https://www.economist.com/culture/2022/01/22/a-history-and-defence-of-venture-capital-in-the-power-law

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CultureJan 22nd 2022 edition

Risky business
A history and defence of venture capital in "The Power Law"

It is a vital feature of modern capitalism, says Sebastian Mallaby

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Jan 22nd 2022

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The Power Law. By Sebastian Mallaby. Penguin Press; 496 pages; $30.
Allen Lane; PS25

NOT EVERYONE is a fan of venture capitalists (VCs). One academic
famously questioned whether they were "soulless agents of Satan, or
just clumsy rapists?" Paul Graham, the co-founder of the Y Combinator
startup incubator, published a "unified theory of VC suckage", in
which he likened the industry's investment process to a body-cavity
search by someone with a faulty knowledge of anatomy. Venture
capitalists, he concluded, resembled classic villains: "alternately
cowardly, greedy, sneaky and overbearing".

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More recently, VCs have been blamed for propagating some of the ills
of Big Tech: the monopolisation of markets, the erosion of privacy
and the degradation of workers' rights in the gig economy. By
prioritising growth over governance at all costs, they stand accused
of feeding a recklessly aggressive capitalist culture that
contributed to scandals at Uber, WeWork and Theranos.

In "The Power Law", Sebastian Mallaby acknowledges some of the
industry's shortcomings, most notably its shocking lack of diversity.
But he zealously defends the overall achievements of the VC industry,
which has funded many of the modern world's most useful inventions
(search engines, smartphones, vaccines), disrupted cosy monopolies
and generated eye-popping wealth. He even claims that VCs have
emerged as a "third great institution of modern capitalism",
combining the organisational strengths of companies with the
flexibility of markets. Little surprise that the VC model has now
gone global, with particularly striking results in China.

In his well-researched book, leavened by lively portraits of leading
figures, Mr Mallaby explores the history of the VC industry and the
reasons for its vitality. A journalist at The Economist in the
1980s-90s (and husband of the current editor-in-chief), he previously
wrote a study of the hedge-fund industry and an acclaimed biography
of Alan Greenspan.

Some histories of Silicon Valley, such as Margaret O'Mara's "The
Code", have emphasised the importance of American military spending
in seeding the west-coast tech industry. Mr Mallaby's focus is
overwhelmingly on the entrepreneurs, investors and firms that
nurtured its growth. Much of the VC industry's success is attributed
to its mentality. In evaluating investments, VCs still take after the
pioneering Arthur Rock, who zeroed in on the "intellectual book
value" of a company rather than the financial kind. They accept
extreme financial risk, embrace immigrants and tolerate nerds and
misfits, who account for so many successful entrepreneurs. Four of
PayPal's six early employees reputedly built bombs in high school.

While VCs love backing companies that enjoy so-called network
effects, they benefit from their own version of this phenomenon, too.
Sand Hill Road, where many of the leading VC firms are clustered, may
have the air of a row of gentlemen's clubs but it has enabled the
free flow of ideas, favours and connections. That is partly why the
Silicon Valley model has been so hard to replicate elsewhere.

As the author describes, the VC world has experienced considerable
churn in the past 60 years and has lately been disrupted as much as
it has been disruptive. Capital-rich outsiders, including DST Global,
SoftBank and Tiger Global Management, have all muscled in on what was
once a cottage industry. By deploying masses of money later in the
investment cycle, these indulgent newcomers have enabled startups to
delay listing on public markets. In Mr Mallaby's view, that trend
partly accounts for the misgovernance at some scandal-ridden tech
companies because it has cut the ties between interventionist VC
investors and freewheeling entrepreneurs.

Some west-coast VC firms, such as Sequoia Capital and Andreessen
Horowitz, have responded to the new challengers by raising
ever-bigger funds and diversifying, both geographically and
sectorally. This has only fuelled talk that Sand Hill Road is
becoming the new Wall Street. Yet even the biggest traditional VC
firms remain tiny compared with giant public-market funds. Some
investors wonder why they should bother with risky VC bets when the
returns in public markets can be so spectacular.

Take Apple, which recently popped above $3trn in market value
compared with the $1.8bn it was worth when it floated in 1980. It
seems improbable that the VC industry, which has helped so many
startups to "blitzscale", can ever do so itself. #

John Thornhill We identify the reviewers of books connected to The
Economist or its staff. Mr Thornhill is Innovation Editor of the
Financial Times.

This article appeared in the Culture section of the print edition
under the headline "Risky business"

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