Mastering the Power Law: The Key to Success in Venture Investing
Book Review "The Power Law" Written by Sebastian Mallaby
Dive into this week's insights:
Dear Reader,
I hope you've had a fantastic start to 2024. February is a month when many countries observe mid-term or winter breaks, providing an excellent opportunity for parents to spend quality time with their children.
That’s why I have used the time this February and dedicated my efforts to expanding the podcast format, adding a new element to the offering:
Book Reviews
The pandemic has significantly accelerated the adoption of AI and social media within deep-tech B2B industries. In 2024, decision-makers increasingly rely on social media, AI, and search engines to discover useful information.
I aim to develop the podcast further into a comprehensive resource for budding entrepreneurs and investors. It's an ideal platform for sharing success stories and failures, offering insights into values and beliefs, and helping the next generation embark on their startup or venture capital journey with a wealth of knowledge. Moreover, it serves as an invaluable tool for connecting people.
In February 2024, the podcast and newsletter reached over 12,000 people through social media distribution.
The book reviews section will feature works that I find essential for understanding deep-tech entrepreneurship and venture investing. The inaugural book review in the podcast and newsletter is:
Sebastian Mallaby’s "The Power Law"
This crucial book outlines the history of Venture Capital and provides in-depth insights into the varied approaches of the funds that have shaped the world as we know it today.
By sharing real people's stories and books on topics such as
Entrepreneurship,
Private and Public Investing,
Strategy and Leadership,
Communication & Sales, and
a Healthy Lifestyle,
I aim to make the podcast and newsletter valuable resources I wish had been available when I started this journey 35 years ago.
Thank you for your ongoing support, and I hope you enjoy the upcoming
Livestreams
Podcasts and
Book Reviews
Best regards,
Christian Soschner
How the Power Law Rules Venture Investing
“I’ve got it,” she said simply.
“What?” her partner asked.
“I was at the incubation program, remember? We need funds.” she didn’t wait for his answer.
He remembered, but her look made him feel otherwise.
Time seemed to slow.
“We raise venture capital money,” she added.
“For what? It is just a pitchdeck yet. And we’re nearly broke,” he countered.
“Exactly,” she said.
“That’s why it’s now. We’ve got four weeks.” Her certainty was stark. No room for his doubts.
“We’re not beaten yet. We have our plan. It’s time,” she stated.
Her words were direct, leaving no space for hesitation. A clear path lay ahead, lit by her resolve.
Conversations like this happen before future entrepreneurs pick up the phone and call me with one question:
"Do you know Venture Capitalists?"
Of course, they expect a list of 100 VCs on a silver platter, including colloquial introduction calls — a month's work — for free.
This is the usual situation when people raise funds for the first time.
For a long time, I was looking for a book I could recommend to first-time founders to give them a competitive advantage:
Understand the Venture Business, its origin, development, and current state before investing time and money into fundraising.
Sebastian Mallaby wrote this book:
The Power Law
Who is Sebastian Mallaby
Sebastian Mallaby isn't just any author; he's a renowned journalist and commentator on finance and economics.
His resume speaks volumes:
a contributor to the Financial Times,
a columnist for The Washington Post, and
a senior fellow at the Council on Foreign Relations.
But what truly sets Mallaby apart is his unique ability to weave complex economic and financial concepts into compelling narratives.
His previous works, like 'More Money Than God: Hedge Funds and the Making of a New Elite' and 'The World's Banker: A Story of Failed States, Financial Crises, and the Wealth and Poverty of Nations', have been widely acclaimed for their insightful and accessible analysis of the financial world.
But why does this make him the ideal author to tackle the enigmatic world of venture capital?
His deep understanding of global finance and his knack for storytelling allow Mallaby to bring the secretive world of VC to life.
Besides presenting facts and figures, he delves into the personalities, the conflicts, and the high-stakes gambles that define venture capital.
In 'The Power Law,' Mallaby leverages this expertise to offer the reader a front-row seat to the decisions and dynamics that drive the VC industry.
His comprehensive research and engaging writing style illuminate the successes and failures, the visionaries and the risk-takers, and the sheer force of will that fuels this fascinating world.
Tl;Dr Overview
Mallaby invites the reader to see venture capital as a realm of true adventure.
It's not about the safe bets; it's about leaping into the unknown, backing ideas that are too bold, too raw for traditional funding.
This is where Mallaby's narrative shines — revealing a world where messy information leads to binary, make-or-break decisions, where the norm is to be frequently wrong yet resiliently optimistic about the future.
Some might see this world as one driven by greed or a lack of skepticism, as pointed out in the New York Times article.
But Mallaby digs deeper.
He shows the reader that venture capital is more than a hunt for the next big payday.
It’s a pursuit of innovation, of breakthroughs like synthetic insulin or plant-based meats — ideas that once seemed far-fetched but now shape our everyday lives.
However, Mallaby doesn't ignore the industry's complexities and contradictions. He acknowledges that venture capital can sometimes create distorted playing fields or back founders who later stumble. But he also argues that these are outweighed by the industry's ability to fund disruption and drive progress.
In 'The Power Law,' Sebastian Mallaby takes the reader from the origins of venture capital with the Traitorous Eight and Fairchild Semiconductor to the present day's tech behemoths.
Mallaby gives a vivid picture of the venture capitalists — mentors, coaches, and those betting on unorthodox genius. It's a diverse portrait showcasing varied philosophies and approaches to funding innovation.
But it's not all rosy. The book reveals a venture capital world grappling with shortcomings — a world too white, male, and elite.
Mallaby's call for diversity and inclusivity in this field is crucial, highlighting a need for change in an industry that shapes our future.
7 Key Insights
Let's dive into some of the most striking takeaways from the book.
These insights are not just theoretical; they're blueprints for understanding and navigating the world of innovation and investment.
If you have little time, read this segment for a quick overview of the key lessons from the book.
Embrace Risk as a Pathway to Reward:
Venture capital is fundamentally about embracing risk.
Mallaby's narrative shows that the biggest breakthroughs often come from the boldest bets. Understanding and accepting the inherent risks can lead to unprecedented rewards, whether an entrepreneur or an investor.
One of the most sobering yet inspiring lessons is the dual nature of risk and reward.
As Mallaby puts it, 'The most you can lose is 1X your money. But the most you can win or miss out on is unlimited.'
This encourages a fearless approach to risk — a fundamental attitude for anyone looking to make a significant impact.
The Power of Visionary Thinking:
The success stories highlighted in the book underline the importance of visionary thinking.
Entrepreneurs who can see beyond the present, imagining what could be rather than what is, often attract venture capital, for anyone looking to make their mark, cultivating a visionary mindset is key.
Mallaby highlights that the most groundbreaking advancements often come from those outside traditional fields of expertise.
Figures like Elon Musk, Jeff Bezos, and Mark Zuckerberg didn't just follow the trends; they envisioned and built new paths, reminding us that radical rethinking is often the precursor to true innovation.
The Significance of the Power Law in Success:
Mallaby elucidates the 'power law' — the idea that a small number of investments yield the most significant returns.
This concept isn't just applicable to venture capital; it's a principle that can be observed in various business and personal growth aspects.
Identifying and focusing on the areas with the highest potential impact can optimize outcomes in any endeavor.
The Dual Role of Venture Capitalists:
Venture capitalists are more than just financiers; they're mentors, strategists, and partners.
Mallaby's accounts reveal that the most successful VC-entrepreneur relationships are those where there is mutual respect, shared vision, and active collaboration.
This insight is invaluable for anyone looking to forge productive partnerships in business.
The Impact of Venture Capital on Society:
Finally, Mallaby challenges us to consider the broader impact of venture capital — not just on technology and the economy but on society at large.
From fostering innovation that addresses global challenges to reshaping industries, the role of venture capital is profound and pervasive.
The Value of Networks:
Metcalfe's Law and the importance of network effects demonstrate how the value of a network grows exponentially with each new participant.
This principle, vital in the tech industry, also applies to personal and professional networks.
Embracing the Unknown:
Vinod Khosla's investment test simplifies the venture capitalist's dilemma: Can you identify why a venture might fail, assess the founder's capabilities, and foresee significant returns?
This mindset is essential, not just in venture capital but in all forms of entrepreneurship and innovation. Often, VCs invest in entrepreneurs operating in totally new territory.
What is The Power of Law
In the opening chapter of 'The Power Law,' Sebastian Mallaby lays the foundation of a concept that's as captivating as it is crucial to understanding the venture capital world.
Here, we're introduced to the principle that not only defines but also dictates the pace and direction of innovation and investment.
This principle? The power law itself.
But what exactly is the power law?
It’s a concept revealing that a few investments generate the vast majority of profits. In this principle, winners advance exponentially, leaving linear progression in the dust. This isn’t just a theory; it’s the reality of venture capital.
Another luminary of the investment world, Peter Thiel, puts it succinctly:
‘The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund.’
The power law is the essence of venture capital: a high-risk, high-reward domain where the power law reigns supreme.
This skewed distribution of outcomes, where a handful of investments can outshine the rest, isn't confined to financial portfolios.
It's a phenomenon mirrored in the wealth of nations, the citations of scientific papers, blockbuster music, retail investor portfolios, and the success of startups.
In the book, there are many stories about success and failure. I have selected two stories that describe "The Power Law" and the spirit of venture investing in detail:
Genentech Story — When did VCs start investing in Biotechs?
Today, it is normal for universities to spin out technologies in Startups. The founders apply for some grants, go on a roadshow, and happily raise a few million to deliver the next generation of medications with better efficacy and safety profiles.
Once the VC-backed companies deliver solid proof of concept data, a pharmaceutical company either buys the entire organization or acquires an exclusive license to finalize development and commercialize the new drug.
Conferences like #bioeurope are where tech transfer, founders, investors, and pharma business developers gather.
But this wasn't always the case. Before the 1970s, the place for innovation was big corporations.
The Genesis Moment of VC investments in Biotech happened in 1976.
In the 70s, Kleiner Perkins hired 26-year-old Bob Swanson. At KP, he met with noble laureate Donald Glaser, who piqued his interest in rDNA.
Swanson failed to impress Kleiner and Perkins and was soon fired. Like every young man, he had plenty of time for two things:
Ringing through the Silicon Valley companies to find a new job and
learn more about his latest obsession: rDNA.
"This idea is fantastic! It is revolutionary! It will change the world! It's the most important thing I have ever heard!"
He told Perkins when he ran into him one day after being fired. Perkins was anything but interested.
Getting fired didn't stop Swanson. He made a list and rang through scientists working in the rDNA field.
"For sure, there is a huge commercial potential," they said. "But here is the thing: Decades away."
On January 16, 1976, Swanson met Herbert Boyer. They started talking about rDNA, and Boyer expressed that commercial applications aren't decades away — a few years at best.
What was meant to be a short meeting lasted several hours. Boyer knew science, Swanson business. Both were obsessed with the potential of rDNA.
A perfect match for founding a company.
"Bob," Boyer said, "you gotta sit down and write some research grants."
"What if we had all the money? And don't need to write those grants?" Swanson asked.
On April 1, 1976, both arrived at the Kleiner Perkins office and convinced Tom Perkins to invest in the technology.
To bring the technology to a commercial level, many technological problems needed to be solved. But this was exactly what KP was looking for.
"Market risk is inversely proportional to technical risk because if you solve a truly difficult technical problem, you will face minimal competition. Thanks to the high barrier to entry."
This is known as Perkin's Law.
On that day, Perkins decided to invest in Genentech because the technical challenges were so formidable that the market entry barriers would be so high that they had a monopoly.
Genentech became a huge success story. Their first commercial project — Insulin — achieved blockbuster status in no time.
Thus, the Biotech Industry was born.
Still today, Venture investors in Deep Tech, Biotech, Class 3 Medical Devices, or any other industry with scientific roots follow Perkins Law.
Impossible Food and Khosla Ventures
This introduction chapter doesn't just explain; it enthralls, drawing the reader into stories of investments like Khosla's backing of Impossible Meat, illustrating the high-stakes game of venture capital.
It's a game where the risks are monumental, but the rewards?
Even more so.
Khosla, a venture capitalist who embodies the power law, doesn't look for the safe bets.
He seeks out the radical, the dreams so daring they could render entire industries obsolete.
To Khosla, the question isn't whether an idea will likely succeed but whether its success could be transformative.
This mindset, where 'the most you can lose is 1X your money, but the most you can win…has no limit,' isn't just about finance; it's about daring to reshape the human predicament.
The Story of Impossible Foods perfectly describes how venture investing works.
After an academic career with highlights like becoming an investigator at the Howard Hughes Medical Institute and an assistant professor in the department of biochemistry at Stanford University School of Medicine, Patrick Brown took an 18-month sabbatical to figure out what the rest of his career should look like.
Brown decided that the world’s largest environmental problem, and the problem where he could have the most impact, was using animals to produce food.
He knew how to solve that and decided it was time to get outside funding. What could have been a better fit as an investor like Vinod Khosla, who said:
“Most people think, improbable ideas are unimportant, but the only thing that’s important is something that’s improbable.”
Khosla wasn’t looking for companies Warren Buffett would buy: Established markets, simple business models so an idiot can run them, and a long-term perspective. Khosla likes the opposite.
And Patrick Brown was a perfect fit for this search pattern.
In 2011, he rode a bicycle to Khosla’s office and presented his slide deck.
The first slide said:
“Rendering the entire meat industry redundant.”
Where the average savings account investor would laugh, stand up, and leave, Khosla thought to himself:
“If there is a one-in-a-hundred chance that this works, this is a shot worth taking.”
Patrick Brown wouldn’t just start a company. His long shot could take over an entire industry and return a minimum of 100x of the invested capital.
Venture Investors usually put their capital into moon-shots with a 90% chance of failure.
But the 1 out of 100 investments that work well can return an entire fund multiple times.
And this is what VCs are looking for.
Venture Capital and the book “The Power Law.”
The book is worth reading for everyone interested in starting companies that redefine entire industries or create new ones.
It helps understand how the Venture Capital Value Chain works, different VCs' approaches, and what cases are a viable fit for “The Power Law” Model.
In a journey spanning over three decades, from student societies to the forefront of the life sciences industry, my path has been anything but ordinary.
My early fascination with business simulations evolved into a profound engagement with real-world ventures, from European Union-funded research projects with universities like Harvard, St. Gallen, and Uni Graz to leading roles in life science companies.
This diverse experience prepared me for the enigmatic world of Venture Capital, a realm I entered through a spinout led by Rodger Novak, later the founder of CRISPR Therapeutics.
Venture Capital first appeared as a mystery. The notions of no revenues, burning capital, and negative equity were foreign to my corporate-conditioned understanding. Yet, through interactions with leading fund managers like Nomura Phase 4 Ventures, HBM Partners, Wellcome Trust, Biomed Partners, GLS Ventures, and Novartis Venture Fund, I began to grasp the essence of Venture Capital:
The pursuit of exponential returns through investments in groundbreaking potential.
Sebastian Mallaby's 'The Power Law' offered me a panoramic view of the Venture Capital landscape, tracing its evolution from the last century to the present.
Mallaby delves deep into the mechanics of Venture Capital, elucidating the strategies that have shaped its success stories. From the pioneering days to contemporary titans like Andreessen Horowitz and Sequoia Capital, Mallaby captures what makes Venture Capital a critical driver of innovation.
' The Power Law' is an indispensable guide for anyone poised at the intersection of innovation and investment. It charts the course of Venture Capital's past and lights the way for its future, encouraging a new generation to embrace the challenge of turning visionary ideas into reality.
Upcoming Conversations and Events:
March 14 - 02:00 pm CET - Marc Penkala - General Partner @ āltitude
Podcast Episodes about “The Power Law”
#92: Sebastian Mallaby - The Power Law - A Brief History of Venture Capital
From Zero to Billion: How Venture Capital Shapes Our World | 'The Power Law' Review
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My Book Pick of the Week
Everybody is talking about the genius entrepreneurs of the last 4 decades:
Steve Jobs
Jeff Bezos
Mark Zuckerberg or
Elon Musk
When Steve Jobs passed away, an unknown man in the public eye took over one of the most promising companies in the world:
Tim Cook
In 2011, I thought: “Who can take over Apple? What will become of Apple when the genius visionary founder has passed away?
Today, 2024, we know. Tim Cook has carried on the work of Steve Jobs and built Apple towards becoming one of the world’s biggest and most successful companies.
But who is this man?
Where did he come from?
What is his vision of the world?
Although I have been interested in entrepreneurship and investing for over 35 years, I had to admit last year:
I don’t know anything about one of the most successful CEOs of our times.
In my search for more information, I found the Biography of Tim Cook, written and researched by Leander Kahney.
Everyone looking to invest or build the next Apple or a similar story in other industries should read this book.
Best Quote from this week
“Tom Perkins’s dictums: you succeed in venture capital by backing the right deals, not by haggling over valuations.” - from “The Power Law” written by Sebastian Mallaby
How often do investors and founders get caught up in a month-long back and forth about pre- and post-money valuations?
Tom Perkin has a pragmatic approach.
He thinks that valuations don’t make much difference in succeeding in venture investing. In his eyes what matters more is getting to the table of the right deal.
1% of 100 billion is a billion, while 90% of 0 remains nothing.
Tom Perkins (1932-2016) was a pioneering figure in the venture capital industry, co-founding Kleiner Perkins Caufield & Byers (KPCB), one of Silicon Valley's most renowned venture capital firms. His work and investment strategies have played a significant role in shaping the landscape of modern technology and venture capitalism.
Born in New York City, Perkins graduated from the Massachusetts Institute of Technology (MIT) with a degree in electrical engineering and later earned an MBA from Harvard Business School. Before entering the venture capital world, he had a successful career in business, including a notable tenure at Hewlett-Packard.
In 1972, Perkins, alongside Eugene Kleiner, a founder of Fairchild Semiconductor, established Kleiner Perkins Caufield & Byers. The firm quickly became a major player in the venture capital sector, funding and supporting numerous startups that would go on to become giants in their respective fields. Among their most successful investments were companies such as Genentech, a biotechnology firm that has had a profound impact on the pharmaceutical industry, and Tandem Computers, Sun Microsystems, Compaq, and Google.
Perkins was known for his hands-on approach to venture capital, often working closely with the companies he invested in to provide not just funding, but also strategic advice and management support. This approach was somewhat novel at the time and helped set the tone for the way venture capital firms operate today.
Aside from his professional achievements, Perkins was also known for his luxurious lifestyle and interests, including yachting and collecting rare and expensive cars. He authored a memoir, "Valley Boy: The Education of Tom Perkins," detailing his life and career, providing insights into the evolution of Silicon Valley and the venture capital world.
Tom Perkins's legacy in venture capital and technology is profound, having helped to launch and nurture companies that have become foundational to the tech industry and the world at large.
In essence, this quote is a call to focus on the bigger picture—identifying and nurturing potential rather than getting bogged down by immediate financial metrics. For both entrepreneurs and investors, it’s a reminder that the most successful ventures are often those built on strong partnerships where both parties share a belief in the company’s future success, beyond just the numbers.
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