Book Review — The Power Law by Sebastian Mallaby
Two days ago, I finished The Power Law: Venture Capital and the Making of the New Future by Sebastian Mallaby. Mallaby was a contributing editor for the Financial Times and a columnist and editorial board member at The Washington Post. The book was written in 2022.
This hefty 496-page book is a lucid account of the beginning, growth, and development of the American Silicon Valley, the global center for high technology and innovation and home to many of the world’s largest high-tech corporations, including the headquarters of more than 30 businesses in the Fortune 1000 and thousands of startup companies. The story is told from the viewpoints of entrepreneurs and venture capitalists who funded, trained, and guided them these entrepreneurs toward making products and services that we take for granted today.
The starting story of the defection and funding of the traitorous eight in 1957 brings this story home. Arthur Rock, the father of venture capital, encouraging and backing those employees to leave and start their own company made all the difference. “We were blown away. Arthur pointed out to us that we could start our own company. It was completely foreign to us.” By 2014, an astonishing 70 percent of the publicly traded tech companies in the Valley could trace their lineage to the company they funded. Such is the impact of venture capitalists. There were tons of intriguing stories about venture capitalists, including that of the PayPal mafia, taking and receiving bets from people who did not dream at all or did not dream enough.
The impact is even more profound when government policies align with the flow of capital. The rule of law and price stability, coupled with a government willing to reward those who risk their capital, can create enormous wealth. When Ronald Reagan cut the capital gains tax in the 1980s, the United States opened the floodgates to an avalanche of creativity. It made venture-backed firms go public without showing a history of profits. Employee stock options were taxed only when they were finally exercised, not when they were initially granted. Limited partnerships were exempt from tax, and they protected investing partners from lawsuits. No other country was so friendly to the venture industry. There would be no Amazon, Facebook, or Tesla, at least not the way we know them now, without those incredibly startup-friendly policies.
Even at that, as you will see from stories about Apple and 3Com, not all venture capitalists are created equally. A fellow was offered one-third of Apple for $50,000 but rejected it. He lived to regret it. “I was so smart, I said no. It’s kind of fun to think about that when I’m not crying,” he later said. Yet it should not be taken for granted that, come what may, Apple would have been successful. In fact, Apple’s success is largely due to its ability to secure the best distribution channels, which came about because it was able to hire the best people. It was able to hire the best people because of its well-connected backers. They may be late to arrive, but once the VCs arrived and removed the white-hot risks, they pulled strings to ensure Apple got everything it wanted. Several times, it was people like Arthur Rock, the legend with the capital L, assuring financiers and potential recruits that “the people running this company… are very bright, very creative, and very driven” that made all the difference. Believe me, the chapter dedicated to Apple was gangsta. You should read it.
#DoYouKnow When VCs hounded Google’s founders, Page and Brin, to get a CEO, they said Steve Jobs was the only one up to the task.
The proliferation of successful entrepreneurs flush with cash who could also back other entrepreneurs boosted the confidence of those venturing into startups. The story was told of an entrepreneur who was untroubled by the prospect of failure because he had seen that failure often meant that you raised more venture dollars the next time. Chuck Geschke duly started Adobe and has gone on to mentor many entrepreneurs looking for success. Others have gone so far as to invite potential founders’ families to dinner in order to persuade their spouses to let them take the risk.
It is not just spouses that VCs have to work on; they are also in the business of mediating between competition and cooperation. VCs spread their funds widely, and as it often happens, it is not strange to see a VC back rival companies. They source for the same workers, suppliers, and even intellectual properties. So, how come costly litigation is rare in Silicon Valley? VCs nurtured the garden where reputation and trust were comfortable. As a result, the Valley became home to 39 of America’s 100 fastest-growing electronics firms. Its rival, Boston, claimed just four of them.
#DoYouKnow Lerner and Bosack created Cisco so as to send love notes to each other on the campus of Stanford University.
For some, all VCs are the same, but as the reader will see, there are different kinds of VCs. From those who concentrate on specific industries, to those who would back you as long as you have a viable product, to those who have a dedicated in-house team to guide the business to success, to those who, like Google, require that an external CEO be brought in to steer the ship. And there is another type, like Masayoshi Son, who invests only in growth companies, requiring no board seats and thereby giving more leverage to the founder. When Son, the outsider to the Valley, entered the scene with his investment in Yahoo, he altered the venture capital landscape forever. VCs now know that huge growth-capital checks conferred kingmaker powers and that it paid to think bigger than just the Valley.
More than any venture capital company in history, Sequoia embodied this the most. Moving beyond the Valley, Sequioa and other veteran Silicon Valley VCs landed in China as the country became open to capitalism and helped build almost all of the most successful companies in China today. China’s technology boom was forged to a remarkable extent by American investors, and the Chinese VCs who emerged alongside them were themselves quasi-American — in their education, professional formation, and approach to venture capital. They had studied at top U.S. colleges, worked at U.S. companies, and carefully absorbed the U.S. venture playbook: equity-only funds, stage-by-stage financing, sleeves-rolled-up involvement, and stock options for startup employees.
As American VCs spread across the world, their influences spring up and even challenge them on their turf. Just like Masoyoshi Son, there is Yuri Milner, who caused the VC world to rethink their models. But more often than not, the home of Venture Capital is capable of learning its own lessons, as in the case of Bill Gurley with Uber, Bruce Dunlevie with WeWork, and even showing the world that Elizabeth Holmes of Theranos could get away with so much because she actively avoided established VCs.
#NewWordAlert Potemkin
Based on such lessons and more, adventurous and creative funds like Paul Graham’s Y-Combinator and Peter Thiel’s Founders Fund were created. While not mentioned in the book, another innovation that is rippling through the VC community is the controversial Thiel Fellowship, which gives $100,000 to young people who want to build new things instead of sitting in a classroom. Several teenagers and those in their 20s have dropped out of college to key into this initiative to build great companies. Successful companies from this fellowship include Figma, worth $20 billion, and Ethereum, which is worth multiples of that figure.
In the last pages, Mallaby analyzes why critics of the venture industry are not being rational. Of course, it has to do better with its gender balance, but to say venture capitalists encourage out-of-control disrupters and could allocate society’s resources in some better way glosses over the fact VCs have always backed any and every kind of company. History has shown that venture capital is the go-to source of finance for innovative and ambitious startups worth anything from a few million to a few billion dollars. So long as the startup is targeting a lucrative market and has a shot at delivering 10x or more to its investors, it really doesn’t matter what sector it is in. As to the critic’s claim that it encourages out-of-control disrupters, it is more of a warning to founders than VCs. Venture capitalists are the first to proclaim that cautious founders should raise money elsewhere. Venture capital is suitable only for the ambitious minority that wants to take the risk of growing fast, and VCs of all kinds have an interest in being open about this. If they force-feed capital to unsuitable firms, they know they will lose it.
The impact of Venture Capitalists is undeniable. From 1995 to 2019, VC-backed companies accounted for fully 47% of U.S. nonfinancial IPOs; in other words, a VC-backed firm was orders of magnitude more likely to make it to the stock market than a non-VC-backed one. Even better, while VC-backed firms accounted for 47% of IPOs, they accounted for 76% of the market value. All these cannot be detached from their incredible commitment to innovation, as can be seen in the fact that they account for fully 89% of R&D spending.
Any country looking to prosper must recognize the role of venture capital. As detailed in the book, Europe lags in innovation behind places like Israel, Singapore, China, and the United States because of its laws, which inhibit the full expression of venture capital. Some lessons and many case studies here for African countries.
This book is a riveting fly-on-the-wall account of the emergence of this unique and crucial sector in finance, based on extensive interviews with some of the most successful Venture Capitalists. Mallaby has earned my respect for this book, and this is not the last book of his I will be reading.
