How Venture Capital Made the Future
Sebastian Mallaby's The Power Law explores how venture capital and public policy helped shape modern technology.
The Power Law: Venture Capital and the Making of the New Future, by Sebastian Mallaby, Penguin Press, 496 pages, $30
"Liberation capital," as investor Arthur Rock called it, "was about much more than keeping a team together in the place where its members happened to own houses." In 1957, Rock took a gamble on the "traitorous eight"—a team of promising engineers at Shockley Semiconductor Laboratory—and counseled them to free themselves of their authoritarian boss by quitting en masse and striking out to form Fairchild Semiconductor.
Rock was an amalgamation of consigliere and connector. He helped the group secure funding, cementing his place in history as the father of modern venture capital, which offered an alternative to stuffy East Coast financial institutions that were leery of lending to tech ventures they perceived as risky.
In The Power Law: Venture Capital and the Making of the New Future, journalist Sebastian Mallaby draws on interviews with scores of high-profile venture capitalists (V.C.s)—and other sorts of reporting, including four years of sitting in on firms' meetings—to tell the story of Rock's new paradigm: a form of financing that centers on funding high-risk, high-reward companies in their early days. Mallaby, who similarly embedded himself in the world of hedge funds when writing his 2010 book More Money Than God, smartly details the well-placed V.C. interventions that produced technologies too many industry critics take for granted today.
While detractors frequently downplay how much public policy can help or hinder innovation, Mallaby never neglects the subject. A reduction in the maximum individual capital gains tax rates in the late 1970s and early '80s—from 35 percent for most of the '70s to 20 percent by 1982—left venture capitalists flush with cash and eager to invest. Without these preconditions, Apple and Atari might not have flourished; Leonard Bosack and Sandy Lerner's Cisco, which pioneered multiprotocol routers, might not have received enough investment; and advances in computing might not have taken off at the time and speed that they did. As Silicon Valley competed with larger, more established investing firms in Boston and Japan, its nimble spirit—a "bubbling cauldron of small firms, vigorous because of ferocious competition between them, formidable because they were capable of alliances and collaborations"—made it rich with creative ferment, especially when compared with the "self-contained, vertically integrated" cultures of its faraway competitors.
Three decades later, public policy was still shaping Silicon Valley. "While Wall Street recovered painfully from the crisis of 2008, its wings clipped by regulators aiming to forestall a repeat taxpayer bailout," Mallaby writes, "the West Coast variety of finance expanded energetically along three axes: into new industries, into new geographies, and along the life cycle of startups." Many politicians today threaten trustbusting crusades against Google and Amazon, or rumble about changing which types of speech are allowed on Facebook and YouTube. What legislators and regulators do now could shape V.C. appetites for years to come, altering which types of investments firms make or how many new entrants can emerge in the face of greater regulatory costs.
One of the book's strongest throughlines is that there's no one correct way to evaluate a company's promise or to foster its growth. On Sand Hill Road in Silicon Valley, there are activist V.C.s such as the late Don Valentine of Sequoia Capital, who would aggressively intervene in the decisions made by leaders at his portfolio companies, and there are passive V.C.s like Peter Thiel, who have deliberately chosen to be more deferential to founders. There have also been safety-net V.C.s whose presence has allowed outside management to take the risk of coming aboard young ventures, knowing their V.C. network would help them land on their feet if all hell broke loose.
That's what happened when Kleiner Perkins' John Doerr wanted to bring in an outside founder as a condition of investing in a promising company called Google. Doerr convinced Eric Schmidt, who at the time was running a software company named Novell, that he should take a chance on the search company, signaling to Schmidt that Kleiner Perkins would help him land in a comparably good position if Google failed to take off. And so the right manager made the right jump at the right time.
V.C.s have served as bubble enablers, fecklessly pumping cash into startups that are poorly managed or that peddle flawed products. They have been envoys to Wall Street and establishers of credibility. And they have been crazy gamblers like billionaire Masayoshi Son, whom Mallaby accuses of "barely pausing to sort gems from rubbish."
Although outsiders may not see it, V.C.s have strong incentives to mediate competition. Silicon Valley, in Mallaby's telling, is a land of cooperative as well as competitive pressures. In the late '90s, Max Levchin pitched Thiel on an encryption technology he was working on, and Thiel applied the tech to cash payments. They called the payment processor PayPal and named the company Confinity, but they struggled to raise money from top Silicon Valley firms, instead getting funding from the Finnish company Nokia. Competitor X.com, helmed by Elon Musk, secured five times as much Sequoia funding as Confinity, although Confinity's technical talent was arguably better than X.com's. "Pretty soon," Mallaby writes, "both sides understood that they could fight to the death or end the bloodshed by merging."
Back in the '80s, Thomas Perkins "presided, Solomon-like, over the dispute between two Kleiner Perkins portfolio companies," Mallaby recalls. Sometimes the future echoes the past, even in the land where all things must be creatively destroyed: "Twenty years later [Sequoia's Michael] Moritz was determined that cooperation should prevail. Sequoia would be better off owning a small share of a grand-slam company than a large share of a failure." Moritz thus had a clear incentive to facilitate the birth of PayPal after rounds of heated negotiations (and a power struggle between Thiel and Musk). PayPal's ongoing dominance is evidence that Moritz's instinct was correct. And the universe of technology companies that have sprung from, or been funded by, people involved in the early days of PayPal—Tesla, YouTube, Palantir, LinkedIn—has shaped our world in ways good, bad, and unexpected.
Some of today's biggest tech critics have long been thorns in venture capitalists' sides, nursing grudges and filing suits long before they set their sights on dismantling Section 230 of the Communications Decency Act (which protects free speech on the internet), breaking up tech companies, or attacking the idea of a Twitter run by Elon Musk. Investor Ellen Pao, who last April wrote in The Washington Post that "Musk's appointment to Twitter's board shows that we need regulation of social-media platforms to prevent rich people from controlling our channels of communication," unsuccessfully sued Kleiner Perkins for alleged gender discrimination back in May 2012. Pao said she was denied a promotion because of her gender; supervisors claimed it was because of her performance. She lost the lawsuit in court. Since then, she has spent eight months as CEO of the message board platform Reddit (a Y Combinator company) and, more recently, has been a tech critic and a promoter of diversity and inclusion initiatives.
Mallaby treats Pao and other early critics fairly, detailing some evidence of bad practices in Silicon Valley. There were sexual come-ons, he reports, and some women were cut off from male V.C. networks. But he doesn't think there's airtight evidence that women were systematically denied promotions. It is interesting to see the same names calling for new tech regulations in The Washington Post a decade later.
Mallaby also notes that some V.C.s, such as Kleiner Perkins' Doerr, made deliberate efforts to bring more women into the Sand Hill investment scene, believing that "exclusion of women represented wasted talent" and that such talent ought to be profitably captured. But Doerr failed to appropriately manage the integration of more women into the firm, which some female V.C.s claim hindered their longer-term success at Kleiner. There's a lesson there for those who call for governments to mandate corporate diversity quotas. In the V.C. world, blunt-force initiatives didn't create the lasting change that was desired; it was incrementalism that brought a better situation for women in tech, creating incentives that spurred investors like Doerr to address festering problems.
The Power Law is a useful, thorough corrective to tech critics who don't recognize the delicate balance that allowed the tech boom of the last half-century to happen. As V.C.-backed companies struggle with profitability and possible layoffs loom, and as we face a broader sense that the tech party may be over, it's more important than ever to understand the components that made this period of flourishing possible.