The Secret History of Silicon Valley 11: The Rise of “Risk Capital” Part 1

This post is the latest in the “Secret History Series.”  They’ll make much more sense if you watch the video or read some of the earlier posts for context. See the Secret History bibliography for sources and supplemental reading.

This is the first of two posts about the rise of “risk capital” and how it came to be associated with what became Silicon Valley.
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Building Blocks of Entrepreneurship
By the mid 1950’s the groundwork for a culture and environment of entrepreneurship were taking shape on the east and west coasts of the United States. Stanford and MIT were building on the technology breakthroughs of World War II and graduating a generation of engineers into a consumer and cold war economy that seemed limitless. Communication between scientists, engineers and corporations were relatively open, and ideas flowed freely. There was an emerging culture of cooperation and entrepreneurial spirit.

Slide1

At Stanford, Dean of Engineering Fred Terman wanted companies outside of the university to take Stanford’s prototype microwave tubes and electronic intelligence systems and build production volumes for the military. While existing companies took some of the business, often it was a graduate student or professor who started a new company. The motivation in the mid 1950’s for these new startups was a crisis – we were in the midst of the cold war and the United States military and intelligence agencies were rearming as fast as they could.

Yet one of the most remarkable things about the boom in microwave and silicon startups occurring in the 1950’s and 60’s was that it was done without venture capital. There was none.  Funding for the companies spinning out of Stanford’s engineering department in the 1950’s benefited from the tight integration and web of relationships between Fred Terman, Stanford, the U.S. military and intelligence agencies and defense contractors.

These technology startups had no risk capital – just customers/purchase orders from government/military/intelligence agencies.

This post is about the rise of “risk capital” and how it came to be associated with what became Silicon Valley.

Risk Capital via Family Money   1940’s
During the 1930’s, the heirs to U.S. family fortunes made in the late 19th century – Rockefeller, Whitney, Bessemer –  started to dabble in personal investments in new, risky ventures. Post World War II this generation recognized that:

  1. Technology spin-offs coming out of WWII military research and development could lead to new, profitable companies
  2. Entrepreneurs attempting to commercialize these new technologies could not get funding; (commercial and investment banks didn’t fund new companies, just the expansion of existing firms,) and existing companies would buy up entrepreneurs and their ideas, not fund them
  3. There was no organized company to seek out and evaluate new venture ventures, manage investments in them and nurture their growth.

Several wealthy families in the U.S. set up companies to do just that – find and formalize investments in new and emerging industries.

  • In 1946 Jock Whitney started J.H. Whitney Company by writing a personal check for $5M and hiring Benno Schmidt as the first partner (Schmidt turned Whitney’s description of “private adventure capital” into the term “venture capital”).
Jock Whitney writes himself a check to fund J.H. Whitney Co.

Jock Whitney writes himself a check to fund J.H. Whitney Co.

  • That same year Laurance Rockefeller founded Rockefeller Brothers, Inc., with a check for $1.5 million.  (23 years later they would rename the firm Venrock.)
  • Bessemer Securities, set up to invest the Phipps family fortune (Phipps was Andrew Carnegie’s partner,)

These early family money efforts are worth noting for:

  1. They were “risk capital,” investing where others feared
  2. They invested in a wide variety of new industries – from orange juice to airplanes
  3. They almost exclusively focused on the East Coast
  4. They used family money as the source of their investment funds

East Coast Venture Capital Experiments
In 1946, George Doriot, founded what is considered the first “venture capital firm” – American Research & Development (ARD). A Harvard Business School professor and early evangelist for entrepreneurs and entrepreneurship, Doriot was the Fred Terman of the East Coast. Doroit had the right idea with ARD (funding startups out of MIT and Harvard and raising money from outsiders who weren’t part of a private family) but picked the wrong model for raising capital for his firm. ARD was a publicly traded venture capital firm (raising $3.5 Million in 1946 as a closed-end mutual fund) which meant ARD was regulated by the Securities and Exchange Commission (SEC.) For reasons too numerous to mention here, this turned out to be a very bad idea. (It would be another three decades of experimentation before the majority of venture firms organized as limited partnerships.)

The region around Boston’s Route 128 would boom in the 1950’s-70’s with technology startups, many of them funded by ARD. ARD’s most famous investment was the $70,000 they put into Digital Equipment Corporation (DEC) in 1957 for 77% of the company that was worth hundreds of millions by its 1968 IPO. It wasn’t until the rise of the semiconductor industry and a unique startup culture in Silicon Valley that entrepreneurship became associated with the West Coast.

Georges Doriot the first VC

Georges Doriot the first VC

Doriot and American Research and Development are worth noting for:

  1. Some of the very early VC’s got their venture capital education at Harvard as Doriot’s students (Arthur Rock, Peter Crisp, Charles Waite.)
  2. ARD was almost exclusively focused on the East Coast
  3. ARD proved that institutional investors, not just family money had an appetite for investing into venture capital firms.

Corporate Finance
One of the ironies in Silicon Valley is that the two companies which gave birth to its entire semiconductor industry weren’t funded by venture capital. Since neither of these startups were yet doing any business with the military—and venture capital as we know it today did not exist, they had to look elsewhere for funding. Instead, in 1956/57, Shockley Semiconductor Laboratory and Fairchild Semiconductor were both funded by corporate partners —  Shockley by Beckman Instruments, Fairchild by Fairchild Camera and Instrument.

More on the rise of SBIC’s, Limited Partnerships and the venture capital industry as we know it today in Part XII of the Secret History of Silicon Valley here.

6 Responses

  1. [...] The Secret History of Silicon Valley 11: The Rise of “Risk Capital” Part 1 « Steve Blank steveblank.com/2009/10/26/the-secret-history-of-silicon-valley-11-the-rise-of-%E2%80%9Crisk-capital%E2%80%9D-part-1 – view page – cached + The Secret History of Silicon Valley 11: The Rise of “Risk Capital” Part 1 + Ardent War Story 6: Listen more, talk less + Ardent War Story 5: The Best Marketers Are Engineers + Ardent War… (Read more)+ The Secret History of Silicon Valley 11: The Rise of “Risk Capital” Part 1 + Ardent War Story 6: Listen more, talk less + Ardent War Story 5: The Best Marketers Are Engineers + Ardent War Story 4: You Know You’re Getting Close to Your Customers When They Offer You a Job + Ardent 3: Supercomputer Porn + Fun For Hours + Ardent 2: Get Out of My Building + Ardent 1: Supercomputers Get Personal + Durant Versus Sloan – Part 1 + Unintended Lessons * Archives + October 2009 + September 2009 + August 2009 + July 2009 + June 2009 + May 2009 + April 2009 + March 2009 + February 2009 * Other Stuff + Steve Blank + Entrepreneurship o Books/Blogs for Startups + Secret History (Read less) — From the page [...]

  2. The first VC were indeed from the Boston area but they predated Doriot by more than 100 years.

    While traveling to England on vacation in 1810 Francis Cabot Lowell, who was already wealthy from his families shipping business, became fascinated by English power looms. Unable to buy any plans or models he committed the details to memory. When he returned to Boston he put together a business plan to build a water powered mill that required a $400k investment – $100k for the factory and $300k for start-up costs. He raised the money by selling stock to prominent Boston families who – seeing the benefit of the joint stock company – went on to found, railroads, banks, and insurance companies based on this new model.

    http://www.economicadventure.org/decision/lowell.pdf

  3. [...] play in the entrepreneurship ecosystem. But where did they come from? Here’s a little history lesson, courtesy of serial entrepreneur Steve [...]

  4. [...] the capital infrastructure in the valley is the key – but remember that in the beginning there was no venture capital, and the early valley prospered without it.  Stanford professors were the first angels investors. [...]

  5. [...] of innovation that Steve Blank, professor of entrepreneurship at Stanford University said in his Secret History of Silicon Valley, “Silicon Valley would still be a bunch of engineers working in their garages without a culture [...]

  6. [...] of innovation that Steve Blank, professor of entrepreneurship at Stanford University said in his Secret History of Silicon Valley, “Silicon Valley would still be a bunch of engineers working in their garages without a culture [...]

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