Lessons from The Power Law
How the best venture investors stay ahead and build an edge, and venture's benefits to societies
Over the last month, I read the excellent The Power Law by Sebastian Mallaby, an overview of the history and dynamics of the venture capital industry. One of the fun parts of the book is the great background and stories on VC firms that have typically been under the radar. The story of the founding of YCombinator is fairly well-known, but Mallaby is able to tell origin stories around Tiger Global’s venture investing and the early days of VC in Asia that were entirely new to me.
In addition to the great stories, I found there were a number of important takeaways from the book for fintech investors as well as policymakers. In this post, I’ll highlight the importance of luck vs. systems in venture investing, how venture investors have been able to develop strategic advantages, and the importance of a robust venture industry from a national industry perspective.
There’s always a question of whether an investor’s success is due to luck or skill. Mallaby quite persuasively argues that there’s a significant amount of skill involved in successful venture investing, highlighting the success of Sequoia Capital as an example. Reading about Sequoia in the book, I observed a few key systematic elements to Sequoia’s success:
Building an ecosystem: Sequoia was one of the earliest VC firms to develop a scout network and constantly nurtured relationships with angel and seed investors. These investments in the early-stage investing ecosystem have paid off many times over; an example is given where Sequoia’s strong relationship with YC helped facilitate a Series A lead investment in Stripe.
Developing and refreshing talent: Sequoia has been highly effective at developing homegrown talent as well as refreshing its leadership team regularly. Roelof Botha, now one of the leaders of the firm, was once a young talent who developed his career and investing prowess at Sequoia. Refreshing leadership is very hard to do in venture (and tech generally) given the personality-driven nature of the industry, but Sequoia has been systematic about constantly elevating skilled performers and changing up their leadership team.
Constant innovation: I’ll cover this more in a bit, but Sequoia has made sure not to lose too much ground to other players when it comes to innovations in venture itself. For example, soon after growth investing became common in tech, Sequoia built out a growth fund, and just this week, Sequoia announced a crypto token sub-fund.
All that being said, I would argue that one area where luck is pretty important is in the performance of a VC firm’s first fund. Both in my personal experience in investing, as well as in this book, I have observed that investment firms can coast off stellar first fund performance for a long time, but it is very hard to recover from a subpar start.
I often hear from investors that venture has become an extremely crowded space, and there’s no question that everywhere you look these days, people seem to be starting venture funds. That being said, creativity in the field has been rewarded over time. For example, the book dives deeply into the story of Tiger Global and DST, two funds which pioneered an analytical and global approach to growth investing. The story of DST’s growth investment in Facebook shows how Yuri Milner, the founder of DST, was able to think differently about Facebook’s prospects than the rest of the investing field, and his bet paid off handsomely. Similar points are made about Founders Fund’s at-the-time unique focus on empowering forceful and visionary founders (i.e. SpaceX, Airbnb). Sometimes a novel bet in venture will go sideways, such as Kleiner Perkins’ first foray into cleantech. But if you don’t try to do something differently from the pack, your returns likely won’t be different from the pack either.
One intriguing area the book covered was around detailing the national-level economic and social benefits of a robust VC industry. It’s unquestionable that venture investing has pushed innovation and economic growth forward in regions across the world, most notably the U.S and Asia. But a closer look reveals just how valuable venture capital has been to America. VC has funded American “national champions” in fintech (Stripe, PayPal, Coinbase), defense (SpaceX, Palantir, Anduril), and diversified tech (Apple, Google, Facebook, Amazon). These are all companies that have come to define the 21st century American economy, and they all took venture financing in their early days. Venture capitalists have fostered a culture of embracing risk-taking, failure, and innovation in business that has created massive positive spillover effects throughout society. This is one of the reasons I was heartened to see a recent Economist special report on venture finance going global.
To summarize, key lessons for investors from this book: build a methodical and systematic approach to investing, and think differently than your peers about some aspect of the investment process. For countries and societies, it would be to embrace the culture of risk-taking and creativity that venture investors have built so effectively in the United States.