Investing in the Intangible
Every now and then a new technology comes along and causes a step change in how society - and the economy - operate. Rockefeller knew this when he founded Standard Oil, as did Carnegie when he founded his eponymous Steel Company.
When Don Valentine left National Semiconductor to found Sequoia Capital, he was betting that integrated circuits - and the software that runs on them - would be the next such shift.
Unlike Rockefeller and Carnegie, who built their fortunes by controlling physical and finite resources, Valentine's bet was not on silicon or floppy disks loaded with software, but the intangible knowledge that led to their creation. The value was not in the chips or the code, but the skills and experience required to build and program these machines: the institutional knowledge rapidly building up amongst those with the talent, curiosity - and crucially, freedom - to explore this new world.
Sequoia could not instil talent or provoke curiosity, but it could provide freedom, and so that's what it did. In exchange for allowing fresh-faced Stanford graduates to explore their passions and create anything and everything they could dream up, Sequoia would share in the value they created.
Those early investments in Atari and Apple may be from a different era, but the investment thesis has remained largely the same ever since: that the best way to profit from developments in this intangible web of knowhow is to find talented, hard-working people with an entrepreneurial spirit, and give them the freedom to explore in exchange for some of the value they create.
Modern technology has created value in forms that were categorically impossible before, medicine being perhaps the least contentious example. The technology companies of today have also captured a lot of value by replacing the businesses that served those customers before, Amazon and bookshops being a common example.
It does not matter to the investor whether their returns come from value newly created, or simply displaced from elsewhere, and so the dollars have always flowed to where they can be best leveraged. When there are enough new foundational pieces to displace existing businesses, that is the safest bet, and that is where the dollars go. Hello Uber. When there are no businesses left to replace with the existing foundational pieces, we need new ones.
The past few decades have seen foundational pieces like lithography advance in parallel with consumer-facing businesses like e-commerce and instant messaging. Value captured at the top of the chain has been reinvested at the bottom, leading to seemingly endless cycles of exponential growth.
The cycles started by the internet, smartphones, mobile internet and cloud computing all happened in quick enough succession and with enough overlap that by the time new foundational pieces were needed, their development was already well under way. The dollars always had somewhere useful to go.
Until now. Marc Andreessen famously said in 2011 that software was “eating the world”, and now it has. Everything that can be an app on your phone, already is. Instead of displacing traditional businesses, today's startups aim to replace software companies started just a few years ago. They entice new users with the smallest sliver of incremental value, or generous and unsustainable discounts funded by deep-pocketed investors intent on being the last company standing.
The world is desperate for the next transformational building block. The hype surrounding crypto must have led to more money than ever before being invested into a technology that is still - over 10 years after its invention - searching for a use case.
It's worth stopping for a second to just let that sink in. Billions has been invested into a technology for which - despite countless dollars and person-hours spent - there is still no consensus on how, or to whom, it is useful. It is hard to imagine this happening in a world where there was still a sustainable supply of demonstrably valuable opportunities to invest in.
The newest darling of the tech world, "AI", is still too new to pass judgment on, but so far it seems to be closer - in terms of transformational power - to crypto, than smartphones or the internet. (AlphaFold and some others provide tangible - if hard to capture - value, but the dollars so far seem to be going to the generative algorithms that provide instant gratification to the masses.)
Perhaps the reason for the record levels of "dry powder" that VCs are sitting on is, in part at least, because the smart money has realized that it's time for a change in strategy. Previous generations have solved the hard problems and displaced all the businesses they could find. Giving someone smart and hard-working the freedom to go create no longer works.
Whatever the next foundational piece is, it seems likely it'll be the result of a lengthy and distributed effort. Today's LLMs are built on decades of research that happened across academia, a handful of startups, gaming-focused hardware companies, and ultimately, Big Tech. Whilst there have been pivotal discoveries and breakthroughs along the way, the problems are too complex for one person, one team, or even one company, to get the whole way there independently. This is a problem, if your investment thesis is that picking the right people and setting them free will lead to a big return.
What if it were the other way round? What if instead of subsidising the tech-focused while they take over existing businesses, we empower those existing businesses to thrive in today's tech-first world?