Sebastian Mallaby: Venture capital as an engine of courage — #8

Steve Hsu and Sebastian Mallaby discuss venture capital, tech startups, business model and technology innovation, global adoption of the Silicon Valley model, and the future of innovation.

Steve Hsu: Welcome to Manifold. My guest today is Sebastian Mallaby.

Sebastian is one of the leading writers and journalists who covers international economics, financial markets, technology, innovation, and deep economic history.

It's a pleasure to have Sebastian on the podcast. We will devote most of the time to discussion of his new book, which is about venture capital. Welcome Sebastian.

Sebastian Mallaby: Thank you, Steve.

Steve Hsu: So I want to start this podcast with a recollection, which I think is factually correct. Five years ago. It was just after the Brexit referendum. You and I were at a very fancy meeting of financiers, and titans of capital. We were staying at the estate of a billionaire on Lake Como, which is a beautiful lake, one of the most beautiful places in the world, up in the Italian Alps, and on a motor boat. The driver of the motor boat was an employee of this, of our host taking us to the meeting.

You and I had a long discussion of your book, which had just, just come out about Alan Greenspan. But then when I asked you, what was your next project? And I believe this was about five years ago. You said you were working on a book on venture capital. And so I've been awaiting that book the last five years. And now finally, we can talk about it.

Sebastian Mallaby: I think that's all true. And all I can say is, I do take five years. I'm sorry. My kids say that I'm lazy and I say I'm a perfectionist.

Steve Hsu: I want to emphasize this five-year project schedule or pace that you're on because to me, I think that, you know, you do very, very deep, thoughtful and analytical work, which is, which is why I really treasure your books. And to me, it's almost like that five year timescale you give yourself is required to really do deep work.

These are very complex topics. There are lots of personalities involved. There's lots of special history that needs to be unearthed. And I don't see how you could do it if you just said, oh, I have, I have this contract from the publisher. I gotta get this done in a year. And, you know, I think the book would suffer. So I congratulate you for having the intellectual courage to do projects on such long timescales. And I even feel like one could compare each of the books you've done to something like a PhD dissertation. So it's as if in your own life, you're doing many, many PhD dissertations, getting yourself really immersed in lots of really interesting topics.

So how would your kids react to what I just said?

Sebastian Mallaby: Well, so as it happens, I do have a daughter who is doing an astrophysics Ph.D. And I would never have the courage to compare myself and my work to her work. I mean, that would just be disastrous for my relationship [and] probably totally unfair to all her hard work. So I'm glad that you said it, Steve, so I didn't have to.

Steve Hsu: Well, you know, I may, okay. Astrophysics is its own thing, but compared to say the work that a historian does or an economic historian does for their Ph.D. dissertation, I think the content of your books compares favorably to that output.

Sebastian Mallaby: I hope so. Right. Do I do have enough and that's, to, you know, qualify for scholarly status? I think.

Steve Hsu: Yeah. And I think these topics are fully worthy of the depth of treatment. The thing I don't understand is, you know, Journalists are under time deadlines and financial debt, financial pressures, but academics, once they're tenured professors, they can work on what they want to work on.

And I'm just surprised more professors don't try to produce the kind of product that you produce and a little bit surprising and in a way you're, you're like totally unique in the world of journalism.

Sebastian Mallaby: Well, I suppose I'm trying to use the academic literature on whatever field I'm writing about, absorb it, and then take an extra step or two by doing our hell of a lot of field work, where I actually go and interview the main protagonists multiple times. And I already tried to gain trust and I'm incredibly patient in that process.

So the reason that these projects took me five years, is partly because it takes a long time to get to know the people who would introduce you to the people who will then introduce you to the real people. And, you know, that just means a sort of relay race. And it tends to take a long time. An example in the current book I've just come out with, is that early on, I had an introduction to Michael Moritz, who is the sort of leading knight or has been of Sequoia Capital.

And, you know, he is a British guy by origin. He's a former journalist and book author like me and, like me, he's sort of stuff I've done in America. And so we have a lot in common, including a lot of friends in common. I went to see him and in a very nice way, he said to me, it's good to meet you, Sebastian, but there's no way we're going to talk to you because we're the leading venture capital partnership instead of karate, we have no need for any publicity. We have no interest in giving away our secret sauce. So nice to meet you, but it just doesn't make sense.

And it took me about three years, or thereabout, to network my way sufficiently into Silicon Valley so that I had interviewed every single person who used to work at Sequoia. I interviewed the people, you know, who had served as other venture capitalists from other partnerships alongside Sequoia people on the boards of startups. I of course interviewed entrepreneurs who had been backed by Sequoia partners. And then when I had the opportunity to get another warm introduction to a different leader at Sequoia, this time the answer was, yeah, I bet. I think we will talk to you. And, then that led to a few meetings after which I was told I was a good return on investment from that point of view, because they trusted me and they thought I would do a serious book and I ended up having more interviews than I could count. But, you know, certainly way more than 10 or 15.

Yeah. of time spent with Sequoia partners.

Steve Hsu: Yeah. You know that in the field hustling that you had to do, maybe that is the explanation for why more academics aren't willing to try to produce a book like yours, because they're just not good at it. And maybe don't have the stamina for that process. I've seen you at work at some of the meetings that we both attend, where I can see you discussing something very attentively with one of these titans of capital. And of course, if they don't respect you intellectually, they're not going to give you all of that time. Right? So, there's an important requirement that you be a good listener, but they also can tell that you're digesting what they're saying to you.

Sebastian Mallaby: Yeah. And you know, I also play a fairly open book and so I believe it's a good thing when you've done a draft of a chapter and let's say one third of it is dealing with a particular titan of capital, to go to that person and say, okay, we had a conversation a while back. I've spoken to other people who worked with you. I've done a lot of research. Here's what I wrote about you. If you'd like to take a look, I'm not promising that I will change a single comma, but I am promising that I will listen carefully to what you say, and any and all feedback is welcome.

And that often produces a whole extra round of conversations where they say, you know what you wrote here isn't wrong, but you've left out several points. And if you think about it in a different framing, you might come up with a different emphasis. And it elicits a lot more extra information and you have to be willing when you go into that process to be willing to throw away your first draft and write an entirely new draft. And it might take you an extra 10 days. But I think it's worth it because you end up with a better product that's closer to the truth. And in the end, you know, there are thousands of books that get published every year. It's only really worth doing one that will stand the test of time.

Steve Hsu: Yeah, I mean that last observation, it's something that we often say to each other in theoretical physics. We often say that the main thing we're trying to accomplish is to produce some new results of quote, lasting value, right. And lasting value is very different from just turning books and selling books. You know that then a few years later are forgotten.

Sebastian Mallaby: That's right. So, you know, who knows? No doubt. It's a bit like the startup world where some books you write, or some startups that you start won't quite make it, but at least my book about hedge funds, More Money Than God is in its 19th edition, 12 years after it was published. So that feels like it's got staying power. And whether or not I attain that goal, you know, that's what I'm shooting for with each project.

Steve Hsu: I wanted to tell you that I like the title of your new book. Your new book is called The Power Law: Venture Capital and the Making of the New Future. But the favorite title of your books is More Money Than God. I always thought that was the greatest title ever for, especially to describe hedge funds.

Sebastian Mallaby: The funny thing is that the hedge fund industry itself loves the book, but don't like the title. And I've heard that comment from them

Steve Hsu: Yeah.

Sebastian Mallaby: and time again. And my reaction is tough. You know, tough. If you don't get it, if you don't get it, that's the way that people see you. It's probably quite a good thing that I used that title to make you realize.

Steve Hsu: Yep. I love that title. me okay. We've we've already, we've already kind of gotten into your process and a little bit about the new book. I want to back up because when I have guests on the podcast, I like to try to go through their background and upbringing and education a little bit so that the listener has a little bit of psychological insight into how they were formed and, and how their worldview came about.

So do you mind if we just do a few minutes about your early life and background?

Sebastian Mallaby: Sure.

Steve Hsu: Okay. So I learned a lot looking at your Wikipedia entry, things that I didn't know, despite having, you know, met you various times over the years. So number one, you, you have the kind of elite educational background that, for example, you share with Boris Johnson. So you're a graduate of Eton and Oxford.

Sebastian Mallaby: Yeah. So not only that we are precisely the same age. So I sat in the same classrooms as him, for some of my teenage years. I can report with greater authority that he was kind of the same then as he is now.

Steve Hsu: Okay. And he was actually a journalist for a long time before he went into politics.

Sebastian Mallaby: Yes, he was, he got fired once or twice for making stories up, but, you know, I guess that bit carried through as well.

Steve Hsu: Now at Oxford you were both history majors. Was it the same part of history that you guys were majoring in?

Sebastian Mallaby: Actually, he majored in, he did classics. He did Greek and Latin.

Steve Hsu: Okay.

Sebastian Mallaby: I did history. So he was very much into student politics. Whereas I was into student journalism. So there was a bit of a divergence there.

Steve Hsu: Got it. So for us, untutored Americans, you know, from the, from the frontier, what is it, and I realize this is a very kind of subtle and complicated issue for, for the British, but what does the world look like to a kid who attends Eton and Oxford?

Sebastian Mallaby: That's a great question. I mean, I think there is a sense of entitlement you've gone through, particularly the Oxford bit of that. You know, it's a competitive entry system to get into Oxford and Cambridge, you know, pretty much every graduating high school senior would love to go to one of those two colleges. There is no legacy. This is an important thing for Americans to understand. There is no legacy favoritism in UK college admissions.

So if you get into Oxford or Cambridge, and then if you thrive there and you exit with good exam results, you kind of feel a bit like a French graduate of [unclear]. And that does breed some arrogance.

And the Eton bit, you know, if you put that in the mix too, it probably means that your family background is such that you have grown up around people who are successful in their various professions. And again, that creates this role model where you're expecting to do well.

I think this sort of slightly mitigating factor for me and for some of my contemporaries is that if you were thinking bigger than just the UK, then there was a whole extra set of challenges. And particularly if you wanted to go work in the U.S., which is what I did for 18 years where I joined the Washington post editorial page and wrote a Washington post column, and then joined the Council on Foreign Relations, very American institutions. There you're making it on a new playing field and you're competing against a different set of characters. And any connections you might've had in your background are irrelevant. And so I think that was something that in a healthy way, counteracted the somewhat arrogant sense of entitlement that I might've had if I had stayed in Britain.

Steve Hsu: Yes. So the thing I learned from your Wikipedia entry that I didn't know previously was that your father had been the UK ambassador to both France and Germany. Am I correct in that?

Sebastian Mallaby: Yes, he was a career civil servant. A state department official, or that would be the equivalent language in the U.S. So he was not a political appointee. And, you know, he worked his way up from the rank of third secretary or whatever it was in the embassy in Moscow, in the 1960s, to being ambassador in Germany and then Paris.

One little funny story is that when he was ambassador in Germany in the late 1980s, early 1990s, I was doing my first job as a foreign correspondent for the Economist Magazine. And I was based in Southern Africa and I was in Namibia in November 1989 when the majority rule election, which was going to liberate Namibia from white rule, was taking place.

And every single Africa correspondent in the Western press corps had descended upon Namibia in the happy expectation of finally making it onto the front page of their respective newspapers. Because you know, this, this, this sort of symbolic election, this transition of power to Black majority rule was going to get you onto the front page.

And it turns out that the results of the new Namibia election of 1989 came out on the same day as the Berlin wall fell down. So everybody's stories were on page 18, whereas, you know, Mallaby Jr was frustrated, but Mallaby Sr., as the ambassador in Germany, had a front row seat to one of the most exciting historical transitions of the postwar order.

Steve Hsu: Incredible. So if you were at a dinner party and the person next to you asked you, what, what was family life like for a kid growing up with their father in her majesty's diplomatic service? How would you summarize the effect on your child?

Sebastian Mallaby: I think the biggest thing was just, just to have a sense that Britain was small and it was exciting and fun to go live in other countries, and to learn other languages, and that, you know, variety in terms of where you lived was sort of the spice of life. And so in my childhood, my father served in Germany. He went to Russia. He went to New York for three and a half years when I was sort of like second grade through fifth grade.

Meanwhile, by the way, my mother was French. And so that introduced an additional dimension of being international. And so by the time I was about 19 or so, I spoke, not terribly well, but I spoke with naked, French, pretty good German, pretty bad, but still functional Spanish. And then in my twenties, I learned Japanese as a correspondent when I went to Japan. So I spend an enormous amount of time on just trying to soak up different international experiences.

Funnily enough, I then switched when I moved from Japan to the United States in my early thirties, and I stayed in the U.S. for 18 years, and then I moved to Britain and I've stayed here for eight years.

So I've, I've gone Anglophone, I've gone, I've gone less peripatetic. And so that effect from our childhood seems to have worn off.

Steve Hsu: At what point did you think or know that you were going to be a writer?

Sebastian Mallaby: You know, when I was 16, I was put through some exercise at my school. I, where you are supposed to kind of to help you figure out what to do at college. The UK system is different to the U.S. one because instead of arriving at college and then choosing your major after a year or so, in the UK, you choose your major before you even apply. And indeed it's not merely a major, it's kind of what you do. So if you say you're going to do history, you just do history for your entire undergraduate period.

So in any way to, to, to orient a 16 or 17 year old toward making the right college major choice, this British school of mine made me do a questionnaire.

And part of it was what do you want to do as a job later? And so I didn't have a very strong idea. I was only 16, but I wrote down journalism and writing. And so it turned out I never really deviated. I had at one point a couple of backup plans, but it was always my plan to write, just because I found the intellectual process exciting. And I also loved going out and talking to people and extracting their stories and sort of the empathetic process you go through as a listener of just understanding people. I find that very absorbing and exciting. And so I did a lot of student journalism and that confirmed my sense that I'd like to be a journalist.

And when I left Oxford, I went pretty much straight into the Economist Magazine and had a fantastic time.

Steve Hsu: Yeah, I think, again, back to my distinction between academics and journalists, I think the desire to actually meet the real movers and shakers and try to understand them and their thought processes. I think that's somewhat unique to journalism. I don't think very many academics get that chance.

Sebastian Mallaby: I did. Yeah, I did apply and I got a position to do a master's in political science at Stanford. And I was quite happy not to do it and go to the economist instead, because it's partly a funding issue, to be honest Stanford might've been a bit expensive. But, you know, that I was very happy to embrace the idea of, you know, learning things in a different way, through a different lens of having the economist brand next to my name so that I could go and, you know, make a call to almost anybody, and, and ask questions.

Steve Hsu: Yeah. I think if you, think if you're intellectually curious, that's gotta be a very strong perk of the job to be able to do that.

Sebastian Mallaby: Somebody compared it to having the Willy Wonka chocolate factory, the, you know, the golden ticket that allows you entry into all these different rooms. and it is a huge privilege.

Steve Hsu: Yeah. It's fantastic.

So let me get back to the book now to about venture capital. So for the audience, I have a list of basic facts about the venture capital industry. And I think you I've heard you in other interviews, just cite, rattle off, metrics that indicate the, you know, the impact of venture capital and the economy and how it's evolved. So maybe we'll just go through that even though it's, I think it's pretty familiar, familiar material to you. It may not be familiar to all the listeners.

So what's a compact way of characterizing the impact of VC on the overall economy?

Sebastian Mallaby: Well, there's a qualitative point, which is, you know, we all realize that we're using the products every day of venture back companies or companies that were originally venture backed. And so whether that's, you know, Google or Apple or Facebook or Intel, or what have you. These products are affecting how we communicate with each other, how we entertain ourselves, how we find information, how we arrive at our own epiphanies and how we think. So that's qualitatively impactful.

Quantitatively, the number I like to cite is that less than 1% of the companies that get started in the United States each year receive venture backing, but three quarters of the market cap created by companies in the last 25 years has been from venture backed companies.

So a tiny input creates an enormous, but I think that's a good measure of the impact of this sector.

Steve Hsu: I think if you were a policy maker in some other country, which didn't have a strong venture capital ecosystem, that fact alone that you just stated would suggest that governments assuming governments could actually, you know, ameliorate the creation of that ecosystem. They should try because obviously so much innovation is just disproportionately concentrated in the companies that have venture backing.

Sebastian Mallaby: That's right. And that's very much the kind of response I get as I speak to foreign audiences. I've done some speaking in London. I've been in touch with people in India, who seem to be very enthusiastic about the book, which is being sold over there. And what I try to explain, and sometimes I'm explaining, and sometimes I'm just reinforcing what the audience understands already, but I think the big point is that venture capitalism machine for manufacturing courage.

There are people who have ideas, but to actually go and take the leap of starting a company is scary and risky and many startups do fail. So it takes a venture capitalist to come along and make that risky step easier. And it's partly saying, you've got the idea and I'll give you the money to try it. And if you fail, you can fail with somebody else's money. But it goes way beyond that, because it's also about, you've got to take this step. You haven't done it before. It's scary, but I, as the venture capitalist, have been on the boards of 25 other startups, I've seen that process over and over again. And I can coach you and mentor you and guide you on how you're going to do this. I will be there.

And then there's an additional thing where the company founder might say, well, gee, you know, I'd like to do this. You're going to give me the capital. You're going to give me some guidance, but I'm going to have to hire some really great engineers to help me build this product. And I'm not sure how I can persuade those engineers to come and join a startup. I mean, it's risky. And then the venture capitalist says, you're right. It is risky. But what we're going to do is I'm going to go speak to these people too. And I'm going to explain to them that startups might fail. If they join your company, it may fail. But I, as the venture capitalist, back lots of other companies, and if they find they've joined a fading startup, I'll get them a job in a different startup.

And so in this way, venture capitalists de-risk entrepreneurship. They de-risk the choice of becoming an employee of an entrepreneurial company and thus they manufacture courage.

Steve Hsu: I certainly agree with the thesis that venture capitalists play a very, very central in the tech ecosystem and back to my own experience when my first tech startup, which was venture backed it was right around the year 2000. And so that was sort of the first internet bubble. I could see a huge difference between the depth of venture capital networks and also portfolio size between say Silicon Valley and Boston, for example. Boston being another place where there's a huge concentration of technologists and also tech companies.

So I definitely acknowledged that part of it. I, I do think from the entrepreneur's point of view, the, the, the pitch that you just gave, in other words, the, the, the kind of pep talk that the venture capitalist gives the entrepreneur or the engineer that, that they're recruiting about the extent to which the VCs network is actually de-risking life for you, that's part of their pitch. It turns out not to be quite as rosy as what the venture capitalist tells the entrepreneur or the engineer, but it is certainly what they say. And maybe, maybe as we go on in the conversation, we can talk a little bit about what, how the world looks a little bit different to the tech entrepreneur than to the venture capitalist.

I'm not sure how many entrepreneurs you've talked to for your book, but venture capitalists have a certain worldview. And some of that is, you know, it's self interested, right, for them to propagate that worldview.

Sebastian Mallaby: Yes, I should say that, you know, festival, I, I agree with what you just said. Of course the entrepreneur is super important and of course, venture capital backed startups, you know, fail more often than they succeed. So I'm not pretending that the risk is taken away. The entrepreneur has certainty working incredibly hard, pouring energy and talent into something that is super difficult.

And the venture capitalist is in a much more comfortable position of having to diversify a set of bets and ultimately it’s on the shoulders of the entrepreneur. So I don't want to detract from that. I guess what I'm slightly saying there is that I think the more common like the popular narrative outside of these tech ecosystems is that there are books about Steve Jobs. And there are books about, you know, Travis Kalanick of Uber. And there are books about, you know, Mark Zuckerberg and all that. I think there's a bit less in the way of books that try to see it through the lens of the investors. And so whilst I agree with everything you just said, I, I'm just offering a kind of the other parts of the story.

Steve Hsu: Yeah, I think it's very valuable and I think actually it's not untrue. It's just a question of, you know, to what extent, you know, they, they want you to think they've de-risked it for you. you may find out five years later, it hasn't been completely de-risked for you. But you know, that's just part of the, part of the reality.

Now you mentioned the payoff distribution, which is in the title of your book, the power law. So in a typical portfolio of say 10 companies, which the venture capitalist has backed, maybe a couple of them are big hits. Maybe a couple of them roughly break even, or make a little bit of money. And then the rest generally don't make any money. And I think emphasizing that it's really the big hits that shape the track record of the venture capitalist is something not everybody understands.

Sebastian Mallaby: Yes. I completely agree with that, which is where I think the parallel was sort of the necessary title to really hit home. The reality of that distribution. And to also argue that once you've understood that some venture capital behavior, which seems a bit weird, becomes quite logical. I mean, when Peter Tiel sort of who's takes this contrarianism to an extreme says he would like to back, you know, total contrarians. And it's a good thing if you made a bomb in high school, and he'd really liked to back flying cars, you know, it sounds sort of crazy far out. But unless you are starting with that kind of mindset, you'll probably back companies which are a bit too reasonable, which therefore there'll be four or five different versions of them.

And there'll be a lot of competition in this space and trying to charge a decent margin for the resulting product will be tough because of the competition. So to really create a differentiated product, that's going to make a lot of money, it probably may help to be a slightly unusual founder. Not a requirement, but I think it's not crazy.

And some of the crazier ideas like let's upend the entire hotel business by, you know, constructing something on the premise that homeowners will have total strangers to sleep on their couches. I mean, that was a crazy idea, but of course it was Airbnb and it worked. And so I think, you know, this, this embrace of the improbable follows logically from the power law.

and unless you get the full implications of the power law, it just looks like weird behavior.

Steve Hsu: Yeah, I think, I think you're very right to emphasize that. And I'm glad you mentioned Airbnb because I'm would have to say that, you know, during the very long torturous birthing process of Airbnb, I was, I was a skeptic, know, for a very long time that really people are going to do this. What would I do? And now I'm one of the, you know, I'm one of the biggest endorsers of Airbnb. When I travel to London, I always try to get an Airbnb. I hate staying in hotels now. So, it's just an amazing story.

Then, of course, the flip side of that is, you know, waking up one morning and finding 10 different branded scooters, electric scooters, you know, on the pavement in front of your house, because there's a land grab going on based on some crazy theory that scooter transportation is gonna revolutionize urban life.

So you get both things, right? You get a miracle construction of an amazing ecosystem. I mean, this a collective notion that we can rent property to each other in this informal way. And that there's a platform for it. It's just an amazing, it's unlocked so much value in the general economy, but the process to get from A to B was so torturous.

It's amazing people have the courage to accomplish it.

Sebastian Mallaby: And you could only generate the multiple experiments that you need. and, therefore find a couple that work. If you have this power law mentality where it's okay to make bets that fail, that you sort of expect that. And so, you know, you're, you're, you're, you're, you're happy with these low probability of success, but very high consequence outcome type of propositions.

And I think that is the way that we make progress with applied science, with commercializing applied science.

Steve Hsu: Yes. I mean, I think, you know, having lived through 20 years of tech companies, I really see this as a very strong cultural kind of development. And of course, Silicon Valley was the first place to have it. But this idea that you're going to have faith in an idea, you're going to burn three to five years of your life on the idea, and if it doesn't work out still, you learned a lot, you made a lot of connections. The experience is actually valuable. You're not a loser because of that experience. That has to be kind of reinforced by the society around you to also believe that so that, you know, okay, maybe your mother-in-law's still very disappointed in you, but, but, but the people around you who are your age are telling you, no, no, that was okay that you, you started that company and it didn't work out.

And I think the big question in my mind is how rapidly this is going to take that kind of collective attitude is going to take off in other countries. So I think in China, for sure that if you go to Beijing or Shenzhen, there's a very strong kind of pro-startup mentality. Maybe in London now. Don't know that much about continental Europe, how widely accepted it's becoming, but I'm curious what you think.

Sebastian Mallaby: So you mentioned the mother-in-law test. I had a terrific conversation yesterday with a venture capitalist based in Bangalore, India, who's been doing venture capital there since 2010. by origin. Worked in the U.S. Got a, I think, an MBA in the U.S. Came back to India, started doing venture. And he told me this terrific story that totally sums up this process of the culture shifting.

At the beginning, you had a portfolio founder profile portfolio company, a founder who wanted to get married and the woman he wants to get married to needed her father's permission. And the father was refusing to allow his daughter to marry an entrepreneur because an entrepreneur was by definition a loser. So the venture capitalist was roped in to make a call to the obstreperous, obstructive father, to say, listen, you know, I know about business. I went to an American MBA program. I spent 10 years working there. I know all about elite American business practices. Let me assure you that this potential son-in-law of yours, he's legit. He is an entrepreneur, but he's certainly not a loser. And then the marriage could go ahead.

Now, fast forward 10 years from that episode. And the same venture capitalist is never required to go and persuade the obstructive father in law of anything because Indians by the millions are watching the show Shark Tank in Hindi. Right? So I mean, the culture in India in a decade has shifted from complete skepticism of the value of entrepreneurship to being obsessed with entrepreneurial shows like Shark Tank. And it happened in one in one decade.

And so I think that if you take continental Europe, you know, which has sort of a, you know, famously risk averse place by tradition, it's terribly bad at creating new companies. If you look at the kind of rates of new company value creation, and you compare it to China or to the U S Europe is leagues behind.

But I do think it's changing and engineers in Europe are actually quite plentiful. There's more software engineers I'm told in Europe than there are in the U.S. And once you bring in American style venture dollars who are willing to finance people with good ideas, and then some of them take off and you get rolled bottles like Spotify, which is now worth, you know, between 50 and 60 billion. I think that it starts to change attitudes. And so I'm pretty bullish on Europe. I think it will take another five years or whatever, but I think attitudes have already begun to change and they're going to change more.

Steve Hsu: I agree with you. I actually think we're past the tipping point in Europe as well now, and for some time in India. So yeah I think, I think we're going to enter a very different world of tech and business model innovation, where you're just, you have millions of experiments going on all around the world and capital has learned the lesson that you know, they should. Some little chunk of their pension fund portfolio, and it should just be constantly funding these experiments. And I just think the world is going to be, I think the pace of innovation is just going to accelerate.

Sebastian Mallaby: Yeah, I totally agree. And the way I frame this is because I do like history is to put a bit of a historical frame on this. And I think that, you know, capitalism in one sense is sort of static because price signals and markets and all that, you know, have been around forever. But in another sense, capitalism is in flux all the time because the shape of the company of of kind of corporate formation changes with technology and with financial and legal mechanisms.

So the quick kind of three stages that I see, you know, you start with a period before steam and electricity and railways, and in those days you couldn't really make any use out of scale. So the typical company was a one man shop and that lasted until about 1850.

Then in phase two, you have steam, electricity and roadways. And now the scale is super valuable because you can introduce capital goods and make workers more productive and they're powered by electricity. And then you can distribute your products with railways all over the country. So then you get the limited liability joint stock company, which was made possible in Britain in 1867 and then was brought to the U.S. And the big company becomes the dominant capitalist structure.

And this continues notwithstanding the antitrust movement, you know, right through to the fifties and sixties when Organization Man was the title of a famous business book. And, you know, you had big, big labor, big government and big corporations. And the thing that really changed that was the advent of the personal computer, which meant that you could unbundle big corporations. You didn't need all that middle layer of sort of clerical workers doing by hand accounting cause you had spreadsheets. And so then you had leveraged buyouts and private equity, and these guys came along and they delayered everything in sight. They unbundled, re-engineered, and created the lean corporation. And so you had a new kind of different sort of corporate structure.

And after those three stages, I think you're totally right, Steve. We're in a new phase where because capital is increasingly intangible, that is to say, we're not talking about machinery and plant and equipment and fleets of trucks anymore. We're talking about ideas and software and patents and customer relationships and business processes and all those intangible assets are best financed by hands-on investors who could tell the difference between, you know, a software project, which might've cost 30 million. And that's what it says in the financial disclosure, but it could be zero if it's bad software or it could be worth 3 billion if it's good software. And you have to be a hands-on type of investor, like a venture capitalist is hands-on, in order to see the difference.

And you also want to do lots of experiments because that's the way you discover these new types of intellectual intangible capital. And so I totally agree that we're in a new phase of capitalism where venture capital is spreading around the world. It's spreading into new types of industry and it's spreading along the lifecycle of the companies, which used to go public at a valuation of half a billion, and now stay private, even though they might be worth 50 billion.

Steve Hsu: Yes. You know, one thing I, I think a listener might get the wrong impression from power law discussion is that the venture capitalists are just throwing darts. So you could say, oh, they need to sample some broad range of, you know, business model innovations or tech innovations. So they're just randomly choosing.

But typically when I meet venture capitalists, they have some core theses that they've arrived at through their own experiences and deep thought. And actually some, some venture firms actually have teams of researchers that generate these kinds of forward outlooks. And so they're, they're, they're often pattern matching against some big trend that they think is happening.

Like blockchain is gonna, you know, become very useful or, you know, clean energy is going to be a huge thing. So they have some rubrics that they're using to guide their investing. But of course they have to sample quite a lot of randomness.

Sebastian Mallaby: That's right. Exactly. That's very well put. And I think one of the big things I was grappling with in my book is what is the road of luck versus skill? And you can tell a story that, you know, if you had a sample of a hundred venture capitalists that started in year one one or two of them by the law of probability would probably have several hits in the first couple of years.

And once you have a couple of hits, you then get a good reputation and therefore you get good deal flow, you get access to the best entrepreneurs. And then the success becomes self perpetuating. So that would be the story that says it's all luck. And I end up arguing that it's not all luck. Of course, there is some luck involved. I'm not denying that. But, as you say, Steve, venture capitalists come to their investing with a point of view. And in fact, Accel, one of the partnerships, that I write a bit about, in 1983, when it got founded, started with this idea of what they call the prepared mind. There was a quote from the chemist, I guess Pascal who said chance favors the prepared mind.

And the idea was, that, you know, if you see a new technological wave and you mentioned, you know, clean technology is one example, or, you know, the blockchain is another, or it could be the advent of cloud computing, or what have you, you think through in advance all the different business models that need to be created to exploit that new wave. And then once you've thought through that, okay, you're going to need a new kind of semiconductor, a new kind of SaaS software, whatever it is, a new type of security that will work in the cloud. Once you thought through all the different business models, then you've got and try to find entrepreneurs who want to build companies that match against those expected business forms. And so there is a lot of skill in pre-thinking in, in having that prepared mind. That means that you know what you're looking for when you listen to a pitch from an entrepreneur.

Steve Hsu: Yeah. So you've, you've put your finger on the issue of where is the alpha, where, where does the alpha come from? So alpha, for those listeners familiar, it's a term used finance theory to describe performance relative to the general market. So if you make a portfolio, that's roughly as volatile as the portfolio that I'm investing in. If I have positive alpha, then my return will be higher than that reference portfolio. And if I have negative alpha, my performance will be worse. And of course you're always looking for investment managers who can outperform. And so the question is in venture, what is the source of alpha for particular venture investors?

Sebastian Mallaby: Yeah, exactly. So I mentioned one just now having a good prepared mind. I would mention four others. one is that, you know, once you've got your prepared mind and you hear a lot of pitches from entrepreneurs who are offering company ideas, that match what you believe is roughly the right direction, you then have to make a yes, no decision in a, in a, in an environment of a lot of uncertainty. And it's helpful to integrate insights from behavioral psychology into your partnership's decision process. So an example would be human beings are wired to have loss aversion, meaning that they will gamble to avoid a loss, but they won't take the equivalent amount of risk when they are really reaching for the upside. And of course, venture capital is about reaching for the upside. And so you have to start, you rewire the human brain in order to correct for that bias and the way that Sequoia, for example, one of the most successful venture partnerships that I write about the way they do that, is that when an investor writes the decision memo ahead of the partner's meeting about a possible investment, that memo is required to include a section in which the investor says what might happen to the startup if everything went right. Dream about it. Tell me how great could this be if everything went right.

And the reason you're required to write that down is human beings are embarrassed to admit to how fantastic something could be, because normally in life, something goes slightly wrong. And then you're feeling dumb that you were that optimistic. But as a Sequoia partner said to me, you know, our job is to be embarrassed. And so we have to write that down to get through that inhibition about it. So that's one thing. In addition to the prepared mind, you have to use decision science.

Then you also have to add value after the investment. And Andreessen Horowitz is a partnership that's famous for doing this. They've got a whole consulting business sort of in that partnership that's best to help startups find the right office space, write the first press release, tell them if some political change in Washington, DC might affect the policy environment around that startup.

So there's a menu of services. Probably the most important of all is talent recruitment that venture capitalists try to provide to their portfolio companies. And then the last one I would mention is that you've got to focus also on the internal glue of the partnership because you have to develop younger investors who can only really learn to be great investors through experience.

And, you know, John Doerr of Kleiner Perkins once said, learning to be a great venture capitalist about a bit like learning to be a great fighter pilot. You know, you won't be really good until you've crashed a couple of $5 million jets and had to eject. And it's a brutal analogy, but there's some truth to it. You know, and as a young venture capitalist, you need to be helped through that bruising experience of ejecting from the cockpit, because it's real people that are feeling the consequences, you know, when a startup closes, as you well know firsthand, Steve, it's painful. I mean, people who have, you know, put all their energy into the project for several years, are going to lose out. And so, you know, that's a tough, psychological, emotional process to go through. And although the investor is somewhat shielded from it, there is some bruising, if that person is human. And so I think to kind of be encouraged to pick yourself up and still look at the next project and go into it with enough optimism, to be able to make a fresh bet. It's something that you need to be helped to do by your partners.

And so in different ways, the partnership internally in the venture capital shop has to be good at getting the most out of all the different players.

Steve Hsu: Yeah, it's incredibly challenging. I've never been a venture capitalist, although I guess I do some consulting for venture capitalists on occasion. But yeah, it's incredibly challenging to think about building a partnership that's going to last, you know, maybe over a multi-decadal period that, you know, executes well, but then also trains up the new people to execute well and just can continue hitting on all cylinders for, you know, 30 years or something.

It's, it's very, it's very daunting.

Sebastian Mallaby: Yeah. And there's often a point where a generational transition is due, but the top people don't want to leave. And then the younger people get discouraged. And maybe as part of that process, when the top people are not yet ready, quite ready to leave, but, you know, they're, they're wanting to maximize how well they do. If a young investor brings in a project and it looks really promising, the older investor may pull rank and say, great, we're going to do this investment. And I will be the one to go on the board of the startup and that's demotivating for the younger venture capitalist. And also it means that the younger venture capitalist is sort of in a catch 22, where in order to have the standing to get on a board, you have to have been on a board. But if the older partners won't let you do that, you'll never get to do that. And so they're really successful model is again, I mean, I'm going to cite Sequoia. They have done the opposite. And if the young partner brings in a good investment, there's a pairing up that goes on where an older venture capitalist will go on the board to begin with. The younger one will go along as the shadow board member so that the younger one understands how the job is done. If the startup fails after two or three years, the bad mark is on the CV of the older VC who can take it. And the younger one walks away without that negative halo effect. But if the startup goes well, then the two switch positions so that the younger one gets the positive halo effect of having been on the board of a successful startup.

So a lot of deliberate thought goes into structuring the development of the younger venture capitalists at the most successful places. But you do have to be deliberate about it.

Steve Hsu: Yeah, that's a very enlightened way to structure things. The thought that entered my head, though, when you were describing that setup is that I think what they care more about is who actually gets the comp, the compensation, for the upside for that particular investment. And so I'm, I'm curious whether in your conversations, you spent a lot of time talking about compensation and how profits from the firm are divided.

Sebastian Mallaby: I spent some time talking about it. Of course, you know, as with many human beings, you can be open until the point where you're asked how much you're earning then people, you know, somehow clam up. But I did have some enlightening conversations with people who had left partnerships and then talked about the tensions that had existed, oversharing comp when they had been in the partnership. And I also had conversations with some partnerships, which made a great virtue of the fact that they try to sidestep those battles by having a blanket rule that everybody would share equally in the carry, in the compensation generated by hit investments.

So I mean, I have a sense that you're absolutely right. There are tensions around that sharing. exactly the way those tensions play out is often difficult to penetrate.

Steve Hsu: Yeah, the, the, you know, at an extreme, very different from the enlightened process that you are just describing. Another extreme is a partnership where there's maybe one more famous or most famous partner who basically takes all the, you know, all the upside or almost all of it. And that person often can justify it because they're the ones that can go to the LPs and raise the funds.

And so a whole other part of venture, which I think people are the least aware of, is not how they pick startups to invest in, but how they convince pension funds and, you know, the Harvard endowment, et cetera, to invest in their structures. So that the fundraising side.

So I'm often talking to, when I talk to a venture capitalist, you know, about investing in one of my companies, you know, sometimes the conversation will just drift to like, oh, the guy will say, I'm raising, we're raising a new fund. We're raising fund six now. And I'm like, well, how's that going? And he's like, yeah, it's taking all my time. You know? So, there's that whole other side of the activity that they're involved in.

And then of course you might have a partner who's really good at picking companies, networking with engineers and young founders, but another guy who really knows how to talk to the pension funds, right? So it's almost a different job specialization.

Sebastian Mallaby: Yeah, that's right. I mean, I think that that sort of specialization is actually healthy where you split off the investor relations a bit from the investing. I think where it becomes problematic, in terms of good investing itself, is if nobody can say no to the kingpin partner who decides that you're going to go all in on one kind of company.

And so the famous example of this is that Kleiner Perkins, which was the number one venture capital partnership in Silicon Valley around 2000-2001, essentially blew itself up, partly by going too big on clean tech at the wrong time. And that happened because John Doerr, the sort of kingpin partner at Kleiner Perkins, was a believer in clean tech and the people who might have checked him and balanced him within the partnership had quit around the early two thousands. So if he knowed Koestler, who was equally successful as John Doerr had been, had gone off and started his own company and a couple of other people who maybe a little bit less successful, but super important in terms of the kind of internal dynamics of the partnership and who had worked with John Doerr long enough to have the standing to say no to him, those people left as well.

And the people who stayed behind just didn't have the stature to stop John Doerr from going overboard on an idea. And so, although John Doerr was, you know, a terrific person who backed a string of amazing companies from Netscape to Google to Amazon, he also went too far in on clean technology at a time when the government seemed to be signaling that it would tax or cap and trade carbon, and then it didn't and those bets went wrong and it cost Kleiner Perkins dearly.

Steve Hsu: Yeah, it's a common story. Whether you're in a hedge fund or a venture fund, if you have some really dominant founder, founder, or partner often when that person gets old, the whole thing can go off the rails. I mistakenly thought, oh, Buffet is getting old some years ago. And I thought, well, maybe I won't put any money into Berkshire Hathaway, but of course he's, he's, you know, kept on going strong. And it was a stupid mistake not to put some money in Berkshire many years ago.

Sebastian Mallaby: Yes. Exactly. Exactly. You were being perfectly reasonable. I wouldn't call it a mistake.

Steve Hsu: Yeah. I mean, because I've just seen that pattern, just speaking from personal experience, a lot of funds that I've gone to, younger partners know what's up, but they have to get the deal approved by some older guys on the investment committee. And those guys often are checked out, you know, they're they made their fortunes on some previous generation of funds but they still run the company. And, you know, if they love you, that's great. They'll just write you a check. But if they don't like you, no matter how good your stuff is and how much the junior people in the firm like it, they're not going to invest.

So, you know, just varies the decision process, the real way, the decision process works at different funds varies enormously.

So I wanted to look into the future and, you know, so I think we both agree that any country that knows what it's doing is going to try to encourage tech entrepreneurship and venture investing, and et cetera, et cetera. So we may be heading for a future where this is an exaggeration, but you know, you might have a VC on every corner. At the same time, I'm starting, just starting to see democratized venture investing, where through some online platform, a little guy who I think doesn't even need to be a qualified investor. That's a, that's a sort of a U.S. Securities Exchange category for individuals. You have to have a certain income level or net worth to be a qualified investor in the United States. But these democratizing platforms would let, I think almost anybody, collectively invest in some early stage startup idea by just pulling their money through an internet platform.

I'm curious what, if you have any ideas on how the industry is going to look, say 10 years from now?

Sebastian Mallaby: My sense is that new innovations in terms of the check size of the investors, how they access the companies, is it through some internet platform or to have a, those will happen and they will change the industry around the margins, but they don't change the core. If you think about innovations that have stuck. For example, angel investors were not really a factor until the late 1990s. Now they're a big factor and they have been institutionalized because you have incubators like Y Combinator that, in a very systematic and sort of process oriented way, take batches of founders and give them equivalent of angel or seed checks to help them get started.

So this has become a new wing of the tech investing ecosystem. But it doesn't really change the Series A game that much. And the Series A, the Series B, the Series C, the classic sort of company building venture capital stuff. It's remarkably as it was in the 1970s or 1980s. So I think the same is true about these crowdfunding platforms, which may be able to generate some dollars for startups that are just beginning. Or you get things like AngelList, which has a list of companies. And angels can go onto that list online and choose which they want to invest in.

Or you get people talking about the decentralized autonomous organizations as part of the metaverse, as a new way of coordinating groups of people who can both discuss ideas and raise money together and maybe even implement stuff.

I think all of those things can have a little bit of traction, but I don't think they're going to displace the fundamental sort of Silicon Valley style venture shark. Because basically these guys are bringing their money and their networking and their experience. And I think these are the three ingredients that startups fundamentally need. I'm not sure they're going to be delivered in a fundamentally different package.

Steve Hsu: Yeah, that's an interesting question. I, I sort of accept that. I mean, I think when the check size gets somewhat large, there hasn't been that much change in the way things are done even over the last 20 years. I mean, the size of what you mean by a large check has changed, but the way it's done has not changed.

At the very early stage funding level, I do start to see, I start to run into more startups that just completely crowdfunded their, you know, their seed and maybe even raised a few million dollars that way or something like that. I think that's becoming common.

Sebastian Mallaby: Another innovation of this type, which kind of was very hot three or four years ago is the initial coin offering. and that went away pretty much because the coins were often so obviously worthless that people got fed up with buying them. But, you know, there's hope springs eternal and I'm not against hope and people will come up with some innovations.

The most important and sticky of these innovations has been, you know, the Y Combinator model of bringing very, very early stage company ideas into sort of summer school type startup settings. And you see that happening, not just in freestanding incubators, but actually the established venture capital partnerships have created their own version of Y Combinator internally, and they might call it startup school, or they might call it bootcamp or whatever they call it. But basically they're doing the same thing of offering some coaching to really early stage entrepreneurs, some, you know, initial capital in very small amounts, and then helping founders get towards C Series A when they would write a classic normal venture check.

Steve Hsu: Yeah. You know, Y Combinator is an amazing phenomenon. I, again, I've been around long enough that I remember when Y Combinator first started. When I think I was at a, a, an, a meeting kind of very informal meeting. And I think it, Paul Graham gave a little talk about it and he was super honest, intellectually honest. And he said, we're not sure this is going to work actually. You know, we're right in the middle of it. But he was very honest in saying they weren't sure. And then it turned out to just be a phenomenal success.

Sebastian Mallaby: He was a classic sort of reluctant entrepreneur pushed into starting Y by a funny sort of mix of circumstances. You know, his girlfriend at the time was very interested in being a venture capitalist, but hadn't actually broken in and hadn't gotten a job yet. And they were chatting about this and they realized that she wanted to do the sort of organizational side of venture capital. And he was great at the mentoring of computer scientists part of it. And if they teamed up together, they could, you know, maybe do some, some good deals together. And so they did this and to get started, they said, well, let's just do a whole bunch of deals to begin with and we'll call it a summer school.

And then that turned out to be the batch system, which proved incredibly efficient and successful because instead of mentoring founders, one by one, which is sort of inefficient, especially when you're dealing with very small seed investments, you could do a whole batch of founders in a group, bringing them together for his Tuesday night dinner, bring in a speaker that they would find interesting and helpful, and immediately that speaker has communicated to, you know, 20 founders, as opposed to setting up 20 separate one-on-ones.

Steve Hsu: Yeah, I'm a little too old to have experienced Y Combinator because by the time it came around or became mature, I'd already done startups the old fashioned way, I was always very interested in watching it, from the outside. And I remember going to meetings when so there's a guy called Sam Altman that maybe, you know, who's, he's currently the CEO of Open AI, but for a while he was actually, I think, the president of Y Combinator after the, the original founders, like Paul kind of stepped back.

But when this guy Sam was very young, he was just a kid, but he was kind of representing Y Combinator. And when he would talk, everybody in the room would just listen because somehow he had convinced the people within Y Combinator of the strength of his ideas and intellect and judgment. And so he just, he just ascended to, you know, this, this managing role so incredibly quickly. It was an incredible story.

Sebastian Mallaby: In addition to that, not only were the young company founders listening to him, but the older venture capitalists were listening equally intently because for them, the Y Combinator summer school was sort of a feeding stream of, of great young who would then graduate from Y Combinator. And the best ones would get investment checks from the established Series A venture capital companies.

and so the VCs wanted to be on good terms with Sam Altman so that he would point the best entrepreneurs to them.

Steve Hsu: Yeah, just incredible. And, and, you know, to his credit, Sam, you know, he had the vision to, when I kinda got to know him better on a more personal level, he was I guess at that point he was president of Y Combinator. I think that was his title. And, but then he stepped away from that completely because of the vision he had for Open AI. And now Open AI is an incredible success.

So, it's just amazing. I feel very privileged to have been around the industry and just, just watch it evolve. I mean, it's all part of history now.

Sebastian Mallaby: Absolutely. But it's history that's still evolving. The invention of the future has never finished.

Steve Hsu: Yeah, it's never finished, but, but I just feel that at least in countries, in many countries and increasing numbers of countries, the idea that we can accelerate innovation, we should build these kinds of ecosystems to accelerate innovation. I think that's not going to go away. And I, I just, I see an acceleration in, in the rate of progress.

Sebastian Mallaby: Yeah. I mean, sometimes I frame it in the following way, you know, when Ronald Coase, British economist, he spent most of his career at Chicago, did some of the work that won him the Nobel Prize in economics. Some of his work was around this idea that, you know, there are two basic mechanisms of, of capitalism. You know, as I've said earlier, there's the markets and then there's the companies. But in some ways, these venture capital backed networks or startups are a clever mixture of the two because on the one hand, a VC is choosing which ideas to back. And so he's a bit like a, you know, strategic manager at a big corporation saying I will direct research resources to this project and this project in this project, but not those ones over there.

And then moving the talent, you know, hiring the people to go work on these different ideas and providing the money and then deciding when is that research project is failing, when should you cut the money. So there's a bit of that corporate direction that's going on. But there's also a market signal because in the venture capital world, you provide six or nine months of runway. And when the money runs out, the company has to raise another round and there'll be a price evaluation for that round. And if nobody is buying at that price, pretty much the startup has to be closed down.

And so there are both price signals and company style direction. And I think this is sort of the middle institution of how we're going to be seeing economies function more and more in the future.

Steve Hsu: Yeah, I completely agree with your analysis. And the big difference is when you were an internal project within Bell Labs or IBM, you weren't getting that external signal of market approval for, you know, your prototype or signing contracts with customers, things like that. You weren't getting that feedback. And so it was just the judgment of some VP at IBM as to whether this project would live or die.

Sebastian Mallaby: Exactly. And that would encourage no dysfunctional office politics as opposed to actually building the product.

Steve Hsu: Exactly. So, so it's this, it's this mix of the VC allocating resources, but informed by good market signals along the way.

The one thing I would say though, that I noticed is it's very, it's a very -- it's something that really sticks out to me, is that among founders now, the demographics have, have diversified quite a lot. And I don't mean by race or gender, there's still a problem with race and gender, but in terms of class or even educational credentials, you meet a lot of founders now who don't necessarily come from the top universities. You either could be scrappy guys who went to, you know, some state flagship university or something. But, you know, if they talk a good game and they have some chops, you know, they can get funded.

But if you look at the teams, the people that are actually who can get jobs in, roughly speaking venture, hedge funds or private equity, they're all coming from really still the very top institutions. And so there's, that's a very desirable job. It's a very important job in terms of directing capital in our society. But the pipeline or the pathway to get into those seats is still very restricted, as far as I can tell.

Sebastian Mallaby: Yes, that's a good point. I think the possibly the slight exception is where you've got people who become venture capitalists because their background is that earlier they started a company

Steve Hsu: Yes.

Sebastian Mallaby: And those people may, you know, have been scrappy when they started the company. And then they achieved a status that enabled them. One of the great founders of the whole venture capital world was Don Valentine. He founded Sequoia in 1972 and he went to Fordham University, which is not part of the big elite. But, you know, he left Fordham. He went to be a semiconductor salesman at national semiconductor. He was very good at that. He worked incredibly hard. He had a lot of hustle. And he started doing his own angel investing or when it wasn't really called that, but that's what he was doing. And when that worked well, he was picked up via a financial firm and given a job as being a tech investor. And he parlayed that into founding Sequoia.

So the origin story is scrappier than your observation, but I think your observation is broadly true.

Steve Hsu: Yeah, I mean, generally the real innovators are scrappy, but once it becomes a well-defined career path, like, oh, I want to be a venture investor. Oh, what do you do? Oh, you get an MBA at Stanford. Or you do your undergrad at Harvard. And, you know, through the alumni connections, you get interviews at Sequoia and other places.

So if you look at the young people who, you know, honestly, they may have great credentials, but they've literally done nothing. Like they've not actually done anything in the real world, to what extent can someone based on their pedigree get a job offer from a good venture firm that is still a very tightly restricted pipeline?

Sebastian Mallaby: Yeah, but, you know, I mean, I think it's probably true that you can get a job in a venture capital partnership, but you wouldn't be a partner. I mean, if, if all you've got is the right credentials, I don't think you're going to be made an investing partner. And so, I mean, just to illustrate, Andreessen Horowitz began life in 2009 when they founded the firm with a rule that in order to be investing partner, you had to have founded your own startup before. Now that turned out to be an overly restrictive filter. And so they've relaxed that, you know, after about 10 years. But the fact that they even began with the filter is telling you that, you couldn't just go get your engineering degree from MIT and your MBA from Stanford, and then say, hello, I want to be a venture capitalist.

You wouldn't have gotten the job, at least not at Andreessen Horowitz. And I think also not at Sequoia or somewhere like that. I mean, if you take the profile of someone like Roelof Botha who was hired when he was around 30. Yes, he had had a Stanford MBA, but you'd also been the chief financial officer of PayPal. You know, a very successful startup after that. And it was certainly the latter experienced the qualified him to be hired as a venture partner.

Steve Hsu: Yeah, I think, I mean, one path into it is you've accomplished something in the real world, i.e. you, you built your own startup and people know you, and then they say this guy would make a great venture partner, so let's bring him in. But the sort of tried and true path where you come in as a junior, you know, an associate, that seems to be very pedigree focused still.

And of course not all of those junior people are going to rise to the level of an actual partner at the firm, but a pretty big chunk of the partners are drawn from that pool.

So I just noticed that, that path, like, I guess I'm thinking this way, cause I have kids, right. And I'm thinking, oh, if my son wants a good career path and he wants to do he's interested in venture or something like that, he should probably go to an elite undergraduate school.

That would probably be step one. And so I can't help but notice that pattern.

Sebastian Mallaby: Yeah, no, I, I agree with you. And, I just make a tangential point, which I think is worthwhile, which is when it comes to the startup founders, we often talk about people who do well nice because they of course are smart and hard working, but a standard line would be, yeah, but they also started with money and connections. And the thing about venture capital is that it provides somebody with an idea with money and connections. And so to some extent, it's not a perfect substitute, but to some extent, when a venture capitalist is backing an idea from a founder who comes from a scrappy background, it's an egalitarian mechanism for providing that money and that connectivity and knowing the right people that the founder by himself might not have had.

Steve Hsu: Oh, I agree with that. I think overall venture, in terms of the entrepreneurs that it funds is a vehicle for a egalitarianism and also meritocracy because the incentives are aligned to really say, you know, of course you, you might have some belief that, oh, because of the guy went to Princeton, he'll be a good entrepreneur, but I don't think too many venture capitalists feel that way. So they really are trying to evaluate the individual as an individual to say like, is this guy going to be a great founder for this company?'

So yeah, in that sense, I think the incentives are properly aligned in venture to help talented people get ahead regardless of their background.

So, Sebastian, I think we're well over an hour and I'm conscious of not using too much of your time, although I really enjoy this conversation. Do you want to make any final remarks, any, any aspects of your book that you think should be emphasized that I didn't get to?

Sebastian Mallaby: I guess maybe just a last thought is that one of the things that surprised me the most in my research was to find how the origin story of China's tech ecosystem was kind of similar to the origin story of the Silicon Valley one. You know, I, I sort of had an inkling that if I went to look at how Silicon valley really took off and how it overtook Boston, the venture investors would be part of the answer. And that did turn out to be the case that I think really because the west coast venture capitalists were more risk hungry, and moved faster, hustled more, and were more hands-on they enabled the west coast companies to overtake the uh, east coast cluster around Boston. And so around the 1980s, Silicon Valley emerged as the top innovation cluster in the world.

But what blew me away, was that when I went to China and figured out, how did Alibaba or Baidu or Tencent or [unclear], or NetEase or any of these early Chinese digital economy companies, how did they get started? The answer was again that they got American venture capital and they got American venture legal advice, which enabled them to issue stock options to employees and therefore attract really talented people who could build a world-class company.

And so that centrality of venture to building entrepreneurship across two very different countries was a remarkable finding.

Steve Hsu: Yeah, I think your characterization is historically accurate. So it was really a lot of American funds reaching out very early on in China that got a lot of the biggest platform companies started in China. I think that's exactly what happened.

Now, I would say things are quite different now. So now there's really a huge indigenous venture ecosystem, you know, in China and it's actually spread over multiple, obviously multiple megalopolises in China.

So it's, it's now its own thing. But it definitely had its seed in west coast venture firms trying to get in on the China action.

Sebastian Mallaby: Exactly.

Steve Hsu: All right. My guest today has been Sebastian Mallaby. Sebastian has been a pleasure. I urge every listener out there to buy a copy of the "Power Law: Venture Capital and the Making of the New Future."

© 2022 Steve Hsu