the valuation rise, and the corporate governance erode “ a T Rowe price exec about WeWork (T Rowe sold off much equity to SoftBan in the big $4.4b round)
Lesson for other Series A investors: If they didn’t have growth investments, would governance and their investments erode? It’s in part why many early stage started adding growth stage too
Bill Gourley from Benchmark was excited by research from Brian Arthur on network effects; OpenTable inspired him to think of an alternative to taxis. He found TaxiMagic but didn’t want its reliance on regulatory taxi cabs. He found Uber in 2009 but wasn’t interested until Travis Kalanaick wold take on CEO full time
Kalanick took cheaper money from Menlo partners over lower valuation from a16z
Gurley wirh Uber and Dunlevie at WeWork : early investors who lost governance control and influence
Theranos did not win over any Silicon Valley investors; all outside money (ie Walton’s); WeWork only had benchmark which represented just 1% of overall funding , and Uber got even less funding from traditional VC: author argues that these are not as clear examples of VC excess
Impact of Fed low rates and new late stage money that didn’t want to write $10m checks it wanted $100m checks
Matthew Salganik and sugar man phenomenon: blockbusters are random
Between 1979-2018, the median VC fund narrowly underperformed stock market; the top 5% trounced it
NBER 2018 paper used Salagnik logic for VC: each IPO among a VC’s first 10 predicts 1.6% higher IPO rate later; due to network effects
This book argued that VC still requires skill: 1) path dependency just concentrates some of the many who have skill; 2) some partnerships have shaped the whole industry 3) many serious firms compete so it requires skill to navigate entrepreneurs to get into the right deal 4) vc are coaches not athletes and so it’s similar murky but clear differences emerge
When air travel improves connections between a VC and a startup, performance improves https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12370
Tiger Global and Yuriy Milner invented late stage investing; Paul Graham shaped batch processing of early stage
Lifting of restrictions on pension funds and reduction in capital gains taxes brought in much more venture investing
Tim O’Reilly wrote “blitz scaling isn’t really a recipe for success, but rather survivorship bias masquerading as a strategy.”
Josh Kopelman wrote “I sell jet fuel… Some people don’t want to build a jet.”
Israel Singapore and New Zealand are exceptions where government intervention helped drive VC, otherwise taxpayer dollars have been wasted to grow venture capital
In 2009, Josh Lerner’s Boulevard of Broken Dreams argues many failed attempts to blossom VC
Lessons on making change that do work: (1) tax breaks not subsidies (limited partnerships are example, as they avoid double taxation of corporations for both company and shareholder, by being pass through entities); (2) couple VC tax concessions with encouraging employee stock options (3) invest in science (1980 Bayh-Dole act for universities) (4) compete globally (compete for talent via immigration and adapt policies when other countries show promise
“Tax concessions for venture capital can be coupled with higher inheritance tax”
How should US respond to China? Don’t stop US financing there; but do consider stopping flow of Chinese dollars into US ; restricting Chinese talent is far murkier

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