Allen Lane, January 2022
Many of the household names of the twenty-first century – Apple, Google, Uber, Amazon, eBay, Facebook, Twitter – were backed by venture capital. But whereas the names of the founders of these companies never leave the news headlines, those behind the machine which enabled their companies, and in many respects our modern way of life, rarely get a mention beyond the business pages.
The story of venture capital is key to understanding the contemporary mindset, which makes this ostensibly niche book seminal. Journalist Sebastian Mallaby, whose previous books include a study of the hedge fund industry and a biography of Alan Greenspan, has built on 4 years of intensive research - including some three hundred interviews - to produce an impeccably comprehensive study of the behind-the-scenes industry which forms the bedrock of the world today.
Mallaby starts by taking us back to 1957 when, intrigued by an opportunity in the burgeoning technology hot-bed of the West Coast, young Wall Street financier Arthur Rock persuaded eight Stanford scientists to leave their volatile professor William Shockley’s nascent semiconductor firm and set up on their own, striking a deal with businessman and technology enthusiast Sherman Fairchild to finance the venture – which is now famous as the first venture-backed business, Fairchild Semiconductor.
Strikingly for us today, it had never occurred to the eight disgruntled employees (which included one Eugene Kleiner, who went on to co-found Kleiner Perkins) to set up their own company. Starting a firm back then generally involved either taking out a loan, which, without a track record or assets to use as security, was usually out of the question – or being funded by the profits of a large corporation. Nobody would take a risk on an unproven idea. But Rock described his new method as “liberation capital”, which had one metric: backing promising founders to unlock human talent. His future business partner, Tommy Davis, subsequently described the concept as “intellectual book value”, which has stuck in financial parlance.
From Rock’s beginnings, Mallaby takes us on a journey through the evolution of the West Coast venture capital industry, including an early state-backed attempt (SBICs) which completely misfired by requiring the target companies to pay a dividend.
He takes us through the shift from the East to West Coast, both in terms of capital and mindset; Silicon Valley fighting off Japan’s tech boom; the rise of the hands-on VC with Kleiner Perkins and Don Valentine’s Sequoia; the importance of network effects illustrated by the financing of Apple; Masayoshi Son’s $100m investment in Yahoo; Benchmark and eBay; and the move to multi-stage funding (seed, Series A, growth).
He documents how the tide turned with the notion of the “founders’ revolt”, leading Paul Graham and Jessica Livingston to focus on incubation rather than investment stage with their pioneering incubator Y-Combinator; Peter Theil’s Founders’ Fund (founders investing in founders); then on to hedge fund Tiger Global’s foray into VC and, conversely, Sequoia’s foray into hedge funds; and Andreesen Horowitz’s notion of “by entrepreneurs for entrepreneurs”.
In parallel, Mallaby follows the rise of venture capital in China, starting with Shirley Lin and Goldman Sachs’s investment in Alibaba (ultimately, Goldman didn’t get the VC model, leading Lin to set up on her own) and Kathy Xu’s investment in JD.com, moving through the established Silicon Valley firms’ attempts to get in on the scene, and concluding by speculating on the extent to which China’s world-class tech industry was enabled by US investors.
Why does all this matter?
The maturation of venture capital is associated with the rise of the internet, but its beginnings were part of an earlier trend which fed into this: the upending of power structures post World War II. In my last blog, I wrote about how Mary Quant heralded the shift of power in the fashion industry from the establishment (pre-war, young people simply wore a version of what their parents wore) to the young, who have been at the forefront of changing fashions ever since. The Beatles represented a similar effect in the music industry.
Arthur Rock was putting together his deal for Fairchild Semiconductor on the Sand Hill Road in Silicon Valley at the same time as Mary Quant was establishing her boutique, Bazaar, on the King’s Road in London, in the mid-1950s when society was on the cusp of radical change. Both of them ignored established power structures and started from a blank slate, precipitating a trend which, over the next half century, would see the demise of corporatism and the rise of the empowered individual.
Mallaby defines the power law thus: the best way to manage risk is to embrace it fearlessly. Try and fail, don’t fail to try. Tradition, structure and its associated caution had been inverted.
In this new era, talent is rewarded and capital earns it place. But, even before the coming of the internet, another factor was at play: network effects. Mallaby succinctly points out that the core business of venture capital is linking ideas, people and capital – not financial engineering. Indeed, it operates more in the vein of eighteenth-century coffee shop culture than twentieth-century closed-shop corporatism. A classic example of this is the financing of Apple in 1977: it had faced multiple rejections from individual investors, but found success with a network of VCs who co-operated with each other.
Mallaby identifies venture capital as the commercialisation of applied science; I would go further and say it’s the acceleration of meta-trends based on an understanding of human behaviour. The industry originally focused on pioneering new technology, which meant that Masayoshi Son’s whopping $100m investment in Yahoo in 1996 is not only notable for its size - but also for the fact that he was backing not the technology per se, but acting on a hunch that the search engine’s ad-funded model could be huge. As we transitioned from Web1 (selling things) to Web2 (networking, funded mostly by advertising), an understanding of the intangibles of psychology and wider trends was to play a greater part.
This kind of business could never have been funded by traditional finance. As Mallaby says, venture capital is predicated on the notion that the future can be discovered, not predicted. The most valuable company assets are now for the most part intangible, whether it be technology, research, data, marketing, brand, or networks. As Marc Andreesen famously says, “Software is eating the world.”
In a world in which most information is at our fingertips, betting on the next big thing is a much more nuanced art.
Where next? If Web1 was about optimising transactions and Web2 about network effects, Web3 is set to be about decentralisation. And I would argue that it’s also about the creative economy, with content at the top of the value chain in an automated world.
On this note, an emerging trend amongst the new breed of venture capitalists which Mallaby doesn’t cover is the advent of VCs as content creators. This foray into thought leadership was pioneered by Andreesen Horowitz with their proliferation of a16z blogs, podcasts, tweets and live events dissecting and predicting trends, and is now a pre-requisite for anyone aspiring to operate in the space. Some notable examples are Harry Stebbings’s Twenty Minute VC, Prime Venture Partners, Samir Kaji’s Venture Unlocked, Village Global’s live events and Venture Stories podcast, and Jamie Burke of accelerator Outlier Ventures.
Conversely, as VCs are jostling for prominence in the content space, we see established celebrities and other content creators becoming angel investors, starting funds (and SPACs), and establishing their own consumer brands.
What’s certain is that venture capital will continue to evolve, and that, in a world where access to finance and participation in capital markets (witness the rise of retail investing over lockdown) is becoming increasingly democratised - and the decentralisation of Web3 looks to level existing power structures - its players can no longer afford to remain behind the scenes.
In charting the history of venture capital, Sebastian Mallaby has crystalised the bedrock behind the transition from the twentieth century to twenty-first century, not only in terms of financial markets but as a basis for much broader cultural and societal trends. As such, this book deserves to earn its place as a definitive record of how to understand the world today.