In our last post, you learned about pre-WWII “venture capitalism”, which bears only a slight resemblance to the practice today. After the war, the US went through a few changes that created the perfect environment for the business to flourish into what we now know.
1958: Venture Capitalism might not exist if not for the Small Business Investment Act of 1958, yet few have heard of it. The Act addressed crucial concerns raised by the Federal Reserve that long-term funding for growth-oriented businesses wouldn’t be available without changes to existing laws. With these changes, the government provided venture capital firms access to federal funds, allowing them to compete with wealthy families looking to buy, not invest in, other companies. Though there was success in that strategy, the greatest gain from the Act was the pool of professional private equity investors that the program developed. Some say that it wasn’t the government’s care for small businesses but its longing to compete with Soviet Union technologies that led to this bill’s passing, but it was undoubtedly necessary for venture capitalism to evolve.
1959 – 1971: Venture capitalism underwent three specific changes in the 1960s that brought it closer to what it is today. Though it wasn’t yet as yearned-for a profession as it is now, those whom it appealed to shaped its structure and strategy forever.
With the Act in place, government-funded venture capital firms focused their investments on the fields of electronics, medicine, and data-processing technology. But they weren’t the only firms that developed after the Act lifted former restrictions. Corporate firms took to the practice as well, focusing on strategy over specificity. There was no pattern in the industries that gathered corporate investments—at the time, investors were more interested in the state of the company itself. Notable financiers like Jerome Kohlberg Jr. and his protégé Henry Kravis began a series of “bootstrap” investments (the investment term means something much different now) and targeted family-owned businesses that were facing post-war succession issues. These companies lacked a viable exit for their founders yet were too small to be taken public, making them easy targets. Through this strategy the men were successful, acquiring companies like Orkin Exterminating Company, Cobblers Industries, and Eagle Motors.
Also in the 1960s, the common structure of private equity firms came into being. These firms organized limited partnerships, though they weren’t a new concept for businesses elsewhere. Limited partnerships had been around under different names since the 10th-century in Italy (where they were used for financing maritime trade). The idea had made it to the United States in the 19th century, but was unpopular because of the restrictions that the SBI Act demolished. Now it grew, and soon most private equity firms separated investment professionals (general partners) and investors (the limited partners) in responsibility and consequently payout.
Thirdly, the decade brought an increase in leveraged buyouts. The trend of preferred stock, though popularized by Warren Buffett and Victor Posner, was actually pioneered by Malcom McLean. In 1955 his company, McLean industries, bought both the Pan-Atlantic Steamship Company and the Waterman Steamship Corporation. Under the terms of transactions, McLean raised $7 million in preferred stock alongside traditional fundraising. When the deal closed, he gave $20 million of Waterman cash and assets to retire $20 million of his loan debt. Then, the newly elected board of Waterman paid an immediate dividend of $25 million to McLean. So though Victor Posner is credited with creating the term, “leveraged buyout”, he wasn’t its pioneer. It was adapted over time by Buffett, Posner, and many others, evolving closer to the practices of later public equity firms.
1972 – 1981: Until 1972, only a few well-known venture capital companies called the West Coast their home. Before, the East Coast was the place to be—that was, after all, where the money was. But in 1972, two independent investment firms emerged on Sand Hill Road—Kleiner, Perkins, Caufield & Byers and Sequoia Capital. Because of their convenient location in Menlo Park, California, these firms were right in the middle of the burgeoning technology industries in the area. Early computer and semiconductor companies attracted their interest, as well as those of aspiring venture capitalists who were moving into the area. Together with their aspirations they formed the National Venture Capital Association, which was meant to serve as a trade group for the venture capital industry. All was looking up for these companies staring down the road of what would soon be called the Silicon Valley.
Because of a stock market crash in 1974, most progress in venture capitalism slowed down until 1978, when venture capitalists everywhere rejoiced at the industry’s first major fundraising year (which was around $750 million). With this boom came an increase in the number of venture firms, including many notable companies that are still around today.
Post-1981: With venture capitalists bordering the Silicon Valley and more firms blossoming around the country, venture capitalism grew into a thriving industry. Through thick and thin, passionate VCs have made their mark on the business of entrepreneurship, catalyzing promising companies to their peak performances.
Some say that the industry of venture capitalism is a dying one, but I disagree. It might be far newer than entrepreneurship but in an era when the world is flat, the growth it allows is irreplaceable.