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Last week’s book examined American capitalism across broad stretches of time and various industries. This week we selected a book that focuses on one industry that is highly relevant today: the venture capital (VC) industry. Today’s US economy is hardly imaginable without the dynamism contributed to it by the homegrown technology industry. At some point in their development, most of the best-known technology companies in the USA accepted a check from a VC firm. In The Power Law, Sebastian Mallaby – of the Washington Post and Council on Foreign Relations – wrote an accessible narrative history of American venture capital. Its title refers to the phenomenon of a small percentage of venture-backed startups making investors the majority of their returns.
Like Mallaby’s other books, The Power Law is an entertaining read that skillfully introduces readers to a field in a way that is mostly review for people who have worked in or studied up on the subject before. A cynical Bay Area insider might accuse him of overemphasizing the VC-related stories that the East Coast media and outsiders of a certain vintage seem to care about most. Examples include the initial funding of Apple, the struggles of Theranos and WeWork, and ethical practices inside companies like Uber or VC firms themselves.
However, Mallaby does a lot more than play the hits. He tells a comprehensive story from the birth of Silicon Valley as we know it in the 1950’s to the landscape of 2021, when he appears to have finished the book. We’re treated to classic stories like that of the “Traitorous Eight” who left Shockley and founded Fairchild Semiconductor, a move that helped establish the area’s reputation for technological innovation. While many historians have cited the presence of components of the military industrial complex in the area as the primary fuel for the rise of Silicon Valley, Mallaby asserts that this has been overemphasized. Instead, he argues a cultural milieu that encouraged entrepreneurs who were both fiercely competitive in the commercial arena while allowing the free flow of ideas and information provided the perfect soil for startups which could outcompete slow-moving large corporations.
We also learn about early pioneers like Arthur Rock and the institutionalization of venture capital in the form of firms like Kleiner Perkins. The story then takes a series of twists and turns as new capital allocators – Sequoia, Founders Fund, Y Combinator, Accel, a16z, Benchmark, etc. – sprout up and respond to changing trends in technology and tech investing. They fund a series of legendary companies like Genentech, Cisco, Paypal, Google, Facebook, Alibaba, ServiceNow, etc. through highs and lows on their paths to Silicon Valley glory.
The details of this twisting story are well worth the read; they’re the prologue required to understand the state of the American and global technology industries today. Mallaby is critical of VC’s in select areas, but generally positions them as the beating heart or connective tissue network of the tech ecosystem. After studying the industry in depth, he concludes that VC’s get a bad rap when their success is attributed primarily to luck causing positive feedback loops. Mallaby reasserts the role of merit by pointing out VC firms who fizzled as their investments stopped working, how many became successful in the first place by innovating a common VC practice, how West Coast VC’s generally got access to the same set of deals and how VC’s often make meaningful contributions to their portfolio companies.
Skill and hands-on investing look set to matter even more in the near future. Current market conditions are very scary for many in the tech ecosystem. Since valuation levels peaked in November 2021, the market has been trending downward, and high-flying companies valued off rosy future prospects have been brought back down to earth by stock market investors. Fears driving investor decisions have included persistently high inflation, the resulting pivot from the Federal Reserve to raise interest rates faster, the then-prospect of war in Ukraine and supply chain constrictions caused by COVID-19. Venture capitalists have had to respond accordingly by slowing the money spigot for venture-backed startups at various stages of development. As a result, many companies are rushing to raise money at whatever price they can get, and others are looking to tighten their belts.
A few rounds of layoffs have been announced at notable startups in the last few days, with VC’s on twitter issuing eerie warnings about more to come. We feel for employees and their families who will be impacted by these layoffs and by other second-order effects of poor market conditions. It remains to be seen whether this will be a brief blip before a return to halcyon days, or whether we could be returning to a deep recession and years-long period of lean times for startups. If it’s the latter – and it does feel like it’s not a drill this time – then readers of The Power Law can expect venture capital firms to play a central role. They will have to find ways to support portfolio companies. In the meantime, the balance of power between these check-writers and the founders who they support will likely swing back in the favor of capital. In this way, 2022 continues to be an odd year where historical cycles screech painfully toward mean reversion.
All the best,
The Citizen Scholar Team
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Discussion #39: The Power Law: Venture Capital and the Making of the New Future, by Sebastian Mallaby