Sebastian Mallaby’s The Power Law: Venture Capital and the Making of the New Future is a go-to book for budding and experienced investors. Shortlisted for the 2022 Financial Times Business Book of the Year and named one of The Economist’s Best Books in the same year, The Power Law quickly rose to critical success.
In the book, Mallaby highlights the strategies of some of the world’s most celebrated venture capital firms. These include Andreessen Horowitz, Accel, Sequoia, Benchmark, Kleiner Perkins, and Yuri Milner’s DST Global. Much of these firms’ investment success lies in the power law.
What Is the Power Law?
The power law refers to the extreme ratio of failure to success in a highly profitable venture capitalist’s portfolio. Mallaby explains that only a small percentage of a venture capitalist’s investments will have big returns.
Because of this, it’s essential for a venture capitalist to be comfortable with most of their investments flopping. They must keep making strategic, high-risk moves to uncover a diamond.
The Power Law in Google and Facebook Investments
The power law has played out for investors supporting some of the world’s biggest companies. One of the most famous examples is Google. In the early noughties, Google wasn’t particularly well-known in the saturated search engine market. However, venture capital firms Kleiner Perkins and Sequoia saw the potential in its unique search algorithms. Their high-risk investments paid off more than imaginable.
Another example of the power law in practice is Yuri Milner’s industry-changing investment in Facebook, which he made shortly after the youth revolt of 2005. At the time, many startups didn’t want to rely on older venture capitalists who might try to take control of their companies.
Facebook’s founder Mark Zuckerberg and former President Sean Parker were amongst those prioritising long-term visions over the short-term gains that come with venture capital.
As Mallaby explains, they “liked nothing better than to snub prestigious venture partnerships.” They even attended a meeting with prospective investors Sequoia late and wearing pyjamas, playing hard to get.
Yuri Milner’s Iconic Facebook Investment
Already an established company, Facebook wanted to raise growth capital at a valuation of around $10 billion. However, because of the 2008 financial crisis, few venture capitalists were investing.
Facebook’s CFO even left the U.S. and went to the Middle East in an attempt to raise funds, but he didn’t have any luck. However, unknown-at-the-time Milner wanted to invest. Initially, the CFO turned him down because he had never been to Silicon Valley. However, Milner booked a flight to San Francisco and asked to meet the CFO again. This time, he gave Milner a chance to make his case.
Making An Appealing Offer
Milner met the CFO in a Starbucks and proposed a starting offer of $5 billion. Intriguingly, he had already invested in an international social media platform, VKontakte, and had experienced this company’s growth first-hand.
He had also collected data from several international social media companies. He used this data to identify growth opportunities for Facebook, such as spending incentives for users.
On top of this, Milner proposed that he wouldn’t take a board seat at Facebook and that Zuckerberg could vote his shares however he pleased. This appealed to Zuckerberg’s desire for full control over the company and stood out against other prospective investors.
Furthermore, Milner offered to buy employee stock, paying one price for company-issued stock and a lower price for secondary stock that employees sold.
Ultimately, Zuckerberg couldn’t turn down the offer. Milner’s investment company DST Global bought $200 million worth of company-issued stock and received a 1.95% stake in return. The firm also purchased over $100 million worth of secondary employee stock.
With Milner’s investment and guidance, Facebook’s profits skyrocketed. Within 18 months, the company was worth $50 billion, and DST Global had profited more than $1.5 billion. It’s no surprise that many investors have emulated Milner’s investment strategy since.
After this success, the Eureka Manifesto author went on to invest in companies like Spotify, Alibaba, WhatsApp, Snapchat, JD, and Twitter (now X), generating profitable returns each time. His power law success with Facebook set him up for a highly successful investment future.
