Venture Capital & Term Sheets
Venture Capital and the Making of the New Future
A history of venture capital that explains why investors behave as they do, through the one statistical rule that drives their returns.
The big idea
Mallaby traces venture capital from its early backers through the major Silicon Valley firms to today's global growth investors. The organizing idea is the power law: in venture, a few investments produce most of the returns, so investors hunt for outliers rather than safe bets. Seen through that lens, behavior that confuses founders makes sense, from passing on good businesses to piling into a hot company. He also examines the industry's failures, including weak oversight of celebrated founders.
Key takeaways
Venture outcomes are not spread evenly. The best investment in a portfolio can return more than all the others combined, and many investments return little or nothing. Investors therefore focus less on avoiding losses and more on making sure they hold the rare company that becomes enormous.
Fund size and expected ownership determine how big an exit has to be to matter. That is why the same company can be a poor fit for a large fund and an excellent one for a small seed fund. Target investors whose fund your realistic outcome can meaningfully move. Venture firms are built around this fact.
Mallaby shows that the influential early venture capitalists did much more than write checks. They helped recruit executives, open doors to customers, and shape governance. Arthur Rock's backing of the founders who left to start Fairchild Semiconductor, which Mallaby calls liberation capital, gave talented people the means to strike out on their own.
Staged financing lets investors spend a limited amount to eliminate the most important uncertainty, then raise more at a higher valuation once that risk is gone. Tom Perkins's approach with Genentech, focusing early money on proving the core science, is the book's classic example. Each stage then earns its price.
Because the power law rewards outliers, strong investors put more money behind companies that are breaking out rather than spreading follow-on capital evenly. The same logic applies inside a startup: shift time and money toward the channels and products clearly outperforming. Pruning weak efforts frees resources for strong ones.
Mallaby describes how a wave of investors competed by offering founders large checks with few controls, and how some high-profile companies, including Uber and WeWork, suffered from weak oversight. His view is that empowered founders do best alongside engaged, independent boards. Independent directors and real information rights protect everyone, including founders.
The framework
Look up the size of the fund the investor is investing from.
Estimate the stake the investor is likely to hold at exit after dilution.
Fund size divided by ownership gives the exit needed to return the fund once.
If your realistic outcome falls far short, look for a smaller fund.
Apply it this week
Read next
An investor's-eye view of how venture funds work, so you can read a term sheet and pick partners with open eyes.
Long-form interviews with experienced venture investors on how they choose companies, judge founders, and work with the startups they back.
A data study of billion-dollar startups that tests common beliefs about which founders and companies succeed, and finds many of them wrong.
This page is an original summary and commentary prepared by XRAYCLOUD.AI with AI assistance. It is not affiliated with or endorsed by the author or publisher, and it is no substitute for the book — read it for the full argument.