Chasing Unicorns

The Power Law

By Sebastian Mallaby

(Penguin Press, 482 pages, $30)

 

"The average venture-capital fund launched in 2011 outperformed the S&P 500 by 7% per year.

But that statistic understates the astronomical returns earned by a few top performers -- and the mediocre returns earned by the rest.

Between 1979 and 2018, the median fund underperformed the S&P 500, while the top 5% of funds nearly tripled the index's performance.

The investor Bill Gurley, of Benchmark, describes venture capital as a "grand-slam business."

In "The Power Law," business journalist Sebastian Mallaby argues that venture is defined by its most extravagant successes. A few deals explain the majority of returns, a few funds drive the majority of asset-class performance, a few wild ideas change the world.

Venture's contribution to innovation and entrepreneurship is massive. Mr. Mallaby notes that between 1995 and 2019 venture-backed companies accounted for nearly half of U.S. nonfinancial IPOs. These firms are orders of magnitude more likely to launch an IPO than startups that don't receive venture backing. The U.S. economy's dynamism depends in large part on the Silicon Valley ecosystem.

Mr. Mallaby believes this success is the result of a unique mind-set: "the patina of the counterculture" combined with "a frank lust for riches." Venture capitalists will fund almost any idea, no matter how seemingly crazy or unreasonable. But the checks stop coming if measurable results are not forthcoming, forcing every company to constantly confront the harsh realities of a competitive marketplace.

Boston was once the leader in venture capital. The legendary Georges Doriot, who taught at Harvard Business School, is considered the father of venture capital for his role in founding American Research and Development in 1946. But Doriot couldn't bear to see the companies he invested in fail, and his focus was more on people and patriotism than profits. "Capital gains are a reward, not a goal," he told his underpaid employees.

Silicon Valley, by contrast, developed into a ruthless ecosystem that accelerated corporate evolution by killing off the weak while helping the strong to pursue technological and market dominance.

Mr. Mallaby tells a gripping fly-on-the-wall story of the rise of this unique and important industry based on extensive interviews with some of the most successful venture capitalists.

Arthur Patterson, the "self-consciously cerebral" co-founder of Accel, devised a systematic approach centered on the idea of the "prepared mind." In an off-site meeting in 2003, the firm's partners identified social networking as one of the most promising new innovations and a focus for the firm's deal makers. Months later, a young partner named Kevin Efrusy persuaded Mr. Patterson to visit a new company called Facebook. The firm would invest about $13 million -- and earn a profit of $12 billion when Facebook went public.

In contrast with Accel's patrician intellectualism, Sequoia Capital built its reputation on immigrant grit. Three of the firm's top deal makers hail from abroad: Michael Moritz from Wales, Douglas Leone from Italy and Roelof Botha from South Africa. Sequoia's partners first connected with Arash Ferdowsi, the co-founder of Dropbox, through a Persian rug merchant whom the firm had hired to network with the Bay Area's Iranian-American community. Patrick and John Collison, two brothers from a small town in Ireland, founded Stripe, the fast-growing payments company. They partnered with Sequoia, John told Mr. Mallaby, because of the firm's reputation for backing "young immigrant founders with pluck."

Though the book focuses on the winners, Mr. Mallaby doesn't shy away from criticism, especially in his description of the decline of Kleiner Perkins. The firm was successful in the 1990s, but lead partner John Doerr became more interested in virtue signaling than in profit making. He started a cleantech fund, based on a conversation with his teenage daughter about saving the planet, that put a significant dent in the firm's long-term track record. And he embarked on a highly publicized gender-equity campaign to hire female partners, only to see some of the most talented women quit and then see the firm be sued by a disgruntled employee for gender discrimination.

Telling stories of rich investors betting on young visionaries and earning insane profits could become tediously repetitive, but Mr. Mallaby writes a fast-paced narrative. He also has a journalist's eye for revealing details: Mr. Patterson, of Accel, serves a new recruit a dinner consisting of nothing but 12 ears of grilled corn and a bottle of Bordeaux; an executive assistant at Sequoia scrambles a replacement Porsche for a chief executive when his car breaks down at 3 a.m.; one bigwig uses a silver bell to summon his waiter at his San Francisco mansion.

Mr. Mallaby's "More Money Than God," published in 2010, was a narrative history of the hedge-fund industry based on extensive insider interviews. "The Power Law" can feel, in part, like a spinoff of the earlier book, substituting venture funds, which have profited from the rise of smartphones and cloud computing, for hedge funds, which have struggled to keep up with a soaring S&P 500.

In his closing words in "The Power Law," Mr. Mallaby warns that it's "unwise" to bet against venture. But public markets have recently turned against IPOs and other venture-backed companies, sending venture-style portfolios like Cathie Wood's ETF into steep losses. With the IPO window closing and tech stocks selling off, some venture investors might well be thinking: "There but by the grace of God go I." Only time will tell if Mr. Mallaby has timed the publication of his book with the peak performance of the venture-capital asset class.

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Mr. Rasmussen is the founding partner of the hedge fund Verdad Advisers." [1]

1. Chasing Unicorns
Rasmussen, Daniel. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 03 Feb 2022: A.15.