The Power Law: Venture Capital and the Making of the New Future
496
The Power Law: Venture Capital and the Making of the New Future
496eBook
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Overview
Named a Best Book of 2022 by The Economist
“A gripping fly-on-the-wall story of the rise of this unique and important industry based on extensive interviews with some of the most successful venture capitalists.” - Daniel Rasmussen, Wall Street Journal
“A must-read for anyone seeking to understand modern-day Silicon Valley and even our economy writ large.” -Bethany McLean, The Washington Post
"A rare and unsettling look inside a subculture of unparalleled influence.” —Jane Mayer
"A classic...A book of exceptional reporting, analysis and storytelling.” —Charles Duhigg
From the New York Times bestselling author of More Money Than God comes the astonishingly frank and intimate story of Silicon Valley’s dominant venture-capital firms—and how their strategies and fates have shaped the path of innovation and the global economy
Innovations rarely come from “experts.” Elon Musk was not an “electric car person” before he started Tesla. When it comes to improbable innovations, a legendary tech VC told Sebastian Mallaby, the future cannot be predicted, it can only be discovered. It is the nature of the venture-capital game that most attempts at discovery fail, but a very few succeed at such a scale that they more than make up for everything else. That extreme ratio of success and failure is the power law that drives the VC business, all of Silicon Valley, the wider tech sector, and, by extension, the world.
In The Power Law, Sebastian Mallaby has parlayed unprecedented access to the most celebrated venture capitalists of all time—the key figures at Sequoia, Kleiner Perkins, Accel, Benchmark, and Andreessen Horowitz, as well as Chinese partnerships such as Qiming and Capital Today—into a riveting blend of storytelling and analysis that unfurls the history of tech incubation, in the Valley and ultimately worldwide. We learn the unvarnished truth, often for the first time, about some of the most iconic triumphs and infamous disasters in Valley history, from the comedy of errors at the birth of Apple to the avalanche of venture money that fostered hubris at WeWork and Uber.
VCs’ relentless search for grand slams brews an obsession with the ideal of the lone entrepreneur-genius, and companies seen as potential “unicorns” are given intoxicating amounts of power, with sometimes disastrous results. On a more systemic level, the need to make outsized bets on unproven talent reinforces bias, with women and minorities still represented at woefully low levels. This does not just have social justice implications: as Mallaby relates, China’s homegrown VC sector, having learned at the Valley’s feet, is exploding and now has more women VC luminaries than America has ever had. Still, Silicon Valley VC remains the top incubator of business innovation anywhere—it is not where ideas come from so much as where they go to become the products and companies that create the future. By taking us so deeply into the VCs’ game, The Power Law helps us think about our own future through their eyes.
Product Details
| ISBN-13: | 9780525560005 |
|---|---|
| Publisher: | Penguin Publishing Group |
| Publication date: | 02/01/2022 |
| Sold by: | Penguin Group |
| Format: | eBook |
| Pages: | 496 |
| Sales rank: | 173,659 |
| File size: | 12 MB |
| Note: | This product may take a few minutes to download. |
About the Author
Read an Excerpt
Introduction
Unreasonable People
Not far from the headquarters of Silicon Valley's venture-capital industry, which is clustered along Palo Alto's Sand Hill Road, Patrick Brown strode out into his yard on the Stanford University campus. Atop a little hill behind his house, Brown got down on his hands and knees, a shaggy fifty-four-year-old professor in a T-shirt, peering at the vegetation through rounded glasses. Proceeding delicately, like a detective collecting samples that might yield a vital clue, Brown began digging out the roots of some wild clover plants. It might impress the ordinary gardener to know that those roots would soon yield $3 million.
Brown was one of the world's leading geneticists. In 1995, his lab had published pioneering work on DNA microarrays, which help distinguish between normal and cancerous tissue. He had been elected to the National Academy of Sciences and the National Academy of Medicine. He was the recipient of a Howard Hughes award, which guaranteed no-strings-attached research funding. But his objective on that hilltop had nothing to do with genetics. The year was 2010, and Brown was using a sabbatical to plot the downfall of the meat-industrial complex.
A friend had set him on this path by means of a stray comment. Possessed of a keen environmental conscience, Brown had been worrying that animal husbandry occupied one-third of the world's land, causing significant greenhouse gas emissions, water degradation, and a loss of biodiversity. The planet was clearly going to need a better kind of food for the growing population of the twenty-first century. Then Brown's friend mentioned that if you could make a vegetarian burger that tasted better than a beef burger, the free market would magically take care of the problem. Adventurous restaurants would serve it, and then McDonald's would serve it, and pretty soon you could eliminate meat from the food system.
The more Brown pondered this, the more he grew agitated. If you could make a yummier vegetarian burger? Of course you could make a yummier vegetarian burger! Why was nobody treating this as a solvable problem? "People just figured we have this insanely destructive system and it's just never going to go away," Brown fumed. "They thought, 'Bummer, but there you are.'"
In most places and at most points in human history, Brown's epiphany would have been inconsequential. But, as Brown himself reflected later, he had "the very good fortune of living in the epicenter of venture capital." Because Stanford sat at the heart of Silicon Valley, its golf course laid out along the edge of Sand Hill Road, Brown was digging up his yard with a clear purpose. Those clover roots contained heme, an iron-carrying molecule found in hemoglobin, which gives blood its red color. If Brown could show how this plant molecule could mimic the properties of bloody meat, there was a good chance that a venture capitalist would fund a plantburger company.
Brown dissected the clover roots with a razor blade and blended them up to extract and culture the juices. Pretty soon, he had what he needed to fashion a vegetarian burger that smelled and sizzled and dripped and squished like 100 percent Grade A beef. "I got to a point where, though I didn't have much data, I'd enough to go and talk to some venture-capital companies-of which there are a ridiculous number in Silicon Valley-and hit them for some money."
A scientist friend mentioned that Vinod Khosla, a venture capitalist who ran the eponymous Khosla Ventures, was interested in environmentally friendly, "cleantech" projects. What he didn't mention was that Khosla was also a preacher of the Valley's most bracing creed: the belief that most social problems can be ameliorated by technological solutions, if only inventors can be goaded to be sufficiently ambitious. "All progress depends upon the unreasonable man," the "creatively maladjusted," Khosla declared, borrowing eclectically from George Bernard Shaw and Martin Luther King Jr. "Most people think improbable ideas are unimportant," he loved to add, "but the only thing that's important is something that's improbable." If you were going to pitch Khosla an invention, it had better not fall into the incremental category he called "one sheet of toilet paper, not two." Khosla wanted radical dreams, the bolder and more improbable the better.
Brown rode a bicycle to Khosla's office, a sleek designer building of glass and wood. He had prepared a slide deck that he admitted "in retrospect was ridiculous." The first slide laid out his goal: rendering the entire meat industry redundant. Those rounded glasses-the John Lennon, Steve Jobs, visionary look-seemed altogether appropriate.
Khosla has large eyes and chiseled features and thick, cropped gray hair. He fixed his visitor with an impish stare.
"That's impossible!" he said, delightedly.
Silently, Khosla was thinking to himself, "If there is a one-in-a-hundred chance that this works, this is a shot worth taking."
Brown explained how he proposed to out-beef the beef industry. He would break the challenge down into its component parts: how to replicate the smell, the consistency, the taste, and the appearance of a real beef burger. Once you analyzed each question separately, an apparently impossible ambition became a set of soluble problems. For example, the clover-root juices would drip like blood onto hot coals; they would turn from red to brown as they sizzled on a barbecue. Dr. Frankenstein had met Ray Kroc. Nobody would eat ground cow flesh again.
Khosla ran through a test that he applied to supplicants. The onus was not on Brown to prove that his idea would definitely work. Rather, the question was whether Khosla could come up with a reason why it obviously could not work. The more Khosla listened to his visitor, the less he could rule out that he was onto something.
Next, Khosla sized up Brown as a person. He was fond of proclaiming a Yoda approach to investing: empower people who feel the force and let them work their magic. Brown was evidently brilliant, as his credentials as a geneticist demonstrated. He was gate-crashing a new field, which meant he was unburdened by preconceptions about what conventional wisdom deemed possible. Moreover, Brown was clearly as determined as he was bright: he was ready to leave his academic perch-the prestige of a Stanford professorship, the blank check from the Howard Hughes foundation. All in all, Brown fitted Khosla's archetype of the ideal entrepreneur. He had the dazzling intellect, the willingness to put his own neck on the line, the glorious hubris and na•vetŽ.
There was one last test that Khosla cared about. If Brown managed to produce a yummy plantburger, would he generate profits that would be commensurately succulent? Khosla routinely put capital behind moon shots with a nine-in-ten chance of failure. But the low probability of a moon landing had to be balanced by the prospect of a large payout: if the company thrived, Khosla wanted to reap more than ten times his investment-preferably, much more than that. There was no point gambling for success unless the success was worth having.
Brown had gotten to his final slide, where he stuck all the mundane market data that failed to interest a scientist. He noted matter-of-factly that "it's a trillion-and-a-half-dollar global market being served by prehistoric technology."
Khosla latched on. If plant patties could mimic the experience that customers expected from beef-the taste, the consistency, the browning, and the bleeding as you flipped the burger on the grill-the potential was cosmic.
Brown looked Khosla in the eyes. "I promise to make you even more insanely rich than you already are, if you give me this money," he told him.
At that, Khosla bet $3 million on Impossible Foods, as Brown fittingly named his company. Recounting this story in 2018, Khosla happily noted Impossible's progress since 2010: the company would soon have more than $100 million in annual revenues. But the main message that Khosla emphasized transcended dollars and cents. "You can imagine, if Pat fails, the hubris of saying he could eliminate animal husbandry; he'll be mocked for that," Khosla observed. But, he continued, the mockery would be misplaced. Which is better: to try and fail, or to fail to try? Reasonable people-well-adjusted people, people without hubris or na•vetŽ-routinely fail in life's important missions by not even attempting them; the way Khosla saw things, Brown should be hailed as a hero, whatever happened to his company. Truly consequential changes are bound to seem outrageous when they are first imagined by messianic inventors. But there is no glory in projects that will probably succeed, for these by definition won't transform the human predicament.
Khosla was himself an unreasonable man, creatively maladjusted. As a boy in his native India, he rebelled against his parents' religion, declined to follow his father into the army, and refused an arranged marriage. On his wedding day, he set his watch alarm, declaring that the religious portion of the ceremony had to be done inside thirty minutes. As soon as he earned an engineering degree, he left for the United States, where he studied more engineering at Carnegie Mellon University. After that, he set his sights on Stanford Business School; learning that he needed two yearsÕ work experience to qualify for admission, he did two jobs at once and declared after one year that he had met the requirement. In 1982, after completing his business degree, Khosla teamed up with three computer scientists to found Sun Microsystems, whose powerful workstations stamped their mark on the evolution of computing. Cocky and obnoxious, Khosla was soon fired. He became a venture capitalist.
Joining the storied venture partnership of Kleiner Perkins, Khosla discovered his true métier. His unreasonable impatience-his determination that anything might be possible and everything should work his way-made him one part tyrant, two parts visionary. In later life, he bought a village with forty-seven cottages on the California coast and fought a series of losing court cases to block public access to the beach, even though he never found time to spend the night there-not once, ever. But he channeled his contempt for conventional thinking into a series of dazzling investments, frequently losing his money and sometimes generating bonanzas. By the time he met Patrick Brown, everything about Khosla-his risk appetite, his love of hubris, his quest for improbable ideas-made him the living embodiment of the power law, the most pervasive rule in venture capital.
Many phenomena in life are normally distributed: nearly all the observations in a data set cluster around the average. For example, the average height of an American man is five feet ten inches, and two-thirds of American men are within three inches of that average. When you plot height on an x axis and the probability that a man will have that height on a y axis, what you see is a bell curve: the greatest probability is that a man's height will be the average height, and the probabilities decline as you move away from that midpoint. The chances of meeting a man whose height is ten inches from the average-that is, less than five feet or more than six feet eight-are exceedingly small. Further away from the mean, the thin tails of the curve taper toward zero.
Not all phenomena follow this pattern, however. A chart showing the wealth of Americans rather than their height looks very different. People who are richer than the median are sometimes vastly richer, so the far right side of the wealth chart features an extended fat tail between the curve and the x axis. Because the very rich are numerous enough and wealthy enough to impact the average for the whole nation, the average is pulled to the right: unlike in a normal distribution, the mean is higher than the median. In a normal distribution, moreover, you can remove the biggest outlier from a sample without affecting the average: if a seven-foot NBA star walks out of a cinema, the average height of the remaining ninety-nine movie-watching men falls from five feet 10 inches to five feet 9.9 inches. In a non-normal, skewed distribution, in contrast, the outliers can have a dramatic effect. If Jeff Bezos walks out of the cinema, the average wealth of those who stay behind will plummet.
This sort of skewed distribution is sometimes referred to as the 80/20 rule: the idea that 80 percent of the wealth is held by 20 percent of the people, that 80 percent of the people live in 20 percent of the cities, or that 20 percent of all scientific papers earn 80 percent of the citations. In reality, there is nothing magical about the numbers 80 or 20: it could be that just 10 percent of the people hold 80 percent of the wealth, or perhaps 90 percent of it. But whatever the precise numbers, all these distributions are examples of the power law, so called because the winners advance at an accelerating, exponential rate, so that they explode upward far more rapidly than in a linear progression. Once Jeff Bezos achieves great riches, his opportunities for further enrichment multiply; the more a scientific paper is cited, the better known it is and the more likely it is to attract further citations. Anytime you have outliers whose success multiplies success, you switch from the domain of the normal distribution to the land ruled by the power law-from a world in which things vary slightly to one of extreme contrasts. And once you cross that perilous frontier, you better begin to think differently.
The rethinking required is especially pronounced in finance. Investors who focus on currencies, bonds, and stock markets generally assume a normal distribution of price changes: values jiggle up and down, but extreme moves are unusual. Of course, extreme moves are possible, as financial crashes show. But between 1985 and 2015, the S&P 500 stock index budged less than 3 percent from its starting point on 7,663 out of 7,817 days; in other words, for fully 98 percent of the time, the market is remarkably stable. Because the distribution of price changes in these widely traded markets approaches normal, speculators concentrate on harvesting profits from the modest fluctuations that occur on most days. Like the seven-foot NBA star in the cinema, unexpectedly large price jumps are rare enough and moderate enough that they do not affect the average.
Now consider the returns in venture capital. Horsley Bridge is an investment company with stakes in venture funds that backed 7,000 startups between 1985 and 2014. A small subset of these deals, accounting for just 5 percent of the total capital deployed, generated fully 60 percent of all the Horsley Bridge returns during this period. (To put that in context, in 2018 the top-performing 5 percent of subindustries in the S&P 500 accounted for only 9 percent of the index's total performance.) Other venture investors report even more skewed returns: Y Combinator, which backs fledgling tech startups, calculated in 2012 that three-quarters of its gains came from just 2 of the 280 outfits it had bet on. "The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund," the venture capitalist Peter Thiel has written. "Venture capital is not even a home-run business," Bill Gurley of Benchmark Capital once remarked. "It's a grand-slam business."
Table of Contents
Introduction Unreasonable People 3
Chapter 1 Arthur Rock and Liberation Capital 17
Chapter 2 Finance Without Finance 40
Chapter 3 Sequoia, Kleiner Perkins, and Activist Capital 58
Chapter 4 The Whispering of Apple 81
Chapter 5 Cisco, 3Com, and the Valley Ascendant 93
Chapter 6 Planners and Improvisers 120
Chapter 7 Benchmark, SoftBank, and "Everyone Needs $100 Million" 149
Chapter 8 Money for Google, Kind of for Nothing 173
Chapter 9 Peter Thiel, Y Combinator, and the Valley's Youth Revolt 194
Chapter 10 To China, and Stir 222
Chapter 11 Accel, Facebook, and the Decline of Kleiner Perkins 249
Chapter 12 A Russian, a Tiger, and the Rise of Growth Equity 273
Chapter 13 Sequoia's Strength in Numbers 301
Chapter 14 Unicorn Poker 339
Conclusion Luck, Skill, and the Competition Among Nations 375
Acknowledgments 405
Appendix: Charts 409
Notes 415
Timeline 465
Index 469
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