The Power Law: Venture Capital and the Making of the New Future

by Sebastian Mallaby

With the coming of the internet, the hottest kind of company produced little more than code: it had no need for large amounts of capital with which to build manufacturing operations. Meanwhile, the open-source movement made chunks of software available for free, and the internet itself slashed the cost of marketing and distributing new products.[69] For all these reasons, the new generation of startups required relatively little cash, but venture capitalists were out of step with this development.[70] Thanks to the bubble of the late 1990s, they had grown used to managing big funds and collecting correspondingly big fees. As a result, they force-fed startups with more capital than was good for them, like farmers stuffing geese to make foie gras. The way Graham saw things, force-feeding by VCs created at least three problems. First, big investments meant big valuations for startups, which narrowed the odds of a profitable exit. Many founders might be happy to sell their company for, say, $15 million, but VCs who had already marked up the valuation to $7 million or $8 million would not be satisfied with a mere 2x multiple. Second, big investments meant that VCs took “agonizingly long to make up their minds,” and their dithering distracted founders from their highest calling, which was to write code and create products. Finally, big investments meant that nervous VCs were quick to eliminate the wondrous and weird features of startups. They installed humorless MBAs to oversee ...