When the Venture Capital Biz Was Just Another Risky Startup
WHY YOU SHOULD CARE
Because how often does a Frenchman known as “the General” reshape the landscape of American capitalism?
By Sean Braswell
Today in the U.S. it’s almost taken for granted that if you’ve got a good idea for a business, you’ll get funding, even if it’s just $25 from your mother on Kickstarter. The size of the U.S. venture capital (VC) market reached a staggering $33 billion in investments in 2013 — and worldwide it’s nearly $50 billion.
But it wasn’t so long ago that the VC venture itself had trouble getting backers, until a few intrepid New England intellectuals, led by a French-born Harvard professor and former Army general, launched institutional venture capital as we know it shortly after World War II — and with it thousands of new world-altering enterprises.
You could say that early colonial settlements in America like Jamestown were essentially VC-funded expeditions chartered by the British Crown. And patronage from families like the Carnegies, Medicis and Vanderbilts has certainly funded legions of entrepreneurs. But for most of history, banks and institutional investors considered startups excessively risky, and it wasn’t until 1946, with the creation of the first independent, publicly traded VC organization known as American Research and Development (ARD), that venture capital became a legitimate and structured investment option.
We cannot float along indefinitely on the enterprise and vision of preceding generations.
Ralph Flanders, former U.S. senator from Vermont
ARD, according to research by scholars David H. Hsu and Martin Kenney, was a conscious response to a postwar, post-Depression investment marketplace in which high income taxes on wealthy Americans and proliferating low-risk investment trusts (early mutual funds) had “dampened private investment in high-risk ventures” and stymied the creation of new enterprises. As Ralph Flanders, a future U.S. senator from Vermont, said at the time, “We cannot float along indefinitely on the enterprise and vision of preceding generations. … We must have a reasonably high birth rate of new undertakings.”
For its president, ARD chose Georges Frederic Doriot, the son of a Peugeot bicycle plant foreman who had earned an MBA from Harvard shortly after emigrating from France in 1921 and spent over 20 years teaching at his alma mater. During World War II, Doriot was a U.S. Army officer helping direct research and development at the Pentagon. At that time, as Spencer Ante details in his book, Creative Capital: Georges Doriot and the Birth of Venture Capital, the Army developed “dozens of innovative items … including water-repellent fabrics and shoes … insecticides, sunscreen, and plastic armor.”
The General — as Doriot, who’d risen to the rank of brigadier general, was affectionately known — considered himself more of a father figure when it came to the companies he nurtured, providing capital to “creative men with the vision of things to be done.” But he also had a discerning eye — sharpened from reading thousands of business proposals — and famously kept a stopwatch atop his desk. “Sometimes I use it,” he quipped, “to see how long it takes someone in a meeting to tell me the same thing three times.”
The challenge facing Doriot and ARD in 1946 was not only convincing institutional investors and wealthy individuals to sink their money into an unproven enterprise but also to show some sort of short-term gain lest they discredit the very notion of venture capital. “ARD realized,” as Fortune reflected in 1952, “that if it failed, or did only passably, the [VC] experiment might not be repeated.”
But by early 1947, ARD had raised more than $3.5 million, largely from institutional investors like life insurance firms and university endowments, and Doriot wanted to be sure that the new chest of “venture capital” — a term first used by DuPont in 1938 — would be deployed wisely. To maximize quick returns, ARD initially chose to fund small existing firms in the chemical and industrial equipment sectors (which Doriot knew well), rather than true startups. Over time, ARD discovered what is common knowledge today — that technology startups were its most rewarding bet — and 73 percent of ARD’s investments would be funneled to that sector.
Of the hundreds of tech companies that ARD funded, by far the most notable was the $70,000 it gave to an MIT engineer named Ken Olsen in 1960 to start Digital Equipment Corporation (DEC), a computer manufacturer that would eventually return $355 million for ARD. Like many prominent angel investors today, the General — who provided Olsen with financing and personal counseling, prized the skills and integrity of the startup’s founder above all else — commenting that “a creative man merely has ideas; a resourceful man makes them practical.”
Despite its pioneering role, however, ARD was sold off and dissolved in 1972, ultimately hobbled by its failure to retain its talent and keep up with the competing funding entities it helped spawn, including the U.S. government’s Small Business Investment Company (SBIC) program. Over its 25-year life span, ARD gave its investors an average annualized return of 15.8 percent; but if you exclude its winning bet on DEC, that figure drops to just 7.4 percent, well below the 12.8 percent return of the Dow Jones Industrial Average for that period.
But as any angel investor will attest, it’s the gold strikes that pay for the many, many misses. And by the time ARD and its persevering General cashed out, they could boast of one more successful startup: the VC industry itself.