Mallaby treats the “power law” like something on the order of the law of gravity.
As Mallaby writes, “Venture capitalists look for radical departures from the past. Radical transformation, not the ordinary ebb and flow of price competition, is what matters venture seeks out companies that are able to attain and hold a monopoly position for a period of time because they have developed something that never existed before. So a venture fund seeks out those companies that break all the rules and launch into new territory-for only in this way will it recoup its losses and succeed. Rather than looking to the average-the “bell curve” distribution of results, in which most cluster near the middle with marginal cases on either side-the VC model privileges the outlier phenomena (the “long tail” of the distribution), insisting that these are the cases that matter the most. If nine out of 10 new firms in which a VC fund invests go bankrupt, but the tenth gives investors a return 100 times the initial investment, the fund will still be wildly successful.
The basic idea is that, while most startup companies fail, those that succeed grow at an exponential rate that more than makes up for the losses. Take the title of the book, which comes from the idea that the “power law” is what differentiates venture capital from other approaches to investing. In part, this is because Mallaby spends much of his time repeating much of what venture capitalists say about themselves, with little distance or critique. In other words, it’s a critical time for a serious exploration of the world VC is building, what its investments are, and what its economic but also political impact has been, and is likely to be. Venture capital equaled 11 percent of all nonresidential fixed investment in 2021, significantly more than the 7 percent it equaled in 2000, the height of the dot-com frenzy, let alone the average of under 2 percent per year between 19 (figures that do not come from Mallaby but from the economics writer Doug Henwood). Today, there are more than 1,000 such “unicorns” around the world, compared to fewer than 200 in 2016. Record numbers of private companies have stock valued at over a billion dollars on paper-known as “unicorns,” a term coined in 2013 by financier Aileen Lee-even though they have yet to test this by going public. We are in an important moment to think about venture capital, because the past year has seen a flood of new money pour into VC funds, with the number of deals funded at all-time highs. Besides all the tech, without this “strange tribe of financiers,” a “staggering amount of wealth might never have been created.” By helping to create “networks” that link inventors with ideas to investors with capital, VC funds have played an “unmistakable” part in developing new technologies, ranging from personal computers to routers to e-commerce to biotech.
Memories of 1929 come to mind when reading The Power Law: Venture Capital and the Making of the New Future, British journalist Sebastian Mallaby’s jaunty depiction of venture capital (VC for short) and its role in the U.S. As John Kenneth Galbraith wrote in his history of the Wall Street crash, academics in the run-up to disaster praised the stockbrokers of their day for shaking off the “heavy armor of tradition” and adopting “vision for the future and boundless hope and optimism.” In June 1929, financier Bernard Baruch explained the rapid rise in stock prices by insisting it reflected a sober appraisal of economic fortunes: “The economic condition of the world seems on the verge of a great forward movement.” As the NYSE soared, one Princeton economist saw fit to comment that stocks were “not at present overvalued.” And in mid-October 1929, Irving Fisher of Yale made one of the most infamous predictions in the history of forecasting: “Stock prices have reached what looks like a permanently high plateau.” Speculative bubbles have a way of leaving in their wake dozens of discredited economic writers, whose careers after the crash are forever haunted by the enthusiastic pronouncements they made while prices still rose.
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