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The Power Law

Sebastian Mallaby

From a section about Impossible Foods doing veggie ‘meat-like’ burgers: “People just figured we have this insanely destructive system and it’s just never going to go away.”
“Reasonable people… routinely fail in life’s important missions by not even attempting them… There is no glory in projects that will probably succeed, for these by definition won’t transform the human predicament.”
On thinking things from the ground up, as an outsider: “Retail innovation did not come from Walmart; it came from Amazon. Media innovation did not come from Time magazine or CBS; it came from YouTube and Twitter and Facebook. Space innovation did not come from Boeing and Lockheed; it came from Elon Musk’s Space X. Next-gen cars did not come from GM and VW; they came from Tesla.”
On rapidly closing failing projects down: “If there are no buyers for the next tranche of the startup’s equity, the price signal will do its work: the VCs will close it down, avoiding the waste of resources that comes from backing speculative R&D beyound the point at which success appears impossible.”
Georges Doriot, sometimes viewed as father of VC link.
On Fairchild differentiating themselves from other semiconductor companies: “They were out talking to the customers; even before developing their first transistors, they had met potential buyers in military avionics and figured out what kind of device would sell… the Fairchild founders were more focused on the market. They wanted to understand what products would be useful and what would make the value of their equity go up.”
SBICs were launched in 1958 by the Gov. They were broadly a failure because of bad incentive structures: you couldn’t give investment staff stock options, couldn’t invest more than $60k in a biz, they required borrowers to pay back interest meaning start ups needed to pay dividends.
The limited partnership stepped into the gap. They flew under the regulatory radar by keeping the number of passive investors under 100.
Getting VC started required a disregard for traditional financial metrics such as P/E ratios. This meant backing the right people was especially important.
Some of Arthur Rock’s characteristics to avoid in founders: “Self-contradiction, wishful thinking, a fondness for ingratiation at the expense of honesty.”
Some of Arthur Rock’s characteristics to admire in founders: “Intelligent consistency, gritty realism, fiery determination. ‘Do they see things as they are, or they way they want them to be?‘”
Read this essay (Tom Wolfe on Robert Noyce) Link
Noyce and Moore (from Fairchild), go on to found Intel. This is the same Moore that Moore’s law is named after.
On market risk vs. technology risk: “Instead of technology risk, Atari involved business risk, marketing risk, and what might be termed wild-man risk.”
Jimmy Treybig and Tandem (building fault tolerant computers): “If they could build a fail-safe system, he was sure he could sell it. In an inversion of Atari, the technical risks were daunting, but the market risks were negligible.” Tandem was an example of Perkins’s law: “Market risk is inversely proportional to technical risk.” If you solve a really difficult technical problem, you will face minimal competition.
On Don Valentine’s (founder of Sequoia) first raise for his fund: “Valentine considered raising capital from rich individuals… but a friend pointed out that individuals had a habit of dying or divorcing, so that their property had to be divided, which meant that it had to be priced. A venture fund that took money from individuals thus risked endless arguments about the value of fledgling investments.” It took 18 months to raise his first $5m, mostly from institutions that enjoyed charitable status (e.g. college endowment funds).
Successive funding rounds (seed, series-A, etc) were a major innovation in unlocking value: “As successive risks were eliminated, each financing round valued Genentech higher than the previous one, so the founders could raise larger sums while givin away less equity.”
Genentech was a major home run for Kleiner Perkins. 200x. Of that first fund, 95% of profits came from two investments. Hence this idea of the ‘power law’ holding for VC investment activity.
Apple was passed over by many of the big VCs and angels. Kleiner Perkins refused to meet Steve. Draper wrote them off as arrogant. “Rejected repeatedly, Jobs cast his net as far as Stan Veit… proposing that Veit acquire 10% of Apple for $10k.” The Valley network was strong enough though that Jobs found his way to Valentine. “Valentine had established himself as the toughest wrangler of wild young founders.”
Venrock invested $300k for 10% of Apple. “We went into the hall… we looked at each other, and we shrugged our shoulders and said, What the hell? People gave us too much credit later for being smart about this decision.”
“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. Circular logic could be sound logic.”
Anthony Montagu acquired $450k of Apple Stock by waiting in the lobby and refusing to go. In the afternoon, Woz needed some cash to buy a house so sold him his stock.
In 1978 Congress slashes CGT from 49% to 28%. Incentives!
AnnaLee Saxenian. Contends that small numbers of tight relationships makes for less idea sharing and innovation than a large number of loose relationships.
“Hierarchical organisations can be good at coordinating people when the objectives are clear: think of an army. But when it comes to commercialising applied science, the Valley’s culture of ‘coopetition’ has proved more creative than the self-contained, vertically integrated corporations of Boston or Japan.” The porousness of Valley network is helped by the California law banning non-competes. Mallaby thinks the real reason it’s so porous is down to VCs actively cultivating ‘weak ties’.
Bob Metcalfe founds 3COM, and raises money quickly. “I’ve always resented MBAs, they always got paid more than I did, and I was smarter than them.”
Cisco. “Spurned by investors, the Cisco team soldiered on tenaciously. They kept the lights on by maxing out credit cards and deferring salaries; Lerner took a side job to help pay the bills, and one co-founder made a personal loan to the company.” Bosack (co-founder) says “Sincerity begins at a little over a hundred hours a week. You have to get down to eating once a day and showering every other day to really get your life organised.”
“Valley rainmakers were unlike rainmakers elsewhere: they positively wanted to be bothered. Making and taking introductions was their stock-in-trade. If Leonard introduced them to a long-shot entrepreneur, it could only boost his standing.”
Mitch Kapor founds Lotus. “Before founding a software company, he had worked as a disc jockey, a psychiatric counselor, a stand-up comedian, and a teacher of transcendental meditation.”
On recruiting the first engineers for Mosaic (Andreessen’s first browser). “Offered these astonished $6.85-an-hour employees a $65k salary plus 100k shares of stock.”
Tom Perkins “You succeed in venture capital by backing the right deals, not by haggling over valuations.”
On Valentine hiring Moritz: “He overruled these objections because he had seen in Moritz a versatile learner, and he preferred to hire a hungry upstart than someone who was coasting on experience.”
Moritz: “We’re trying to imagine what can happen if everything goes right.”
Pierre Omidyar founded eBay as a side gig from his main job. He initially didn’t require sellers to send him any cut. By the end of the year he was receiving $400k monthly!
When Google was founded there were already 17 other firms offering search.
On the role of the stock market: “In ordinary times, the bubbly bias of the venture crowd is balanced by the stock market. VCs know that when startups go public, they will face a tougher audience… this prospect disciplines venture behaviour: it deters VCs from bidding private valuations up so high that public exits won’t be profitable. But in the late 90s, the stock market stopped performing this disciplinary function.
Zuck turned up in pyjamas to Sequoia’s offices to snub them for the perceived wronging of Sean Parker by Moritz.
Thiel’s philosophy: Entrepreneurs who weren’t oddballs would create businesses that were simply too normal. They would come up with a sensible plan, which, being sensible, would have occurred to others. Consequently, the would find themselves in a niche that was too crowded and competitive to allow for big profits.
a16z invest in Insta in 2010. For their £250k they made $78m (312x) two years later when FB buys it. A debacle given the fund was was $1.5bn so needed another 19 $75m payouts to break even.
Shirley Lin, one of the early chinese VC investors. Admitted to Harvard at 16 and skipped her Freshman year!
Donda West taught at Nanjing University. Kathy Xu, one of the early chinese VCs was there and remembers seeing her son, Kanye, performing acrobatic tricks on campus.
An analyst can point out both sides of an issue, but that was different from taking a stand, and this difference defined the psychological gulf between being a venture capitalist and not being one. In the end, venture investing came down to that scary jump from messy information to a binary yes-or-no call.
Interesting chapter about Yuri Milner and his investment in Facebook. He was able to look at data from VKontakte and determine that Facebook was undervalued. “Thanks to his global perspective, the Russian who had never set foot in the Valley understood Facebook better than the Palo Alto mafia.” He had been inspired to get into internet companies by reading a report from Mary Meeker.
Scott Shleifer at Tiger Global: Rather than looking at profit margins, he looked at incremental margins, meaning the share of revenue growth that falls to the bottom line as profits. The Chinese net portals profit margins were appalling, but their incremental margins were fantastic.
Stalking the Tenbagger.
Horowitz in response to Casado’s (of Nicira) idea that he could sort price later: “There is no single decision you will make that will impact your company value more than the pricing.”
Since his early life as a business journalist, Moritz had admired the “purposeful cadence of a relentless, disciplined march… the stamina and willpower that patiently built success, one advance upon another.”
Sequoia went through some tough times with their hedge fund business. “The easiest and most expedient choice is to close the business.” But he insisted that the original promise of the hedge fund remained sound. Sequoia had a privileged window on digital disruption; a better team of managers would have an excellent chance of building an outstanding business.
Fortuitously, the financial crisis coincided with the advent of smartphones, cloud computing, and the mobile internet, setting up an opportunity to build brilliant businesses atop the new platforms: it was the perfect moment to switch capital from financial engineering to technology.
Gurley to Kalanick: “You’re not gonna win by having a more innovative finance program, you’re not gonna win by having a more innovative legal program, you’re not gonna win by reinventing H.R. They’re areas where experience carries a lot of weight.”
In the hands of less thoughtful investors “blitzscaling” has come to mean little more than “get rich quick.” From Tim O’Reilly: “Blitzscaling isn’t really a recipe for success but rather survivorship bias masquerading as a strategy.”
The European Commission allocated more than 2bn euro for venture subsidies. Cumbersome labour laws, underdeveloped stock markets, and no recognition of limited partnerships hindered subsequent growth. VC partnerships were not interested in competing with subsidized public investors. Worse, because government sponsored investors were less skilled and motivated than private ones, this displacement reduced teh quality of European VC.