[00:02:18] Clay Finck: Media innovation did not come from Time Magazine or CBS. It came from YouTube, Twitter, and Facebook. Retail innovation did not come from Walmart. It came from Amazon. Now, our show largely focuses on value investing, and I wanted to cover this book to help cover our blind spots as value investors. Many value investors tend to focus on stable businesses with established business models, but we now live in the age of disruption.

[00:02:44] Clay Finck: Businesses that we thought were totally indestructible are now seeing new businesses launched overnight start to compete with them. Understanding power laws can help us better understand that the new up and comers in an industry can look totally different from the incumbent players and we need to be open minded to the future looking much different than the past.

[00:03:04] Clay Finck: If we’re open minded to the potential that emerging players could reach, then we won’t be surprised when the next Teslas or the next Amazons of the world with a brilliant CEO burst onto the scene while all other value investors ignore or quickly dismiss these companies. The first venture capitalist that’s mentioned in the book is Vinod Khosla, who’s one of the top venture capitalists in Silicon Valley.

[00:03:26] Clay Finck: Khosla is a billionaire who ran Khosla Ventures, and he was interested in environmentally friendly cleantech projects. He also believed that most social problems could be solved by technological solutions if only investors could be motivated to pursue such strong ambitions. Kholsa has said, all progress depends upon the unreasonable man, the creatively maladjusted.

[00:03:49] Clay Finck: Most people think improbable ideas are unimportant, but the only thing that’s important is something that’s improbable. Kholsa was someone who actively looked for radical dreams. The bolder and more improbable, the better. Typically, Khosla’s VC investments were moonshot bets. Odds are that 9 out of 10 of its investments would lead to failure.

[00:04:10] Clay Finck: But the hope was that, that gain from that 1 winner out of 10 would far outweigh the other 9 losses. There was no point in gambling for success unless that success was worth having. As a successful venture capitalist, Kholsa understood the power law probably as well as anybody. Furthermore, his risk appetite, his love of hubris, and his quest for improbable ideas made him a living embodiment of the power law, which is the most pervasive rule in venture capital.

[00:04:39] Clay Finck: Many phenomena in life are normally distributed. In a normal distribution, most data points are around the average. And there are an equal number of data points above and below the average. For example, the average height of an American male is 5 feet 10 inches.

[00:04:55] Clay Finck: And two thirds of Americans are within 3 inches of that average. When you plot a normal distribution on an x y axis, you’ll see a bell curve. The more the height moves away from the average, the lower the probability of any man being that height. But not all phenomena follows a normal distribution. If we look at the wealth of Americans rather than height, it looks much different.

[00:05:17] Clay Finck: It has more of what we can refer to as the power law distribution, where the wealthiest people are disproportionately wealthier than the average person. Because the wealthiest people are numerous enough and wealthy enough to impact the average wealth of the nation, the average is pulled to the right, unlike the normal distribution.

[00:05:35] Clay Finck: If we had a movie theater of 100 people and the tallest person who’s a 7 foot NBA player walks out of the room, the average height of the room actually doesn’t change that much. In this example, the average height in that room goes from 5 feet 10 inches to 5 feet 9. 9 inches, hardly a difference at all.

[00:05:52] Clay Finck: But if we measure the average wealth and Jeff Bezos walks out of the room, the average wealth would fall off a cliff because his wealth is just so far above the average. This skewness also ties in well with the Pareto principle, which refers to the 80 20 rule. The idea is that 80 percent of the wealth comes from 20 percent of the people, 80 percent of the people live in 20 percent of the cities, or 80 percent of your work output comes from 20 percent of the hours.

[00:06:18] Clay Finck: There’s nothing special about the numbers 80 and 20, but it essentially outlines how most of the results come from a small number of the inputs. This is also important to understand as an investor. Mallaby also brings up the great point that success tends to be get success. Once Jeff Bezos achieved a high level of wealth, he was presented with more opportunities to do business and make investments, which led to more creation of wealth.

[00:06:44] Clay Finck: Some investors just tend to advance at an accelerating or even an exponential rate. Anytime you have outliers who success multiply success, you switch from the domain of a normal distribution to the land ruled by the power law. From a world in which things vary slightly to one of extreme contrasts. And once you cross that perilous frontier, you better begin to think differently.

[00:07:08] Clay Finck: In the world of venture capital, Horsley Bridge found that 5 percent of their capital invested accounted for 60 percent of their returns over a 30 year time period. Y Combinator found that returns were even more skewed. In 2012, they calculated that 75 percent of its gains came from just two out of 280 companies, which is just 0. 7 percent of the total number of companies. Even the podcast you’re listening to has benefited tremendously from the power law. By our estimates, we’re in the top 0. 1 percent or top 0. 01 percent of podcasts in terms of downloads and revenue generated. While the average podcast receives around 1000 downloads per month, We Study Billionaires average 1. 4 million downloads per month in 2024. And my best guess is that the average podcast makes less than 10, 000 in revenue per year. TIP generated roughly 1. 7 million in profit before tax. And TIP is by no means the biggest podcast out there. Joe Rogan signed a nine figure deal with Spotify, which makes TIP look like nothing in comparison.

[00:08:16] Clay Finck: What people tend to forget is that to be in the top 0.1 percent of podcasts, big sacrifices are necessary. While I didn’t personally start the show, I was an early listener. Preston Pysh co-hosted the podcast together, and they went at least three years of making practically no money and producing one episode every single week.

[00:08:37] Clay Finck: I’ll turn the discussion back to how this relates to venture capital, but if you’d like to learn more about the story of TIP, you can check out episode 481, where I interviewed Stig about the story. Peter Thiel had said, the biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund.

[00:08:57] Clay Finck: And Bill Gurley had stated, venture capital is not even a home run business. It’s a grand slam business. What this means is that venture capitalists need to be ambitious to be successful. Many value investors would be happy to double their capital over five years, which is essentially a 15 percent average annual return.

[00:09:16] Clay Finck: But if venture capitalists sought after those same returns, they would almost guarantee failure because the power law generates relatively few startups that will double in value in five years. Most fail and have their equity values go to zero. While a handful of outliers hit the proverbial Grand Slam, the only thing that matters in venture capital is to own a piece of those winners.

[00:09:39] Clay Finck: Venture capitalists also have to strike some sort of balance. If they invest in a project that is literally impossible to achieve, then they’re just simply wasting their precious capital. But if they invest in something that is easy for others to replicate, then it will be difficult for the firm to extract profits.

[00:09:56] Clay Finck: So they have to invest in the moonshot entrepreneur reaching for the near impossible. That’s also somewhat crazy enough to think that they might actually be able to pull it off. Vinod Kholsa had a number of big payouts throughout his career in venture capital. His first jackpot was an investment in Juniper Networks, which built internet routers.

[00:10:15] Clay Finck: He invested 5 million and reaped an extraordinary 7 billion for the Kleiner’s Fund, multiplying his initial investment by 1, 400 times. He not only entered a mega Grand Slam investment, but he also sold out in August of 1999 at the perfect time, recognizing that the buyout price that was offered by Cisco was very, very generous.

[00:10:36] Clay Finck: Mallaby shares the idea that venture capitalists must view the world through a different lens and reimagine what the future could look like. While value investors tend to find something stable and predictable and forecast the future based on the recent past, venture capitalists that are investing in these big disruptors simply can’t predict the future based on past data because such innovations are so thoroughly disruptive.

[00:11:00] Clay Finck: Mallaby writes here, mature , comfortable societies dominated by people who analyze every probability and manage every risk should come to terms with a tomorrow that cannot be foreseen. The future can be discovered by means of iterative, venture backed experiments. It cannot be predicted. End quote. As I alluded to at the start of the episode, experts may be the most likely to create these incremental advances in technologies and in society, but radical rethinks tend to come from outsiders, the Elon Musks, the Jeff Bezoses, and the Reed Hastings of the world.

[00:11:38] Clay Finck: What’s also interesting about venture capital is that in order to be successful, you need to understand how businesses operate and what types of people will be able to scale a business from zero to a multi billion dollar organization. While much of Wall Street is trading millions of dollars in paper assets in the blink of an eye, venture capitalists are taking stakes in real businesses and holding onto them for a number of years.

[00:12:02] Clay Finck: I also think it’s important to study venture capital because they will be funding much of what the future will look like. As I recently discussed with Adam Ziesel on episode 686, technology companies are becoming more and more prevalent in the stock market, and these new business models are important to understand and keep an open mind to.

[00:12:21] Clay Finck: I recall owning shares in Tesla back in college because I really admired the future that Elon Musk had envisioned, and I thought his vehicles really had the potential to gain steam globally. Then I started learning more about value investing, and I realized that Tesla was likely significantly overvalued relative to other car makers, and it was tough to justify their steep valuation based on the number of cars they sold and the intense competition that was sure to come very soon.

[00:12:47] Clay Finck: That was back in 2016, and since then, shares of Tesla are up nearly 30 times. It’s a harsh lesson that the most innovative companies can become much, much bigger than we might initially forecast. I thought a market value of 50 billion for a company like Tesla, which made no profits, was way too high, and it’s also in a very capital intensive industry.

[00:13:08] Clay Finck: Looking back, I think I should have viewed it more like a venture bet where it would start out as a small percentage of my portfolio. And if it ended up working out, then I could be hanging on to a multibagger, you know, make five or 10 times my money. And if it didn’t work out, then I might lose anywhere between 50 percent to a hundred percent of the initial capital I put in.

[00:13:27] Clay Finck: So chapter one of the book gets into the foundational roots of Silicon Valley. Mallaby argues that the genius of Silicon Valley is not their capacity to innovate, but lies in their capacity and willingness to capitalize on such innovations. The first precursor of the World Wide Web started in Minnesota.

[00:13:46] Clay Finck: The first web browser was developed by Mark Andreessen at the University of Illinois. The first search engine was invented by Alan Emtage at McGill University. And the first internet based social media site was launched by Andrew Winrick. In New York City, all of these inventions lie outside Silicon Valley.

[00:14:06] Clay Finck: Mallaby also highlights the counterculture in the Valley of Hippies who thought differently and were more willing to question conventional norms. Steve Jobs is someone who’s mentioned a number of times in the book. Mallaby writes here about Jobs, Steve Jobs was among the many who embodied both sides of this contradictory culture.

[00:14:24] Clay Finck: He was too modestly egalitarian to demand a bosses of reserves slot in the company parking lot. But too arrogantly entitled not to sThiel the space designated for disabled drivers. He was a communalist collaborator sharing his intellectual property freely with rivals. He was also a capitalist competitor, paranoid and controlling.

[00:14:45] Clay Finck: It was this combination of laid back creativity and driving commercial ambition that truly defined Silicon Valley. Making it the place where flights of imaginative fantasy begat businesses that shaped societies and cultures. End quote. Venture capital in the grand scheme of things is a relatively new industry.

[00:15:05] Clay Finck: After the Great Depression, post 1929, the big investment firms were much more interested in preserving capital rather than putting any of it at real risk. It was in the late 1940s that funds started to emerge and invest in early stage companies that dreamed big. It was actually the Rockefeller family who was one of the early pioneers of the VC industry.

[00:15:27] Clay Finck: And apparently they got into it not for financial reasons, but because they felt like providing capital to projects that needed it would help make the world a better place. Lawrence Rockefeller didn’t feel that it was right that capital would only be provided to opportunities that were perceived to be very safe.

[00:15:43] Clay Finck: And it was sort of mind blowing to read about this given that today we have so much capital chasing all these fairly risky projects. While in the 1940s many companies traded at around their net asset value, today’s safe companies are perceived to be the apples and Microsoft’s of the world, which trade at PE multiples of 35 to 40.

[00:16:02] Clay Finck: The Rockefellers ended up underperforming the broader stock market. One reason likely being that they weren’t necessarily looking for strong economic returns on their investments. Reid Dennis was also an early venture capitalist who saw promise in the tape recorder industry. He bet on a company called Ampex, a maker of tape recorders, as he believed that the technology was going to be useful for a lot of things in the future.

[00:16:26] Clay Finck: His 15, 000 investment in 1952 turned into 1 million by 1958. When the company went public, so that was a 67 X return, Georges Doriot founded one of the world’s first venture capital firms, and he was regarded as the father of venture capital. In his lectures, he shared his belief that the greatest rewards were to be found in the most ambitious and least obvious projects.

[00:16:50] Clay Finck: The investors would have to wait patiently for returns to mature over the longterm. And that the best prospects involved advanced technology, not orange juice or fishing in Asia. He also understood that a venture capitalist’s role wasn’t just to provide capital, but also to provide managerial counsel, assistance with hiring, and tips on everything from marketing to finance.

[00:17:12] Clay Finck: But over time, Doriot did make some key mistakes. Instead of just raising capital through a partnership, he took his firm public, making him subject to strict regulations. He also made poor use of financial incentives within his company and told his employees that they were in the business not to make money, but to serve their country.

[00:17:31] Clay Finck: Additionally, he would never abandon underperforming portfolio companies, even if they hogged capital that could be more productively deployed elsewhere. Despite his faults, he still managed to make his original investors 30 times their money in 25 years, thanks to the help of the power law and some big winners far outperforming the S&P 500 over that same time period.

[00:17:51] Clay Finck: The modern version of the venture capital profession was further cemented with two advancements in the 1950s. First, technology investors embraced the idea of an equity only, time limited fund, rejecting various rival formats, and second, technology investors devised a new kind of risk management better suited to a venture portfolio.

[00:18:12] Clay Finck: Venture capitalists can no longer diversify their risks across stocks, bonds, and real estate, which meant that lumpy returns and concentrated bets on a small number of technology startups were to be expected. Interestingly, in 1958, the US government encouraged the growth of a new kind of venture vehicle after the Soviet Union launched the first man made satellite.

[00:18:32] Clay Finck: Venture capitalists put together what was referred to as a small business investment company which could receive cheap loans and tax concessions, but to qualify for assistance, the fund couldn’t be larger than 450, 000, and no investment could be larger than 60, 000. So this really targeted very small companies and investment allocations, but nonetheless and encouraged the growth of the industry overall.

[00:18:57] Clay Finck: But since the industry was so nascent at the time, these really early funds could still get a sizable stake in a startup because these startups didn’t really have any other option to raise capital. These SBICs ended up not working well for the most part because they had taken on debt that needed to be serviced.

[00:19:13] Clay Finck: So if they needed to pay, say 5 percent interest on a loan, they would need some sort of income to service that debt, which meant that they invested in companies that could pay a dividend, which meant that they really couldn’t apply the VC approach that we know of today, where a lot of these companies simply aren’t profitable.

[00:19:30] Clay Finck: This led to the private limited partnership model that began in 1961, Arthur Rock and Tommy Davis launched a limited partnership by raising 3. 2 million, which allowed them to be significantly larger than these SBICs and they weren’t burdened to servicing any debt. Hi, everyone. My name is David. So let’s get started.

[00:19:47] Clay Finck: Rock and Davis promised to liquidate the fund after seven years, which meant that they had a relatively long time horizon to invest in startups, but also had the urgency to really get capital deployed whenever they could find a good opportunity. They also had an incentive structure in place where Davis and Rock would be compensated with 20 percent of the fund’s capital appreciation.

[00:20:06] Clay Finck: And they also sought to provide equity to the employees of portfolio companies in order to align the incentives there as well. Generally, founders were able to keep about 45 percent of their company. Employees would get around 10 percent and the venture capital firm would get the remaining 45%, which was split between the limited partners and the general partners.

[00:20:25] Clay Finck: During the 1960s, modern portfolio theory was bursting onto the scene, which stressed the importance of diversification and owning a broad mix of different assets with uncorrelated risk profiles. Davis and Rock ignored this teaching and sought to make concentrated bets on a dozen or so companies. One benefit they had with their approach is that they would sit on the board of the companies they owned and had a say in the business’s strategy.

[00:20:49] Clay Finck: And they would only invest in companies that were ambitious and showed promise for high growth. They wanted to invest in companies that had the potential to increase their value by at least tenfold in five to seven years. While many would call these hurdles outlandish, Davis believed that it would be unwise to accept a less stringent hurdle fully knowing that most startups failed, and the few winners had to make up for a number of losers.

[00:21:13] Clay Finck: He had stated that trying to play it safe in small companies is self defeating, and in their approach, they acknowledged the logic of the power law. The way Mallaby puts it, the best way to manage risk is to embrace it fearlessly. At this time, investors like Warren Buffett would assess companies based on price to earnings ratios or price to book ratios.

[00:21:32] Clay Finck: And since companies seeking a venture investment had zero earnings and practically no assets, these ratios might as well have been useless. Davis’s investment approach could be summed into four words. Back the right people. He formed a habit of skipping through the financial projections they had sent and go right to the founder’s resumes.

[00:21:51] Clay Finck: Rock had said the single most important factor in the long run for any company is of course management. I think these sort of statements tie in well to modern day value investing. Of course, PE ratios and metrics like return on invested capital are important, but at the end of the day, business is all about people.

[00:22:09] Clay Finck: Rock referred to human talent as the intellectual book value. This is something that simply can’t be measured. He wanted to understand their character. He wanted high levels of integrity and honesty and get a feel for how committed they were to the success of the business. Before they launched their fund, they decided that they did not want to invest in computer startups since IBM dominated that space.

[00:22:32] Clay Finck: Davis heard from his consultant, who went on and on about this mathematician named Max Palevsky, claiming that this would be the most exciting proposition he had ever seen. Well, Max Palevsky, he was in the business of making computers. Davis decided to meet with Max anyways, and he was really impressed by him.

[00:22:52] Clay Finck: He went to the best university in Chicago, he studied logic there, which fit in well with computing. And with the advent of semiconductors, Max was now able to build his own machines that could outperform IBM’s machines. Rock was pretty skeptical with this proposition as well, but he was also impressed after he met Max.

[00:23:12] Clay Finck: Rock had said that entrepreneurs with managerial magic cannot lose. If their strategy doesn’t work, they can develop another one. So they invested $257,000 into Palevsky’s new company Scientific Data Systems, which turned out to be a fast growing computer maker of the 1960s. By the time the partnership was shut down in 1968, that $257,000 grew to 60 million, an increase over 230 times their money.

[00:23:43] Clay Finck: I think this goes to show that for many investments, the people are oftentimes just as important, if not more important than the specific idea they are pursuing at the time of the investment. In 1969, Xerox would purchase SDS for 1 billion, making it the corporate sale of the decade. When the Davis and Rock partnership was wound down, their success was overwhelmingly tied to SDS, but also to defense contractor Teledyne, which our audience is likely familiar with.

[00:24:12] Clay Finck: The initial fund of 3. 4 million grew to almost 77 million, generating a total return of 22X their money in just seven years. So that nets out to an average annual return of 56 percent per year over that time period. This would have been one of the first successful venture capital firms, which would then serve as a model for the funds that would be set up in the future.

[00:24:35] Clay Finck: And of course, when a partnership puts up such mouthwatering returns, others are going to want in on that action. This was really an era where capital was now available to back startups with no assets, no profits, just talent and ambition. And this is a great transition to talk about Sequoia Capital.

[00:24:53] Clay Finck: Sequoia Capital is certainly one of the most well known VC firms. According to their website, they’ve compounded at 13. 4 percent per annum since 1972, and that’s relative to the S&P 500’s return of 11. 4%. An investment of 10, 000 into Sequoia’s fund in 1972 would be worth over 9 million today. Sequoia Capital and Kleiner Partners would pioneer a new form of venture that would be highly involved in the company’s operations, including helping the founders determine who to hire, how to market and sell, and capital would be infused into the company in tranches based on milestones that the company was able to hit over time.

[00:25:34] Clay Finck: Sequoia was founded by a man named Don Valentine. Don had an appetite for risk and control. Had he started an SBIC, he would have had to take on debt, which is something he never really believed in. And he wouldn’t take money from pension funds because they weren’t interested in investing in these riskier projects.

[00:25:52] Clay Finck: In a year and a half, he was able to go around and raise 5 million for his first fund, primarily from universities and endowments. After a strong run in the economy and the stock market in the 1960s, the 1970s was a time to proceed with more caution with low growth and higher inflation. This allowed Valentine to be a bit more selective in the deals that he was investing in.

[00:26:14] Clay Finck: One of the first deals he had his sights set on was Atari, which had just created the very popular game called Pong. The business was run in a very unorganized manner, you know, it wasn’t business people, it was really these software type people. So instead of investing, Valentine put together a business plan for them.

[00:26:31] Clay Finck: And was open to the idea of investing if they could get their business act together and implement that plan. Valentine had also connected them with Sears through his own personal connections and Sears ended up placing an order for 75, 000 Home Pong machines. Which gave Valentine the green light that the product was desired by these big players in the market that could distribute it at scale.

[00:26:54] Clay Finck: In June of 1975, he made a seed investment of 62, 000 and by August, Atari had raised another million dollars, which Valentine participated in. This was amidst the background of the entire VC industry swindling to a mere 10 million. Atari needed larger capital infusions soon after to continue growing, so they would end up getting sold for 28 million in 1976, and this delivered a three times return for Sequoia in less than two years.

[00:27:24] Clay Finck: This new venture formula delivered exceptional returns to Sequoia and Valentine. The first fund they raised, it put up returns of almost 60 percent per year by 1980 versus just 9 percent for the S&P 500. So when I think back to Atari, I was curious if Steve Jobs had worked there during this period and he was there for a brief stint in 1974.

[00:27:45] Clay Finck: And that is where Valentine first met Jobs, where he was a line engineer at the company. And then of course, Sequoia would end up participating in Apple’s very first fundraising round in 1978. This was a hugely successful investment for the fund. It would be easy to say that Sequoia’s early success was purely due to luck, but they were highly influential in the company’s success.

[00:28:08] Clay Finck: So they brought their business experience to the table to help the founders work through these growing pains and create a viable business that could really scale. The way Mallaby puts it is that, by force of character and intellect, they stamped their will on their portfolio companies. In Chapter 4, Mallaby shares Venture Capital’s role in fueling the early growth of Apple.

[00:28:30] Clay Finck: So Apple was founded in 1976 by Steve Jobs and Steve Wozniak, and in many ways, they were the picture perfect candidate for an investment firm venture capital. Many insiders in the space knew that the personal computer would be a really big deal in the years ahead. Yet, all of the big players decided not to enter the market initially, which aligns with the thesis of the innovator’s dilemma laid out by Clayton Christensen.

[00:28:53] Clay Finck: Xerox was worried that a computerized paperless office would harm its core photocopy business. Intel and National Semiconductor feared that making a computer would put them in conflict with existing computer makers, which were among their top customers, and HP thought that building a cheap home computer would undercut its premium machines, which sold for around 150, 000.

[00:29:17] Clay Finck: All four companies had too much at stake in the status quo to risk disrupting it. Despite this attractive setup, most VC investors who came across Apple thought it was a joke, and likely for good reasons. One investor wondered what sort of use a computer would have at home. Jobs had pitched Stan Veit, the owner of New York City’s first retail computer store, to buy a 10 percent stake in Apple for a mere 10, 000.

[00:29:43] Clay Finck: Stan looked at Jobs as a long haired hippie and thought to himself that he would be the last person to hand over 10, 000 to. There’s one story of a VC investor being introduced to jobs after he had just come back from India for some sort of meditation experience, and he came off as someone who hadn’t showered for quite some time.

[00:30:02] Clay Finck: So it’s pretty easy to see why most people would have said no to this off the wall character. Nolan Bushnell, who had hired jobs at Atari, was offered a third of Apple for 50, 000 and he thought he was quite smart to say no. As a courtesy, he did give him an introduction to Don Valentine of Sequoia. After Valentine’s experience with Atari, he established himself as someone who could handle working with young founders that were difficult to get a hold of and trust.

[00:30:30] Clay Finck: Valentine was actually a good fit for a startup whose greatest challenge would be to convince unsuspecting consumers that they would want computers in their kitchens. Although Valentine was skeptical, he did want to try to help Jobs and see if an investment down the road would come to fruition. He connected Jobs with someone in his network named Mike Markkula, who had experience as an engineer and a sales executive.

[00:30:54] Clay Finck: Markula arrived at the garage that jobs and Wozniak were working out of, and after getting over the hurdle of talking with these unusual entrepreneurs, he realized that Wozniak was actually building something in his garage that was really impressive. The Apple 2 prototype was free of the standard mess of circuit board strung together with fiddly connectors.

[00:31:17] Clay Finck: The whole machine worked on a single board and there were slots for plugging in printers or other devices. So Markula was totally on board with this. He became an advisor at Apple. He wrote their business plan and he served as the chief of marketing and the company chairman. He also invested 91, 000 for 26 percent of the company.

[00:31:38] Clay Finck: Markkula wasn’t even a venture capitalist. He may have been the Valley’s first, what we could call angel investor, somebody who had grown rich from the success of one startup, and then they went and recycled that wealth into other startups. What was also great about Markkula was his extensive network, which nowadays is an important part of the VC industry.

[00:32:00] Clay Finck: When you get a VC investment, you don’t just want the capital, but you also want access to an extensive network of people that can help you solve really complex problems, connect you with the right people in that network. Apple also secured another 300, 000 investment from Venrock for 10 percent of the company, valuing them at 3 million in 1979.

[00:32:22] Clay Finck: After Valentine saw the very early success of Apple, I think he was feeling a bit of FOMO and Markkula made sure to get him involved since having a top VC investor on board would help create further momentum for the company. And further expand their network to tap into as well. Apple had started as something that was a company that nobody wanted to touch.

[00:32:45] Clay Finck: And then word of mouth started to catch fire and the VC community really wanted to be a part of it. And it turned into something they sort of had to buy into simply because others were buying into it. I think the main takeaway with the early days of Apple with regards to VC is just how valuable the VC network can be to a startup.

[00:33:04] Clay Finck: Had the VC network not been available to Jobs and Wozniak, then they likely wouldn’t have been able to attract high quality talent to get them off the ground and establish a really viable business strategy. Valentine would actually sell out of Apple early. He sold a stake in 1979 for a quick 13x profit that boosted his first fund’s returns, but then he missed Apple’s next leg of growth, to the best of my knowledge.

[00:33:30] Clay Finck: One early VC investor saw his investment go up by 378 times after Apple would go public in 1980, just four years after the company was founded. And at this point, the VC industry really started to have more legs for growth overall. So in 1978, Congress cut the capital gains tax from 49 percent to 28%, increasing the incentive to invest in venture capital.

[00:33:54] Clay Finck: In 1979, the government relaxed its standards for pension funds, opening the door to invest in the VC industry. And in 1980, the capital gains tax was cut again to 20 percent when Ronald Reagan took office. These changes alongside the few big winners that the industry saw, such as Apple, it encouraged more and more money to pour into the space.

[00:34:14] Clay Finck: In the mid 1970s, the average amount of capital raised would be 42 million annually. And by 1980, the average inflows were nearly 1 billion. The book covers a few other VC deals in the years that followed, including Cisco Go, which would end up being a failed VC bet that left investors with practically nothing, and Yahoo.

[00:34:35] Clay Finck: But I wanted to jump to the story on Google. So Google was founded by Sergey Brin and Larry Page in Palo Alto in August of 1998, four years after Yahoo was founded and saw incredible levels of growth, success, and attention from venture capitalists. When Google was started, there were already 17 other firms offering internet search services, but Brin and Page were confident that they could create the best offering in the market.

[00:35:03] Clay Finck: Some investors were concerned that since there were so many players in search, it would end up being a low margin commodity business. Others believed that brand would be extremely valuable on the internet and that a search tool would simply be a plug in on the most popular websites like the Yahoo’s of the world.

[00:35:20] Clay Finck: They generated search results that were much more relevant for users since they put together a system for ranking websites based on how many other sites had linked to them. The co founders discussed with an engineer named Andy Bechtolsheim, who had success with his own startup, and he enjoyed using the wealth he built to back other founders, so he was an angel investor, so after briefly discussing the business with them, he pulled out his checkbook and just wrote a check for 100, 000.

[00:35:47] Clay Finck: They hadn’t even incorporated a company at this point, had no business plan, and had ruled out running banner ads and pop up ads on their site, which was a standard way for an internet business to make money at that time. And these types of investments were becoming more and more common at the time. So these are, of course, angel investments.

[00:36:05] Clay Finck: There were a number of entrepreneurs in Silicon Valley who had built vast amounts of wealth and they had a passion for backing other founders. So if you had 50 million from selling your startup, you probably don’t care about losing, say, 100, 000 to back these co founders that you really like. And maybe you write 20 of these checks and you really only need one to pay off to see a positive return on your investment.

[00:36:29] Clay Finck: And there can be a number of unforeseen benefits from doing this as well. So, you know, you get to be a part of these different networks, be connected with these really interesting founders. So Google would go on to raise over 1 angel investors to get them kick started. One of the seed investors Bezos. He invested 250, 000.

[00:36:50] Clay Finck: Bezos had later said that he had fallen in love with Larry and Sergey after meeting them. Now there’s some pros and cons to going into the angel investor route versus the venture capital route. With raising money from angel investors, you’re likely giving up less equity. Angel investors won’t be checking in on you each week because they’re busy with their own projects and you likely aren’t going to get access to this extensive network of people to pull from.

[00:37:17] Clay Finck: Whereas with venture capitalists, you’re probably going to give up more equity, but you also get access to the extensive network and you’re held to high standards in terms of the growth targets you need to hit and whatnot. In some ways, it’s a way for founders to force their hand and really go all in on their business because you know, they have these funds backing them and at the end of the day they need to deliver returns to their investor base.

[00:37:41] Clay Finck: Although Google didn’t participate in VC initially, the VC industry overall was really booming. So the number of VC partnerships hit 750 up from 400 a decade earlier. Inventor capital actually helped fuel the tech bubble in 1999 because venture capital just tends to be less sensitive to valuations when hot money is chasing a new industry, they tend to pay the going price in order to get their capital deployed, and they always had the concept of the power law to fall back on.

[00:38:14] Clay Finck: They may think that they’re paying a nosebleeding valuation, but if just one company still reaches scale and achieves their growth targets. Then it could still really pay off big time on the back end. I think at certain points falling back on this idea of the power law can lead to some investing just purely based on FOMO if they aren’t getting a handle on their emotions.

[00:38:36] Clay Finck: Greed starts to kick in when you see an investor like John Doerr and the success he had. So Doerr invested 8 million in Amazon in 1996 for 13 percent of the company. And by 1999, Amazon was a 20 billion company. Generally, the stock market isn’t as generous in providing lofty valuations to businesses who weren’t cashflow positive and were largely built on the back of a dream.

[00:39:00] Clay Finck: The 1999 tech bubble is the first example of the overall market ceasing to be rational with this regard. So during 1999, people had the internet to share ideas and the mainstream media would pump these narratives on TV. And the power law concept had struck the broader public. Many speculators understood that if they owned just one big winner, it would make up for the many losing tech companies in their portfolio.

[00:39:23] Clay Finck: It goes to show that even some of the best ideas in these laws of the universe can be taken too far at sometimes. So Google would go on to pitch VC investors and share their mission statement, which was we deliver the world’s information with one click. When they would eventually go public, the IPO prospectus invoked the company’s quote unquote responsibility to the world, which was to deliver free, abundant, and unbiased information.

[00:39:49] Clay Finck: At the time Google was handling half a million searches daily, John Doerr figured that if Google could muscle its way into being the top tier search firm, it could potentially reach a market valuation of 1 billion. And then Doerr had asked Page how big he thought the company could get, and he believed that they could reach 10 billion in revenue.

[00:40:11] Clay Finck: Which would imply a market cap 100 times larger than what Doerr initially assessed. Google ultimately decided to take on a venture capital named Ron Conway, primarily as a way to try and get Sequoia in the Doerr later down the line, which at the time was led by Doug Leone and Michael Moritz. When Leone heard about Google, he took a meeting with them almost immediately.

[00:40:34] Clay Finck: He saw that the Google search results were more useful than Yahoo. And at the time Yahoo was even considering using Google’s technology to power search on their website. And it’s important to keep in mind the hindsight bias here. It’s easy to say in 2025 that Google was a no brainer, but at this time you had a ton of different search companies.

[00:40:54] Clay Finck: Maybe this would end up turning into a commodity business where there’s no real moat. Things are rapidly changing with the internet and companies are constantly being disrupted and running out of capital. The idea that Google would even eclipse Yahoo and Amazon in market cap terms was by no means obvious.

[00:41:12] Clay Finck: On June 7th, 1999, Google secured VC funding from both Kleiner and Sequoia, which displayed the huge bargaining power that they had at this time over VC, given that typically one or the other of these big firms would lead the round of funding. This was nearly perfect timing to close around the funding with these two because in the year 2000, the VC window of capital infusion virtually just slammed shut.

[00:41:40] Clay Finck: John Doerr’s investment in Martha Stewart. It lost 60% of its value in the first four months of the year. His investment in at home had a market cap of 35 billion in early 1999, and in 2001, the company filed for bankruptcy, and as many in our audience likely know from peak to trough, Amazon stock fell by 93% in the public markets.

[00:42:03] Clay Finck: At the peak, in 2000 new capital commitments to VC firms hit $104 billion. And by 2002, they were down to around 9 billion. Between 2001 and early 2004, Silicon Valley lost 200, 000 jobs, which is honestly pretty mind blowing. In the meantime, the venture capitalists were essentially begging Brin and Page to bring in an outside CEO who had more professional experience.

[00:42:31] Clay Finck: It took them a while to come around to that idea, but they eventually did. Brin and Page were interested in poaching Steve Jobs, who was of course not going to leave Apple. The man they found for the job was Eric Schmidt, who had a computer science background. And Google was not an obvious choice for Schmidt, since he wasn’t really sure about the future of search.

[00:42:51] Clay Finck: The backing of Sequoia and Kleiner would ultimately give him kind of that stamp of approval and confidence to join the company that was started by two guys in their twenties who still had full control of the company. Google was also one of the early pioneers in the dual class share structure, which allowed the company to continue to raise capital in the public markets.

[00:43:11] Clay Finck: But the founder would own the class of shares with more voting power so they could still maintain full control of the voting shares in the company’s direction long term. Mallaby shared a great point in the book here regarding the short term nature of the stock market. So Brin and Page, they argued for the dual class share structure because they said that the stock market was too short sighted.

[00:43:31] Clay Finck: And it would lead to managers wanting to maximize near term profits at the expense of long term profits. Brin and Page believed that if they maintain full control, then they would ensure that the company is going to focus on maximizing the long term shareholder value. The IPO perspective stated, we will not shy away from high risk, high reward projects because of short term earnings pressure.

[00:43:55] Clay Finck: And this ties into the other best division, which is so widely known today, Google would end up going public on August 19th, 2004. The dual class share structure ended up working well for both types of shareholders, so that model would later be copied by Facebook later on. In the first three years of trading, Google’s stock would quintuple.

[00:44:14] Clay Finck: Google’s success really signaled a turning point that dot com companies could be extraordinarily successful in generating profits and creating value for shareholders. And the success of Google gave some startups a bit of a upper hand because Google went the non traditional route of not giving up control of their company, and it was still a massive success.

[00:44:35] Clay Finck: People like Paul Graham even suggested that founders should be wary of venture capitalists and be open to the idea of living on a shoestring budget in those early years. One interesting idea is that internet companies weren’t nearly as capital intensive as these other business models, or at least businesses of the past.

[00:44:52] Clay Finck: So founders could be a bit scrappier and growing a startup with that limited initial capital base and have more bargaining power when negotiating because each venture capitalist is looking for the next Google. Venture capitalists are generally incentivized to convince founders that they needed all this money so they could get more equity and put more capital to work through their fund.

[00:45:14] Clay Finck: So these founders needed to be a little bit careful that they weren’t going to be taken advantage of by these venture capitalists. The book also gets into Peter Thiel’s role in the venture capital industry. So Mallaby referred to Thiel as a Silicon Valley maverick. He had two degrees from Stanford, neither of which were engineering or business.

[00:45:34] Clay Finck: He started his career trading derivatives in New York and wanted to get out of the corporate treadmill. So he quit his trading job to head back to California and he started his own small hedge fund. Thiel would get connected with Max Levchin and together they would launch PayPal, originally known as Confinity.

[00:45:52] Clay Finck: We covered the full story of the PayPal Mafia with Jimmy Sony a couple of years ago. If you’re interested in hearing that story, you can search TIP417 on Google or your favorite podcast app, or I can get that linked in the show notes as well. Confinity would run into Elon Musk’s X. com, and the two would later merge to form what’s now known as PayPal.

[00:46:13] Clay Finck: Thiel would temporarily become the CEO of this newly formed company, and after the NASDAQ had fallen by half in February of 2001. He managed to raise 90 million in Series D funding, thinking that if the tech sector would continue to slump in the near future, then PayPal may be able to outlast their competitors who might not be able to raise money down the line, to which he was actually right.

[00:46:36] Clay Finck: In July of 2002, eBay would buy PayPal for 1. 5 billion, netting Thiel 55 million in his mid 30s. In 2005, Thiel launched the Founders Fund, which seeked to invest in founders who created companies like PayPal and promised to treat this new generation of founders with the respect that they themselves had wished for.

[00:46:57] Clay Finck: Thiel believed that founders should control their own companies. Google had previously laid out the blueprint and Mark Zuckerberg of Facebook had doubled down on that strategy. Mark Zuckerberg had showed up to a presentation with Sequoia Capital. He was wearing his pajamas and he titled his presentation, The Top 10 Reasons You Should Not Invest in Wirehog.

[00:47:18] Clay Finck: Sequoia was interested in investing, of course, in Facebook, not Wirehog, by the way. So Zuckerberg went the route of raising capital from angel investors early on, and then Thiel invested 500, 000 in August of 2004 for 10. 2 percent of the company. Now, the Founders Fund was technically a venture capital fund, and Thiel was the first venture capitalist to explicitly speak about the power law, he understood that radically unequal outcomes were common in the natural and social world.

[00:47:49] Clay Finck: For example, he has stated that the most destructive earthquakes are many times more powerful than all smaller earthquakes combined. In big cities, dwarf all small towns put together. It was therefore not just a curiosity that a single venture capital bet would dominate the entire portfolio. He also felt disdain towards the traditional VC model of getting really involved with the business and maybe even replacing the founder with an outside CEO.

[00:48:18] Clay Finck: He argued that venture capitalists should not be mentoring founders because mentoring founders is based on the belief that the tried and true methods trumped outside the box experiments. Mallaby writes here, If the power law dictated that only a handful of truly original and contrarian startups were destined to succeed, it made no sense to suppress idiosyncrasies.

[00:48:42] Clay Finck: To the contrary, venture capitalists should embrace contrarian and singular founders. The wackier, the better. Entrepreneurs who weren’t oddballs would create businesses that were simply too normal. They would come up with a sensible plan, which, being sensible, would have occurred to others. Consequently, they would find themselves in a niche that was too crowded and competitive to allow for big profits.

[00:49:07] Clay Finck: It was surely no coincidence, Thiel continued, that the best startup founders were often arrogant, misanthropic, and borderline crazy. Four of the six early PayPal employees had built bombs in high school. Elon Musk spent half the earnings from his first startup on a race car. When he crashed it with Thiel in the passenger seat, all he could do was laugh about the fact that he had failed to insure it.

[00:49:32] Clay Finck: Such extremes and eccentricities were actually good signs, Thiel concluded. Venture capitalists should celebrate misfits, not coach them into conformity, end quote. So some really interesting insights there from Thiel and Mallaby. I feel that so many of us want to naturally fit into the mold and reject the misfits to a large extent.

[00:49:54] Clay Finck: I feel that’s why so many value investors would have avoided investing in Tesla ever since their IPO. Thinking that Musk is too volatile and too unrealistic when that in itself is needed to create a trillion dollar company from scratch in the electric vehicle space or create SpaceX and launch all these rockets into space.

[00:50:14] Clay Finck: From the beginning, the Founders Fund believed that a founder should never be ejected from their company. And after 15 years of operation, they upheld that principle. Thiel stayed connected with Elon Musk after Musk was ousted from PayPal, and the Founders Fund would invest 20 million in SpaceX in July of 2008 for 4 percent of the company.

[00:50:34] Clay Finck: One decade later, SpaceX was worth 26 billion, which cemented the Founders Fund as one of the top performing venture vehicles. In 2005, Paul Graham launched Y Combinator, which would invest in very early stage companies and support them in the process. It was a vehicle to provide support to young founders, provide feedback on their projects, and offer a community for them to get to know other founders.

[00:50:58] Clay Finck: And in return, Y Combinator would get 6 percent of equity in each of these micro companies. The acceptance rate to get into Y Combinator was only 3. 5%, so there was this big scarcity value where it was really hard to get into that program. Graham believed that many people made building a startup more complicated than it needed to be.

[00:51:18] Clay Finck: He had once said, build something users love and spend less than you make. How hard is that? But Ben Horowitz viewed it differently. As outlined in his compelling memoir, The Hard Thing About Hard Things, which captured the trauma of entrepreneurship. So Graham was of course another disruptor to the conventional VC industry.

[00:51:37] Clay Finck: Mallaby also gets a bit into the luck versus skill debate for venture capital. The success of a VC firm can be very path dependent. Venture capitalists who back winning startups garner a reputation for success, and in turn the venture capitalists with a good reputation are oftentimes the ones who get the first seat at the table with the next hot startup.

[00:51:58] Clay Finck: And they can get, you know, more favorable terms than the other firms. So it’s this cycle where prestige boosts performance and performance boosts prestige. But a good reputation in itself can’t guarantee success as some firms have, of course, fallen by the wayside. Kleiner Perkins is one example. So they believed that the green energy trend was going to be bigger than the internet.

[00:52:21] Clay Finck: So they started betting on these startups starting in 2004. Things like solar power, biofuels, electric vehicles. In 2008, Kleiner doubled down, deploying a 1 billion growth fund exclusively to this sector. But green energy was really a tough field for venture investors, and just because an industry can make for a large market, doesn’t necessarily mean it will make for a profitable one.

[00:52:45] Clay Finck: Mallaby writes here, startups working on wind power, biofuels, or solar panels were capital intensive, heightening the risk of losing large sums. Projects took years to mature, depressing annual returns on the few that succeeded. To compensate for the large capital requirements and long timeframes, clean tech investors could, in theory, have invested at lower valuations and demanded additional equity.

[00:53:09] Clay Finck: Compounding this error, Doerr’s early clean tech forays focused on businesses that lacked an obvious moat. Solar and biofuel projects involved producing energy, an undifferentiated commodity whose price is wildly cyclical. And Doerr estimated the federal government’s willingness to deliver honest promises of tax or regulate carbon.

[00:53:30] Clay Finck: Kleiner’s rounds of fundraising as a result were really a mixed bag. So some investors, they lost money while others ended up okay after having invested in companies like Beyond Meat, which generated a 107X return and Enphase, which generated a 25X return. So, like with the stock market, venture capital requires a bit of luck and a bit of skill to be successful.

[00:53:53] Clay Finck: Perhaps more luck is required in the world of venture capital due to the volatile nature of the business, the volatile nature of the economy, like what we saw in the tech crash and the great recession, plus the amount of disruption that just happens in the world of startups. So much has to go right to have invested in the next Amazon or Google or Facebook.

[00:54:13] Clay Finck: After the great financial crisis, an investor named Yuri Milner would help shift the VC industry yet again and also change the landscape of public markets. Milner was an investor based in Moscow, and in 2009, he called Gideon Yu, who was the CFO of Facebook, and let him know that he wanted to invest in the company.

[00:54:34] Clay Finck: Given that Facebook was in the midst of the great financial crisis, Zuckerberg’s plans of allowing employees to cash out some of their shares had been thrown for a loop. Most VC investors believed that with Facebook at 100 million users, they were nearing their saturation point. But Milner believed that there was still much more growth to come in the United States based on the data he saw with other social media sites from other countries.

[00:54:57] Clay Finck: In other countries, social media sites were among the top three sites visited, and in the U. S., Facebook still hadn’t cracked the top five. He also saw that there were many Facebook users outside of the U. S., showing that they can monetize their platform globally. So Zuckerberg had this issue that his employees weren’t able to cash out at the valuation they would have liked, but Milner solved this issue.

[00:55:20] Clay Finck: So he agreed to invest at a valuation of 10 billion. And the US VC investors thought he was just insane. This was a ridiculously high price. They thought it was just dumb money coming in from overseas. So Milner invested 200 million for company issued primary stock. It was around 2 percent of the company.

[00:55:39] Clay Finck: And as Milner predicted, Facebook’s audience and revenues rapidly grew from there. So in the 18 months that followed, this would have been late 2010 now, Facebook was valued at 50 billion. I can’t help but think that some investors were just scarred from the tech bubble and assumed that valuations would normalize.

[00:55:59] Clay Finck: So this allowed a savvier investor like Milner to recognize the great opportunity for growth that still lied ahead for Facebook. Now, this investment by Milner was a pretty big deal because it showed that Facebook did not need to necessarily go public in order to allow employees to cash out on some of their equity.

[00:56:16] Clay Finck: This shift in the industry overall meant that great companies would be able to go public later in their life cycle, giving these VC investors more of the upside in the company’s growth. Also, staying private allowed Zuckerberg to really focus on his business. He didn’t have to worry yet about quarterly calls with Wall Street analysts, regulatory disclosures or hedge fund traders shorting his stock.

[00:56:38] Clay Finck: Now this is one reason why I personally like to shy away from tech IPOs. If a tech company is hitting the IPO market, that sort of tells me that the milliners of the world aren’t interested in investing. And given what the valuations are for many of these companies at their IPO, the risk reward trade off oftentimes doesn’t make a lot of sense to me.

[00:56:58] Clay Finck: So to give a couple of examples here, shares of Airbnb are flat since 2020, despite the company continuing to grow at a pretty good clip and generating a lot of cash. Shares of Uber were flat from 2019 through 2023, and they’ve had a solid run ever since then actually just recently, but overall the total returns have substantially lagged the broader market.

[00:57:20] Clay Finck: Around the time of the Milner investment in Facebook, Ben Horowitz and Marc Andreessen started to rise onto the VC scene. They raised 300 million in June of 2009. They implemented a bit of a dual strategy of both backing ambitious startups and what we could call growth investments of more established businesses, like what Milner did investing in Facebook.

[00:57:43] Clay Finck: Andreessen had said that Milner had had an effect on the way he invested in being more willing to invest in companies who weren’t in these really early stages of their growth. Andreessen and Horowitz bet on many companies our audience would be familiar with, including Skype, Zynga, Foursquare, Twitter, Groupon, Pinterest, and Airbnb.

[00:58:01] Clay Finck: For the fund they launched in 2009, they generated a 44 percent annual return net of fees. Three times the return of the S&P 500. This put them in the top 5 percent of funds launched in 2009. Mallaby also shares that some of Andreessen’s funding grounds did not fare as well, putting them more in the middle of the pack of the VC firms underperforming the S&P 500.

[00:58:24] Clay Finck: If we jump to the 2010s, we see continued growth of venture capital. From 2009 to 2019, the number of venture capital investors in the U. S. more than doubled, and so did the number of startups that they founded. Many venture capitalists specialize in specific industries related to tech, like artificial intelligence, biotech, cryptocurrencies, ag tech, big data, and cloud.

[00:58:47] Clay Finck: Sequoia largely led the charge in VC, as they became by far the top firm in the industry, dominating the business in both the US and China. They backed unicorns like Airbnb and WhatsApp, and they seemed to succeed at everything they touched. There’s also a lot here in the book talking about Sequoia and their investment process, but one thing I thought was interesting was that despite their tremendous success, they found that oftentimes they sold their positions too early.

[00:59:17] Clay Finck: One prominent example was the sale of YouTube to Google for 1. 6 billion dollars in 2006. As a standalone company today, YouTube would be worth around 400 billion dollars. Malibi writes here, in accepting Google’s acquisition offer, the founders had behaved precisely as behavioral experiments predict.

[00:59:37] Clay Finck: People are often willing to gamble in order to avoid a loss, but they are irrationally risk averse when it comes to reaching for upside. Examining the pattern of Sequoia’s investments, they determined that premature profit taking occurred repeatedly at the firm, despite Moritz’s earlier efforts to extend the partnership’s holding periods.

[00:59:57] Clay Finck: The behavioral literature also drew attention to another tendency that they observed. VCs suffered from confirmation bias. The practice of filtering out information that challenges a position you have taken. At Sequoia, the partners sometimes missed attractive Series B deals because they wanted to make themselves feel good.

[01:00:16] Clay Finck: They hated to admit that they had been wrong in saying no to the same startup at the Series A stage. End quote. So I think this really ties in well with public equity investing. The first step to try and overcome our biases is to recognize them. Every stock that’s been a 10 bagger was at one point a double, a triple, and then a 5x along the way.

[01:00:37] Clay Finck: And almost certainly there were investors who believed that they should take chips off the table, incur capital gains taxes, and allocate that capital elsewhere. When you’re holding onto a winning stock, this is oftentimes a mistake for most investors. Holding on to your winners enables the power law to work for you rather than against you.

[01:00:55] Clay Finck: The second mistake is the mistake of omission. You might have passed on a great company for various reasons in the past, and I think all of us have an aversion to buying a stock at 150 that we passed on last year at 100. By definition, the best companies are going to continue to hit new all time highs with the passage of time, meaning that if you want to participate in that stock, you’re going to need to overcome that bias of anchoring on the initial price we analyze for that business.

[01:01:23] Clay Finck: For me, my mistake of omission was not investing in Tesla. I briefly owned shares in Tesla years back, but sold because of valuation concerns. Had I treated the investment in Tesla more like a venture bet, then that would have paid off handsomely for me. Luckily, we don’t need to bat 100 percent to be a successful investor and hit our financial goals, so I don’t really regret having made this costly mistake.

[01:01:46] Clay Finck: I’ve been lucky enough to hold a few winners that have been multi baggers and grown to be much larger than I initially anticipated they would. Sequoia would run post mortems on their investments to learn from both the success and failures of the investments they did and did not make. They also would write up a pre parade on each investment, sharing how the company would turn out, assuming everything went to plan.

[01:02:09] Clay Finck: This gave those leading the deal permission to share their excitement about a company. Jim Goetz said, we all suffer from the desire not to be embarrassed, but we’re in the business of being embarrassed, and we need to be comfortable enough to say out loud what might be possible. End quote. I also liked this excerpt here on serendipity and it ties in well with how many public equity investors discover new ideas.

[01:02:34] Clay Finck: Sequoia’s tight team and loose experiments illuminated the enigmatic skill in venture capital. Taken individually, the story of every venture bet can seem to hinge on serendipity. Investor receives a random referral. Investor meets inspired young misfit. Investor meets to connect with youth by means of an opaque alchemy.

[01:02:54] Clay Finck: Explaining this bonding process, Yahoo’s Jerry Yang had remarked mysteriously that Michael Moritz had soul, while Tony Zingale, another Sequoia backed entrepreneur, stated that he got along with Doug Leone because he’s another fiery Italian. But despite these trivializing explanations, Sequoia illustrates the method behind the seeming arbitrariness and chance.

[01:03:19] Clay Finck: The best venture capitalists consciously create their luck. They work systematically to boost the odds that serendipity will strike repeatedly. One thing I’ve found in studying many successful people is that luck plays a major role in their lives. But they were able to help manufacture their own luck.

[01:03:37] Clay Finck: As investors, we should be open to bringing in new investment ideas from any source to allow that serendipity to strike in whatever way necessary. Mallaby shared from 2000 to 2014, Sequoia’s venture investments achieved a return of 11.5 times after netting out fees. The weighted average for venture funds was only two times.

[01:03:57] Clay Finck: So Sequoia stands head and shoulders above the vast majority of firms. Of the 155 US venture bets, over time, 20 of them generated a return of 10 x or more in a profit of at least $100 million. And none of this came easy for them. They took their success in the us, they replicated it in China, and they even decided to expand further into India and Southeast Asia.

[01:04:22] Clay Finck: It’s remarkable what they’ve done in terms of their returns, their global reach, and the billions of dollars they’ve been able to successfully deploy. And that’s not to mention all of the unicorns they helped grow that ended up touching billions of people’s lives. Jumping to the conclusion of the book here, Mallaby shares an interesting case study to help us wrap our minds around the power law.

[01:04:42] Clay Finck: A sociologist was intrigued by the idea of the power law, and why a tiny number could reap such a disproportionate majority of the spoils. So, he put together an experiment. He created a website where people could listen to songs by unknown artists, then choose which songs they’d like to download to their library.

[01:05:02] Clay Finck: Participants were randomly assigned to different virtual rooms, which really can be thought of as parallel worlds. Unsurprisingly, the participants in this study were more likely to choose songs that others had downloaded, responding to social influence. And as a result, each virtual world had its own mega hit that was significantly more popular than the rest, but in the different cohorts of people, different songs came out on top.

[01:05:28] Clay Finck: So, for example, one song named Lockdown, it came in first in one of the worlds, and then 40th out of 48 in another world, even though it was the exact same song competing against the exact same rivals. The sociologists concluded that Blockbuster hits were random. This can humble a star venture capitalist.

[01:05:48] Clay Finck: Because of the feedback effects in a power law business, some venture capitalists will dominate the sector, raising a lion’s share of the dollars, getting access to the hottest deals and generating the best returns. Meanwhile, the rest of the industry is going to struggle. It’s estimated that the median fund narrowly underperformed the broader stock market, while the top 5 percent of firms outperformed the index by a very wide margin.

[01:06:13] Clay Finck: And it might be just a few lucky breaks that can make or break the performance of a VC firm. So the main takeaway is that the power law seems to be a natural law in many fields. And by applying the power law to venture capital, we know that just a few winners will become outsized stars relative to the pack, and there’s an element of luck in who the stars are.

[01:06:34] Clay Finck: And if you listen to my episode with Hendrik Bessembinder on episode 667, you’d know that in the stock market, a small number of companies generate the vast majority of the returns, meaning that there’s really a similar element of luck at play when picking individual stocks. However, this shouldn’t take away the aspect of skill for the great venture capitalists and the great investors we interview here on the show.

[01:06:57] Clay Finck: Over multiple decades, I believe that both luck and skill play a critical role and we can’t compute exactly how much each plays a role because it’s really unquantifiable. If you’re like me and can’t help but find out if you have what it takes to be in the top 5 percent of investors, you might be interested in joining the private network that I help manage here at TIP.

[01:07:19] Clay Finck: It’s called the TIP Mastermind Community. We have a small community of around 100 private investors, portfolio managers, and high net worth individuals who are passionate about value investing and lifelong learning. We also host weekly live zoom calls to share ideas. Tune in to member presentations or tune into stock presentations as well.

[01:07:40] Clay Finck: And we’ll be getting together this year in Omaha in May during the Berkshire weekend and in New York City in October. While I love that the community helps me become a better investor, it also puts me in touch with so many high quality people because we vet each member who joins the community to ensure we keep the group high quality.

[01:07:58] Clay Finck: So if this sounds interesting to you, I would encourage you to join our waitlist to apply since we’re capping the group at 150 members. To do so, please click the link in the show notes or visit theinvestorspodcast.com/mastermind. Well, that’s all I had for today’s episode. I thoroughly enjoyed reading The Power Law and I hope you enjoyed hearing my takeaways from the book.

[01:08:19] Clay Finck: There’s a lot I really didn’t have time to get to during this episode since it’s a pretty long book, 400 pages. So to learn more, I’d encourage you to order it off Amazon, which we’ll be sure to link in the show notes as well. With that, that’s all we had for today’s episode. Thanks so much for tuning in.

[01:08:33] Clay Finck: I hope to see you here again next week.

[01:08:36] Outro: Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app, and never miss out on episodes. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.