Tue. Jan 18th, 2022

In May 1976, a California securities regulator wrote to venture capital fund Kleiner Perkins to warn about the risk of its $ 100,000 investment in Genentech, an early biotechnology startup. “We are making highly speculative investments,” his co-founder Eugene Kleiner calmly replied.

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

Yet half a century later, while “software is eating the world”, in the words of Marc Andreessen, co-author of the groundbreaking Mosaic browser, venture capital has eaten up the stock market. Apple, an example of California technology risk-taking, has reached market capitalization of $ 3tn. Facebook, Google and Elon Musk’s Tesla dominate investment portfolios.

The Genentech investment shows why: Kleiner Perkins made a 42-fold return on its first investment fund after Genentech went public in 1980 on a turbulent valuation. This proved the power law of venture capital: a small minority of investments yield most of the returns. It only had to get a few financial bets out of a lot to generate big profits.

Line graph of market value ($ billion) showing a small number of venture capital investments yielded large returns

Sebastian Mallaby’s comprehensive and authoritative history of the venture capital revolution, from its roots in the cottage industry in the 1950s to its colossal influence today, tells a secret story. More attention was focused on the entrepreneurs who rebuilt the world with technology, such as Jeff Bezos, Elon Musk and Mark Zuckerberg, than those who supported them.

Mallaby fixes it with The Law of Power. A Briton who is a senior fellow of the Council on Foreign Relations is not an obvious Boswell to a cabal of American financiers, but he has sympathy with their conflicting cage rattle. If it does not shine, it is a worthy successor to More Money than God (2010) and The Man Who Knew (2016), his award-winning books on hedge funds and Alan Greenspan, former chairman of the US Federal Reserve.

The venture funds around Palo Alto and Menlo Park, from Benchmark and Sequoia to Andreessen Horowitz, the fund set up by Andreessen, exert extraordinary influence. Their financial support has given all sorts of disruptive businesses an imprimatur, from social media platforms to today’s cryptocurrency and blockchain hopefuls.

The Law of Power is comprehensive to an extent that sometimes puts the reader’s patience to the test, but Mallaby enlivens it by diving into the personalities, and the tensions, behind the industry’s evolution. This includes the speakers Mike Moritz (now Sir Michael) of Sequoia, the mercury Andreessen and Pieter Thiel, the vengeful libertarian behind Founders Fund.

The question is, as Mallaby writes, “Did the VCs create the success, or did they just show up for it?” In the early days, they played a major role. There were fewer investors then willing to put money on risky ideas, and funds often “worked with entrepreneurs in an entrepreneurial way,” as Tom Perkins of Kleiner Perkins put it. In other words, they handed out a lot of advice.

Mallaby attributes this alchemy to a “combination of relaxed creativity and the pursuit of commercial ambition” reinforced by “an open-minded lust for wealth”. A key venture capital insight was to invest just as much in founders as technology, as the latter was impossible to judge. It was easier to identify individuals, often ambitious immigrants, who would not tolerate failure.

Bar venture capital invested in the US ($ billion) showing US investment in the US exceeding $ 100 billion in 2020 for the third consecutive year

But as more investments yielded exorbitant returns (Sequoia and Kleiner Perkins jointly put only $ 24 million into Google in 1999; when the company was announced five years later, it was valued at $ 23 billion), entrepreneurs’ self-esteem grew. If capital was easy to capture and they were the key to success, how much did they need the Moritze of the world? Many founders, such as Zuckerberg at Facebook, thought Sand Hill Road’s old guard was being paid to show up.

Thiel turned resentment into a philosophy, arguing not only that venture capitalists offer little more than cash, but that their oversight actively caused harm. Since the most original founders were “arrogant, misanthropic or borderline crazy”, it was best to let them go their own way. Mallaby notes that several early PayPay employees built bombs while in school.

The uprising coincided with capital becoming much looser. Sand Hill Road was proud to invest limited amounts wisely, but its success yielded a wall of money. Masayoshi Seun of SoftBank in 1996 made a $ 100 million investment in Yahoo by “shooting from the hip”. Benchmark’s $ 1 billion fund in 1999 was 10 times the size of its first one, four years earlier.

It had to end in tears and it did so at Uber, where Benchmark had to conspire to defend the willful co-founder Travis Kalanick, and at WeWork, whose guru-like leader Adam Neumann was flattened by a failed attempt at an IPO. The saving grace for Sand Hill Road was that no big name invested in Theranos, the fraudulent blood testing business founded by Elizabeth Holmes.

The scandals have generated a bit of humility among a group for whom it does not come naturally. In the wake of the WeWork debacle, Son withdrew to grow companies “leaner, faster, bigger”. But SoftBank and its Vision Fund have not stopped taking bets with other people’s money, and Sand Hill Road is still pursuing 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? Venture capitalists’ secret was to look through the doubt and “imagine. . . what can happen if everything goes right ”, as Moritz told Mallaby. Despite the industry’s nasty side, including its male-dominated, testosterone-tinted culture, it has changed the world.

Mallaby judiciously concludes that “venture capitalists as a group have a positive effect on economies and societies ”. They undoubtedly proved powerful. Behind Facebook, Google, Uber, SpaceX, Amazon, Deliveroo and all the rest were venture funds with unlimited financial appetite and very strong nerves. You should quite admire it.

The power law: Venture capital and the art of disruption by Sebastian 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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