Follow The Money

1. How Venture Capital Works

Most founders never deal with VCs at all — early money comes from savings, friends, family, and angels. But once a company needs serious capital, you must understand how the people writing big checks think. Professionally pooled venture funds are a surprisingly recent invention, dating to the late 1940s; before that, wealthy individuals and families backed new ventures directly. The Sand Hill Road ecosystem took shape in the late 1960s with pioneers like Sequoia, Kleiner Perkins, and Mayfield.

• Limited partners (LPs) supply the capital; the VC invests it in startups over a multi-year fund life and returns most of the profits to the LPs.
• Fees follow the 2-and-20 rule: a 2% annual management fee on fund size (a $200m fund throws off $4m a year to run the firm) plus 20% of the gains — the carry — which is where VCs really get paid.
• Returns trace a J curve: fees and early failures drag the fund underwater at first; the whole game is whether and when it climbs back above break-even.

2. The Power Law of Returns

The naive model sorts investments into tidy buckets — failures return nothing, the mediocre roughly break even, winners return 3–10x — with results spread comfortably across the portfolio. Reality is radically skewed: venture outcomes follow a power law, the financial cousin of the compound interest Einstein reportedly called the most powerful force in the universe.

In Founders Fund's 2005 fund, the best investment was worth about as much as every other investment combined; the second-best was worth about as much as everything from third place down — and the pattern kept repeating. PayPal's $1.5bn sale to eBay made early investors with large stakes roughly a fund's worth of money, which merely meant breaking even, since the rest of the portfolio underperformed. Series B investors did well on PayPal itself and still lost money at the fund level.

To a first approximation, a VC portfolio will only make money if your best company investment ends up being worth more than your whole fund.

3. Thinking in Exponents

Two consequences follow for investors. First, the only question that matters before writing a check: is there a plausible scenario where this stake becomes worth the entire fund? Second, a 100-company portfolio signals sloppy thinking — a disciplined fund holds 7 or 8 companies it genuinely believes can return 10x, rather than a drawer of lottery tickets. The difficulty is that human experience is linear; we systematically underestimate what exponential growth does.

Founders Fund backtested a simple rule: always exercise full pro rata rights in up rounds led by smart VCs, and never add money in flat or down rounds. It worked remarkably well — because most VCs do not truly believe in the power law, prices for exponentially growing companies feel too steep and stay too low. Flat rounds, priced by investors hoping for 2x, usually mask real deterioration. And a single down round tends to be disastrous, mostly because it poisons relationships among everyone involved.

• Joining or starting a startup puts all your eggs in one basket, so the shape of the distribution you are stepping into matters enormously.
• A post office job has a flat distribution — what you see is what you get; a tech startup's outcomes are violently skewed.
• When weighing an equity offer, where the company sits on the curve can matter more than the percentage: the 100th employee at Google did far better than the average venture-backed CEO of the decade.
• Thiel rejects the objection that it is all a lottery — the power law is real, not random, a claim he defers to a later class.

4. The View from Sand Hill Road

The second half of class is a conversation with Paul Graham (Y Combinator) and Roelof Botha (Sequoia Capital). Thiel opens with a twist: most VCs do not actually make money. Botha blames the 1990s — spectacular returns pulled in blind capital until the industry was overfunded. Graham's advice to founders: VCs are neither evil nor corrupt, and your best protection is competition among them. In practice you tend to end up with two interested investors or none, because many VCs wait and imitate one another.

• Capital is a commodity: Botha argues no firm earns Sequoia-level returns just by cutting checks — the differentiators are network, counsel, and discipline, including tight 3–5 page research memos; a company that cannot be described succinctly probably has nothing there.
• The power law runs inside companies too: one revenue stream almost always dominates, so a pitch promising streams A through E frightens investors — LinkedIn's three balanced streams is the exception that proves the rule.
• Scale arrives faster than ever: PayPal grew up with roughly 300 million internet users; with 2 billion users plus mobile and cloud, an entrepreneur's possible impact is qualitatively larger.
• Graham sees the whole world drifting into a power-law shape as people leave uniform big-company career tracks and split toward the extremes.

Thiel recalls PayPal's best up round: a 5x jump in valuation within months, sellable only as a story about the future. Without a specific future to point to, people anchor on the past and balk at the new price.

The real value is always in the future.

5. Founders, Money, and Motivation

1. 1

   Bootstrap or raise?

   VC money lets you borrow against future growth and move fast, and backing from a top firm opens doors and helps hiring. If speed does not matter, reconsider — but in a winner-take-all market, Thiel says trading a quarter of the company for a shot at owning the industry is a good deal.

2. 2

   Founders over ideas

   Graham funds relentlessly resourceful people; the idea mainly shows how the founders think. It is fine to be lame in many ways as long as you are not lame in the important ones — Apple's founders dressed terribly but understood microprocessors.

3. 3

   Hedgehog beats fox

   Borrowing from Isaiah Berlin's essay: the fox knows many little things, the hedgehog one big thing. Thiel says in business, forced to choose, be the hedgehog — while still picking up little things along the way.

4. 4

   Failure and second acts

   Failed founders can raise again — Max Levchin stumbled twice before PayPal, and Silicon Valley stigmatizes failure far less than, say, France. But do not take failure lightly: it still carries real cost, and why you failed matters.

5. 5

   How many founders?

   One can work (Drew Houston applied solo), two equal co-founders works very well, four is too many. In a power-law world the right co-founder tends to more than double the outcome, so giving up half the company is usually worth it.

One thread runs through the panel: Botha walks away the moment he senses a founder angling for a quick flip. Great companies start from problems that genuinely frustrate their founders — Google grew out of irritation with AltaVista — and the people who build them are usually reluctant to sell, never for lack of offers.

People who are heavily motivated by money are never the ones who make the most money in the power law world.

Then vs. now (2026)

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