The law of power – how venture capital ate the stock market

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In May 1976, a California securities regulator wrote to venture capital fund Kleiner Perkins warning them of the risky nature of their $ 100,000 investment in biotech startup Genentech. “We are making highly speculative investments,” replied its co-founder Eugene Kleiner calmly.

Silicon Valley’s “adventure capitalists” have sparked skepticism and sometimes hostility since Kleiner Perkins became the first partnership to open an office on Sand Hill Road – the indescribable highway that has become the Wall Street equivalent in Northern California – in 1972. Paul Graham, an influential technology investor, described them as “the classic villain: alternately cowardly, greedy, devious and bossy.” Another critic denounced them as “the soulless agents of Satan.”

Yet half a century later, as “software eats the world,” in the words of Marc Andreessen, co-author of the revolutionary browser Mosaic, venture capital has eaten the stock market. Apple, the embodiment of California technology risk-taking, has reached a market cap of $ 3 billion. Elon Musk’s Facebook, Google and Tesla dominate investment portfolios.

Genentech’s investment shows why: Kleiner Perkins made a 42-fold return on his first investment fund after Genentech went public in 1980 at an exhilarating valuation. This has proven the power law of venture capital: a small minority of investments produce the most returns. It was enough for him to make a success of a few financial bets among many others to generate big profits.

Sebastian Mallaby’s radical and authoritative story of the venture capital revolution, from its artisanal roots in the 1950s to its colossal influence today, tells an undercover story. More attention has been paid to the entrepreneurs who reshaped the world with technology, such as Jeff Bezos, Elon Musk and Mark Zuckerberg, than to those who supported them.

Mallaby remedies it with The law of power. A Briton who is a senior member of the Council on Foreign Relations is not an obvious Boswell to a cabal of American financiers, but he sympathizes with their backlash. If it is not sparkling, it is a worthy successor to More money than god (2010) and The man who knew (2016), his acclaimed books on hedge funds, and Alan Greenspan, former chairman of the US Federal Reserve.

The venture capital funds scattered around Palo Alto and Menlo Park, from Benchmark and Sequoia to Andreessen Horowitz, the fund co-founded by Andreessen, wield extraordinary influence. Their financial support has given an impression of imprimatur to all manner of disruptive businesses, from social media platforms to today’s cryptocurrency and blockchain hopes.

The law of power is complete to a degree that sometimes tests the patience of the reader, but Mallaby enlivens it by delving into the personalities and tensions behind the evolution of the industry. They include Sequoia’s talkative Mike Moritz (now Sir Michael), Mercurial Andreessen, and Peter Thiel, the vengeful libertarian behind Founders Fund.

The question is, as Mallaby writes, “Did VCs create success, or did they just come forward for it?” At first, they played a big role. There were fewer investors then willing to bet money on risky ideas, and funds often worked “with entrepreneurs in an entrepreneurial manner,” as Kleiner Perkins’ Tom Perkins put it. In other words, they gave a lot of advice.

Mallaby attributes this alchemy to a “combination of relaxed creativity and driving commercial ambition” boosted by “a frank thirst for wealth”. A key idea of ​​venture capital was to invest as much in the founders as in the technology, because the latter was impossible to assess. It was easier to identify individuals, often ambitious immigrants, who did not tolerate failure.

Column chart of venture capital invested in the United States (in billions of dollars) showing that venture capital investments in the United States topped $ 100 billion in 2020 for the third year in a row

But as more and more investments produced disproportionate returns (Sequoia and Kleiner Perkins jointly invested just $ 24 million in Google in 1999; when the company went public five years later, it was valued at 23. billion dollars), the self-esteem of entrepreneurs has increased. If capital was easy to trap and was the key to success, how much did it demand from the Moritz of the world? Many founders, such as Zuckerberg at Facebook, believed the old guard on Sand Hill Road was being paid to show up.

Thiel turned resentment into a philosophy, arguing that not only venture capitalists offer little more than money, but their oversight is actively causing harm. Since the most original founders were “arrogant, misanthropic, or bordering on madness,” it was best to let them go their own way. Mallaby notes that several of PayPay’s early employees built bombs at the school.

The revolt coincided with capital becoming much more loose. Sand Hill Road prided itself on investing limited sums wisely, but its success created a wall of money. SoftBank’s Masayoshi Son made his way into a $ 100 million investment in Yahoo in 1996 by “pulling from the hip.” Benchmark’s $ 1 billion fund in 1999 was 10 times the size of its first four years earlier.

It was to end in tears and it happened at Uber, where Benchmark had to plot to defend voluntary co-founder Travis Kalanick, and at WeWork, whose frontman Adam Neumann was toppled by a failed attempt at an introduction in stock Exchange. . The saving grace for Sand Hill Road was that no big name had invested in Theranos, the fraudulent blood testing start-up founded by Elizabeth Holmes.

The scandals have produced a bit of humility within a group that does not come naturally. In the wake of the WeWork debacle, Son recanted that businesses are getting “crazier, faster, bigger.” But SoftBank and its Vision Fund haven’t stopped taking bets with other people’s money, and Sand Hill Road is always chasing the next big thing with crypto.

Something will go wrong, but how useful is it to warn about it when history suggests the opposite lesson? The secret of venture capitalists has been to see through doubts and “imagine.” . . what can happen if all goes well, ”as Moritz told Mallaby. Despite the wicked side of the industry, including its male-dominated, testosterone-tinged culture, it changed the world.

Mallaby wisely concludes that “venture capitalists as a group have a positive effect on economies and societies ”. They have unquestionably proved to be powerful. Behind Facebook, Google, Uber, SpaceX, Amazon, Deliveroo and all the rest were venture capital funds with unlimited financial appetites and very strong nerves. You have to admire it in a way.

The power law: Venture capital and the art of disruption by Sébastien Mallaby, Allen Lane £ 20 / Penguin Press $ 30, 496 pages

John gapper is an FT Weekend columnist

Data visualization by Keith Fray

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