📖 Book Review - The Power Law

Overlooked #113

Hi, it’s Alexandre from Eurazeo. I’m investing in seed & series A consumer and consumer enablers startups all over Europe. Overlooked is a weekly newsletter about venture capital and underrated consumer trends. Today, I’m sharing a post about a book on VC’s history called The Power Law.

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I read a great book on Venture Capital's history called The Power Law written by Sebastian Mallaby and published in 2022. I took some notes while reading and I wanted to share them. I did not want to write an exhaustive summary of the book. Instead, I wrote about the best practices highlighted in the book from 4 top US funds: Sequoia, Accel, Benchmark and Founders Fund. I'd love to have your feedback on this format and on the book if you've read it!

Sequoia

• Constant ability to reinvent itself and to lead the industry forward. Sequoia's innovations listed in the book include: (i) leveraging platform shifts (e.g. writing code to track the performance of mobile apps on smartphones which led to an investment in Whatsapp), (ii) building a powerful relationship with YC which led to investments in companies like Airbnb, Dropbox and Stripe, (iii) expanding geographically in China and India, (iv) investing in growth and public market, (v) launching Sequoia's heritage to manage the wealth of its partners and successful entrepreneurs with a diversified investment strategy besides venture.

• "Serendipity on the surface, systematic effort deeper down." "Sequoia’s tight team and loose experiments illuminated the enigmatic skill in venture capital. Taken individually, the story of each venture bet can seem to hinge on serendipity. Investor receives random referral. Investor meets inspired young misfit. Investor manages to connect with youth by means of an opaque alchemy. [...] But despite these trivializing explanations, Sequoia illustrates the method behind the seeming arbitrariness and chance. The best venture capitalists consciously create their luck. They work systematically to boost the odds that serendipity will strike repeatedly. Most of the modern Sequoia’s venture triumphs can be traced to this sort of systematic work, put in place in the first years of the new century."

• Be successful at handling partnership successions. Doug Leone and Michael Moritz established a successful tandem to manage Don Valentine's succession. Moreover, they managed to also give the reins to their successor with Roelof Botha now the main leader at Sequoia.

• Strong ability to recruit and grow talents in the investment team. Roelof Botha is a great example. He joined Sequoia at 30 years old from PayPal and he will become in July 2022 Sequoia's Senior Steward, replacing Doug Leone. In his early days, senior team members mentored him. He started by shadowing experienced colleagues on board meetings. He had a special deal with a senior partner for his 1st deal which was a remittance company called Xoom. The senior took the board member seat and Roloef an observer seat. If the investment worked out, the senior would leave the board seat to Roelof. If not, the senior would keep it to preserve Roelof's reputation.

• Winning as a team. "WhatsApp had been a “classic Sequoia gang tackle.” More than a dozen partners had contributed to this win: Sequoia’s in-house talent scouts had helped WhatsApp quintuple the size of its engineering team; Botha and Moritz had advised the company on its distribution and global strategy; Sequoia’s teams in India, Singapore, and China had provided on-the-ground intelligence; the partnership’s communications chief had prepared Jan Koum, WhatsApp’s introverted CEO, to be a public figure."

Accel

• Prepared mind. To break into the venture market, Accel's founders decided to start as a specialised fund in software and telecom. This positioning helped them spot great investment opportunities, to convince entrepreneurs to work with Accel and to excel in supporting portfolio companies with a huge network and expertise in telecom and software. Accel believes that knowing a market inside-out is key to generate outsized returns because "chance favors only the prepared mind" like Louis Pasteur said.

• Invest in circles. Once you're on top of your sector, you should have a better understanding of the future. You should see emerging trends thanks to your expertise and the pain points faced by your portfolio companies ("every deal should lead to the next deal"). You should also be able to understand and fund consecutive iterations of a given technology (e.g. Jim Swartz backed 3 videoconference startups in 1986, 1988 and 1992 and made a 14x return on two of these three bets).

• Hustle. I loved the story of how Accel managed to invest in Facebook. At the time, Accel had missed many social media companies like Skype or Flickr. Social media founders were different from experienced engineers that Accel was used to back. Social media companies should be measured with a new set of metrics. In reaction, the Accel's team took a step back and started to focus on the category. Its first massive win was to invest in Facebook. Kevin Efrusy tried everything to get in touch with Mark Zuckerberg and Sean Parker who were extremely hostile to VCs: multiple emails, warm introductions, phone calls, etc. Kevin and an Accel's cofounder Arthur Patterson ended up going to Facebook's office to meet them. They told Facebook's founders to come to pitch to the whole partnership on Monday and made them an offer to invest in the company the same day. Facebook turned down the 1st offer at $60m premoney valuation because they had a more attractive term sheet from The Washington Post. The next day, Accel sent another term sheet at $70m premoney and won the deal.

Benchmark

• Small is beautiful. Benchmark has a small team and small fund laser focused on series A. It wants to have enough time to pick the best investments and to add extremely high value to portfolio companies. "“God is not on the side of the big arsenals, but on the side of those who shoot best."

• Remunerating performance. Benchmark is known for charging lower management fees and a higher carried interest than the industry average.

Founders Fund

• Successful founders and operators are best positioned to back the next wave of founders. "Founders who had created companies like PayPal were out to back the next entrepreneurial cohort, and they promised to treat this new generation with the respect that they themselves had wished for."

• Tight application of the power law in venture capital. In venture, most returns are produced by outliers founders and companies. As a consequence, (i) VCs should look for contrarian and singular founders and (ii) VCs should stop thinking that they need to mentor founders because entrepreneurs who are outliers don't need external coaching.

• Strict refusal to bring external CEOs. "Founders Fund resolved that it would never eject founders from their startups, no matter how strangely they behaved; fifteen years later, it had stuck faithfully to this principle. Indeed, Founders Fund never once sided against a founder in a board vote, and was generally content to do without a board seat."

• Decentralised ownership to make investment decisions. "To banish consensual thinking, Founders Fund broke with the industry practice of Monday partnership meetings, replacing the Sand Hill Road tradition of collective responsibility with radical decentralization. Founders Fund investors sourced deals independently, even writing some small checks without consulting one another. Bigger bets required consultation— the bigger the check, the more partners had to assent—but even the biggest investments did not require a majority to vote in favor. “It usually takes one person with a lot of conviction banging their fist and saying, ‘This needs to be done,” one partner explained, by way of summary."

• "Unusually aggressive risk-taking" by (i) writing large cheques and taking large ownership in companies and (ii) backing "increasingly audacious projects". "[Peter Thiel] intended to go after the “somewhat riskier, more out-of-the-box companies that really have the potential to change the world.” Rather than confining himself to fashionable software, he would underwrite moon shots in less obvious fields that might be more important and lucrative."

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Thanks to Julia for the feedback! (🦒) Thanks for reading! See you next week for another issue! 👋