Don’t judge a book by its cover. I’m not sure I’ve ever seen a less inviting one.
Sebastian Mallaby’s The Power Law: Venture Capital and the Making of the New Future and its awful cover sat on my floor for almost a year, but I finally got around to reading it. The book chronicles the evolution of VC from its beginnings to the present and does a great job mixing high-level history with fun stories and insightful analyses. My timing ended up being perfect as I’ve been increasingly curious about VC, both as a general interest and as a theoretical/unlikely career path. It’s a fun read if you have any interest in VC or “tech”, and it definitely left me wanting to learn more.
A quick summary:
VC is a really recent “invention”! I assumed it had been going on in some form for at least a couple centuries, but it turns out it really only got started in the 1940s and 50s. A small number of wealthy “early stage” investors did exist prior to then (whaling is a famous example of 1800s “VC” that I wish he discussed), but there was no such thing as a “VC firm”, and startups relied primarily on hard-to-get loans.
The VC story starts with a group of lab-mates (known as the “Traitorous Eight”) in 1957 who had profitable research ideas but felt stuck and limited in the lab they worked at. It never occurred to any of them that they could simply start their own company and pursue their ideas until an early VC got in touch with them. They ended up starting Fairchild Semiconductor, which would go on to invent some of the key hardware components of modern computing (ex. Integrated circuits).
Since then, VC has been the most common form of financing in the “tech” industry, playing important roles in all the famous computer and internet companies that have come and gone in the past half century. “The Power Law” is the key behind the success of VC investing. If a VC makes a bad $1M investment, they can lose $1M. If they make a good $1M investment, they can make $1B (1000x return). Given the asymmetries of these returns, VCs usually try to make a lot of risky investments with high upsides. One very good investment can easily make up for a hundred bad ones.
While VC’s financial success is widely known, they aren’t given much credit for the Tech industry’s success. The value of a good VC isn’t JUST that they allocate capital to the most promising firms. They also provide valuable guidance and often step in when founders are out of their depth or leading the company in the wrong direction (ex. investors ousted the founders of Cisco and Uber when they became too scandalous and hard to work with).
Some other fun nuggets from the book:
Giving employees equity in their company only became common in the 1960s
Mallaby thinks VC is the primary reason for the emergence of Silicon Valley. It wasn’t clear to me why VC ended up centered on the West Coast. This might just be contingency, where the first couple big VC firms happened to be there, and then that attracted more founders and future VCs. But once it was established there, it made sense for startups to be there as well.
It’s really hard to tease out how much of VC is luck vs skill, especially because once a firm has a couple good bets, their future investments will increase in value just through brand name association (i.e VC success has a strong path dependency)
It’s kinda funny how companies can be AMAZING investments even if the time that company spends “on top” is very limited (ex. billions were made on Yahoo, Skype, MySpace, etc.)
How VCs deal with eccentric founders was very interesting. Some avoid them entirely, but history has shown this is usually at their own peril. Others put up with all sorts of annoyances (ex. Facebook was intentionally super rude to investors) in order to be a part of promising companies. Does not sound very fun either way
There was an intriguing chapter on the history of VC in China that gave US VC (and Chinese VC) a lot of credit for China’s impressive growth. Not sure how much I should buy that idea, but BIG IF TRUE.
There have been multiple periods with too much money chasing too few opportunities. One negative result: founders can ignore advice and get away with bad behavior because they will still get funded. Also leads to bubbles
Mallaby argues Theranos was NOT an example of VC gone wrong and that most of their major backers were megarich non-VCs that were swayed by Elizabeth Holmes’ charisma (ex. Walton family, Rupert Murdoch, Henry Kissinger)
From a societal perspective, it seems very un-ideal that a founder who maintains voting control can essentially destroy their company and billions of dollars worth of value, and no one can stop them*. This nearly happened with Uber, and investors were only able to get Travis Kalanick to step down through blackmail. The “Unicorn Governance Issue”, as Mallaby calls it, seems essentially unsolvable as long as there is lots of “stupid money” going around.
*This applies to any company! It’s not just a VC/startup issue. A billionaire could theoretically buy a social media giant and run it into the ground
Questions I have:
When do VCs usually sell their stakes in a company and how do they decide when to sell?
What are average VC returns like these days? What is the distribution of returns between firms?
Why don’t (some) VCs take a more analytical approach? It seems like a combination of the typical personality/intuition-based VC approach and the digging-into-numbers “finance” approach would yield better returns than either on its own. This seems especially true for less transformative technologies (i.e a better fit for “digital health” than flying cars).One response is Home Runs Are All That Matters in VC, and identifying talent leads to home runs much more than poring over data/trends. Perhaps the talent identification could at least be more data-driven/less intuition-based.
How has VC done outside of low-capital “tech”? There’s a section on VC failing in “cleantech” in the 1990s and 2000s, but is it doing better now? Biotech is only briefly mentioned, but I’m curious what the returns have been there and if VC has been as influential as it has been with “tech”. To me, biotech, hardware, and greentech/energy are much more important than software, so if the VC model isn’t as workable for them that would be disappointing.
What do most VC failures look like? Given The Power Law, a MISSED investment is 1000x worse than an investment-gone-wrong, but I still would have liked to read about some investments-gone-wrong (or at least gone meh), especially since the (heavy?) majority of investments are in this category.
I barely touched on any of the stories and anecdotes in the book, but there are a lot of fun ones from some very famous companies. These alone make the book worth reading even if you don’t care for the analysis (or the cover)!
P.S I also read Mallaby’s biography of World Bank president Jim Wolfensohn (The World’s Banker) before The Power Law. Recommended as well.
P.S.S: I also liked this Jason Furman review: Sounds like I might have to check out Mallaby’s hedge fund book! I definitely hold VC in a much higher regard than hedge funds, so it will be interesting to read a defense of them. I recently read a defense of Private Equity (Money Games: The Inside Story of How American Dealmakers Saved Korea's Most Iconic Bank), which was enjoyable and a convincing defense of at least that specific type of PE (rescuing failing institutions in developing countries).
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