A US 100 dollar bill is seen on December 17, 2009.

LONDON, Jan 21 (Reuters Breakingviews) – What is good for venture capitalists is not necessarily good for venture capitalists. It’s a message from “The Law of Power: Venture Capital and the Art of Disruption”, Sebastian Mallaby’s absorbing new story of startup investing. Successful early tech backers invited imitators, commodifying capital and empowering the founders of Cocksure. Even though the $1.8 trillion industry is breaking fundraising and transaction records, its influence on companies may have peaked.

Mallaby traces the origins of venture capital to the late 1950s, when financier Arthur Rock helped eight frustrated engineers break away from their wayward boss to found Fairchild Semiconductor. The investment terms would make modern VCs drool: in exchange for $1.4 million, backers retained an option to buy the entire company for $3 million. In 1959, the transistor designer’s net income was $2 million, meaning the backer could take it back at a multiple of just 1.5 times earnings. At the time, IBM shares (IBM.N) were trading at a price-earnings ratio of 50.

Unsurprisingly, the model caught on. But startup funding has remained scarce enough that VCs have the upper hand in negotiations with entrepreneurs. It seemed right. After all, while traditional investors like Warren Buffett advocated buying stocks at a discount to a company’s book value, VCs offered money to unprofitable companies that had no equity. tangible assets – “finance without finance”, as Mallaby puts it. Most of these bets would fail. But a home run like Fairchild or rival chipmaker Intel would more than make up for the losses.

So pioneers like Don Valentine of Sequoia Capital and Tom Perkins of Kleiner Perkins sometimes wielded more influence than the entrepreneurs they backed. In 1976, Valentine pushed the Atari founder to sell the computer game group, tripling Sequoia’s money and securing a vital first win for the fledgling fund.

Perkins, which entered into a partnership with one of the first Fairchild detachables, was even more active. At Genentech, he pushed management to outsource research rather than do everything in-house. Perkins would drive to the biotech group’s office in his Ferrari to ship orders and announce product lead times. “Don’t come back until you’ve done some insulin,” he told a researcher after inviting him to dinner at his hilltop mansion. In 1980 Genentech went public and Kleiner Perkins got its money back 200x.

Mallaby presents these examples as evidence for one of his main points: venture capital investing is primarily a matter of skill rather than luck. It’s controversial. After all, the Genentech scientist may have “got some insulin” regardless of Perkins’ intervention. Atari might have been worth more if it had waited longer to sell. Startup investors these days often admit that their best investments just happened to be in the right place at the right time, while pointing to evidence that suggests inexperienced founders benefit from their advice.

Mallaby touts the ways Sequoia, Accel, Benchmark and others make their own fortunes by cultivating broad networks and hiring partners with deep technical expertise. He spends less time on the graveyard of companies that have tried the same approach but haven’t discovered a lottery-winning startup like Airbnb (ABNB.O) or Stripe. One University study finds that success breeds success, suggesting that established venture capitalists have better access to attractive deals, increasing their chances of landing a home run. Does this mean that legendary venture capitalists profit from the hard work and inventiveness of entrepreneurs?

In the 1990s and early 2000s, founders were asking similar questions. Paul Graham, who founded e-commerce facilitator Viaweb and later created the Y Combinator investor and boot camp, has released his Unified Suction Theory VC. Meanwhile, the capital that has flowed into Silicon Valley in search of wealth on the internet has shifted the balance of power. Google’s Sergey Brin and Larry Page initially raised funds from wealthy technologists rather than VCs. In 1999, they dictated their terms to Sequoia and Kleiner Perkins, each offering them 12.5% ​​of the search engine in exchange for $12 million. “I’ve never paid more money for such a small stake in a startup,” said John Doerr of Kleiner Perkins.

It was just one example of an inexorable power shift. In the 1960s, Fairchild backer Rock expected 45% of any startup he funded and sometimes chaired the board. Standard venture capital ownership fell to one-third in the 1970s and 1980s. Google’s Brin and Page divested a quarter of the company in 1999, while Accel got only an eighth of Facebook in 2005, after founder Mark Zuckerberg insulted Sequoia by arriving late to a meeting in pajama bottoms. Single-digit percentages are now common. Late-stage megafunds like Tiger Global are writing huge checks without expecting a seat on the board.

The wall of money has transformed VCs from activist investors into cheerleaders. One of Uber Technologies’ (UBER.N) early backers has shaved the ridesharing company’s logo out of his hair. Such obsequiousness can help seal deals, but also empowers self-assured entrepreneurs to use high-voting stock to entrench themselves. Benchmark’s Bill Gurley has pretty much ousted Uber’s indomitable founder Travis Kalanick. by WeWork Adam Neumann is the ultimate cautionary tale. In short, the story of Mallaby shows that the cult of the founder is above all a consequence of the transformation of capital into a commodity.

The continued influx of venture capital would therefore suggest that the power of the founders will only increase further. That might not be a bad thing if entrepreneurs were the ones creating value all along. But if Mallaby is right, and investor interventions were integral to building Silicon Valley’s big companies, their waning influence suggests trouble ahead.

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(The author is a Reuters Breakingviews columnist. The views expressed are his own.)

BACKGROUND NEWS

– “The Power Law: Venture Capital and the Art of Disruption” by Sebastian Mallaby will be published by Allen Lane, an imprint of Penguin Books, on January 25.

Editing by Peter Thal Larsen and Karen Kwok. Graphic design by Vincent Flasseur.