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CHAPTER FOUR

In Silicon Valley Your Failures Are Your Credit

I believe so strongly in people that I think talking to the individual is much more important than finding out too much about what they want to do.

—Venture capitalist Arthur Rock

FOR SEVERAL YEARS, FailCon was a popular annual event in San Francisco. Attendees were technologists who would get together to talk—you guessed it—about their stupendous failures.

While Hollywood film directors run as fast as they can from their mistakes—Alan Smithee is the pseudonym directors use to erase their participation in the truly lousy—in Silicon Valley a failed start-up amounts to a badge of honor. Indeed, the frequency of company-crushing errors led to the discontinuation of FailCon in 2014. The confab was cancelled not because it was hurting the ability of technologists to attract venture funding but because, as FailCon founder Cassandra Phillipps observed, discussion of one’s mistakes in the tech sector is superfluous. As she stated in a 2014 interview: “It’s in the lexicon that you’re going to fail.”¹

All of this raises a fairly basic question: Why do box-office disasters in the film industry place those attached to them in credit purgatory, while technologists proudly tout their errors to colleagues and potential investors? More specifically, why does the proverbial credit window shut so quickly for money-losing directors yet remain open for entrepreneurs who preside over imploding start-ups? At a first glance, the obvious answer is that Silicon Valley start-ups generally don’t have $85-million budgets to lose. Assuming Town & Country had cost $10 million, it’s fair to say that Warren Beatty’s reputation in the eyes of film financiers wouldn’t have suffered so much.

Second, and of much greater importance, tech has a higher upside than film does. The number of movies that can claim box-office receipts of more than $1 billion can generally be counted on one hand in a very good year. By contrast, companies valued at $1 billion or more are increasingly the norm in Silicon Valley.

The term used to refer to these billion-dollar companies is “unicorn.” As of August 2015, there were 124 unicorns in Silicon Valley.² When the potential for outsize returns is grand, credit sources are more adventurous and more forgiving of past mistakes.

Despite technology’s upside, which makes it a credit lure, let’s not totally delude ourselves. Credit in Silicon Valley is very expensive. We know this because we’re aware of all the rich venture capitalists who grew that way by virtue of putting money behind eventual tech behemoths, along with employees who have attained wealth that can be measured in the tens of millions thanks to stock options. What this tells us is that to attain credit to grow, tech entrepreneurs must give up not insignificant ownership stakes in their companies for the privilege.

Beyond that, the nature of entrepreneurialism must be taken into account. The great Austrian economist Joseph Schumpeter aptly described the entrepreneur as the individual whose work “consists precisely in breaking up old, and creating new, tradition.”³ In a world of consumers who are frequently resistant to change, the entrepreneur intends to offer the consumer or business a product or service they didn’t know they wanted. That is no easy feat.

Schumpeter further described entrepreneurialism as the “opening of a new market, that is a market into which the particular branch of manufacturer of the country in question has not previously entered.”⁴ Entrepreneurs are doing something entirely new, something that has never been tested by the markets before. By that very description, such ventures are most often going to end in failure.

Billionaire venture capitalist Peter Thiel earned his initial fortune as a cofounder of PayPal. However, his most famous investment success to this day was the $500,000 he invested in Facebook in 2004.⁵ His PayPal wealth meant that he had money to lose, and odds were the then largely unknown social network would not succeed. That his stake would eventually be measured in the billions is all the evidence we need to prove that he risked losing his entire investment. If investors had viewed Facebook as a sure thing back in 2004, Thiel’s $500,000 would have bought him a much smaller portion of the company’s shares. In such a scenario, founder Mark Zuckerberg could have declined to accept Thiel’s money in the first place.

Importantly, Thiel is willing to lose on investments. As he explained in his 2014 book Zero to One, “Most venture-backed companies don’t IPO or get acquired; most fail, usually soon after they start.”⁶ Venture capital firms allocate credit to a variety of different entrepreneurial concepts well aware that most will wind up defunct. It’s the rare Facebook-style success that investors are constantly seeking. As evidenced by the billions of credit coursing around Silicon Valley in pursuit of innovation, one big score can paper over a lot of investment mistakes.

Such is the culture of the technology world, and it’s long-standing. Thomas Edison, one of the original innovators, famously quipped, “If I find 10,000 ways something won’t work, I haven’t failed. I am not discouraged, because every wrong attempt discarded is just one more step forward.”⁷ Edison’s definition of success was how many experiments he could fit into a twenty-four-hour period. His success was all about a frenzied pursuit of knowledge through experimentation; failure was frequently the source of knowledge that would eventually bring success. Importantly, Edison’s tinkering with seemingly everything set him up for eventual global renown as an inventor. From his mistakes he learned a great deal, at which point his knowledge was matched with capital in the form of banking magnate J. P. Morgan.

It’s not uncommon among elite thinkers to disdain inherited wealth. However, such a point of view is shortsighted when we consider what it means for the beneficiaries of it. Wealth, in a sense, is freedom. Some obviously abuse it, just as those who inherit nothing frequently waste their natural talents. But in Morgan’s case, the fact that he had a rich father, Junius Spencer Morgan, meant that J. P. Morgan, like Thiel in 2004, had money to lose.

This truth should not be minimized. While there’s nothing wrong with investing that’s focused on wealth preservation or achieving predictable returns, major entrepreneurial advances don’t often emerge from defensive investing. Big advances that truly expand the amount of economic resources in a society (as always, credit) are, as George Gilder puts it, the result of “surprise.”⁸

Edison’s innovations that led to the electric light bulb and a company that thrives to this day (General Electric) were the definition of surprise. Indeed, Junius Morgan, a keen allocator of capital himself, advised his son against tangling with Edison. As Thomas Kessner wrote in his 2004 book Capital City, Junius “wanted to have nothing to do with the eccentric inventor and his bulb experiments.”⁹ Thankfully, J. P. Morgan was wholly enthralled by the idea of electric light, and his backing of Edison has had a profound economic impact.

It’s important to note that there was credit in the economy that was controlled by patient investors like J. P. Morgan. He was willing to lose a great deal on a daring entrepreneurial idea long before Silicon Valley came into existence. Even better, Morgan bet on an individual who didn’t hide from his numerous dry holes.

In modern times, Edison is most often compared to the late Steve Jobs. Most readers know Jobs as the person who not only founded Apple Computer but who, upon his return to Apple in 1997, oversaw the creation of jaw-dropping innovations such as the iMac, iPod, iPhone, and iPad.

What often goes unappreciated is that Jobs, like Edison, experienced plenty of failure on the way to success. When Jobs stepped down in 2011 as CEO of Apple in order to fight an unsuccessful battle against cancer, Nick Schulz penned a brilliant article, “Steve Jobs: America’s Greatest Failure.” Schulz wrote:

Jobs was the architect of Lisa, introduced in the early 1980s. You remember Lisa, don’t you? Of course you don’t. But this computer—which cost tens of millions of dollars to develop—was another epic fail. Shortly after Lisa, Apple had a success with its Macintosh computer. But Jobs was out of a job by then, having been tossed aside thanks to the Lisa fiasco.

Jobs went on to found NeXT Computer, which was a big nothing-burger of a company. Its greatest success was that it was purchased by Apple—paving the way for the serial failure Jobs to return to his natural home. Jobs’s greatest successes were to come later—iPod, iTunes, iPhone, iPad, and more.¹⁰

When Jobs returned to Apple the former Silicon Valley highflyer was hurtling toward bankruptcy. Thankfully, Bill Gates, the founder of Microsoft, had money to lose, and he invested $150 million with Jobs and Apple despite the former’s string of losses and the latter’s apparent troubles.¹¹ Thus a great company was reborn; interest rates manipulated by economists in Washington were clearly not much of a factor in Gates’ decision. For the talented in technology, credit is often available.

So while stumbles in the technology sector don’t send those who commit the errors straight to credit hell, it’s worth noting that success is a capital magnet, too. The investors in possession of credit don’t grow rich by virtue of making a habit of searching for those prone to mistakes.

Richard Noyce and Gordon Moore were Silicon Valley pioneers from the earliest days. In a preview of the “cheap revolution” that personifies the technology sector to this day, they and their cofounders at Fairchild Semiconductor sold microchips to early adapters for less than they cost the company to make them.¹² The idea was to give their customers an incentive to incorporate Fairchild’s “chips” into their products. That the founders of Fairchild grew rich validated their strategy.

By 1968, they were ready to try something new. When Noyce and Moore approached venture capitalist Arthur Rock (the original investor in Apple Computer¹³), Rock immediately asked, “What took you so long?”¹⁴ Given Noyce and Moore’s sterling track record, Rock couldn’t wait to invest with these two visionaries in what became Intel. Rock was so confident in them that, according Walter Isaacson, author of The Innovators, “He barely asked what they were going to make.” As Rock later explained, “It was the only investment that I’ve ever made that I was 100 percent sure would succeed.”¹⁵

Success is a magnet for credit, interest rates be damned. While it’s true that the credit constantly migrating to Silicon Valley is of the most courageous kind, truly easy credit is always attainable for those who have already earned their investors a return.

Thinking about all of this in terms of the Fed and its various attempts to fine-tune access to the economy’s resources, its movement of the fed funds rate up or down twenty-five basis points is of little consequence. The logical response is that potential returns shrink as the cost of credit rises. But as the story of Silicon Valley investing makes plain, most companies that attract capital still implode. It’s already accepted by these intrepid investors that the majority of the time they’ll get nothing back for the credit they offer. The few investments that succeed do so at levels that make prior losses easily digestible.

The Fed’s machinations are ultimately irrelevant to a sector of the economy that, as Tim Harford wrote in Adapt: Why Success Always Starts with Failure (2011), “has been built on failure after failure after failure.”¹⁶ So, while the Fed’s activity certainly negatively affects the monument to wealth and credit creation that is Silicon Valley, it doesn’t in the way that most would presume.