‘the Power Law’ Offers Key Takeaways on the History of Venture Capital
The area is home to a cluster of elite universities and near military research centers, but neither are solely responsible for the region’s ascent, he writes.
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The Valley’s secret sauce, he writes, is a combination of a counterculture and a “frank lust for riches.”
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2. The birth of venture capital in 1957 starts with eight young scientists at Stanford who escaped a manager they reviled to form their own semiconductor company.
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The group’s defection was made possible by a 30-year-old stockbroker named Arthur Rock, who helped them raise over $1.4 million for their yet unproven venture.
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“The idea was to back technologists who were too dicey and penurious to get a conventional bank loan but who promised the chance of a resounding payoff to investors with a taste for audacious invention,” Mallaby writes. That bet paid off for Rock and other investors.
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The startup, Fairchild Semiconductor, took off and sold to its main backer for $3 million. The founders and Rock’s firm pocketed a 600x return on their investment.
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Their major exit showed how venture capital could nourish talent to form big, successful companies.
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3. The venture industry stands apart from other forms of institutional finance because of its heavy-handed involvement in the business, Mallaby writes.
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One of the chief pioneers of this new style was Don Valentine, the founder of Sequoia Capital. He backed entrepreneurs who were brilliant but undisciplined.
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Before his investment, the video-game startup Atari held business meetings in a hot tub. Valentine rolled up his sleeves and wrote the firm’s business plan, found distributors, and later, orchestrated a $28 million sale.
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“Rather than merely identifying entrepreneurs and monitoring them, as Rock had done, the new venture capitalists actively shaped them,” Mallaby writes.
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4. The success of a venture fund depends on a few startups hitting home runs even while most fail, a statistics-phenomenon known as the “power law.”
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From 1972 to 1984, Kleiner Perkins cut 14 deals out of its first fund, and pocketed a profit of $208 million. (That’s about $562 million in today’s dollars, adjusting for inflation.)
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Fully 95% of its profit came from just two investments: computer-maker Tandem and biotech firm Genentech.
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In the 1960s, early venture firms structured themselves as “limited partnerships” for lower tax rates. The format also protected investing partners from lawsuits.
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They raised money from universities and endowments, which had greater incentive to invest in venture funds as legislators slashed the capital-gains tax in the 1970s.
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“No other country was so friendly to the venture industry,” Mallaby writes.
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6. The funding of Apple showed the power of networks.
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The stars of venture capital first passed on investing in Apple, but rich individuals known as “angel investors” took a bite. They provided the founders with cash, connections, and importantly, credibility, Mallaby says.
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“If Apple was attracting funding, and if its reputation was soaring thanks to well-connected backers, its chances of hiring the best people and securing the best distribution channels were improving, too,” he writes.
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7. The founding of Accel marked the arrival of a new venture style: the so-called prepared mind.
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Accel’s style helped it to avoid fads and back winners. The first five funds multiplied capital 8x on average.
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8. Sometimes the investor who can write the biggest check can choose the winner in a hot market.
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In 1996, Yahoo was blowing through its venture funding on marketing in order to topple its rival search engines. Just as it was about to go public, Masayoshi Son, a self-made billionaire, proposed he invest a full $100 million.
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The Yahoo founders declined, telling Son they could raise tens of millions on the public markets through an IPO.
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Undeterred, Son said if they didn’t let him invest, he would invest in Yahoo’s rivals and effectively destroy them. The Yahoo founders agreed to the deal, under the condition that their company would still go public.
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“Son’s threat was a revelation,” Mallaby writes. “There could only be one victor in the race to be the go-to internet guide, so the investor who could write a $100 million check could choose who won the competition.”
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9. Google raised its first $1 million without ever speaking to a venture capitalist, highlighting a small but serious force in the Valley: angel investors.
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In the 1990s, a spree of companies going public created many new multimillionaires, some of whom wished to put their wealth and experience to use at startups.
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Google’s founders raised a first round of capital “without giving away more than a tenth of their equity, and without signing up for the performance targets and oversight on which venture capitalists insisted.”
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Feeling enlightened, other entrepreneurs “increasingly turned to angels for their early capital,” Mallaby writes.
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10. Peter Thiel put his stamp on the venture industry with his detached, hands-off investing style.
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After he left PayPal, Thiel banded with other alumni to create Founders Fund, a venture firm that promised to treat entrepreneurs with respect and autonomy.
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It vowed to keep founders in control of their own companies, and took a hard stance against providing mentorship to entrepreneurs, believing that didn’t make much difference in the likelihood of success.
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11. Today, there’s a venture firm to suit every founder.
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Benchmark’s founders believed that by staying small, they could carefully evaluate each deal and “descend into the trenches with the entrepreneurs.”
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Founded by two entrepreneurs, Andreessen Horowitz offered coaching and support services for their companies, promising them a wealth of connections.
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There is no right way to run a venture firm, and as firms multiply, their methods increasingly overlap.
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They do have one thing in common …
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“The best venture capitalists consciously create their luck,” Mallaby writes. “They work systematically to boost the odds that serendipity will strike repeatedly.”
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Mallaby devoted four years to researching “The Power Law,” which is based some 300 interviews and countless pages of emails, financial filings, and internal documents.
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