The Power Law: Venture Capital & the Making of the New Future

Key Takeaways

Under Consideration — to be added.

Interconnections

Under Consideration — to be added.

Highlights

• “All progress depends upon the unreasonable man,” the “creatively maladjusted,” Khosla declared, borrowing eclectically from George Bernard Shaw and Martin Luther King Jr.[4] “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.”[5] Khosla wanted radical dreams, the bolder and more improbable the better.
• 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.[8]
• But the main message that Khosla emphasized transcended dollars and even the food system. “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?[13] Reasonable people—well-adjusted people, people without hubris or naïveté—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.
  • #Failure
• Cocky and obnoxious, Khosla was soon fired. He became a venture capitalist.
• 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.
• 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.
• 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.[17]
• “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.[20] “Venture capital is not even a home-run business,” Bill Gurley of Benchmark Capital once remarked. “It’s a grand-slam business.”[21]
• “We could cure cancer, dementia, and all the diseases of age and metabolic decay,” Peter Thiel enthuses, dripping with disdain for incrementalism. “We can invent faster ways to travel from place to place over the surface of the planet; we can even learn how to escape it entirely and settle new frontiers.”[24] Of course, investing in what is categorically impossible is a waste of resources. But the more common error, the more human one, is to invest too timidly: to back obvious ideas that others can copy and from which, consequently, it will be hard to extract profits.
• Venture capital was not merely a business; it was a mindset, a philosophy, a theory of progress. Seven hundred million people enjoyed the lifestyle that seven billion wanted, he liked to say. Bold innovators goaded by even bolder venture capitalists offered the best shot at satisfying human aspirations.[31]
• To illustrate, a huge amount of energy in government, financial houses, and corporations is spent on forecasting the future, mostly by running statistical analyses on patterns from the past; without a clear forecast, committing resources would seem irresponsible. But the way venture capitalists see things, the disciplined calibrations of conventional social scientists can be a blindfold, not a telescope. Extrapolations from past data anticipate the future only when there is not much to anticipate; if tomorrow will be a mere extension of today, why bother with forecasting? The revolutions that will matter—the big disruptions that create wealth for inventors and anxiety for workers, or that scramble the geopolitical balance and alter human relations—cannot be predicted based on extrapolations of past data, precisely because such revolutions are so thoroughly disruptive. Rather, they will emerge as a result of forces that are too complex to forecast—from the primordial soup of tinkerers and hackers and hubristic dreamers—and all you can know is that the world in ten years will be excitingly different. Mature, comfortable societies, dominated by people who analyze every probability and manage every risk, should come to terms with a tomorrow that cannot be foreseen. The future can be discovered by means of iterative, venture-backed experiments.[32] It cannot be predicted.
  • #Forecasting
• Experts may be the most likely source of incremental advances, but radical rethinks tend to come from outsiders.
• “I can’t think of a single, major innovation coming from experts in the last thirty, forty years,” Khosla exclaims. “Think about it, isn’t that stunning?”
• Venture capitalists have achieved this disproportionate impact because they combine the strengths of the corporation with the strengths of the market.
• Through careful reconstruction of celebrated transactions—from Apple and Cisco to WhatsApp and Uber—the story in these pages shows what happens when venture capitalists and startups connect, and why venture is so different from other types of finance.
• Most fundamentally, other financiers extrapolate trends from the past, disregarding the risk of extreme “tail” events. Venture capitalists look for radical departures from the past. Tail events are all they care about.
  • #Forecasting
• The gap between VC rhetoric and VC practice is easily mocked.
• It is the contention of this book that this frenzy of activity explains much of the variation in creativity across regions: by forging connections among entrepreneurs, ideas, customers, and capital, venture capitalists transform a mere agglomeration of smart people into an inventive network.
• Adventure capital could sometimes be defection capital, or it could be team-building capital, or almost just experimental capital.[1] But whichever way you looked at it, talent had been liberated. A revolution was afoot.
• The first transistor was created in 1947, not in Silicon Valley, but at Bell Labs in New Jersey. The first personal computer was the Altair, created in New Mexico. The first precursor of the worldwide web, the network-management software Gopher, was from Minnesota. The first browser was developed by Marc Andreessen at the University of Illinois. The first search engine, Archie, was invented by Alan Emtage at McGill University in Montreal. The first internet-based social-networking site was SixDegrees.com, launched by Andrew Weinreich in New York City. The first smartphone was the Simon Personal Communicator, developed by Frank Canova at IBM’s lab in Boca Raton, Florida.[9] No single geography—not even Silicon Valley—dominates invention. And yet all these breakthrough products have one thing in common. When it came to turning ideas into blockbuster products, the Valley was the place where the magic happened.
• Steve Jobs was among the many who embodied both sides of this contradictory culture. He was too modestly egalitarian to demand a boss’s reserved slot in the company parking lot but too arrogantly entitled not to steal the space designated for disabled drivers.[11] He was a communalist collaborator, sharing his intellectual property freely with ostensible rivals; he was also a capitalist competitor, paranoid and controlling. It was this combination of laid-back creativity and driving commercial ambition that truly defined Silicon Valley, making it the place where flights of imaginative fancy begat businesses that shaped societies and cultures.
• By freeing talent to convert ideas into products, and by marrying unconventional experiments with hard commercial targets, this distinctive form of finance fostered the business culture that made the Valley so fertile.
• In an earlier era, J. P. Morgan’s brand of finance fashioned American business into muscular oligopolies; in the 1980s, Michael Milken’s junk bonds fueled a burst of corporate takeovers and slash-and-burn cost cuts. In similar fashion, venture capital has stamped its mark on an industrial culture, making Silicon Valley the most durably productive crucible of applied science anywhere, ever.
• Gordon Moore, who would later become head of research and development at Fairchild, was chosen as the group’s spokesman. Balding, with bushy brows lurking behind fashion-forward 1950s glasses, Moore was at once unpretentiously quiet and unyieldingly confident.
• The most serious early experiment—the one with a real claim to be seen as the forerunner to modern venture capital—was American Research and Development.
• The Ampex win earned Dennis a reputation among San Francisco brokers, which in turn led to the creation of the informal lunch club that styled itself “the Group.” Starting in 1957, five or six regulars convened at Sam’s or Jack’s in the financial district, restaurants “where the sole was dependable and the sourdough fresh.”[44]
• In 1957—the year the Group started its lunch meetings, and the year of the mutiny against Shockley—Doriot made the bet that transformed ARD’s fortunes. He financed Digital Equipment Corporation, a company founded by two MIT professors who had helped to develop the TX-0 computer at the military-backed Lincoln Laboratory.
• Rock quickly discovered how radical his vision was. The investment groups such as ARD and Rockefeller came up with excuses. The rebels had no management experience; the idea of writing such a large check made them queasy. Meanwhile, the technology companies Rock contacted cited a different objection: they would consider putting up the capital to create a new subsidiary, much as Beckman had done for Shockley, but they were not inclined to back eight scientists without the right to control them.[87]
• Where Rock saw justice in young scientists owning the fruits of their own enterprise, others saw trouble. The whole point of the organization man was that he was instinctively obedient. Why buy workers’ loyalty with stock options when the culture of the 1950s provided it for free?
• After some initial pleasantries, Noyce uncorked the flair that Rock had seen in him. Fixing Fairchild with those blazing eyes, he explained that the future would be built on silicon-and-wire devices, meaning on simple sand and metal, materials that cost almost nothing. Huge profits would flow to the company that fashioned transistors from these basic elements, and Fairchild could be the visionary who backed the winner.[91] It was a version of the “call to greatness” speech that charismatic entrepreneurs would deliver repeatedly in the Valley. Fairchild was sold.
• Other corporate research teams—Bell Labs, Texas Instruments—could claim to rival Fairchild in terms of scientific excellence. But 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.[98]
• Liberation capital was about unlocking human talent. It was about sharpening incentives. It was about forging a new kind of applied science and a new commercial culture.
• In 1955 the rising management guru Peter Drucker, later hailed as the most important business thinker of the era, put his finger on a paradox of mid-century capitalism. Burgeoning pension funds were managing the “small man’s” money, increasingly assuming the effective ownership of great public corporations, but the small man’s money was not being channeled to small companies. The sources of capital were being democratized, in other words, but access to capital wasn’t, because the large pension funds that served as agents for the little guy had no practical way of scoping out startups. As a result, entrepreneurs struggled to find funding. Their likeliest source of capital came from the retained profits of established businesses—thus Beckman Instruments financed Shockley, and Fairchild Camera and Instrument financed the eight traitors. But this form of funding came with a bias. Established businesses “naturally invest in fields with which they are familiar,” Drucker lamented; in consequence, “more promising areas of economic enterprise may have to go without.” There were “clear signs,” Drucker concluded, that the economy was “inadequately nourished with venture capital.”[1]
• “The fortunes of the past were made by stringing steel rails across the country,” Davis remarked. “I came to believe that the fortunes of my generation would come out of men’s minds.”[15]
• Rock and his partner articulated an approach to risk management that would resonate with future venture capitalists. Modern portfolio theory, the set of ideas that was coming to dominate academic finance, stressed diversification: by owning a broad mix of assets exposed to a wide variety of uncorrelated risks, investors could reduce the overall volatility of their holdings and improve their risk-return ratio. Davis and Rock ignored this teaching: they promised to make concentrated bets on a dozen or so companies.
• in the absence of diversification, a venture capitalist could manage his risk by exercising a measure of control over his assets.
• In the early 1960s, when the partners were laying out this vision, academia was turning finance into a quantitative science. But the way Davis and Rock saw things, the art of venture investing was necessarily subjective. Judgments about technology startups would “come from either ‘the seat of the pants’ or the ‘top of the hat,’” as Rock once wrote to Davis.[27]
• The central principle of the venture business, Davis once explained boldly, could be summed up in four words: “Back the Right People.”[28] For his part, Rock made a habit of skipping over the financial projections in business plans and flipping to the back, where the founders’ résumés were presented.[29] “The single most important factor in the long run for any company is, of course, management,” Rock told the Harvard Business School Club of San Francisco in 1962. “However, I believe that in the applied science industry this is especially true.” The only asset of tech startups, and the only possible reason to invest in them, was human talent, or what Rock liked to call “intellectual book value.” “If you are buying intellectual book value, then you’d better place a great deal of emphasis on the people who you hope will capitalize on their intellect,” Rock lectured.[30]
• Rock in particular believed that his intuitions about people gave him an edge as an investor. His shy outsider’s temperament made him an expert listener, and he would meet promising company founders multiple times before committing to back them. His method was to pose open-ended questions—Whom did they admire? What mistakes had they learned from?—and then wait patiently for the entrepreneurs to fill the vacuum created by his silence.[32] Self-contradiction, wishful thinking, a fondness for ingratiation at the expense of honesty: these were the clues that Rock should pass on an investment. Intelligent consistency, gritty realism, fiery determination: these were the signs that he should seize the opportunity.[33] “Do they see things the way they are and not the way they want them to be?” Rock would often ask himself.[34] “Would they drop what they’re doing at a minute’s notice to do something which would help the business, or would they continue their dinner?”[35] “When I talk to entrepreneurs, I’m evaluating not only their motivation but also their character, fiber,” Rock reflected.[36] “I believe so strongly in people that I think talking to the individual is much more important than finding out too much about what they want to do.”
• Davis called Rock, who had not yet even packed up his belongings to make the move from New York. He had found a wonderful investment, Davis explained breathlessly. Together, they had to back this venture: a brand-new computer company that would take on IBM. There was a silence on the other end of the line. Finally, Rock said, “Jesus, I’ve gone into partnership with an idiot.”[39]
• Entrepreneurs with managerial magic can’t lose, Rock reflected later. “If their strategy doesn’t work, they can develop another one.”[41]
• On June 30, 1968, Davis and Rock wound up their partnership. Thanks overwhelmingly to SDS, but also to a defense contractor called Teledyne, their initial fund of $3.4 million was now worth almost $77 million, an extraordinary return of 22.6x; it was a performance that easily eclipsed Warren Buffett in this period, as well as that of the inventor of the “hedged fund,” Alfred Winslow Jones.
• In a famous essay in Esquire, the master storyteller Tom Wolfe presents Robert Noyce, the charismatic leader of Fairchild’s eight traitors, as the father of Silicon Valley.[51]
• Noyce came from a family of Congregational ministers in Grinnell, Iowa, the very middle of the Midwest, where the land was as flat as the social structure. When Noyce moved out to California, he brought Grinnell with him, “as though sewn into the lining of his coat.” He wanted instinctively to run Fairchild without any divisions between bosses and workers. There would be no reserved parking spots for managers, no fancy executive dining rooms, and no limits on who could speak at meetings. Rather, there would be a level playing field, a ferocious work ethic, and a belief that every last employee had a stake in the firm.
• And beyond these colorful stylistic clashes, there was a practical conflict. The West Coast engineers believed that the men who built the business should be rewarded with stock. The East Coast overlords were too greedy and shortsighted to share the bounty.
• Ever since his first meeting with the Traitorous Eight, Rock had grasped that owning a stake in their company was powerfully motivating to the scientists: that was why he had structured Fairchild Semiconductor so that all of them got stock.
• Quite how much credit Rock himself deserves for these developments is of course debatable. But he certainly merits more credit than he has gotten. The prevailing narrative about Silicon Valley’s culture lionizes company founders, and Tom Wolfe’s exquisite storytelling has played up Noyce’s roots in small-town Iowa as the genesis of the egalitarian, stock-for-everyone business culture of the West Coast.[66] But, as we have seen, it was Arthur Rock who provided the impetus for Fairchild’s creation and who opened the founders’ eyes to the possibility of owning the fruits of their research.
• In a letter laying out his thinking in August 1968, Rock described a way of balancing the interests of investors and workers: Intel should avoid equity grants to short-term employees but extend them to everyone who made a long-term commitment. “There are too many millionaires who did nothing for their company except leave after a short period,” he observed wisely.[68]
• If Tom Wolfe had written an epic profile of Rock rather than Noyce, the origins of Silicon Valley’s egalitarian culture might be ascribed not to the entrepreneur but to the financier. No doubt the truth lurks somewhere in the middle.
• But investing in Atari would take a new kind of venture capitalist, because Atari was a new kind of tech firm. When Arthur Rock had backed Fairchild—or SDS or Teledyne or Intel—the gamble lay in the technology: Would the research and development yield products that worked? With Atari, in contrast, the technology was relatively trivial: the first Pong game was rigged up by an inspired tinkerer with a bachelor’s degree from Berkeley. Instead of technology risk, Atari involved business risk, marketing risk, and what might be termed wild-man risk. It was not for the faint of heart.
• If the 1950s had revealed the power of liberation capital, and if the 1960s had brought the equity-only, time-limited venture fund, the advances of the 1970s were twofold: hands-on activism and stage-by-stage finance.
• They were equally forceful and equally suited by temperament to combative activism. Valentine is said to have remarked that underperforming company founders should be “put into a cell with Charlie Manson,” and he once berated a subordinate so severely that the poor man passed out.[7] Perkins, a Ferrari-driving, yacht-owning, self-regarding dandy, loved to flout polite wisdom; in later life, when he splashed $18 million on an apartment in San Francisco, he declared defiantly, “I’m called the king of Silicon Valley. Why can’t I have a penthouse?”[8]
• Valentine also considered raising money from Wall Street. But he lacked the polish and training that preppy New Yorkers expected. He had not attended an Ivy League college or an elite business school, and he hated conceited know-it-alls, a category that he defined to include “people with hyphenated names or roman numerals after their last name, direct descendants of immigrants who arrived on the Mayflower, people who had enjoyed living on the East Coast, and those who wore Hermès ties, suspenders, cuff-links, signet rings, and monogrammed shirts,” as a distinguished lieutenant wrote later.[16]
• Fortunately, this involved a set of issues that played to Valentine’s strengths. Unlike Arthur Rock, he was a hands-on business operator by background, and in his years as a semiconductor salesman he had learned how to translate products into profits. You had to go with the version of your invention that would earn you the fattest margin, and you had to open sales channels to as many customers as possible. In the case of Atari, this meant capitalizing on one of Bushnell’s many semi-formed epiphanies: if Pong could be sold to families rather than bars, the market could be expanded enormously.[25]
• In late 1974, a few weeks after his visit to Atari’s factory, Valentine made a decision. He was not going to invest yet: Atari was too chaotic. But he was not going to walk away: the potential was too terrific. Instead, he would get involved cautiously, in stages, and he would start by rolling up his sleeves and writing an Atari business plan. If all went well—if Bushnell embraced his strategy, and if the plan attracted interest from other venture capitalists—then Valentine would invest. He would risk his money, in other words, only when Atari had been at least partially de-risked. Activism and gradualism would thus combine to make a hot tub culture backable.
• likewise a headline in Forbes wondered, “Has the bear market killed venture capital?”[27] After attracting $171 million in new funds in 1969, venture capitalists raised only $57 million in 1974 and a mere $10 million the year after.[28] A New Yorker cartoon showed two men chortling, “Venture capital! Remember venture capital?”[29]
• Kleiner and Perkins extended their breakfast conversation late into the morning. At a quarter to twelve, the staff at Rickey’s kicked them out so that they could prepare the restaurant for lunch clients; the two men went over to Perkins’s house to continue talking.[48] Perkins spoke grandly, spouting out ideas. Kleiner responded calmly in a rich Viennese accent.
• “We distinguished ourselves right from the beginning by saying: We are not investors. We’re not Wall-Street, stock-picker, investor people,” Perkins later said. “We are entrepreneurs ourselves, and we will work with entrepreneurs in an entrepreneurial way… . We will be in it up to our elbows.”[51]
  • #[[What is an Investor?]]
• Brook Byers, who joined Kleiner Perkins a few years later as a young partner, reflected on the lessons that KP drew from this experience. By focusing exclusively on the “white-hot” risks in a project, you could find out whether the venture was likely to work while risking as little capital as possible.[60]
• A few months later, Tandem made its first sale, and then revenues started to ramp up, multiplying fourteen-fold between 1977 and 1980.[68] Pretty soon, Tandem offered a spectacular demonstration of what became known as Perkins’s law: “market risk is inversely proportional to technical risk,” because if you solve a truly difficult technical problem, you will face minimal competition.[69]
• Perkins’s private estimate of Genentech’s chances was much higher—not one in a hundred, but a bit under fifty-fifty. By coming up with a strategy to isolate and neutralize the white-hot risks, Perkins had transformed a daunting venture bet into an irresistible one.
• “Kleiner & Perkins realizes that an investment in Genentech is highly speculative, but we are in the business of making highly speculative investments,” Kleiner wrote back calmly.[90]
• Perkins also contributed intangibly to Genentech’s culture. He was the first venture capitalist to revel unashamedly in the role of promoter and front man, signaling to the scientists that they had left academia behind and were now part of something glamorous.
• But Perkins was part of a rich venture tradition: to persuade investors to bet on the technologies of tomorrow, you must first unshackle them from the financial metrics of yesterday.
• Was this luck, or was it more than that? Proving skill is difficult in venture investing because, as we have seen, it hinges on subjective judgment calls rather than objective or quantifiable metrics. If a distressed-debt hedge fund hires analysts and lawyers to scrutinize a bankrupt firm, it can learn precisely which bond is backed by which piece of collateral, and it can foresee how the bankruptcy judge is likely to rule; its profits are not lucky. Likewise, if an algorithmic hedge fund hires astrophysicists to look for patterns in markets, it may discover statistical signals that are reliably profitable. But when Perkins backed Tandem and Genentech, or when Valentine backed Atari, they could not muster the same certainty. They were investing in human founders with human combinations of brilliance and weakness. They were dealing with products and manufacturing processes that were untested and complex; they faced competitors whose behaviors could not be forecast; they were investing over long horizons. In consequence, quantifiable risks were multiplied by unquantifiable uncertainties; there were known unknowns and unknown unknowns; the bracing unpredictability of life could not be masked by neat financial models. Of course, in this environment, luck played its part. Kleiner Perkins lost money on six of the fourteen investments in its first fund. Its methods were not as fail-safe as Tandem’s computers.
• Skeptical observers have sometimes asked whether venture capitalists create innovation or whether they merely show up for it. In the case of Don Valentine and Tom Perkins, there was not much passive showing up. By force of character and intellect, they stamped their will on their portfolio companies.
• In the place of a few smart individuals, there was now a thick web of startup connoisseurs, significant because the combined force of their actions was greater than the sum of their separate endeavors. It was like going from a system driven by genius to one driven by evolution. A brilliant person can do great things. A large group of people can try many things. Through an evolutionary process of trial, failure, and occasional breakthroughs, the group may advance faster than the individual.
  • Professionalization of startups
• But just as Bushnell and McKenna had rebuffed Jobs but connected him with Valentine, so Valentine now followed up on Jobs’s openness to hiring an outside marketing expert. It was almost a reflex. A large part of Valentine’s job came down to making and accepting introductions.
• Jobs and Markkula talked about the potential size of the market for PCs; since Valentine’s visit to the garage, they had refined their pitch and now talked grandly about a future in which computers graced every living room. But the partners seemed to zone this message out. “The specifics of what Steve said would not have mattered,” Hank Smith recalled later. “The whole territory was so speculative you could not take that stuff literally.”[21]
• Because Hank Smith had been at Intel, the Venrock team understood that advances in semiconductors made the idea of a PC feasible. Because Smith knew and respected Markkula, they had some confidence in Apple’s ability to deliver. On the other hand, like most East Coast venture capitalists, Venrock was relatively risk averse; it often refused to back early startups, preferring to invest only when they had serious revenues.[23] All in all, they could do this deal or they could walk away; who knew what was the right decision? “We went out in the hall—four or five of us—we looked at each other, and we shrugged our shoulders and said, What the hell?” Crisp recalls.[24] “People gave us too much credit later for being smart about this decision.”[25]
• In the case of Atari or Genentech, follow-on venture capitalists wrote checks once the white-hot risks had been neutralized. In the case of Apple, VCs were being told that they should invest simply because others were investing. However circular this logic, it was by no means crazy. The whispering grapevine was sending a message: Apple would be a winner. In the face of that social proof, the objective truth about the skills of Apple’s managers or the quality of its products might be secondary. 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.[30]
• Hierarchical organizations can be good at coordinating people when the objectives are clear: think of an army. But when it comes to commercializing applied science, the Valley’s culture of “coopetition” has proved more creative than the self-contained, vertically integrated corporations of Boston or Japan. Large companies bottle up ideas and often waste them. Shifting coalitions of small ones conduct myriad experiments until they find the best path forward.
• In this she was building on an insight from one of the most cited social science papers of all time. In a celebrated article published in 1973, the sociologist Mark Granovetter argued that a plethora of weak ties generates a greater circulation of information than a handful of strong ones.[5]
• Ideas spread like wildfire around Silicon Valley because of places like Walker’s Wagon Wheel, a packed watering hole where the engineers from IBM and Xerox PARC traded gossip freely. In other industrial clusters, the same ideas might not have spread at all, because the social relationships were not wired for fast dissemination.[7]
• The main answer to the Saxenian question—the reason why the Valley has a plethora of weak ties—is to be found elsewhere. It lies in the fact that one tribe of professionals is relentlessly focused on cultivating such ties. This tribe is the venture capitalists.
• Bill Younger, who joined Sutter Hill in 1981, set himself the task of taking the smartest people in his Rolodex to lunch; at the end of every meal he’d ask, “Who is the absolutely best guy you’ve worked with?” Younger then made it his mission to meet that best guy—it was almost never a woman—and toward the end of the meeting he would repeat the question: “Who is the absolutely best guy out there?”[10] After a year of moving from one best guy to the next one, Younger had a list of about eighty superstars, and he cultivated each of them methodically. He would send one luminary a technical article that might be relevant to his research; he would call another to mention that an old colleague was asking after him. In this way, Younger spun a web of loose connections that would form the basis for productive startups when the right opportunities beckoned. The social capital that Saxenian stressed did not arise by accident.[11]
• Of course, a brilliant young scientist should not languish at a bureaucracy that failed to make the most of his talents. Of course, if a scientist so chose, he had the option—almost the right—to found his own company. Economists often think in terms of markets and firms. But Metcalfe was betting on that intermediate institution: the network.
• Metcalfe began to take venture capitalists to lunch and solicit their guidance. “If you want money, you ask for advice. If you want advice, you ask for money,” he reflected shrewdly.[27]
• Eventually, after a month of frustration, Metcalfe concluded that the promised $21 investment was a mirage: it vanished every time he neared it. A startup’s scarcest asset is time. Venture capitalists in Boston turned out to be champions at wasting it.
• Metcalfe had failed to get the $20 per share that he had wanted. But he did have the pleasure of calling his Boston tormentors one last time. They would not be investing in 3Com, he informed them. “Why?” came the aggrieved response. “We supported you when no one else would.” “No,” Metcalfe shot back. “You lied to me when no one else would.”[38]
• Doerr, a hyperkinetic evangelist of whom we will hear much, grew so keen on such collaborations that he spoke of a “keiretsu model”: mimicking Japan’s formidable industrial networks, Kleiner would turn its portfolio of firms into a web of fertile associations. Hard-pressed company founders necessarily had their heads down, fixing engineering glitches and worrying about sales. But venture capitalists could see the map and the territory and tell founders how to navigate it.
• “VCs are always walking this fine line between competition and cooperation,” one of Ungermann’s colleagues later reflected. “The whole identity of a VC partnership revolves around managing the relationship between their portfolio companies—around taking advantage of that when it is appropriate and not causing a problem when it is not appropriate.”[45] Kleiner Perkins’s business hinged on its reputation for ensuring fair play. To preserve the deep trust on which its franchise depended, half a million dollars was a bargain.[46]
• In disk drives, West Coast VCs backed more than fifty startups in the first years of the decade, and although the overcrowding resulted in dozens of failures, the survivors ensured that the Valley stole the industry away from the vertically integrated, East Coast computer behemoths.[48]
• Bosack’s ferocious work ethic kicked into overdrive. “Sincerity begins at a little over a hundred hours a week,” he said. “You have to get down to eating once a day and showering every other day to really get your life organized.”[59]
• In a different corner of the world economy, this might have been irrelevant: a lawyer like Leonard would not have bothered senior venture guys on behalf of some random half acquaintance. But Silicon 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.
• Although he was bringing in an outside CEO, Valentine understood that there were risks to this strategy. It was more straightforward, obviously, to retain a gifted founder: as the owners and creators of their firms, founders had the financial and emotional incentives to go for greatness. Sutter Hill’s Qume formula involved bringing in an outside CEO to pair with a technical founder. But complementing founders was not the same as displacing them.
• Valentine made it clear to Morgridge that if he coasted, he’d be out. “I’m not very good at picking people,” he growled, “but I correct my mistakes very quickly.”[77]
• Naturally, most of the region’s storied companies were built by strong-willed founders, and it is not their habit to share credit with investors. When it comes to Cisco, however, the contribution of venture capital is indisputable. Don Valentine took control of the company, ejecting the founders and installing his own team; there is no doubt that the hands-on, West Coast style of venture investing explains the success that followed.
• Accel embraced an approach that it came to call “the prepared mind.” Rather than looking anywhere and everywhere for the next big thing, the partnership carried out management-consultant-style studies on the technologies and business models that seemed to hold promise.
  • Contrary Research
• Magnetic and messianic, Doerr in particular became the go-to investor for fearless founders, who loved him for championing their visions even more passionately than they did. He had “the emotional commitment of a priest and the energy of a racehorse,” one entrepreneur marveled.
• “Hey, there’s no right price,” Doerr retorted. “It’s willing buyer meets willing seller!” After the meeting, Kaplan huddled with his co-founders. “I guess that went well,” he said nervously. “Too well,” one responded. “These sky-high valuations give me a nosebleed.” “Hey, these guys are the experts,” the other retorted. “Who are we to judge? They do financings all the time.”
• As a parable of venture capital, the GO story exposed Doerr’s swashbuckling overreach. He had invested on the basis of an improvised presentation unsupported by a business plan, doing so because he believed that he could will huge technological leaps into being. By embracing maximum ambition, he had probably harmed Kaplan’s prospects, steering him away from the sort of incremental advance that could have been achievable. “They should have got the thing to work in a small area like UPS delivery guys,” Mitch Kapor reflected later. “GO showed me the downside for entrepreneurs of Kleiner’s approach. If it couldn’t be a home run, Kleiner did not care if the company struck out. It was like, go big or go home… . There is an arrogance to the KP approach. All that ego about changing the world.”[7]
• Patterson, in particular, was self-consciously cerebral. The scion of a Wall Street rainmaker, the product of both Harvard College and Harvard Business School, he was less narrowly focused on the next technology than some of his engineer rivals, and more broadly interested in financial markets, business models, and even government policy. He read widely, theorized fluently, and wrote a series of internal papers codifying the Accel approach. It was he who had come up with the Accel watchword, “prepared mind,” having borrowed it from the nineteenth-century father of microbiology, Louis Pasteur. “Chance favors only the prepared mind,” Pasteur had observed sagely.
• Accel liked to say that its strategy of specialization helped it to avoid faddish distractions. Borrowing an analogy from the oil industry, its partners would not be wildcatters, drilling wells almost at random. They would be methodical explorers who studied the geological properties of the territory.
• Accel partners aimed to comprehend entrepreneurs so thoroughly that they could complete their sentences and predict the next slide in their pitches. They spoke internally of the “90 percent rule.” An Accel investor should know 90 percent of what founders are going to say before they open their mouths to say it.[18]
• VCs as individuals can stumble sideways into lucky fortunes: chance and serendipity and the mere fact of being in the venture game can matter more than diligence or foresight. At the same time, venture capital as a system is a formidable engine of progress—more so than is frequently acknowledged.
• Scientists at corporate labs began flocking to UUNET, which, finding itself awash with revenue, gave up its nonprofit status.
• The government had invented the internet, to be sure. But as far as the National Science Foundation was concerned, the job of turning the internet into a mass medium that democratized information and changed lives was best entrusted to the private sector.
• On the other hand, however, Adams needed capital; in fact, he needed a ton of it. The more UUNET expanded, the quicker demand grew, because growing usage made the network more attractive to the next wave of potential users. “The project was swallowing cash by the trash-can full,” recalled UUNET’s chief scientist, Mike O’Dell. “We had to put hardware everywhere. There were these big-boy pants that we had to grow into real quick.”[33]
• Unlike in the case of GO, Doerr was unpersuaded. UUNET was not the sort of company that Kleiner Perkins liked to back. It owned no intellectual property, so was defenseless against larger competitors.[40] It required bucket loads of capital, so Kleiner would be unlikely to generate a home-run multiple.[41] Doerr refused even to meet Adams.
• Jim McLean understood that things were stirring. Visiting the office that ran the NSF internet infrastructure in Mountain View, McLean had been amazed to see racks of expensive servers and routers. How could a government outfit afford this fancy equipment? McLean asked innocently. “We get it all for free,” the engineers told him. The router manufacturers were bartering their hardware for illegal access to the supposedly government-only NSF network. They were so hungry for connections that they would break the law to get them.[43]
  • Compare to Google being scared of AI
• Barris told Adams about the software that GE provided: financial ledgers, customer-tracking programs, human-resource systems, and so on. Would it be possible, Barris wondered, to deliver those same services over the internet? Adams assured him that it would. In fact, the internet could deliver those programs far more cheaply than GE, which relied on expensive mainframe computers accessed via costly dial-up connections.
  • Internet took distribution costs to zero
• Jarve remembered only too clearly how the founder of Menlo Ventures, DuBose Montgomery, had put his arm around his shoulder and said, “John, this better work out.” Now it was not working out, and Jarve worried for his job security. Barris, for his part, recalls listening to Squarzini and experiencing “a very empty feeling.” His NEA partners had not been jazzed about UUNET’s prospects; now there would be an I-told-you-so moment. On the drive back to his office in Baltimore, a loop kept playing in Barris’s head. How would he break the news to his partners? What words were there to say it?
• For the investors in UUNET, there remained only one task: to make doubly sure that Adams and his team capitalized on the opportunity.
• The GE programs that he and Sidgmore had sold to corporate customers could be delivered over the internet at a fraction of the cost. “Think of the margins, and what those margins are going to do to the value of your personal equity,” Barris said, seductively. UUNET represented an opportunity for Sidgmore to modernize and cannibalize the entire GE Information Services playbook.[59]
• In January 1995, UUNET secured the contract to build the network infrastructure that supported Windows 95, Microsoft’s first operating system designed around the internet.
• The magical Mosaic web browser, announced by The New York Times in December 1993, had come out of a taxpayer-backed lab at the University of Illinois: it was another instance of government science kick-starting the online revolution. But the lead inventor of the browser, Marc Andreessen, did not stay in Illinois for long. The government was good at basic science. It was not good at turning breakthroughs into products that changed society.
• Metcalfe’s law was not supplanting Moore’s law, which would have been dramatic enough. Rather, it was compounding it. The explosion of internet traffic would be fueled both by its rapid growth in usefulness (Metcalfe’s law) and by the falling cost of modems and computers (Moore’s law).[71]
• In the face of this sort of bonanza, it really didn’t matter how many Kleiner bets went to zero. In the internet age, it was worth paying whatever it might take for stakes in turbo-power-law companies.
• Moritz kept chatting with Yang and Filo, but now he switched subtly from cross-examiner to courtier. He knew he would face competition to get into this deal: Yahoo was also weighing acquisition offers from two larger internet firms, AOL and Netscape. To muscle out these rivals, Moritz asked sensitive questions, listened intently to the answers, and climbed inside the young grad students’ heads. Years later, asked why he had picked Moritz over other suitors, Yang replied enigmatically that Moritz had “soul.”[9] Despite his unpromising opening gambit, Moritz had connected with him.
• The innovation of backing companies that charged little or nothing for products spread through the venture-capital business like wildfire. Startups came to be assessed not according to this year’s revenues or even next year’s, but rather according to their momentum, traction, audience, or brand—things that could, in theory at least, be monetized in the future.
• Anticipating the dynamics of future internet companies, a precarious circular logic took hold: the key to Yahoo’s growth was that it had to keep growing. As a result, Yahoo’s early success in generating revenues did not translate into profits. Every dollar of advertising income had to be plowed back into marketing expenditures to keep expanding the business.[14]
• There was so much money in the Valley, and so much faith in the logic of the power law, that Yahoo was almost bound to be funded.
• Now, having got wind of the internet gold rush, he was shifting his business from Japan to America. It was an extraordinarily bold jump for an Asian entrepreneur: Silicon Valley’s dense networks could be hard to penetrate for an unconnected outsider. But Son bought control of an American technology publisher and the leading U.S. organizer of computer conferences, acquiring information flow and connections that might help him spot the next exciting frontier.
• After Son dropped his bombshell, Yang, Filo, and Moritz sat in silence. Disconcerted, Yang said he was flattered but didn’t need the capital.[24] “Jerry, everyone needs $100 million,” Son retorted.[25]
• In the new world of winner-takes-all brand competition, Yahoo’s future growth depended on its immediate growth. Therefore it needed growth capital.
• Before the Yahoo team arrived at a decision, Son made a second move that defied all convention. He asked Moritz and the founders to name Yahoo’s main competitors. “Excite and Lycos,” they answered. Son turned to one of his lieutenants. “Write those names down,” he commanded. Then he turned back to Moritz and the founders. “If I don’t invest in Yahoo, I’ll invest in Excite and I’ll kill you,” he informed them.
• Leveraging his new reputation as a digital Midas, he followed the Yahoo bonanza with a dizzying investment blitz, barely pausing to sort gems from rubbish. To borrow the language of hedge funds, he didn’t care about alpha—the reward a skilled investor earns by selecting the right stock. He cared only about beta—the profits to be had by just being in the market. One young investor who managed Son’s funds recalls betting on at least 250 internet startups between 1996 and 2000, meaning that he had kept up an insane rate of around one per week, ten or maybe even twenty times as many as a normal venture operator.[31]
• Branded internet companies faced an imperative to grow, creating an opportunity for investors to provide growth capital. Branded internet companies were not built on cutting-edge technology, so they could flourish far away from the tech hub in Silicon Valley. As often happens in finance, the player who first sees a shift in the landscape, and who has the ready capital to match the novel need, can make bumper profits before competitors wake up.
• The old guard had been born into the Depression and had grown up during the world war; their families had lived in fear of losing everything. “If you are afraid of losing everything, you tend to take your chips off the table too early,” Moritz reflected.[37] In the case of Apple, for example, Valentine had sold out before the IPO, realizing a quick profit but depriving his limited partners of the bounty from Apple’s flotation. Moritz, in contrast, was a child of the postwar boom and had experienced little but success in his own life: he had risen from Wales, to Oxford, to Wharton, to Sequoia; and now, a short time after his fortieth birthday, he had made his golden bet on Yahoo. He and his contemporaries were far less inclined than the older generation to worry about stuff that could go wrong. “I think one of the huge changes at Sequoia is that we’ve been trying, without getting giddy about it, trying to imagine with some of these companies, what can happen if everything goes right?” Moritz reflected.[38]
• Thanks to masterful procrastination, Yahoo generated more gains for Sequoia than all its prior investments, combined, and more than ten times as much as Sequoia had earned from Cisco. The secret, Moritz said laconically, “was just learning to be a little patient.”[39]
• With its professional capital so geographically concentrated, Benchmark’s strength was local rather than global: it was the anti-Softbank.[40]
• “God is not on the side of the big arsenals, but on the side of those who shoot best,” Benchmark’s prospectus insisted.[41]
• Some venture firms believed that selecting the right deal was nine-tenths of the job; coaching entrepreneurs was an afterthought. Benchmark partners tended toward a more fifty-fifty attitude. Knowing with confidence which deal to do was generally impossible; it was in the nature of the venture game that many bets went to zero.[43] Therefore, to be sure of creating alpha, Benchmark had to descend into the trenches with the entrepreneurs; “I’m so far down, I can’t see much sky,” one Benchmark partner said with a chuckle.[44]
• “What’s venture capital?” Benchmark’s co-founder Bruce Dunlevie mused. “It’s sitting at your desk on Friday at 6:15 p.m., packing up to go home when the phone rings, and the CEO says, ‘Do you have a minute? My VP of HR is dating the secretary. The VP of engineering wants to quit and move back to North Carolina because his spouse doesn’t like living here. I’ve got to fire the sales guy who’s been misreporting revenues. I’ve just been to the doctor and I’m having health problems. And I think I need to do a product recall.’ And you, as the venture capitalist, you say, ‘Do you want me to come down now or get together for breakfast in the morning?’”[47]
• Unlike Yahoo, which was pouring money into marketing, eBay’s marketing budget was zero. Its hectic expansion was instead propelled by Metcalfe’s law: as the size of its auction network grew, its value rose exponentially. The more sellers listed stuff on eBay, the more bargain hunters were drawn to the site; the more buyers there were, the more sellers turned to it.
• The writer Randall E. Stross, who reconstructed Benchmark’s early story in masterful detail, captured how Kagle latched onto Omidyar’s focus on community: every other sentence, Omidyar spoke about the eBay community, building the community, learning from the community, protecting the community.
• eBay’s growth rate also impressed the other Benchmark partners. “When companies grow exponentially, they don’t suddenly stop,” Andy Rachleff observed later, adding that it is the “second derivative”—the changes in the rate of growth of a company’s sales—that really tell a venture investor whether to back
• Later that month, Benchmark finally distributed part of its winnings. eBay’s share price gave it a market value of $21 billion; Benchmark’s stake was worth an astonishing $5.1 billion. This bonanza not only dwarfed the records at Sequoia and Kleiner; it far exceeded even Son’s biggest wins, and it had been achieved by risking a mere $6.7 million worth of capital. Benchmark’s cottage-industry style of venture capital suddenly looked inspired. Who needed to write outsized growth-capital checks? Who wanted to bother with an Asia strategy? The remarkable thing was, eBay was not an isolated victory. There was a software distributor called Red Hat that generated well over $500 million for Benchmark. There was an online office-supply company called Ariba, which generated more than $1 billion. By mid-1999, Benchmark had raised and invested three funds, deploying a cumulative $267 million of capital. But after that summer’s crop of IPOs, the value of the portfolio surpassed $6 billion, implying a multiple of about twenty-five times capital.[67] The back-to-basics vision of venture capital was evidently thriving, whatever the message from Masayoshi Son’s example.
• Kagle wasn’t sure. A big fund could cause trouble: if you gave founders too much money, they would lose focus, attempt too many things, and the resources would be wasted. “We might overcapitalize companies,” he said. “I don’t want to follow everyone else into big-check-dom.”
• Benchmark repeatedly found that reckless later-stage investors seized effective control of its portfolio companies by stumping up tens of millions of dollars. Unable to muster equivalent sums, Benchmark lacked the muscle to protect startups from the hubris that came with so much capital. In two notorious cases—the ride-hailing company Uber and the office-rental giant WeWork—Benchmark lived through the painful spectacle of its wards going off the rails.[73] Such was the limitation of the cottage-industry model.
• Before the mid-1990s, semiretired technology executives had sometimes turned their hands to investing: Mike Markkula had backed and shepherded the fledgling Apple; Mitch Kapor had financed and counseled GO and UUNET.[9] But it took the booming tech market of the middle and late 1990s to turn this “angel investing” into a serious force.
• To traditional venture investors, the boom was disconcerting. “It was evident that we were in a bubble,” an old-timer recalled. “All of the things you think about as creating fundamental value were getting punished. And all of the things you think about as bad behavior were being rewarded.”
• Unlike hedge funds, which can bet against a bubble by using derivatives or other tricks, venture capitalists can only bet on values going up. They have one simple business, which is to buy equity in startups, and they have no choice but to pay the going price for it. Moreover, this mechanical difference between hedge funds and venture capital is compounded by a psychological one. Hedge funders tend by nature to be self-contained. When the trader Louis Bacon bought a private island in the 1990s, people joked that it made no difference: he was already an Oz-like figure hidden behind a bank of screens, as insular as he could be. But venture capitalists inhabit the opposite extreme. They maintain offices near each other. They sit on startup boards with each other. They negotiate follow-on financings with each other. Geographically and mentally, they cluster. Because they are first and foremost networkers, it is costly for venture capitalists to even speak of a bubble. An investor who publicly questions a mania is spoiling the party for others.
  • Venture capital isn’t a long-term bet, it’s often a long-term charade of passing the bag.
• Seeking to explain the public’s bottomless appetite for tech stocks, Wall Streeters pointed to the spread of power-law thinking. “There has been a fundamental shift in American capitalism,” marveled Joseph Perella, the chief investment banker at Morgan Stanley. “Basically, the public is saying, ‘I want to own every one of these companies. If I’m wrong on nineteen and the twentieth one is Yahoo it doesn’t matter.’”[18]
• Asked why he had accepted the lower bid, Bezos explained, “Kleiner and John are the gravitational center of a huge piece of the Internet world. Being with them is like being on prime real estate.”[24]
• From 1973, when Sutter Hill invented the Qume formula, to the mid-1990s, when startups such as Yahoo and eBay embraced outside chief executives with open arms, it was almost a given that VCs would bring in a new leader. But now the Googlers cited the handful of successful founders who had retained management control—Michael Dell, Bill Gates, and their own angel investor Jeff Bezos. “What they didn’t see were all the others who had failed. That wasn’t in their data set,” one Doerr lieutenant observed tartly.[37]
• Jobs not being available, Doerr hustled for an alternative. He sometimes described himself as a “glorified recruiter.” “We’re not investing in business plans, we’re not investing in discounted cash flows, it’s the people,” he insisted, revealing how the essence of the venture craft remained unchanged since the days of Arthur Rock and Tommy Davis.[50]
• As of 2003, Sequoia was struggling to prop up a venture fund that had lost around 50 percent of its value; the partners felt honor-bound to plow their fees back into the pot to eke out a return of 1.3x.[64] The equivalent Kleiner Perkins fund performed even worse, never making it into the black. Masayoshi Son, who had briefly become the richest person in the world, lost more than 90 percent of his fortune. Having loaded up with capital during the boom years, many venture partnerships saw no way of deploying the money. Some returned uninvested dollars to outside partners, others stopped raising fresh funds, and the few that tried to raise money were rebuffed by their backers.[65] At the peak in 2000, new capital commitments to VC firms had hit $104 billion. By 2002, they were down to around $9 billion.[66]
• Silicon Valley lost 200,000 jobs between 2001 and early 2004; highway billboards were bereft of ads, and physics PhDs were waiting tables. To be in the Valley was to realize that “only the cockroaches survive, and you’re one of the cockroaches,” as one entrepreneur put it.[67]
• But as animal spirits roared back to life, the venture industry woke up to the echoes and extensions of the Brin-Page challenge. Young entrepreneurs no longer deferred to experienced investors. In fact, they often regarded them contemptuously. The change in mood was crystallized by Paul Graham, a self-described hacker who became an influential guru among young startup founders. In 1995, together with a fellow Harvard grad student, Graham had founded a software company called Viaweb, selling it in 1998 to Yahoo for $45 million worth of stock: it was a classic hacker-makes-good story. Then Graham had turned his hand to writing, expounding on everything from the virtues of the programming language Lisp, to popularity in high school, to the challenges of entrepreneurship. His essays, which celebrated coders and disparaged business types, appeared first on his blog and then, in 2004, as a book.
• “What I discovered was that business was no great mystery,” Graham wrote. “Build something users love, and spend less than you make. How hard is that?” he demanded.
• With the coming of the internet, the hottest kind of company produced little more than code: it had no need for large amounts of capital with which to build manufacturing operations. Meanwhile, the open-source movement made chunks of software available for free, and the internet itself slashed the cost of marketing and distributing new products.[69] For all these reasons, the new generation of startups required relatively little cash, but venture capitalists were out of step with this development.[70] Thanks to the bubble of the late 1990s, they had grown used to managing big funds and collecting correspondingly big fees. As a result, they force-fed startups with more capital than was good for them, like farmers stuffing geese to make foie gras.
• As the average age of VC partners drifted up, the average age of company founders was falling: small wonder that a cultural gap was opening.
• The snubs from the venture-capital A list left Thiel nursing a grudge. The fact that the PayPal service immediately took off raised further questions in his mind about the wisdom of the venture establishment.
• Nosek, who came up with the Founders Fund name, had worked up a passionate dislike of Moritz during his time at PayPal and viewed traditional venture capital as “disgusting.”[36] “These people would destroy the creations of the most valuable inventors in the world,” he exclaimed furiously.[37]
• Thiel saw in the power law an additional lesson. He argued, iconoclastically, that venture capitalists should stop mentoring founders.
• The way Thiel saw things, this evolution was misguided. The power law dictated that the companies that mattered would have to be exceptional outliers: in all of Silicon Valley in any given year, there were just a handful of ventures that were truly worth backing.[41] The founders of these outstanding startups were necessarily so gifted that a bit of VC coaching would barely change their performance.[42] “When you look at the strongest performers in our portfolio, they are, generally speaking, the companies that we have the least amount of engagement with,” one Founders Fund partner observed bluntly.[43] It might flatter venture investors’ egos to offer sage advice. But the art of venture capital was to find rough diamonds, not to spend time polishing them.[44] As if this were not sufficiently provocative, Thiel went further. To the extent that VC coaching did make a difference, he contended, it might well be negative. When venture capitalists imposed their methods on founders, they were implicitly betting that tried-and-tested formulas trumped outside-the-box experiments. To use the old distinction between Accel and Kleiner Perkins, they were saying that the prepared mind was better than the open one. But if the power law dictated that only a handful of truly original and contrarian startups were destined to succeed, it made no sense to suppress idiosyncrasies. To the contrary, venture capitalists should embrace contrarian and singular founders, the wackier the better. 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, they would find themselves in a niche that was too crowded and competitive to allow for big profits.[45]
• VCs should celebrate misfits, not coach them into conformity.
• Venture capitalists who spent their days mentoring portfolio companies would not be seeking out the next batch of investment opportunities. At one point, Luke Nosek allowed himself to be sucked into the troubles at a portfolio company called Powerset: the CEO had left, and the company was desperate to sell itself to an acquirer. “I put tons of effort into this and I made like $100,000,” Nosek remembered ruefully. And because he was preoccupied with Powerset, Nosek failed to pursue opportunities elsewhere, including in Facebook and Twitter. “I was just too busy, and I never ended up meeting with the people.”[49]
• To banish consensual thinking, Founders Fund broke with the industry practice of Monday partnership meetings, replacing the Sand Hill Road tradition of collective responsibility with radical decentralization. Founders Fund investors sourced deals independently, even writing some small checks without consulting one another. Bigger bets required consultation—the bigger the check, the more partners had to assent—but even the biggest investments did not require a majority to vote in favor. “It usually takes one person with a lot of conviction banging their fist and saying, ‘This needs to be done,’” one partner explained, by way of summary.[52]
• Other investors, seeking to manage risk through diversification, lacked the stomach for such concentrated wagers. But in a field ruled by the power law, Thiel was certain that a small number of huge, high-conviction bets was better than a large spread of halfhearted ones.[54]
• Not surprisingly, the speakers often amplified Graham’s own views. One visitor presented a slide with a discussion question for the group: “VCs: soulless agents of Satan, or just clumsy rapists?”[73]
• A couple of years later, when Y Combinator had established itself in Palo Alto, Graham invited none other than Mark Zuckerberg to speak at an event at Stanford. The veteran of the Wirehog presentation stood up and voiced the shared conviction of the rising generation: “Young people are just smarter.”[74]
• “When I graduated from college in 1986, there were essentially two options: get a job or go to grad school. Now there’s a third: start your own company,” Graham wrote. “That kind of change, from two paths to three, is the sort of big social shift that only happens once every few generations. It’s hard to predict how big a deal it will be. As big a deal as the Industrial Revolution?”[75]
• Thanks to a tradition of engineering excellence and clever government support for venture funds, Israel became the standout innovation center outside the United States, with breakthroughs ranging from instant messaging to car-navigation software. But because of the small size of Israel’s economy, the country’s startup cluster was more of an adjunct to Silicon Valley than a competitor. When their inventions showed promise, Israeli entrepreneurs’ first move was to seek U.S. venture backing and to target the U.S. market. In the process, many shifted their business headquarters to the West Coast. Far from challenging the Valley’s dominance, they reinforced it.
• Because of the might of China’s Communist Party, both Chinese and foreign observers tend to ascribe the nation’s technology success to the country’s supposedly farseeing political leaders. But the truth is more surprising. Far from vindicating the industrial strategy of the Communist Party, China’s tech success was a triumph for the financial model created by Arthur Rock.
• The Stanford crowd would do just about anything to win funding from a prestigious firm like Goldman Sachs. Ma, in contrast, was fervently committed to his business plan. He was not going to change it at the suggestion of a financier. Besides, if Ma lacked the polish of the U.S.-educated Chinese, Lin could look to her co-investor to compensate. Joe Tsai was not only determined to back Ma’s project. He was ready to help out actively.
• Goldman duly gave up 17 percent of Alibaba, parceling it out among four other investment companies. Fifteen years later, Goldman could see what it had given up. Alibaba staged a triumphant IPO. That $1.7 million stake would have been worth an astonishing $4.5 billion.
• Ma built Alibaba into a world-class company. It became what Fairchild had been for the Valley—not just a formidable enterprise in its own right, but a training ground for go-getters who spun out and created their own startups.
• In short, U.S. capital, legal structures, and talent were central to the development of China’s digital economy. Without this American input, companies like Alibaba could not have gotten off the ground, and today’s Chinese dominance of technologies such as mobile payments would not have been likely either.
• Lin eventually left the firm, and Goldman went on to sell its Alibaba stake for a forgettable profit of 6.8x on her original position.[39] Goldman’s fit of impatience resulted in one of venture history’s worst-timed exits.
• Kathy Xu, another woman who managed to flourish in China’s venture industry. Rather than studying in the United States, Xu had experienced U.S. instruction at Nanjing University, where she had majored in English. One teacher, an impressive African American woman named Donda West, instilled in her pupils an American ethos. “You are unique, you are a marvel. There has been no person like you in the last 500 years and there will be no person like you in the next 500 years,” she lectured. This paean to individualism was, as Xu recalled vividly, an eye-opening experience for a Chinese teenager from Sichuan.[40]
• “There are not many great companies in the world,” she reflected, sounding like a Chinese version of Peter Thiel, who launched Founders Fund in the same year. “If you’re lucky enough to find one, hold on. That’s how you make money.”[43]
• The chase presented a subtle psychological challenge. “You had to sort of figure out what he’s thinking about and then make him interested in talking to you,” Sun recalled. “We tried to talk about things that he’s not very familiar with, so we could add value.”[64] Annoyingly, Wang had educated himself on an encyclopedia of subjects. It was hard to find a worthwhile topic that he hadn’t mastered already.[65]
• What became known as “the war of a thousand Groupons” ensued, with combatants splurging money on ever deeper discounts in order to attract users. Chinese consumers seized the moment and ate out in droves. As the investor and author Kai-Fu Lee would comment, it was as though the venture-capital community were treating the whole nation to dinner.[68]
• “There is a saying in our business, ‘If you are treated like an analyst, you are going to act like an analyst,’” Efrusy explained later.[2] An analyst could point out the arguments on 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. It came down to living with the reality that you would frequently be wrong. It was about showing up at the next partners’ meeting, rising above your wounded pride, and mustering the optimism to make fresh bets on a bewildering future.
• As Skype’s value soared, the Accel partners recognized the magnitude of their error. In venture, backing a project that goes to zero costs you one times your money. Missing a project that returns 100x is massively more painful.
• VCs who back winning startups acquire a reputation for success, which in turn gives them the first shot at the next cohort of potential winners. Sometimes they get to buy in at a discount, because entrepreneurs value the imprimatur of renowned investors. This self-reinforcing advantage—prestige boosts performance, and performance boosts prestige—raises a delicate question. Is there really skill in venture capital, or are the top performers merely coasting on their reputations? The story of Kleiner Perkins illustrates what academic study has confirmed.[35] Reputation matters, but it cannot guarantee outcomes. Success has to be earned afresh by each successive generation.
• Whatever its existential importance, cleantech was a tough field for venture investors, and Doerr should not have suggested that large markets were the same as profitable ones.
• Having two superstars at the table was much better than one: each could be a healthy intellectual check on the other.
• This change in Kleiner’s culture set the stage for the cleantech fiasco. When Doerr decided to bet the franchise on a challenging sector, nobody was there to check him.
• Moreover, far from swooning over new technologies, Perkins often cautioned that for an innovation to matter, it had to be radically better than what came before. “If it’s not 10x different, it’s not different,” went his mantra.[48]
• As she put it, Kleiner was suffused with “the California art of superficial collegiality, where everything seems tan and shiny on the outside but inside, behind closed doors, people would trash your investment, block it or send you on ‘rock fetches’—time-consuming, unproductive tasks to stall you until you gave up.”[60]
• But by embracing change without slogging through the detailed work of implementing it, Doerr almost destroyed his firm. Venture capital is a team sport, and a dysfunctional team loses.[67]
• Andreessen knew otherwise. Milner was neither crazy nor dumb, nor was he even impetuous in the way that Masayoshi Son was. To the contrary, what distinguished Milner was his data-driven approach. He had meticulously compiled the key metrics on the world’s social-media firms, and his revenue projections told him that a $10 billion valuation was reasonable.
• And whereas Thiel’s deference to founders was grounded in his understanding of the power law, Milner framed his concession more simply. He was investing in a company whose size and sophistication qualified it to go public. Therefore he would behave like a public stock market investor: passively.[13]
• In Silicon Valley, investors pursue deals because other investors are pursuing them. There is a logic to this pack mentality, as we have seen: when multiple prestigious venture capitalists chase after a startup, the buzz is likely to attract talented employees and important customers. But Shleifer’s East Coast training had taught him the opposite instinct. Recently, he had read an investment bible by the Fidelity fund manager Peter Lynch that described how to identify potential 10x bets. “Stalking the Tenbagger,” Lynch called this process.[18] The way Lynch explained things, if you liked a stock but other professional investors did not own it, this was a good sign; when the others woke up, their enthusiasm would drive your stock higher. By the same logic, if you liked a stock and Wall Street analysts did not cover it, this too was a good sign: shares were most likely to be mispriced when nobody was scrutinizing them. Finally, in an uncanny premonition of Shleifer’s China calls, Lynch listed a third important buy signal. When chief financial officers tell you that they haven’t talked to an investor in ages, you really may be onto something.
• Shleifer decided it was time for some fresh thinking on China. Unlike venture capitalists, who have no choice but to stick with illiquid positions, a hedge fund is free to sell at any time. The portals had gone up so much it was not clear that Tiger should still hold them. “We’ve got to dig deeper,” Shleifer remembers thinking. “How durable is the growth? Investments require that you ask different questions at different prices.”[21]
• Unlike venture capitalists, Tiger was not looking to bet on original ideas. To the contrary, it liked companies that implemented a proven business model in a particular market. The goal was to invest in the eBay of South Korea or the Expedia of China. “The this of the that,” Coleman and Shleifer called it.
• Accel had differentiated itself by specializing in certain fields; Benchmark had pitched its “better architecture” of high fees and small funds; Founders Fund had pledged to back the most original and contrarian companies. For their part, Andreessen and Horowitz promised to smooth the learning curve for scientists who wanted to be chief executives.
• In the past, other VCs had hired “operating partners” who focused on helping portfolio companies rather than making investments, but Andreessen Horowitz aimed to build an extensive consultancy under its roof. There would be a team to help startups find office space, another to advise on publicity, and yet others to source key recruits or provide introductions to potential customers.
• “Martin, there is no single decision you will make that will impact your company value more than the pricing,” Horowitz declared, with oracular finality. When a software company markets a new product—something original that nobody has seen before—it has one chance to set the price. Whatever point it chooses will stick in customers’ minds, making it hard to raise prices later. Moreover, any given price difference will generate a bigger difference in a company’s profit margin. If a salesperson earns a $200,000 salary and signs up six corporate customers per year, pricing the product at $50,000 yields revenues of $300,000 and a margin after deducting the salary of $100,000. But if the price is set at double that level, at $100,000, the margin will quadruple to $400,000. To an extent that first-time entrepreneurs seldom realize, this sort of margin difference can transform the value of their company.
  • #Pricing
• Horowitz’s rebuke revealed a distinguishing strength of Andreessen Horowitz. Even though it was a product of the youth revolt, a16z was not necessarily founder-friendly. It aimed to help technical founders succeed, but if they were set on doing the wrong thing, it had no problem confronting them.[50]
• The VC firms that launch with a splash tend to have two things in common. They have a story about their special approach, and they have recognizable partners with strong networks. In a few exceptional instances, the special approach is powerful enough to explain most of the success. Such was the case with Yuri Milner, who arrived in the Valley with no connections and vaulted straight to the top. Such was the case with Tiger Global, which improvised the hedge fund/venture hybrid model. And such was more or less the case with Y Combinator, whose batch-based seed investing was genuinely novel. But in the large majority of examples, new venture firms succeed because of the founders’ experience and status, not because of the claimed originality of their methods. Academic research confirms what is intuitively obvious: success in venture capital owes much to connections.[57] “Silicon Valley is gripped by the cult of the individual,” the British venture capitalist Matt Clifford once remarked. “But those individuals represent the triumph of the network.”
• And where Doerr hired established, fifty-something celebrities, Sequoia had no interest in recruiting comfortable executives who, as Moritz put it, “had been too successful, had lost some spring in their step, were not hungry enough, had too many outside commitments and, most of all, were not prepared to become rookies again.”[6]
• To begin with, the senior partner would go on Xoom’s board, bringing Botha to the meetings as an observer. Then, if Xoom succeeded, the two would switch roles, so that Botha would gain professional standing as a director of a buzzy startup. “Look, if the company doesn’t work out, the stain is on my name, not yours,” the senior partner said. Botha agreed, Xoom ultimately flourished, and Botha duly completed his apprenticeship and stepped up to be a board member.[10] It was the inverse of the experience at Kleiner, where senior partners grabbed the best opportunities off the plates of younger investors. It was superior even to Accel, where the managing partner, Jim Breyer, had occupied the Facebook board seat.
• Sequoia itself went out of its way to ascribe the triumph to the group; successful investments were nearly always a collective effort. For example, when Sequoia toasted the second-biggest windfall thus far in its history, the sale of the messaging service WhatsApp, the partnership’s internal “milestone memo” began by saluting Jim Goetz, the partner who had led the deal and who had been Botha’s flag-football victim. But the memo pivoted quickly to a different message: WhatsApp had been a “classic Sequoia gang tackle.” More than a dozen partners had contributed to this win: Sequoia’s in-house talent scouts had helped WhatsApp quintuple the size of its engineering team; Botha and Moritz had advised the company on its distribution and global strategy; Sequoia’s teams in India, Singapore, and China had provided on-the-ground intelligence; the partnership’s communications chief had prepared Jan Koum, WhatsApp’s introverted CEO, to be a public figure. The milestone memo gave a special shout-out to an office assistant called Tanya Schillage. At 3:00 the previous morning, Koum’s car had broken down en route to finalizing the sale documents, and Schillage had sprung into action and found Koum a new ride. Somehow, in a flourish of nocturnal overachievement, she had managed to supply Koum with nearly the same model of Porsche that he’d been driving.[14]
• Because of Sequoia’s status as the Valley’s leading venture firm, most startup founders were eager to pitch to it; by the partnership’s own reckoning, it was invited to consider around two-thirds of the deals that ended up getting funded by the top two dozen venture shops. But this privileged deal flow was both a blessing and a curse. The partners’ days were crammed with meetings organized at the visitors’ request. It was easy to become reactive.[16]
• Yet a third landscape focused on “the rise of the developer.” Worldwide, a mere twenty-five million coders—one-third of 1 percent of the global population—were writing all the software that was transforming modern life. Anything that boosted the productivity of this small tribe would be immensely valuable.
• “Sometimes we felt that if a particular company had been there the previous Monday, or the subsequent Monday, our decision would have been different,” Botha explained. “That didn’t feel like a recipe for sustainable success.”[19]
• Botha arranged for outside psychologists to present to the partnership. He led his colleagues through painful postmortems of past decisions, homing in on times when they had weighed evidence irrationally. Previously, the partners had tried to extract lessons from portfolio companies that had failed. Now Botha was equally focused on the times when Sequoia had declined to invest in a startup that subsequently succeeded. To enable scientific postmortems, the partners kept a record of all votes at investment meetings. “It’s not about scapegoating,” Botha explained. “It’s just ‘What did we learn as a team?’ If we can get better at decisions, that is a source of advantage.”[21]
• “We all suffer from the desire not to be embarrassed,” Jim Goetz reflected. “But we’re in the business of being embarrassed, and we need to be comfortable enough to say out loud what might be possible.”[22]
• “When a young entrepreneur is exposed to enough successful people, he or she realizes that they are flesh and blood,” Singh said. “And then the young founders say, hey, I can do this.”[56]
• The Summit investors sat at desks under the stairs, making cold calls and plugging numbers into spreadsheets: they were reckoning with reality. The Sequoia folks sat one story above, under a pyramid-shaped ceiling with a bright skylight: they were contemplating potential.
• Botha challenged Grady to be less negative about prospective deals. “Look, any smart person can come up with all the reasons to pass on an investment, but our job is to make investments,” Botha reminded him.[65]
• Having resolved to abolish the traditional silos, Johnson confronted an intellectually terrifying blank slate. It would no longer be enough to decide on an allocation to, say, real estate and then pick some deals to fill that quota. Henceforth, his team would simply look for great investments, and these could come from anywhere: the scope of the challenge was infinite.
• “Look, I think about our business versus Amazon,” he continued. “If you are Amazon, you have customers, warehouses, infrastructure, a whole bunch of things. If you are Sequoia, you have a few investors; you have nothing. “So you better take the shot. The only way to stay alive in my opinion is to risk the franchise continuously.”[82]
• Hedge funds that had thrived on assessing financial risks entered a dull stretch: risk was being dampened by the central bank, so risk analysis ceased to be as profitable.
  • #[[Risk Management]]
• In the popular imagination, Holmes’s fall from grace fed into a broader critique of the new Florence. Hitherto, the usual resentment of plutocrats had stopped short of the friendly geeks who created search engines and iPhones. But precisely because Silicon Valley was booming, its excesses were bound to cause umbrage. The region seemed full of absurdly young people who lucked into equally absurd fortunes, meanwhile showing scant concern for the citizens whom they might harm: those whose privacy might be violated, now that digital information was the new oil; those whose wages might suffer, now that software could do their jobs; those who had relied on Theranos to diagnose their illnesses. This Florence was less a center of enlightenment than a sinister cabal: a tiny elite that presumed to shape society, even as its vision for society involved creation and destruction at a speed that many found intolerable.[2]
• The Benchmark partners loved Neumann’s premature truths, and their bet on him was soon vindicated.[8] They invested $17 million in 2012 at a valuation of just under $100 million; less than a year later, the valuation hit $440 million. The next three funding rounds, culminating in the summer of 2015, transformed WeWork into a unicorn and then a deca-unicorn: its valuation leaped from $1.5 billion to $5 billion to $10 billion.
• To observers who were not inclined to think too critically, perhaps this sounded persuasive: after all, Silicon Valley behemoths from Google to Facebook had pumped themselves up to a commanding size before they had worried about profits. But the truth was that there was nothing particularly digital about an office-rental company, and the alleged network effects were weak, at best.[20] Adding WeWork tenants on New York’s Park Avenue would not improve the experience of WeWork tenants on nearby Fifth Avenue.
• It was only a partial exit; Benchmark still held around 80 percent of its WeWork equity. But it was welcome insurance: thanks to Son’s provision of liquidity, Benchmark knew it would get out with a good multiple, at the minimum.[29] The question for all the watching venture capitalists was whether this escape would be the norm. What if they backed a promising Series A company, celebrated its takeoff, and then watched as its governance was destroyed by late-stage investors? Would they manage to cash out before the reckoning?
• Pishevar was not in the same league as Jordan or Gurley. A bulky backslapper with a gift for self-promotion, he had attracted attention three years earlier for a bizarre essay, lauded as a “rambling, jetlagged, semi-lucid and beautiful email on entrepreneurism.”[40]
• But this time Kalanick was not speaking with another VC. Instead, he was speaking about VCs: he was on the phone to an old friend, explaining his dilemma. He and his company faced a tricky choice: a generous deal from a little-known investor, or a miserly deal from a famous one. Which should he go for? Menlo’s Shervin Pishevar or a16z’s Jeff Jordan? The high valuation or the high-value counsel? “You don’t need validation from a famous venture capitalist,” the friend said. “You are past that.” The way Kalanick’s friend saw things, Uber would need enormous amounts of money to roll out its service nationwide. “It’s about getting the cheapest capital you can. Capital is power. The more capital you have, the more options you have,” his friend urged him.[46]
• With the unfair benefit of hindsight, the Pishevar investment was a premonition of the troubles in Uber’s future. Kalanick had decided that money was power and that expert venture-capital guidance was dispensable. Fittingly, despite the substantial size of his investment, Pishevar became a nonvoting board observer rather than a full Uber director: he had not been chosen for his ability to provide oversight, so observer status seemed appropriate. Rather, Pishevar’s chief function at Uber would be to serve as cheerleader. He shaved the company logo into his hair. He arranged for the rapper Jay-Z to invest. He threw a party featuring a musician who became Kalanick’s girlfriend. Thanks to Google, Facebook and the youth revolt, a patina of founder-friendliness had become almost mandatory for VCs, but Pishevar pushed this fashion to the max, serving as buddy and valet.
• Kalanick’s decision to prioritize cheap capital was also a sign of the times, because it signaled the more problematic side of network businesses. The exciting thing about networks is that the winners win big. The downside is that also-rans may reap almost nothing. Moreover, the winner in a network industry is not necessarily the one that builds the best product. It may instead be the one that achieves scale first, setting the network flywheel in motion.
• If Uber had gone with a strong Series B investor, Gurley might have had a like-minded ally, but Kalanick had chosen a cheerleader. The main Series C investor was little help: Kalanick sidelined his Google board member because of Google’s plans to develop driverless cars that might compete with Uber. That left TPG’s David Bonderman as Gurley’s main support. But two votes were not enough to sway the board. There was no effective check on the chief executive.
• The assorted tech novices—banks, mutual-fund houses, PE firms, and hedge funds—had little interest in allocating $10 million to a startup. Rather, they wanted to write $100 million checks that might move the needle on their multibillion-dollar portfolios. Inexperienced money therefore crowded into big-ticket late-stage rounds, driving valuations skyward.
• In April 2016, Gurley published a second blockbuster critique of unicorns. This time he homed in on a particular threat: because of those liquidation preferences, late-stage unicorn investors had destructive incentives.[64] With their downside protected, they had no reason not to press unicorns to grow recklessly. Faced with a choice about splurging in China, for example, late-stage investors might encourage a unicorn to take the shot: thanks to liquidation preferences, they would get their capital back no matter what, so they had every reason to gamble for the upside.
• Gurley accepted invitations to speak to MBA classes, using these occasions to generate debate on his predicament. If the bright-eyed business students found themselves on the board of a recalcitrant unicorn, what would they do? Gurley discovered that none of them could say. “The only answer we could think of was that the public markets would do a better job of holding companies accountable,” he lamented.[72]
• Gurley found no comfort in the fact that he had seen much of this coming. “Being right and ineffective in venture is not worth very much,” he said later.[74]
• As he lay awake in the small hours, he felt the burden of responsibility for one of the largest unrealized bonanzas in the history of venture: a 13 percent stake in Uber that was now worth $8.5 billion. The gap between this paper gain and what might be the actual gain was eating him alive: What if Uber went the way of Zenefits or Theranos? Many of Benchmark’s limited partners had already booked profits from his presumed grand slam: endowment investment officers had taken bonuses and bought cars and homes; they had distributed proceeds to their universities and foundations. If Gurley’s Uber triumph morphed into a failure, the consequences would ripple back to the lecture halls and laboratories that relied on Benchmark’s performance. What would people say of Gurley then? That he had indulged Kalanick’s aggression. That he had failed to fight the creeping governance changes. That he had permitted a perfect investment to spiral into a catastrophe.
• Looking back on the excesses of WeWork and Uber, it was tempting to paint VCs as the chief culprits. “How Venture Capitalists Are Deforming Capitalism,” ran the title of a retrospective in The New Yorker.[83] But, just as with the backlash following the Theranos scandal, the critique was too sweeping: it glossed over the different types of technology investors. WeWork’s capital had come overwhelmingly from nonstandard players: banks, mutual funds, and then Masayoshi Son, acting as a conduit for Arab Gulf money.[84] The one recognizable VC in the WeWork story, Bruce Dunlevie of Benchmark, had provided only about 1 percent of the $1.7 billion raised before Son wrote his monster check in 2017: it was a stretch to present him as a significant enabler.
• The truth is that standard venture capitalists were not the main villains: not at WeWork, not at Uber, and not at overmighty unicorns more generally. Between 2014 and 2016, more than three-quarters of late-stage venture funding in the United States came from nontraditional investors such as mutual funds, hedge funds, and sovereign wealth funds.[85]
• In his anguished essay of 2015, Gurley had pointed to the clearest fix: that unicorns should go public. A public listing would get rid of those distortive liquidation preferences that encouraged unicorn recklessness.
• Gurley had been right. The IPO process did what broken private governance had failed to do: administer the cold shower that both unicorns needed. But the question was whether larger lessons would be learned and whether the tech world would turn a corner.
• Meanwhile, the financial climate promoted irresponsibility: so long as the Fed kept interest rates low, the abundance of cheap capital would cause capital to be used carelessly. Too much money was chasing too few deals, and the money providers were almost obliged to throw oversight to the winds in order to get into the hot companies. Venture capital had established itself as the best form of finance for innovative young firms. But the industry could not prevent reckless late-stage investors from playing poker with unicorns.
• In 2018, a working paper published by the National Bureau of Economic Research tested this logic directly on the venture industry.[4] Sure enough, the authors confirmed the existence of feedback effects. Early hits for venture firms boost the odds of later hits: each additional IPO among a VC firm’s first ten investments predicts a 1.6 percentage point higher IPO rate for subsequent investments. After testing various hypotheses, the authors conclude that success leads to success because of reputational effects. Thanks to one or two initial hits, a VC’s brand becomes strong enough to win access to attractive deals, particularly late-stage ones, where a startup is already doing well and the investment is less risky, according to the authors. Moreover, those one or two initial hits seem not to reflect skill. Rather, they result from “being in the right place at the right time”—in other words, from good fortune.
• Despite his powerful reputation, Arthur Rock was unsuccessful after his Apple investment. Mayfield was a leading force during the 1980s; it too faded. Kleiner Perkins proves that you can dominate the Valley for a quarter of a century and then decline precipitously. Accel succeeded early, hit a rough patch, and then built itself back. In an effort to maintain its sense of paranoia and vigilance, Sequoia once produced a slide listing numerous venture partnerships that flourished and then failed. “The Departed,” it called them.
• Starting with Arthur Rock, who chaired the board of Intel for thirty-three years, most venture capitalists have avoided the limelight. They are the coaches, not the athletes. But this book has excavated multiple cases in which VC coaching made all the difference. Don Valentine rescued Atari and then Cisco from chaos. Peter Barris of NEA saw how UUNET could become the new GE Information Services. John Doerr persuaded the Googlers to work with Eric Schmidt. Ben Horowitz steered Nicira and Okta through their formative moments. To be sure, stories of venture capitalists guiding portfolio companies may exaggerate VCs’ importance: in at least some of these cases, the founders might have solved their own problems without advice from their investors. But quantitative research suggests that venture capitalists do make a positive impact: studies repeatedly find that startups backed by high-quality VCs are more likely to succeed than others.[7]
• But smartness is still a major driver of results, as are other qualities that VCs bring to the job: hustle, for getting to standoffish founders first; fortitude, for riding through the inevitable dark periods when your investment goes to zero; emotional intelligence, for encouraging and guiding talented but unruly founders.
• Whatever the skills of particular venture partnerships or individual VCs, venture capitalists as a group have a positive effect on economies and societies.
• The doubts can be grouped under three headings. The VC industry is better at enriching itself than at developing socially useful businesses. The VC industry is dominated by a narrow club of white men. The VC industry encourages out-of-control disrupters with no regard for those who get disrupted.
• If the giants have since become threatening, this is because they have become so large: the VC/startup stage in their trajectory is long behind them. Nor can it be argued that VCs somehow programmed irresponsibility into these companies when they were in their cradles. If anything, the opposite is true: the majority of VCs tend to push founders to be more careful about legal and societal constraints, not less so.
• The companies that VCs create are much more a force for progress than a source of regression.
• Venture capital is also attacked for the businesses it has failed to create—for errors of omission. The most common form of this complaint is that venture capital has flowed more copiously to frivolous apps than to socially useful projects, notably the vital area of technologies to fight climate change. But this is not for lack of VC enthusiasm, as we have seen.
• One Flagship startup, the biotech company Moderna, invented a vaccine for COVID-19. There could scarcely be a stronger proof of venture capital’s utility.
• So long as the startup is targeting a lucrative market and has a shot at delivering 10x-plus to its investors, it really doesn’t matter what sector it is in.
• Inevitably, there will always be critics who object that venture capitalists could allocate society’s resources in some better way. But these critics’ subjective priorities could be interrogated, too, and it is not as though all non-venture-backed businesses are virtuous. In putting capital behind products that they can sell at a profit, VCs are at least respecting the choices of millions of consumers.
• The venture industry is a meritocracy, up to a point. It is also what its critics call a “mirror-tocracy.”
• But, in the hands of less thoughtful investors, “blitzscaling” has come to mean little more than “get rich quick,” a phrase to be filed alongside other notorious war cries, from Masayoshi Son’s injunction to be “crazier, faster, bigger” to Mark Zuckerberg’s call to “move fast and break things.”
• In 2019, the entrepreneur Jason Fried declared that venture capital “kills more businesses than it helps,” because large VC war chests create pressure to spend before managers know how to spend wisely. “You plant a seed, it needs some water, but if you just pour a whole fucking bucket of water on it’s going to kill it,” Fried said bluntly.[29] Noting the multitude of VC-backed companies that fail, the entrepreneur Tim O’Reilly offers a provocative idea. “Blitzscaling isn’t really a recipe for success but rather survivorship bias masquerading as a strategy.”[30]
  • SBF “circle jerk”
• If entrepreneurs want to grow their companies at a measured pace, venture capital may well create unwanted pressures. But while inexperienced founders may need to be told of these realities, venture capitalists understand them all too well: they are the first to proclaim that cautious founders should raise money elsewhere. “The vast majority of entrepreneurs should NOT take venture capital,” Bill Gurley tweeted in January 2019. “I sell jet fuel,” Josh Kopelman of First Round Capital agreed; “some people don’t want to build a jet.”[31]
• Of course, dislocation is usually a fair price to pay for technological advance: destruction can be creative. But if dislocation stems not from technology but rather from technology finance, the judgment may be different. When venture capitalists pour money into blitzscaling, the result is a pack of unicorns that can sell their products below cost, disrupting incumbents not necessarily because they are technologically superior but rather because they are subsidized by venture dollars. In ride hailing, for example, venture capitalists paid for artificially cheap fares for passengers, forcing incumbent taxi operators to compete on a distorted playing field. The moral and political justification for tough market competition is that it should be fair. If the market is rigged, it loses legitimacy.
• If it could be shown that subsidized unicorns are elbowing aside more efficient incumbents, then blitzscaling might be harming the overall efficiency of the economy.
• The goal of the blitzscaler is to establish market power—something approaching monopoly. This can harm society in three ways: overmighty companies may underpay suppliers and workers, overcharge consumers, and stifle innovation. But the right answer to this problem is to regulate monopolies when they arise, not punish venture capital. After all, venture capital is all about disrupting entrenched corporate power: it is the enemy of monopoly.
• Besides, even if it were the case that VC skill lay entirely in deal selection, and not in mentoring startups, that skill would still be valuable. Intelligent deal selection increases the chances that the most deserving startups will get the capital they need. It ensures that society’s savings are allocated productively.
• Between 1980 and 2000, VC-backed companies accounted for an already substantial 35 percent of U.S. IPOs. In the ensuing two decades, the share jumped to 49 percent.[37]
• But the right response to inequality is not to doubt venture capital’s importance or throw sand in its gears. It is to tax the lucky people who have prospered fabulously over the past generation—including those who made fortunes as venture capitalists.
• And yet, by a paradox, the success of venture capital sets the industry up for a new challenge. As it spreads around the world, it will increasingly be caught up in great-power rivalry.
• In 2017, much of Silicon Valley was consumed with excitement about cryptocurrency, despite its unproven utility. Meanwhile, Chinese startups rushed ahead in AI, developing applications from instant loans delivered via smartphones to recommendation algorithms to facial recognition.[46] That same year, China overtook the United States as the top source of venture returns.[47] It did not feel like a coincidence.
• U.S. commanders understand AI’s potential equally well, but they seem locked into the weapons-purchasing habits that brought them dominance in the past—a sort of military version of the innovator’s dilemma. Sometime in the 2030s, the U.S. Navy plans to start building its next carrier-based fighter jet, the F/A-XX: it will have a human pilot. Meanwhile, the battlefield of the future will be dominated by intelligent unmanned craft. Software will eat warfare.
• In most cases, four simple steps will pay off more. Encourage limited partnerships. Encourage stock options. Invest in scientific education and research. Think globally.
• If others are daunted by a problem, go there. Try and fail, don’t fail to try. Remember, above everything, the logic of the power law: the rewards for success will be massively greater than the costs of honorable setbacks. This invigorating set of axioms has turned America’s venture-capital machine into an enduring pillar of national power. Six decades after the formation of Davis & Rock, it remains unwise to bet against it.
• Tim Sullivan, “That Hit Song You Love Was a Total Fluke,” Harvard Business Review, Nov. 1, 2013, hbr.org/2013/11/was-gangnam-style-a-fluke.