In the last 35 years, venture capitalists invested more than $441 billion in over 57,000 companies in the United States alone. That’s pretty impressive if you ask me—many of those investments, from Google to Starbucks and even the pacemaker, have become permanently entwined in our daily lives. But like most companies, venture capital didn’t immediately catch on. It’s been around longer than the oldest person, and though some argue this, it is here to stay.
Though the origin of the name “venture capital” has been debated, its first official use was in an Industrial Securities Committee report in 1920. It stated that “the enlistment of venture capital is necessary for the development and growth of the country, as well as for the safety of all investment securities”. My preferred story of the name’s creation is that of Benno Schmidt, who as a partner at J.H. Whitney derived the name from his common saying, “our business is the adventure”. He called it “adventure capital”, and later dropped the prefix so it would roll off the tongue more easily. That was in 1946, however, so the business isn’t generally associated with adventure outside of those who play the game.
What we now know as venture capital was around even before the ISC report, and every few years a new era in the investment was born:
Prior to 1920: A few very wealthy families (the Phipps, the Rockefellers, etc.) informally invested in new ventures. Though today they’d be categorized as angel investors, that distinction wasn’t made until long after their time.
1920-1929: As the stock market took off these families invested in the public market. As a result, venture funds declined.
1929-1931: In the dark time of newspaper shoes and starvation, wealthy individuals with money left — continued to invest, but carefully. They shunned all risky investments and instead allotted more to institutions.
1931-1946: Venture investing became scarce as a result of higher tax brackets for the rich and stricter rules doled out by the IRS. The wealthy families who invested before now shunned the practice, fearing their own financial security. As this happened, power shifted from individuals to institutions, creating “institutional investors” who were restricted to securities on state-approved lists (usually, safe bonds and preferred stock). Both categories of investors, as well as investment bankers, had inherited a natural risk aversion from the Great Depression. And as we all know, risk aversion does not a venture capitalist make.
On the entrepreneur side, this time was equally dark. They had no reason to trust investment bankers, and no one else seemed to want to let go of their dough. Even worse, in 1933 Congress raised the excess profits tax, which penalized young companies more than established ones. Those who didn’t suffer from the law had already suffered the Great Depression, so they had little bargaining power with holders of capital. Bootstrapping was a lot harder during this time for that same reason, so most entrepreneurs chose the safer route and joined larger corporations.
World War II changed a lot of this when the government decided to play the VC in the production of wartime materials. $700 million was invested in 51 synthetic rubber plants in just over two years. And to aid entrepreneurs further, the GI Bill put millions of Americans in college, educating those future business-creators while increasing funding for research many times over.
1946: Though most people believed that the US would fall back into a depression after WWII ended, three important venture organizations were started after the war was over. The organizations were J.H. Whitney and Company, Rockefeller Brothers and Company (later Venrock), and the American Research and Development Corporation (ARD). Perhaps their development during an era of hesitation was exactly what made them good for venture capital: in simply creating their companies, the partners were taking a huge, defining risk.
J.H. Whitney & Co. made some pretty good deals, particularly with the Florida Foods Corporation. That company developed an innovative method for delivering nutrition to American soldiers. That method was Minute Maid orange juice, which was sold to The Coca-Cola Company in 1960.
Rockefeller Brothers Co. had its roots in the 1930s, when Laurence S. Rockefeller pioneered early-staged financing by investing in Eastern Airlines and McDonnell Aircraft. The family’s investment interest generally stuck to that theme, investing in technical, mechanical, and energy-related fields throughout the twentieth century. And in August 1969, the VC firm Venrock was founded, beginning with an extremely lucky investment in Intel.
Non-family venture models, on the other hand, began with the American Research and Development Corp. (ARD), which was founded by Georges Doriot. Doriot, known by some as the “Father of Venture Capital”, partnered with Ralph Flanders, Merrill Griswold, and Karl Compton to encourage private sector investments in new products for the war effort. After the war, ARD gained significance as the first institutional venture capital firm that raised capital from sources other than wealthy families. It sought to bring together cash-poor entrepreneurs with great ideas and an institutional investor community that, though after some time became too risk averse.
This was only the beginning of venture capital. During the second half of the twentieth century and continuing into today, venture capital boomed as an industry and thousands of businesses gained footing as a result. We’ll look into them in next week’s post.