VC: An American History

As expected, this book tells the legendary stories of how VC firms like Greylock Partners, Kleiner Perkins, and Sequoia launched companies such as Intel, Genentech, and Google. But Nicholas also goes back to the early 1800s, beginning with the financing of whale ships. Whaling agents operated similarly to today’s VC firms. And like high-tech investing, a few big hits paid for the unprofitable ventures. From this history, Nicholas describes why VC developed as it did in America. If you are only interested in the stories, you may find the more theoretical sections slow going. But I enjoyed the insights into the nature of early-stage investing, the history of why it thrived in America, and where it might go in the future. SOME INTERESTING POINTS FROM THIS BOOK: • By the middle of the 1800s, nearly 75 percent of the 900 whaling ships in the world were American. One reason for this was that American whaling agents had figured out a way to finance risky whale oil ventures. Just as VC firms intermediate between entrepreneurs and limited partners with capital to invest, whaling agents intermediated between captains and crew with wealthy investors. The payoff of whaling was very similar to venture capital today. • Every whaling voyage had significant exposure to downside risk -- literally sinking! Most ships would only earn a small to modest profit, but a few ships would return full of barrels of oil that would compensate the investor for the other losses. • Nicholas overlays a histogram of the distribution of returns for the whaling industry during the 1800s versus the VC industry from 1981 to 2006. They are incredibly similar. • Nicholas recounts how men willing to risk their capital for higher returns used VC-like financing to build America’s first factories. A particularly good story describes the Brown family of Rhode Island who financed Samual Slater, a 21-year-old immigrant from England, who had a working knowledge of the technology to use water power to spin cotton into thread. He was, as Nicholas recognizes, what we today call a “technical co-founder.” As an interesting addition, Nicholas includes in the book the agreement between Slater and the Browns. In it, we see a thoughtful balance between the VC’s maintaining control while giving Slater, the entrepreneur, the right incentives to maximize profits. • During the 1900s, several wealthy families established investment arms to make VC-style investments. These included the families of Andrew Mellon, Henry Phipps, Laurance Rockefeller, and Jock Whitney. Laurance Rockefeller’s chief goal was to fund innovation in scientific areas he had an interest in, such as aviation (he would fund Eastern Airlines and McDonnell Aircraft). Interestingly, the pain associated with early-stage investing would nudge all of these families towards later-stage private equity investments. • The need for military innovation during World War II, followed by the GI bill, spurred America’s scientific and technological development. But the capital available for start-ups from individuals and family offices was far less than needed. Recognizing this, the New England Council in 1946 created the American Research and Development Corporation (ARD) to seek capital from the large asset owners: investment trusts and insurance companies. The returns for the first ten years were disappointing. Then in 1957 ARD invested $70,000 ($600,000 today) to fund the start-up Digital Equipment Company (DEC). By 1971 that investment was worth $355 million and DEC was Massachusetts’ largest employer. • Nicholas includes a colorful chapter that recounts how Silicon Valley became Silicon Valley and the epicenter of venture capital investing. He tells the stories of Arthur Rock (Davis & Rock), Tom Perkins (Kleiner Perkins) and Don Valentine (Sequoia Capital). Through the founding of Intel, Apple, Genentech and other companies we see the principles that made these funds successful. Rock emphasized the quality of management. Perkins looked for good technology. And Valentine stressed the need for big market demand. I liked how Nicholas refers to the investing principles these VC firms wrote down at their founding. • Venture capital took off with the rise of the personal computer during the 1980s. And by the year 2000, there were more than ten times more VC firms than there had been in the mid-1980s. Investors couldn’t help but notice how Netscape rose 100% from its IPO price on the first day of trading. But later came Pets.com, which dropped from over a $300 million valuation to $0 in less than a year. When the bubble burst, VC firms received blame for financing and bringing to market bad companies. But the asset class was far from done. • This is a history book, so Nicholas doesn’t do much analysis of the last ten years. He knows we need more distance to form an objective view of recent times. • A good quote on why VC investing is hard: Chuck Newhall said about an investment in a West Virginia equipment maker: “I lost 25 percent of my life for five years and I wasted months in exhausting, useless travel.” In the end, Nicholas reminds us that early VC leaders like Georges Doriot, Jock Whitney and Laurance Rockefeller had larger goals than making money: they wanted to build new companies that would grow America’s economy and advance technology and science. In the long-tail, their plan paid off.

If you want to read a book on VC (as in Viet Cong), look elsewhere. But if you want to read a terrific book on VC (as in Venture Capital), then this is for you. Nicholas is an Oxford educated economic historian who teaches at Harvard Business School. Writing in accessible prose but never abandoning scholarly rigor, Nicholas begins with wonderfully informative and often surprising chapters on whaling and textiles in 19th century New England. He covers the 20th century extensively, tracking the eventual emergence of familiar patterns--the importance of Silicon Valley; the use of limited partnerships; reliance of funding from sources such as sovereign funds and the endowments of non-profit institutions; the focus on specific high-tech sectors; and the promise of huge rewards from a very small percentage of investments placed. He makes clear the importance of the federal government's policies and supports even as he makes clear the social value of entrepreneurship. The tables alone are worth the price of admission. Daniel Horowitz, posing as Helen L. Horowitz

The nature of venture capital investing has changed over the decades but the willingness to engage in broad based long tail investing seems to be a more US category of investment which can be found in the countries earliest days. Tom Nicholas writes about venture capital in its various forms with a focus on the case studies of the 20th century but is careful to include the similarities of modern venture capital to speculative investments of earlier days in the United States. This is an informative book that takes the reader through how mechanisms for alignment of interest were formed and how legal structures were created to allow for the venture capital industry to thrive financially and be impactful in the US. The author starts out with a discussion of the whaling industry and its similarity to conceptual VC investing. In particular the author goes through how the whaling industry return statistics displayed long tail characteristics in which there were few, but some expeditions which returned large multiples of their invested capital. The author discusses how equity was split between the crew and the sponsor's how relationships mattered and how the investors diversified their shares in a variety of whaling expeditions. The author discussed the cyclicality of the industry to some extent and the amount of money in modern terms that was swirling around in the whaling business, which was substantial. There were distinct overlaps in distribution of returns for early whaling ventures as well as modern VC investing so the way the equity was structured give good perspective on how people were trying to solve alignment of interest issues from earlier times and how the solutions were broadly similar to today. The author moves into the more modern world when industrial capitalists started to consider how to more systematically invest in very early stage investments. Concepts of social purpose were part of how philanthropy approached venture capital but the most significant advancement was the GP/LP structure that has served as the foundation of modern venture capital investing. The authors discuss the challenges faced by closed end funds and how the timing of investments and cycle of them did not bear itself as well for mutual fund type structuring of VC. The development of the GP/LP structure served as a solution with the capital draw and disbursement mechanism. The author discusses the track records of VC pioneers and some of the early home runs that drove future ambitions. It is interesting to note though that compared to public market returns for many decades of the 20th century VC industry lagged only to catch up abruptly when one event in the long tail distribution was added to the VC returns. The rest of the book goes through the success of VC in California as it tied up to the biotech space and more substantially the semiconductor space. Generally the home runs came from technology and certain VC investments earned over 1000x. The glory years of VC are gone over as well as the main partnerships which drove the industry. Its definitely quite entertaining and there were a variety of personalities and strategies which performed exceptionally. The author discusses the overlap between government and private industry as well as the rotating door of Stanford and the entrepreneurs looking for VC capital. The author argues that the VC industry provided a fertile ground to fund progressive concepts and such a system is non-standard and required a combination of structured financial capital, entrepreneurial spirit and government conducive environment. The author ends up by discussing the internet bubble and the extraordinary gains achieved through that period as well as an increase in notoriety as VC funds were on the selling side of a deceived public in many instances. The author also highlights the relative returns vs public equity markets to remind the reader of the opportunity cost through the periods as well as the weak returns after the bubble burst. VC is an interesting history of long tail investing in the US. It discusses the incentive mechanisms used to align the various parties contributing different things to form the investments. It discusses the distribution of returns and the comparison to public markets, it discusses the uniqueness of American development of the space when it came to the 20th century. So all in all one can get a good picture of both history and the modern environment for venture capital. It is easy to read and interesting, though there are limits to how interesting this subject matter can really be made!

Brilliant read giving a brief insight to an ever evolving space