Venture capital plays an important role in our economy. It allows the people with ideas – some good, some bad and the rare monumental one – to try and turn them into a real business that provides a new product or service to the consumer. At its best, venture capital is the helping hand that allows a start-up to reach its full potential. At its worst, it can be a vulture, prematurely turning out unsteady companies for a quick profit. In this article, we will look at the father of venture capital, Georges Doriot, and the role that he thought it should play in the market, as well as what it's become. (Find out how VC firms make the market go round, and round, and round. Read Cashing In On The Venture Capital Cycle.)
The Making of the General
Georges Doriot was born in 1899 in France. In 1921, he left for the U.S. to study business. Doriot enrolled in Harvard and later became one of its most popular professors. It was WWII, however, that would put Doriot on the road towards founding modern venture capital.
Doriot served as a non-combatant with the American forces in an R&D role. He was responsible for finding scientific ways to improve the plight of combat troops and his work covered the production and distribution of everything from boots to rations to waterproofing uniforms. Doriot's tireless efforts resulted in him being promoted to the rank of brigadier general, and he was nicknamed "the General" thereafter – both for his wartime rank and his later strategic maneuvers in the field of business.
ARDC is Born
Doriot was chosen in 1946 to head the American Research and Development Corporation (ARDC) - the first public venture capital firm. ARDC was initially the brainchild of New England businessmen who believed that new businesses were failing due to a lack of capital and managerial experience. Doriot took over the fund and quickly made it his own.
Before ARDC, entrepreneurs either had to be self-financed or funded by wealthy private families like the Vanderbilts, Rockefellers and others. This is because banks considered start-ups very risky debtors – and they were right, as very few start-ups had the business acumen needed to turn ideas into products and services. ARDC made venture capital a public activity.
In selecting start-ups, Doriot considered the character of the entrepreneur as his primary criteria. More specifically he said, "a creative man merely has ideas; a resourceful man makes them practical." He looked for ideas that would work as businesses and gave them his personal and financial support.
In the Classroom
During this same period, Doriot was also revolutionizing the classroom. He eschewed dry case studies and often sent students to companies for real experience. Doriot's most popular class was manufacturing and it covered his entire philosophy on business and a professional life – even as far as how to choose a wife. Many of his students went on to form or head successful companies. Doriot also used his university credentials to help ARDC, as he and his associates scoured labs for astronautical and military research with commercial applications that were overlooked.
Doriot and DEC
Doriot and ARDC funded over a hundred different start-ups in technology-based industries ranging from telecommunications to healthcare. Some companies took years to turn a profit, and some never did. Doriot believed profit was a byproduct of hard work and commitment, but not the endpoint. He stuck with companies, including the losing causes, for the long-term. No better example can be found of his philosophy – and its payoff – than Digital Equipment Corporation.
In 1957, at the bequest of Doriot, ARDC invested $70,000 in two MIT engineers who founded DEC, a company that wanted to make computers smaller, cheaper and easier to use. ARDC received 70% of DEC's stock in return for the $70,000. In 1972, ARDC sold its holdings for $450 million. During those 15 years, Doriot personally coached the founders, especially Ken Olsen who eventually helmed the company alone when Harlan Anderson left. Olsen was still consulting Doriot as the General was dying of lung cancer in 1987.
Creating an Industry
ARDC funded a select number of the hundreds of start-ups courting it for funds. Doriot believed in scrutinizing every detail and then supporting a lucky few to the bitter end. Doriot's overall success encouraged other investors to enter the venture capital field using Doriot's model. Some of his competitors were people he trained through ARDC. This largely owed to the fact that Doriot was limited by the public status of ARDC. While his shareholders and the entrepreneurs made out well, he was unable to award his people with options in the companies they were building. Unable to keep the talent he attracted, Doriot saw many leave to found their own firms.
Although he had many bitter battles with the SEC over this rule, Doriot never blamed his people for leaving. In fact, he supported many of his former students and new competitors in VC, believing that more new start-ups was a good thing – as long as they were subjected to selective rigor and then properly supported. (Ace your interview by learning how to break down the most common questions asked. Refer to Top 9 Venture Capital Interview Questions.)
The General Retires
Doriot faced a big hurdle when he went to retire in 1971. He had no successor and he feared the 70% share of DEC falling into hostile hands. Unable to secure a merger, he arranged a buyout where the shares were passed on to the ARDC shareholders. ARDC became a division in a larger corporation and Doriot exited the venture capital industry he founded. He later regretted his solution to the DEC problem as he felt the larger corporate structure and impersonal management robbed the company of its flexibility.
Venture Capital Today
After Doriot, and largely due to ARDC's success, floods of capital caused new funds to spout up in VC. As the supply of money grew, the standards naturally fell and the industry moved closer to speculation. VC fund managers started thinking in terms of getting a quick profit from a stock IPO rather than building a company. This same speculative fever in venture capital was a primary cause of the dotcom bubble and ensuing crash. Doriot lamented this change back in a 1971 ARDC shareholder letter, writing, "Venture Capital seems to have shifted from a constructive, difficult task to a new method of speculation."
Venture capital has been around for centuries – America was colonized through venture capital funded expeditions – but Doriot turned it into a structured field of investment. Building on Doriot's work, VC funds gave us the technology sector and they're the driving force behind innovative companies that can't attract traditional investors. Venture capital provides an important pillar to the infrastructure of capitalism by putting capital into uncertain projects that occasionally pay off big – much in the same way entrepreneurial creative destruction prevents market stagnation. Although prone to dangerous speculative phases, there is still constructive venture capital coursing through the market. It's these constructive venture capital funds, more than the vulture funds that appear only when profits are fat, that are heir to Georges Doriot's life work. The General may be dead, but his army marches on. (Make a career out of chasing down the "next big thing". To learn more, check out Seek An Adventure In Venture Capital.)