The transcript from this week’s, MiB: Sebastian Mallaby on the History of Venture Investing, is below.
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BARRY RITHOLTZ; HOST; MASTERS IN BUSINESS: This week on the podcast, I have an extra special guest. Previously, I spoke with Sebastian Mallaby when he released his book, “The Man Who Knew” all about Alan Greenspan. I would argue that Greenspan wasn’t the man who knew. We avoided talking about anything having to do with the maestro or the Federal Reserve or interest rates or inflation and instead spent the full conversation discussing Mallaby’s new book, “The Power Law: Venture Capital and the Making of the New Future.”
I was a so-so fan of the Greenspan book as I’m not a fan of Greenspan. I loved Mallaby’s prior block, “More Money than God” all about hedge funds and this book is, I think, his best yet. The history of Silicon Valley told from the perspective of a story and he really brings a very different lens and filter to looking at how Silicon Valley developed, all the things that are so different relative to traditional investing, East Coast investing versus West Coast investing, how they embraced risk, what a power law is, why you’re not looking for diversification, why you expect most of your investments to fail, and it’s just a handful of companies that are responsible for the vast majority of your returns and hence, the tendency to spread a lot of money around on a lot of companies and a lot of entrepreneurs and a lot of startups looking for that unicorn that’s going to really be the driver of your fund’s returns.
I really, really like the book and I would just say that I thought it was tremendous. I plowed through it over a couple of weekends in the dead of winter. I think you’ll not only like the book, but you’ll enjoy the conversation. So, with no further ado, my interview with Sebastian Mallaby.
ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My extra special guest this week is Sebastian Mallaby. He is the Paul Volcker senior fellow for international economics at the Council on Foreign Relations. He is also a two-time finalist for the Pulitzer Prize in editorial writing. He has been a columnist at “The Washington Post,” the “Financial Times, “The Economist,” “The Atlantic.”
He is the author of multiple books, including “The Man Who Knew: The Life and Times of Alan Greenspan,” “More Money Than God: All About Hedge Funds and the Making of a New Elite.” His latest book is out February 1st, “The Power Law” Venture Capital and the Making of a New Future.” Sebastian Mallaby, welcome to Bloomberg.
SEBASTIAN MALLABY; PAUL VOLCKER SENIOR FELLOW FOR INTERNATIONAL ECONOMICS; CFR: Great to be with you, Barry.
RITHOLTZ: Great to have you again. Last we spoke was about five years ago after the Greenspan book came out and I have to tell you, I’ve really enjoyed your book on venture capital. But before we get to that, I want to just, for people may not be familiar with your career, just do a little background. How did you get started in journalism and what were you covering early in your career?
MALLABY: Well, I joined “The Economist” magazine right out of college and I had stints as the Africa correspondent, the Churchill correspondent and a bit later, I was Washington bureau chief, had some time in London when I was covering sort of fund management and finance. And I was in South Africa actually when Nelson Mandela walked out of jail. I always say my career has been downhill ever since.
RITHOLTZ: Really intriguing. So, you’re covering apartheid. You also wrote a book on that. How did you pivot towards markets and technology and the economy?
MALLABY: Well, it was one of those sort of unplanned step-by-step journeys. As I was saying, I was covering South Africa, Mandela came out of jail, it was incredibly exciting and that was the springboard for my first book, “After Apartheid” which was about what would happen next in South Africa and I wrote that as sort of a young man in a hurry in my late 20s and didn’t write another book for maybe a dozen years or so. And then I wrote a book about the World Bank and development economics and so there was an overlap with the previous book, it had bit of Africa in it and it was about lifting countries out of poverty and development.
But there was also this other factor which was the economics and that was kind of the segue to then writing about finance. I’ve done a lot of financial journalism, but I haven’t written books about finance. But I took on this challenge of writing about hedge funds and I spent a good long time on that and all of my books, the reason I get to come in your show at this five-year interval is I need to speed up the metabolism, so I get to talk to you more often.
RITHOLTZ: Well, I’m going to tell you, I think the reason is you put so much time and effort in research into the book that it’s not the sort of thing that — I’m always impressed with the people who can crank out a book every 12 to 18 months. It’s pretty clear that you put a ton of heavy lifting and deep, deep background. And I’m looking at an advanced copy, so I see all the footnotes of which — and endnotes of which there are thousands, but I don’t see the index. I have to imagine you put a ton of work, research work into this book.
MALLABY: Yes. I mean, my view is it’s better to write a book that’s really worth the reader’s time and to take my time over it and really get it right. I mean, I’m a perfectionist by nature and I indulge that side of my character when I’m doing these books.
So, “More Money than God,” the hedge fund book, took me four or five years. The next book was about Alan Greenspan, so that was another slice of financial history and so does public markets and several banking. And now, I’ve taken another five years or so to do a deep dive into technology investing and venture capital. So, one thing leads to the next.
RITHOLTZ: So, let’s start talking about the power law and we’ll get to exactly what that is in a bit. I want to start just so listeners have an idea of how far back you research goes to 1957 and your discussion of what you call liberation capital or defection capital, which is really a group of folks working for a particular company in California and they decide they’ve had enough, and they want to go out on their own. Tell us a little bit about the genesis of that adventure.
MALLABY: Sure. I mean, liberation capital is the term I use to capture the absolutely key thing about venture capital and what they were doing right at the beginning of the history of venture capital. So, back in the 1950s, it was the time of big business, big labor, big government and so on and people who worked in these big bureaucratic institutions were famously profiled in the book of the time, “Organization Man” and the title kind of tells you what you need to know, all about loyalty to the organization.
And then in 1957, along comes this financier, Arthur Rock who is really the pioneer of West Coast venture capital and he shows up in the valley and he liberates eight scientists who are working at one tech company they didn’t like and they want to leave that company and he raises capital for them so that they can set up their own company and that’s called Fairchild Semiconductor.
And really, that liberation of those eight scientists and it was such a radical thing to do at that time, they were known as the eight traitors like leaving your former employee is a treachery and from the time that they got that money from Arthur Rock and they were able to be liberated and to fund their own company, from that moment of time, the old corporate ideas about hierarchy and loyalty and lifetime employment and retiring with a gold watch, all that stuff was, it was forced onto the defenses and talent had been liberated and the revolution had begun.
RITHOLTZ: So, I want to get into some of the details of exactly how this talent was liberated. But to paint the broader picture, there is a datapoint in the book that’s really quite astonishing. So, Fairchild dates back to 1957. By 2014, well over half a century later, 70 percent, 7-0, of the — 70 percent of the publicly traded companies in Silicon Valley traced their lineage back to Fairchild. That’s really an astonishing datapoint.
MALLABY: And what happened, to explain that datapoint, is that once Arthur Rock, that father of venture capital, after he liberated the eight scientists to set up Fairchild, he then turned around and liberated some of the members of that group of eight another time. He would spin them out, raise capital, move into some other company that he’d invested in.
And at the end of the story in 1968, he liberated even the two leaders of the Fairchild and they set up Intel with capital raised by Arthur Rock and one of the eight scientists was Eugene Kleiner, I don’t want to jump ahead too much in the story, but, I mean, Kleiner set up Kleiner Perkins, which in turn invested in all these other Valley companies.
So, the point is that one liberation led to others, and it set up a kind of Cambrian explosion of all these startups in Silicon Valley and I think it really is straight to the point that if Arthur Rock had not come along and financed Fairchild Semiconductor, the Valley as we know it today might never have developed.
RITHOLTZ: That’s really intriguing. One of the really fascinating observations you make in the book is the difference between the East Coast form of, I don’t even know if I could call it venture capital, it’s really more private equity or asset management, it’s very risk-averse, it’s very diversified, it’s a little slow and maybe I can even use the word timid whereas the West Coast is much more aggressive. To what do you ascribe those really radical differences in risk tolerance?
MALLABY: Well, I think the East Coast, I mean, as you’re indicating, had a whole financial tradition and if we’re thinking about the late ’50s, we need to remember that that financial tradition was still shaped by the memory of the 1929 crash and the depression in the 1930s and (inaudible) hadn’t really quite recovered into the 1950s.
I mean, people were — the companies were called fidelity, they were called prudential, the very names signaled sort of responsibility and risk aversion. And so, although there was some venture capital around Boston and indeed in New York, it was less risk hungry than the West Coast kind.
I remember speaking to one of the Boston — one of the early Boston venture capitalists and he told me kind of privately that he had made, I don’t know, 40 bets for something in his career on different 40 — for 40 different start-ups and only one of them had lost money, and he presented this as a great achievement. Of course, if you said that to a West Coast venture capitalist, the response would be, well, you’re a loser, I mean, you have not taken enough risk. If any one of them fails, you’ll be way too timid. You could never really make a 10X plus return if you’re not taking net cap more than that.
So, there was a different financial culture. I think it began with Arthur Rock as I’ve been saying. I think he just had a willingness to back outside this and he was very quick and very early to understand the key point that I think the East Coast didn’t get and the West Coast did get and that was precisely the power law, the idea that the way to win in venture capital is not to avoid losses because start-ups are intrinsically risky and you will lose money on lots of them.
The way to make money is to make sure that when you win, you win really big. This is the homerun business. This is not a business where you try to make a five percent, a 10 percent gain here and there. This is about swinging for the fences and the best kind of defense is offense.
And Arthur Rock would say this, I mean, I went back and read his speeches that he gave in the 1960s and he was pretty clear about saying it’s not about whether I lose on some of my bets, I mean, you can only lose one time your money. What matters is the bets where you make 10 times, 15 times, 20 times what you put in. That’s the whole game.
RITHOLTZ: And the other factor that I thought was really fascinating that I was aware of but didn’t realize how important it was, but you do a nice job of explaining this in the book, California does not allow noncompete agreements for corporations relative to their employees. If you want to quit McDonald’s and walk across the street to Burger King, the law doesn’t prevent you from doing that. That was a very different setup than a lot of other states especially back East had. Tell us what the lack or the illegality of noncompetes did to the culture in Silicon Valley?
MALLABY: Well, I think the key insight about how innovation happens and why some innovation clusters are more productive and creative than others is that you’ve got to circulate people inside the cluster. It’s all about you got a certain amount of human talent, engineers, marketing executives, people who know how to make startups work, and these people are conducting experiments.
Each startup is an experiment, and each is a long-short experiment because the majority is going to sale. And so, the whole game here is that that network, that ecosystem needs to circulate talent rapidly in order to move the people into the right places where they can be — a talent can be best put to use. And if you’ve got a startup and it’s raised some capital anomaly, the capital is enough runway to last say six months, nine months, and then you identify the talent you want to hire with that money.
If you had to wait for six months because of some noncompete agreement before that person joins your startup, well, then you’ve ran out of runway before they even get there.
RITHOLTZ: Right.
MALLABY: And so, the ability to hire people and have them move in quickly is key and that’s what California law makes it easier because you cannot enforce noncompetes so easily and in California court and that’s different to most states in the U.S.
RITHOLTZ: And to put this into context about how easy it was to set up a company and move forward, Bud Coyle, when the traitorous eight were ready to leave and set up Fairchild, he pulled out 10 crisp one dollar bills and propose that all eight men should sign each of them and that was their contract during the early days of liberation capital. Was it really that simple? Here, all of us, let’s sign a dollar bill and that’ll loosely be our agreement?
MALLABY: I mean, so, Bud Coyle, Arthur Rock’s partner on the Fairchild financing and when — you’re right, when he and Rock reached the agreement with the eight Fairchild scientists, they all signed up a bill and, of course, it was symbolic, right? This was not a real contract.
But I thought it was a pretty vivid signal, right, because it’s partly about the informality all venture contracts that, although I think they had another contract, a real contract which was drawn out a bit later, in terms of kind of the blood bond between them all, signing that dollar bill was the sign they all were in.
And so, partly, the informality and partly the way that fundamentally, all of the invention and entrepreneurship in the Valley is founded on the financing that underwrites the risks. So, the fact that what they signed was money struck me as quite vivid symbol of how Silicon Valley got going.
RITHOLTZ: Quite fascinating. So, let’s talk a little bit exactly what power laws are. Most of us are familiar with the bell curve or more traditional Gaussian distribution that are kind of evenly spread out. It’s a nice smooth distribution. Power laws are not like that. Could use explain to us what exactly are power laws relative to what we’re usually used to?
MALLABY: Right. So, with the bell curve or normal distribution, nearly all the observations are close to the average. So, a good example is the average American man is 5’10” tall and two thirds of American men are within three inches of that. So, there is some basketball players way more or whatever but it’s rare.
And stock market returns are another example of something which isn’t perfectly normal but it’s kind of approximately close and really, wild market swings happen and that’s why we have crashes but they’re actually statistically pretty unusual and it is the time the market is just off making a little bit from day to day.
But some things in life absolutely do not follow anything like that normal distribution. For example, whereas the height of people is a normal distribution, the wealth of people is a power law distribution, meaning some people will be just massively richer than the average and will pull the average up or take academic citations, some small fraction of academic papers capture the lion’s share of all the sites and these skewed distributions are called power law distributions, and that’s what you get with venture capital in startups.
Most startups fail and the investor’s return is zero. They lose all that money. A few like may be 10 percent, 20 percent, depending slightly on which period of time you’re looking at, how strong the tech market is and what have you, but a few are going to just take off into the stratosphere and have this exponential rise.
And so, that minority, I mean, it’s a bit like if you to think about the cinema, the analogy of the cinema and the tallest guy walks out, it’s not going to change the average height in the cinema very much. But if you’re talking about the wealth of the people in the cinema and Jeff Bezos is in the cinema and he walks out, it’s going to radically change the average.
And that’s what you’ve — you’re looking at with venture capital. There’s a few absolutely star companies which dominate the returns of venture capitalists gain and once you understand that, it means as a venture capitalist, you can’t just invest by going for a modest return while protecting your downside.
The whole game is to get a piece of the exponential winners. Venture capital is a game of grand slams and I think that power law has been essential to the way that venture capitalists have to think that that’s why I took it as my title, “The Power Law.”
RITHOLTZ: So, to put some numbers on this venture capital firm, Horsley Bridge ran an analysis over the investments they made over the course of it looks like 30 years into 7,000 startups that they backed and it turned out that only five percent of those startups generated 60 percent of the returns over the total funds and some other people have said it’s even more lopsided. Peter Thiel pointed out the biggest secret in venture capital is that the best investment in a successful fund usually equals who outperforms the entire rest of the fund. So, that sounds like that is really very skewed compared to what we typically think of at least in a diversified portfolio.
MALLABY: Yes. I mean, the whole idea of diversification is something that basically got thrown out of the window when venture capital was invented. If you think about the normal idea, you make another bet, you try to diversify, you’re thinking about your risk return balance, that kind of public market’s mentality is totally alien to venture capital investing where you’re making concentrated illiquid bets in actual companies that you can’t exit and they’re either going to do incredibly well and take off or they’re going to run into the ground.
And they’re all in techs, it’s not diversified and in fact, a lot of venture capitalists specialized personally in some subsection of tech, they’re fast PCs or they are either med tech, medical technology VCs or whatever it is. So, they are completely the opposite of diversified and it’s kind of like — it’s all in, boots on the ground. No hedging at all.
And in way, that’s what partly what attracted me to writing about venture capital. It’s just so different to public market investing in many ways but that’s one of it.
RITHOLTZ: So, I really like the way the various stages of venture capital are elucidated in the book. You started with liberation capital. Let’s talk a little bit about the next phase of venture investing, hands-on activism and stage-by-stage finance. Let’s discuss each of these.
MALLABY: Right. So, after Arthur Rock established the idea of liberation capital, the next phase is the 1970s and this was marked by the founding of two famous partnerships both in 1972, Sequoia Capital and Kleiner Perkins. And as you say, the first innovation that these guys got was really to be hands-on, to be — to roll your sleeves up and get involved in the shaping of the company.
And one of Sequoia’s first investments was in the pioneering videogame maker Atari. They had a game called Ping. It was pretty simple. You paddle the — you move the paddle up and down and you try to kind of hit that little dot on the screen that was coming towards the paddle. And I think the instructions were basically one line, avoid missing ball for high score.
So, you could put this game in a bar and didn’t matter how drunk you were, you could still play. And so, Don Valentine, the founder of Sequoia, backed Atari because the games are popular, and they were selling. But at the same time, Atari as a company was an absolute managerial disaster. I mean, there were no financial controls. The board meetings were held in a hot tub, and it was — people would get paid travel expenses before they traveled, and they would just make up for the money and never show up again. On Friday afternoon, people would race to the car park to jump in their car to get to the bank and cash their paycheck because whoever didn’t move fast enough would find there was no money to collect any money — no money left in their bank account.
So, most investors who would have looked at this mess, they would have visited the factory and inhaled the marijuana smoke that was so heavy in the air. And everyone said, hey, I can’t do this. But Don Valentine, the founder of Sequioa, was not intimidated. When they said the board meeting will now take place in a hot tub, he just took his clothes off and got right into that hit tub. BY the way, he was a former Navy water polo player. So, this business of showing off his chest actually probably worked in his favor.
And because of his physical and intellectual force of character, he basically beat the Atari guys over the head until they had a company that actually did function and he got to the point where it was functional enough for a serious company, Warner Bros., to buy it and Sequoia got out with a great profit.
So, the point here is this is not for the faint of heart. This is — you see the glimmer of genius in a creative startup that has got a good team of engineers who are building, pioneering videogames. You say, I can make something of that even though the rest of the company is a totally chaotic mess. And so, that was the hands-on.
And then second thing in the 1970s which is equally important is the idea of investing stage by stage, putting some money in, watching the progress and if there is progress, you put some more money in. And the best example here was probably the company Genentech, the first biotech company, which created artificial intelligence. And when the Genentech founders tried to raise money, they went to Tom Perkins, the co-founder of Kleiner Perkins, and they asked for half a million dollars to hire scientists, set up a lab and get close to a first assess product.
And Tom Perkins looked at this and he thought, well, making the first ever artificial intelligence, that is a serious technical challenge and it’s just too much for me to risk half a million dollars on something which is serious frontier technology. So, instead of betting half a million which would have been painful to lose, he instead invested 100,000 bucks and told Genentech to use it to eliminate what he called the white-hot risks.
So, in other words, the most obvious thing is they could just kill the whole idea there and if they could get past the white-hot risks with just 100,000, then he would give them some more money and they could go to the next set of risks. And that way, if Genentech was to fail, at least they would fail cheaply. And that idea stage-by-stage financing turned a company that would have just been too risky and expensive to bet money on into something that actually became a very attractive investment
RITHOLTZ: And today, we would think of that really as angel and then seed and then A round, B round, C around that they were inventing the playbook as they went. It didn’t exist the way it does today. But let’s stay with the concept of these new developments and talk a little bit about the network effect. What took place in Silicon Valley as they progressed to create a network that impact the entire region?
MALLABY: Right, So, if we think about the arc of the history, the late ’50s and ’60s is about the idea of liberation capital that we discussed. The kind of first half of the ’70s is about proving these ideas of hands-on investing and stage-by-stage financing.
And then the next thing that happens is you’ve got the basic tools, the basic venture capital toolkit, and you layered on top of that an explosion in the number of venture capitalists throughout their using these tools and what happened is that there were couples of tax changes and regulatory changes about which kinds of institution could put money into venture capital.
And suddenly, fundraising by these went up massively. The average in the mid-70s was like $42 million a year, between ’78 and ’83, it was 940 million a year. So, an enormous increase in the amount of money and that meant that all of a sudden, there are now venture capitalists running around Silicon Valley that they fundamentally changed the business culture.
Everything speeds up. Startups are getting in faster. There are more of them. More new technologies are getting built. Human talent is circulating from one startup to another one at a higher rate. And all of that creates this flywheel where Silicon Valley becomes just the most productive and creative and inventive innovation cluster in the world. Thanks to — it’s great to have a few smart venture capitalists using the basic tools. But when you have a lot of them all running around at the same time, it’s more than just a few deals, it’s a whole culture of taking risks, having the guts to start a new company. All of that becomes enabled by venture capital.
RITHOLTZ: So, there’s a fascinating tale about how some companies that seem to have a hard time getting funded instead get past from venture capitalist to venture capitalist rather than just say, no. It seems there’s this tendency to say, I know somebody who you might be better suited to speak to than me. Tell us a little bit about that network effect and why it makes Silicon Valley such an economic powerhouse.
MALLABY: Sure. Well, I think it comes back to this idea, I just hinted that a bit earlier as we were talking, about how the key to innovative experiment is to have the right people to conduct them. And so, moving people around a cluster is super important. This is, I mean, I just — a little digression here but one of the things I was puzzling over as I was working on this book is that in the economics literature, which I was familiar with, when you write about a cluster, when an economist talks about clusters, they are talking about if you put everybody in the same place who does movies in Hollywood or finance in New York or what have you, this is good because if you want this particular special effects actor, you can find them in Hollywood because this is like exactly the kind of person who jumps out of a full story window and does a certain kind of some sort in the way down or whatever.
Whatever specialty you need in a deep labor market, which will be provided by a cluster, you can find it. And so, there’s kind of optimal matching of skills to the needs, which is why clusters work. And that’s all very well and quite persuasive but it doesn’t tell you why if you have two clusters that had the same number of people in each, why would one cluster do better than the other cluster and that’s pretty much what was going on around 1980, 1985 when you compared Silicon Valley to the Boston tech cluster.
There was this Route 128 saying it grew out of the military industrial complex being these companies like Raytheon and DAC and Wang and so on and so, there were these two rival tech centers in the U.S. And Silicon Valley during the 1980s pulled ahead and absolutely crushed Boston. Why was that?
The best explanation I could find was from a sociologist not an economist at Berkeley called AnnaLee Saxenian who wrote a book called “Regional Advantage” where her story, which I find completely persuasive, is basically that there were vertically integrated hierarchical secretive companies around Boston and if somebody in a Boston company like DAC or Wang or whatever had a brilliant new idea and the boss didn’t like it, the idea was dead. The engineer was not allowed to pursue that idea and the idea would not be leaked to a rival company because everybody was secretive and there was no cross-pollination between these companies.
Whereas in Silicon Valley, there was this bubbling cauldron of startups and people would go to the — there was this dynamic kind of bar place called Walker’s Wagon Wheel and all the engineers would meet there after work and they would trade ideas about stuff they were working on, nobody cared about trade secrets, and that meant that you had this circulation of ideas going on. And as we’ve discussed, there were no noncompete so you could also move from one company to another.
And so, the point is whereas ideas are sort of bottled up in these secretive hierarchies in one cluster, Boston, ideas were circulating and so were people circulating in the other cluster, Silicon Valley. That’s why Silicon Valley won.
And what I’m trying to add with my book is to put on top of that good work by — I mean, an additional idea was just to say, OK, so, it was a circulation within the cluster. The fast moving of ideas, people and money until they reached their optimal use, that’s what made Silicon Valley worked. That’s what made innovation turbocharged.
But where did that fast circulation come from, and my argument is it comes from venture capitalists. Venture capitalists are the people who are financially incentivized to get up in the morning, have breakfast with one person who’s an entrepreneur that they might fund and then have 14 cups of coffee before they go to bed with different people because either it’s another dealer they’re trying to do or it is a meeting with somebody that they funded last year and now they need some advice or it’s a company that needs to hire five more engineers and so they’re going to interview — these VCs are going to interview the engineers.
VCs are like the flowers flying around the garden pollinating the flowers, moving all the bees like — moving their pollen from one flower to another. And that’s what connects up the cluster, the network and that’s sort of just super important for getting all the limited resources of people and ideas and money into the right mixtures to create really first-hand experiments that make the Valley worked.
And so, I think — I’m not sure I’ve given you quite the answer you wanted but in a general way, the key thing about venture capital networks is that they connect to networks, and they transform their productivity.
RITHOLTZ: Really interesting. Let’s talk about two other developments in the venture world, speed and size, and let’s start with size talking about SoftBank. When they came to California from Japan, their approach was we have very deep pockets and we want to give you not just a few hundred thousand dollars or a few million dollars but here’s $100 million and if you don’t take our money, we’re going to go to your competitor and offer them $100 million. There’s only room in the space for one of you and whoever takes our money wins. Tell us a little bit about the impact and advantage of size.
MALLABY: Right. So, that’s a story you’re alluding to of the financing of Yahoo when Masayoshi Son came and made exactly that proposal basically, he said to Jerry Yang of Yahoo, I’ll write you a check of 100 million, and when Jerry Yang said, I don’t want it, I don’t need it, he said, Jerry, everybody needs 100 million and if you don’t take it, I’ll finance your competitor.
And what was sort of the significance of that moment was partly that the VC who had funded Yahoo in the Series A round was Michael Moritz of Sequoia Capital who was just an emerging sort of the leader of Sequoia along with Doug Leone, his partner. And Moritz took away from that experience an absolutely firm determination that he wouldn’t be muscled again. He wouldn’t allow somebody to come in and say, this is a take-it-or-leave-it offer. This is an offer you can’t refuse. Don Corleone style. He was going to avoid that.
And that is why Sequioa in the late 1990s started to try to get its own big check writing capability off the ground. In other words, the growth fund which wouldn’t just be doing as you say five million, 10 million checks to Series A and Series B but would be writing much bigger checks, Series C, Series D, to companies and allowing them to carry on growing before going public.
Now, you can see the logic, right, that if one player like Masayoshi Son from SoftBank has that godfather-like ability, take it or leave it, others are going to want to muffle up and get that capability as well. Whether it’s good for the venture capital system is a different question. I’m not sure it is because I think that at a certain point, going public brings transparency to tech companies and that can be healthy. I don’t think that staying private for too long is necessarily the best way to govern tech companies.
RITHOLTZ: All right. So, that’s the size discussion. Let’s talk about speed and in particular, Tiger Global who seems to be investing at a record pace and forcing the rest of the VC industry to keep up. Is this a smart way to make investments and what are the ramifications of this emphasis on speed?
MALLABY: Yes. Great question. I mean, I spent some time with Tiger Global when I was doing the research and I talked to the two leaders, Chase Coleman and Scott Shleifer quite a bit and I was expecting a lot and they are very smart investors, and they got an amazing company.
And I think the critics outside who say this is purely trading money in the world are exaggerating because I think these guys are smarter than that. But I actually don’t think that what they’re doing is particularly healthy for the technology ecosystem. I think it’s better when capital is a bit tougher to raise, investors cannot be taken for granted, and if you want money, you need to be transparent, responsible and have a convincing plan about how you’re going to use the money. And I think Tiger probably does a much better job than most at being able to combine some sense of what they’re investing in speed right? Because they’ve got a whole machine which has figured out which kind of — which segments of the tech space they believe they’re going to do well who were the market leaders in those spaces.
I mean, they do it almost by matrix right? They have this — here are the 10 technologies we think are going to thrive. Here are the number one and number two players in each space, we’re going to back the two leaders because we think that this is generally a winner takes all, so one of the top two is going to win and if you take those boxes,, then we don’t really need to ask any more questions. we know we want to invest in you, and we’ll move incredibly faster, beat the competition and we will not wear you down. If you are the CEO, we understand, we don’t want your investor chewing up your time because you’ve got to have stuff to do.
So, that’s that flavor. It works for them. It’s a good competitive tool. It probably works for their investors. I don’t think it’s healthy for the tech world as a whole because I think you end up forcing others to be fast which means they don’t do due diligence, which means there’s just the kind of raise to write checks and that’s not thoughtful. It’s not discriminating as between good companies and bad companies and I think, in the end, that just inflates bubbles, and we may be feeling that right now.
RITHOLTZ: So, we already discussed power laws which is the nontypical bell curve distribution where it’s a tiny percentage of the sample set are responsible for the vast majority of the performance. Let’s talk about some other laws that come up starting with Moore’s law. Tell us a li bit about Moore’s law?
MALLABY: Well, Gordon Moore was the — one of the founders of Fairchild semiconductor, the company we started by discussing. And then he went on to be a cofounder of Intel and he made this observation which wasn’t really a law, it was just an empirical observation about this is how things were working is that semiconductors would double in power every two years. And that’s sort of one example of something which some venture capitalists refer to as tech beta.
In other words, if you can invest in a company that is making something using semiconductors and you know that the semiconductor is going to become twice as powerful two years from now, you know that whatever you’re making is going to improve in performance and quality and its ability to delight consumers just because that Moore’s law is kind of like the wind on your back.
So, you can invest in things and if you’re skating to where the parking be, you know that you may be not making much of a margin on the product today but in two years’ time, the components in your gadget will be twice as powerful and you’ll be able to either charge more for it or maybe you (inaudible) the semiconductors in the gadget because each one is twice as powerful but you’ll have that technological change in your favor.
And it’s just — that’s one of the reasons why venture investing can generate these incredible returns 20x, 30x your money because there is this technological progress driving the exponential takeoff of your returns.
RITHOLTZ: So, if Moore’s law is the beta, it’s just the background increase in capability, let’s talk about Metcalfe’s law and the value of networks. Tell us about that.
MALLABY: So, Bob Metcalfe was an engineer who invented the ethernet cable to link up computers to devices or link up computers to each other and this was the start of local area networks which came before the Internet and he, in fact, started a company called 3Com to market his ethernet invention and that’s one of the story that had in my book that illustrates very nicely the way that he busted proverbial, trying to raise money from East Coast ben capitalist because he came from Boston and he didn’t make the West Coast gang and he ended up coming back with his tail between his legs and raising West Coast venture capital because they were the guys who really understood risk and they’re waiting to back him.
But he, Bob Metcalfe, had this observation as he was building ethernet cables, that created networks of computers that the value of the network would rise as the square of the number of uses. So, if you think about, I’ve got a computer and I’m linked up to one other computer, my coworker’s computer, now there are two of that from the network, that same value is the square of two is four.
Now, if you put two more people into our networks so you’ve got four people, we didn’t — that’s doubling the number of computers on the network, but actually, the value, to me, now that I can talk to three other computers and they could talk to each other is actually 16. It’s gone — it’s squared, it hasn’t doubled.
And that’s a story that applies to any kind of network. So, when you get to the Internet and you’re building any kind of social media company or a platform like eBay to do auctions or anything that you’re building on top of the Internet where you’re recruiting more and more users, you get this network effects where the more people sign up, the more valuable it is to everybody else in the network.
And it’s just an enormous tailwind. I mean, it’s like Moore’s law but even more dramatic. And of course, the key thing here is that it wasn’t an either/or for venture capitalist, who are backing companies like eBay. This was both ends. You had the advantages, Moore’s law which meant that the hardware that you were using was becoming twice as powerful every couple of years and you have the power of Metcalfe’s law which said that as you grow the network, the value of a network was raising at the square of the number of people you recruited.
And so, these — I call this sort of turbo power law companies. Companies like eBay that just did extraordinarily well in the ’90s and made enormous amounts of money for benchmark which was the VC partnership with eBay.
RITHOLTZ: And one of the laws we didn’t talk about is Perkins’ law. Tell us about — I believe that’s the Perkin of Kleiner Perkin. What is Perkins’ law?
MALLABY: Yes. So, the cofounder of Kleiner Perkins, Tom Perkins who was a wonderfully flamboyant figure who would be criticized occasionally for his unbelievable extravagance, and he would say things like, hey, I’m the king of Silicon Valley, why can’t I have the biggest penthouse in San Francisco or equivalent comments like that.
And he was — he was unashamed about rolling up in his Ferrari outside some startup he just funded and, yes, he’d scrape into every dollar on the deal but there he was in his Ferrari. And anyway, Perkins’ law states that a very simple idea but it’s quite profound which is that technical risk is inversely proportional to business risk because if you saw the really hard technical problem, you’re not going face much competition from business competitors because they don’t how to solve their problem.
So, you’ve got a company where, let’s say it’s Genentech and they’re going to let’s say — they were the first biotech company, we’re going to solve for this challenge of building artificial intelligence, no one’s ever done anything like this before. It’s super difficult.
So, that’s a huge technical challenge. So, it’s very risky to fund it but if you manage to make the artificial incident, you’re going to have a big, competitive moat, people will not be able to come after you and compete because you’ve done something technically hard and therefore, you can charge a big margin on that product.
On the other hand, if you’ve got something which is simple to build, it’s just an apparently. Then, the business risk is going to be much more intense. The competition from people coming into your space is going to be much higher.
RITHOLTZ: And to do a little compare and contrast, obviously, any sort of DNA manipulation when Genentech first began was unprecedented. On the other hand, what did Yahoo! owned, they essentially were just a little early to manually telling people what they might want to look at on the Internet but there was no technological moat there.
MALLABY: That’s right. I mean, it was two Ph.D. students who actually were not doing something particularly technical. They were just compiling lists of wacky websites that they found amusing and growing and growing that list and doing it, as you say, mostly by hand.
So, there was, to applying Perkins’ law to that, there was not much technical risk who obviously manual compilation of website lists is easy but there was a huge amount of business and commercial risk because other people could compete.
RITHOLTZ: So, let’s talk about some other people who compete with Yahoo!. I love story of angel investors typically described as successful executives or entrepreneurs who have already had their exit from their first company or second company and their board and they have big checkbooks and they want to keep their fingers in the pie, they want to stay involved in technology.
And so, they’ll write checks to startups to really be giving their very beginning, who wrote the $100,000 check to Google where the Google founders said, hey, this check is made out to Google, Inc. We’re not even incorporated. We don’t have a bank account yet.
MALLABY: Yes. That was a funny story. So, Andy Bechtolsheim, the legendary Valley engineer who is one of the cofounder of Sun Microsystems back in the 1980s and had done pretty well. He’d done Sun, he’d done another company after that. He had plenty of money. He wasn’t bored, by the way, because he was still running a company, but he was fascinated by up-and-coming technologies and young entrepreneurs who kind of reminded himself, reminded him as himself when he had been starting Sun.
And so heard about Larry and Sergey, the two Google founders and he came over to meet them one day and this was described to me, he rolls up in his silver Porsche, jumps out, watches a demo of how Google can search for results much better than any other product on the market at the time and he says, wow, that’s cool. Great. Yes. Here’s a $100,000 check and just writes it, right there. Runs to his Porsche, gets the checkbook out, rushes back, it says Google, Inc., 100,000 bucks, there you go.
And as you say, Larry and Sergey, the founders of it, we don’t have a bank account. He says fine. Stick the check in there, when you do have the bank account, whatever, doesn’t matter. And then he leaves.
So, he hasn’t asked what — how many shares he just bought in the company, what the terms of the deal were, nothing. He just writes the check, and he drives off. And $100,000, Andy Bechtolsheim, he’d done two successful companies. That wasn’t a big bite out of his bank balance.
But he just sprayed the money and that didn’t happen, of course, in the early period of Silicon Alley because there wasn’t enough entrepreneurs who’d made the cash to be able to do that. But as you get into the ’90s and even more later on, there were people who could write those checks and they enjoy doing it and typically, what would happen is nobody would have it clear, what share of the company and Andy Bechtolsheim had bought but when the more serious, more deliberative next investment round took place, somebody would sit down and say, well, what do we think that that’s worth and they would kind up reward some number of shares to Bechtolsheim and he wasn’t really counting.
But no doubt, he made more money on whatever number of shares he got in Google, that’s probably end up being worth more to him than Sun Microsystems had been.
RITHOLTZ: Yes. Andy did OK, it turned out. So, a lot of the famed venture capitalists who really put together a string of astounding performance in the 1980s and ’90s, they haven’t done as well since. What are your thoughts as to why the star funds from the early days of VC have been lagging over the past decade or two?
MALLABY: Not only that they’re lagging but you’re right that some do, and I think there’s a couple of problems that come up. One is a succession problem where there isn’t a good mechanism for handing control from the senior partners who may be getting to a point where they might think about retiring but they don’t really want to retire yet.
The younger people that may be plugged into the new technology, they young entrepreneurs and they really ought to be taking over control, but the senior people don’t want to see that control other than the fight about who gets what and that can wind up causing a partnership to break up.
Another kind that you see, though, is actually a problem of success where a partnership does really well. All the general partners who have a share of the carry are suddenly wealthy enough to go off and start their own venture partnerships, but themselves if they want to, and then kind of think of putting up with each other and they spit up.
And a good illustration of this is Kleiner Perkins which was absolutely the top venture partnership circa 2000s, the top moneymaker, the Kleiner Perkins in 2001 was Vinod Khosla who was the number one the Forbes Midas List and then there was John Doerr who was the number three on the Forbes Midas List, if I recall correctly, that year.
So you have the number one and the number three VC in the whole world and they’re the same partnership they’re at the same partnership there, an absolute dream team and then there’s a bunch of people around them who are also good. And they’ve been the wisdom for a decade or so and they know each other well enough that they can kind of challenge each other.
And beat the check and the balance if somebody is getting too enthusiastic (inaudible) about a potential investment, the other people in the partnership have the spending and the statute to say, wait a second, just take a deep breath here and think hard before you do that because I’m not sure I agree with you.
And just Kleiner Perkins got to a point where around 2003-2004, so just a couple of years after that peak, people started to leave and they’ve made so much money that they could go off and do their own fund and Vinod Khosla Ventures, his own company. And a few other people left and started their own company and John Doerr were sort of left standing and there was nobody around with quite the stature to challenge him.
And at that point, he fastened on to the idea of cleantech, investing clean technologies. And I think if he had the right culture around him with proper partnership where people could challenge him, he might have been a bit more cautious about the way he went into that but he didn’t. At that point, he was head and shoulders the most prestigious and successful investor in the partnership, and he just ran with it too far too fast.
And he did the same thing, by the way, in another good cause, I mean, cleantech is a good cause in terms of saving the planet. He also wanted to advance women and he promoted women and that was a good thing. And in fact, some of the women went on to be extraordinarily good investors.
Aileen Lee comes to mind. She’s the one who invented the term Unicorn. But they didn’t become successful investors very much internally within Kleiner Perkins because although John Doerr was good at promoting women, he was not good at creating a culture amongst the rest of his partners that would really make it possible for those women to thrive.
So, Kleiner Perkins wound up with a sexual harassment suit.
RITHOLTZ: I recall.
MALLABY: It wound up with, I mean, I should say that they — that I think they got the upper hand in the verdict on that trial. That was a bit of a messy one. But so, stipulating that in their favor. But they — it turned out to be difficult to build a culture in a new way that allowed women to thrive and it also turned out to be hard to make money off cleantech in the first iteration of cleantech.
And so, Kleiner Perkins went from being consistently ranked number one to being not even in the top 10. It was really quite a precipitous decline.
RITHOLTZ: Really?
MALLABY: And I think that that has to do with you need to pay attention to the glue within the partnership. You can’t just be out investing in other companies and making sure that they have good governance. You need to look at your own company and your own internal governance.
RITHOLTZ: Really, really interesting. Let’s talk about a venture fund that has probably, since the decline of Kleiner Perkins, become the hottest VC in Silicon Valley and that would be a16z, Andreesen Horowitz, tells a little bit about your thoughts on them. The past few years, they seem to be very focused on crypto and blockchain. What are your thoughts on Marc Andreesen and Ben Horowitz and what they’ve built?
MALLABY: Yes. It’s funny. When you were saying the hottest partnership in Silicon Valley, I thought you were about to introduce Sequoia Capital. I think they are probably got the best returns and they’ve also scaled globally. They’ve got …
RITHOLTZ: And they’re one of the oldest, right? Sequoia goes all the way back to the ’80s, right?
MALLABY: Yes. So, they’re not — that’s right. So, if you’re talking about the hottest new entrant, then I agree with you. Anyway, let’s talk about a16z, Andreessen Horowitz. I just wanted to give a mention of Sequoia.
Andreessen Horowitz, I think, started out in 2009. They had a bunch of public relations around what was going to make them distinctive. I’m not sure that that’s anything they’ve said there was really the key to why they did well. I think they did well because both Marc Andreesen, who of course was the — one of the key engineers or maybe the key in each year engineering behind Netscape and the first graphical web browser, so he’s a towering computer scientist and then Ben Horowitz, who himself was a terrific computer scientist had also founded a company in despite the 2000 tech crash has soldiered through that and made it into a successful exit.
So, you had two really, really strong funding partners founding partners in Andreessen Horowitz and they were both computer scientists and they founded in 2009, right about the time when the iPhone had come on stream, cloud computing was taking off, and software, to quote Andreesen’s famous phrase, “was about to eat the world.” In other words, software was just going to displace all kinds of other technologies as the way to build value.
And so, you have these founders. They really understand coding. They know which coders are the best. The coders respect them. And so, they’re happy to take their capital.
And that, I think, explained how they got into companies like Nicira, Okta, some of the — they did a great turnaround deal with Skype. The voiceover IP telephony company.
So, I think it was about having these two strong individuals who would — who were really strong, the hottest technology of all namely coding. They’re not moving and innovating, and I think that’s impressive. They’re moving — they move strongly into crypto and blockchain and Web3.
And I think what’s fascinating to watch there is that Web3 is kind of at its 1993 moment in terms of Internet time where in 1993, the internet was something that a few early adopters were really passionate about and excited by but you hadn’t got to the killer app namely Netscape, the graphical browser, which turned the Internet into something that mainstream consumers would actually want.
And now, with Web3, you’re the same point, I would say. You’ve got some gaming stuff that — that’s breaking out but it’s still in the world where it hasn’t quite gone mainstream and despite all the buzz and I think we’re looking for the killer app that really establishes this as a totally mainstream product.
And what Andreesen Horwitz are doing is that they put enough capital into a crypto blockchain Web3 focused pot of money that they can really experiment with backing lots of ventures, one of which would probably be the Netscape as it were for Web3. I don’t think they found it or we don’t know if they have found it, sometimes you can only see this in retrospect but it’s one of the most interesting stories going on right now in Silicon Valley.
RITHOLTZ: Really interesting. So, we talk a lot about VC successes and we talk about the power law distribution, but one of the things we haven’t really discussed, weren’t just the companies that didn’t make it, we could look at the MoviePass or Quibi or pets.com or whatever but the ones that blow up spectacularly and I’m not so much looking at Uber or WeWork as I am Theranos which really appears to be a fraud.
How do you draw the distinction between on an idea that just doesn’t catch fire the way it was hoped with outright, deception and, hey, Elizabeth Holmes was just convicted on four counts of defrauding investors, how does one make that distinction?
MALLABY: Well, I think fraud is pretty clearly different from just not making money, right? I mean, when you actually misrepresent your product, you claim that your blood test is done with your machine, but actually you’re using another machine you bought from another company, the results are phony, I mean, that is just crossing a line.
I mean, people sometimes, when they’re criticizing Silicon Valley and trying to use Theranos as a way of saying it’s, this is just a sign of how corrupt Silicon Valley is, they kind of blur that distinction between outright fraud and simply business failure. But I think it’s, actually, it’s a pretty clear difference between, on the one hand, you set out to make a product and the product either can’t be built because it’s too technically difficult or you build it but nobody wants it so you don’t get any revenue, those are business failures.
RITHOLTZ: Right.
MALLABY: But if you lie, you’re crossing a line.
RITHOLTZ: Yes. And that was just not more than just an occasional lie, that was a consistent pattern of fraud and misrepresentation and I completely agree with you, you can’t lump the two together, regular business failure, and fraud.
So, before we get to our favorite questions, I have I have one last curveball I have to throw at you which is something pretty fascinating I learned about you when I was doing little homework. When you are in your 20s, your father was the U.K. ambassador to Germany and for five years and then his next gig was U.K. ambassador to France? Tell us about that experience. How did that shape your view of history? I know you studied history at Oxford, what was being the son of an ambassador like for someone who is delving into that space?
MALLABY: Well, by the time my dad became an ambassador, I was in my 20s and I was off being a foreign correspondent in Africa. And in fact, the funny story because I actually lived in Zimbabwe. I made that my base and I roamed around different African countries and in November of 1989, there was the election in Namibia to elect the first majority rule government. So, it was the end of white minority rule and the start of majority rule.
And this election was being overseen the United Nations that was this absolutely massive foreign presence there, historic occasion, the end of colonial — the colonial political setup and all of the press pack that was covering this election in Namibia, me included, so great, we’re Africa correspondents. Normally, we get on to Page 15 of the newspaper if we’re lucky, but now finally, we’re going to be on the front page great.
And on the day that the Namibian election results was announced, then the Wall came down. And all of these Africa correspondents were on Page 15 again, if they were lucky. And so, it was funny for me because there I was, my story had been killed, but whatever, my dad’s story, he was the U.K. ambassador in Germany, that was the story that the whole wide world was talking about.
And he told me afterwards that he flew straight into Berlin where the war was coming down and he realized that was the end of the Cold War and that was super exciting moment for him. So, I didn’t know if it shaped my view of history directly but if it did make for funny family story.
RITHOLTZ: Yes. To say the very list. So, let’s jump in our last few minutes to our favorite questions that we ask all of our guests starting with what have you been streaming these days, what has kept you entertained during lockdown when you weren’t researching or writing the book?
MALLABY: So, I think like probably a lot of people who listen to your show, I love “Succession,” the kind of quasi-Murdoch family drama. I also have quite enjoyed a couple of French series. My mother was French and maybe that’s why. But there’s “Call My Agent!” which …
RITHOLTZ: Love it.
MALLABY: … is all about — yeah. That’s fun. It’s about a movie agency. And I …
RITHOLTZ: I have — by the way, I always have to tell my American friends that I recommend that to that the people who play the actors on that show are actually very famous French actors but to an American, they just look like another French person in the show.
MALLABY: Yes. Exactly. Yes.
RITHOLTZ: Right? I mean, if you don’t know that …
MALLABY: That is — I expected (ph) it.
RITHOLTZ: For us, if we would have a Brad Pitt or a Matt Damon show up on a show about talent agents, everyone in America would know who they are. When you watch — and I think the French version is called “Ten Percent” but when you watch that show and that’s how my wife and I keep our French passable, it’s always interesting to see the actual actors who show up. But I interrupted you. Who — what else have you been streaming besides “Succession” and “Call My Agent!”?
MALLABY: So, the other French one I enjoyed for a while was — it’s a kind of — it’s called “Le Bureau” and it’s about French secret service, like the CIA, the French CIA and they’re fighting all kinds of wars all over the Middle East and sort of exciting.
My wife likes it because the French secret agents are devastatingly good-looking. And I tolerate that because the female leads are quite good too.
RITHOLTZ: I would have imagined.
MALLABY: But it has a lot of good French suspense and we’ve enjoyed that as well.
RITHOLTZ: Very interesting. Tell us about your early mentors, who helped to shape your career?
MALLABY: Well, I joined The Economist, as I was saying at the beginning, right out of college and there were just a terrific group of talented people there who helped me. And I remember there was Neil Harman who was one of the — the older journalists who was incredibly a good mentor and I would file copy and he would say — he would tip his half-moon spectacles down his nose, look over them at me and say, just come sit here for a minute.
And he — I would watch him edit my words on the screen and just add topspin, more and more topspin and just have this knack for turning a reasonable phrase into a good phrase.
And that gave me a kind of special appreciation for the magic of really the craftmanship of writing. But you know, in other ways too, there were colleagues who just thought globally. They thought across finance and politics and economics. They could handle big ideas without getting sort of bogged down in detail, but they were also serious about being accurate.
It was — I would say that the whole experience of 12 years or 13 years on the staff of The Economist was my formative experience.
RITHOLTZ: Let’s talk about books besides your own, what are some of your favorites and what are you reading right now?
MALLABY: Well, a known favorite which I often mentioned is “The Money Game.” Have you read that?
RITHOLTZ: Adam Smith. Sure.
MALLABY: Yeah. Of course. I thought you would’ve done. And I mean, it’s just full of laugh out loud caricatures of these people in the 1960s, go go bull market when sideband gunslingers were ramping stocks and it’s just — it’s kind of financial writing of comedy and I always enjoyed that.
More recently, I’ve been reading a novel called “A Little Life” by Hanya Yanagihara, I hope I’m pronouncing that right. You read that? Youve heard that book?
RITHOLTZ: No. Not familiar.
MALLABY: So, it’s — I’m not a great novel reader but this one is so well done, it’s captivating, it’s a long saga of four New Yorkers who graduated college together, they come to the city and they make their lives in different professions and there’s a sort of a bit of a, they’re really embracing tragedy in the center of the life of the main character. That’s a novel.
But in terms of nonfiction, a bit late. I read Sheelah Kolhatkar’s “Black Edge.”
RITHOLTZ: Sure.
MALLABY: About SAC. I thought that was incredibly well done, sort of suspense story about a hedge fund that goes wrong. And I enjoyed “Black Gold.” I think it’s — am I getting right? “Digital Gold” maybe it’s called. Sorry. And that’s Nathaniel Popper’s book about bitcoin.
RITHOLTZ: Sure. That’s been out for about five-six years already, right?
MALLABY: Yes. That’s right. And again, I was a bit late to that. But I — it basically tells the story of how Bitcoin got traction because different ways of enthusiasts got on board. So, there were the coders who love to code because it was elegant. They were the libertarians who like it for political reasons. There were the people who wanted to do the criminal deals and drugs and guns and so forth, that was the Silk Road thing.
There were Latin Americans who wanted to remit money back to Argentina. Then there were the entrepreneurs that showed up and said, hey, we could do a wallet or go fund some business on top of all these.
And I didn’t think, frankly, my own perspective, I don’t think any of these individual groups had a killer argument as to why the world really needed bitcoin. But cumulatively, they created enough momentum that it stuck, and I think it’s now here to stay.
RITHOLTZ: Really intriguing. And our final two questions, what sort of advice would you give to a recent college graduate who was interested in a career in either finance investment or journalism and book writing?
MALLABY: So, on the journalism and book writing, I have a standard language which I rule out because people asked me this quite a bit. And essentially, I try to dissuade people because I think you’ve got to really, really want to do it if you’re going to go in that direction and if people listen to what I say and then they do it anyway, I’m delighted.
But I think, there’s kind of a thing where people go to college, they enjoy their work in college, they write papers in college and they think how can I extend this and just do more the same and they don’t necessarily look left and right and think about other things they could be doing with their talent and I think it’s good to experiment and do other stuff.
And then if you decide that you actually really do want to write because you like the process of writing even though it’s solitary, even though it’s a huge amount of time to produce something of value, I mean, my books do take me five years and it’s a lot of rejection when you’re beginning a new project and people think why would I talked to some book writer who — who knows if this book will even come out and I have to try to network my way in.
By the end, of course, the thing flips, and you got enough momentum that people that you didn’t call are now courting you because they want to talk to you because they understand your book is going to be serious and make an impact but it — it’s not all plain sailing. And I try and dissuade people but then I’m happy if they — if they do it anyway.
RITHOLTZ: If you — someone were to ask you about a job on Wall Street, what would you say to them?
MALLABY: I think Wall Street is a bit, is regulated, is the main feature of it. Unless you’re a lawyer, that’s great. And if you’re an investor or an entrepreneur, it’s not great. You might want to go to a fintech instead or go to a hedge fund which is sort of bit less regulated and where you can really try to apply original thinking to markets. Yes.
RITHOLTZ: And our final question, what do you know about the world of finance, journalism markets, investing today that you wish you knew 30 or 40 years ago when you were first starting out?
MALLABY: I think what I’ve learned is that the way investors think is actually quite useful for life and when I was writing my book about hedge funds, the central — I guess, epistemological, this discovery was — this idea of asymmetric paths that sometimes you don’t know if you’re right or you don’t know if you’re wrong but a certain goal (ph). But what you should look at is if you were to be right, would the payout be bigger than the loss would be if you were wrong.
So, there are things where you don’t know if this is the right direction to go in, but you should give it a shot because if it works, it’s going to be big. And that’s a basic thing about a lot of macro investing and hedge funds. That’s basically about you bet it goes to currency peg, if you’re wrong, the peg isn’t going to move because the peg won’t break so you won’t lose much from your position.
But if you’re right, the peg collapses, it’s going to move 20%. You’re going to make a huge killing. So, this is a — this is a basic macro investing hedge fund strategy but it’s also a useful thing for life about life decisions. And in the same way, with venture capital, I think the power law idea that sometimes low probability, but high consequence bets are worth trying that you know rather than following the pack, you should try and do something different.
Maybe I like this argument because when I go off and bury myself in some specialized corner of finance of five years, I feel a bit like I’m taking myself away from mainstream debates to really get specialized and deep on one niche. But I think — I think it is healthy to have those ideas in mind and think about how to differentiate yourself, how to do something risky but that don’t might have a really good outcome if you get it read.
RITHOLTZ: Really intriguing. Sebastian, thank you for being so generous with your time. We have been speaking with Sebastian Mallaby, author of “The Power Law: Venture Capital and the Making of the New Future.”
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