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Venture Capital’s Early Pioneers

From its initial days in the late 1950s to the early 1970s, venture capital was managed by a handful of industry barons with the cash to be the first movers.

From its initial days in the late 1950s to the early 1970s, venture capital was a cottage industry. It consisted of a handful of family-run venture funds, small business investment companies managed and operated by financial institutions, and small informal investment groups based primarily in San Francisco and Boston.

The family funds, such as J.H. Whitney & Co., Venrock and Bessemer Ventures, were the creation of the Whitneys, Rockefellers and Mellons, investors who had benefited from industrial change and believed that new, evolving technologies offered the greatest business potential and entrepreneurial opportunities. They had the cash and were willing to be the first movers. As early as the 1930s, Laurance Rockefeller, a navy pilot, invested in a St. Louis aircraft company because he felt sure that planes were the railroads of the future. The company, McDonnell Aircraft, later merged with Douglas Aircraft to become McDonnell Douglas Corp. Today the company is part of Boeing Co., the largest aircraft manufacturer in the world.

The SBICs were the product of government policy. At the height of the cold war, the Eisenhower administration worried that the Soviets were gaining in technology innovation and the space race. In response the U.S. government created a venture capital program in which the government would loan investment funds up to two dollars for every dollar of private equity they raised. The SBIC program had the desired impact. With banks such as Bank of America Corp., Citicorp and Wells Fargo & Co. forming SBICs, a slew of major companies received financing, most notably Federal Express Corp., Intel Corp. and MCI Communications Corp.

Young engineers and finance professionals drove the early wave of informal venture investing. Reid Dennis, who launched Institutional Venture Partners in 1974 with $18 million in capital, recalls the formation of “the Group,” a collection of wealthy San Francisco individuals who would meet whenever any of them discovered a deal that looked promising. If the deal passed muster, each member of the Group would pony up $25,000 to $30,000. They would then call friends to round up the remainder of the $250,000 to $300,000 they would usually invest in a deal. They made their first investment in 1952. Dennis, now 84, says the Group invested in about 25 firms over a ten-year period; of those, 18 “were wonderfully successful.”

For many years venture capital’s new-kid reputation and the volatile nature of the business kept institutional capital at bay. But the passage of the Employment Retirement Income Security Act in 1978 and the new application of the “prudent-man rule” changed that.

ERISA was the watershed event for venture capital. By allowing pension funds to invest a small portion of their assets in so-called alternative assets such as real estate, ERISA paved the way for a whole crowd of new investors to enter the VC pool. Real estate partnerships were the greatest beneficiaries, but VC firms benefited as well. Still, the initial funds were small. Kleiner Perkins Caufield & Byers’s first fund was $8 million, with Henry Hillman, the Pittsburgh mining heir, investing half that amount in 1972.

The ’80s bull market in technology that saw numerous IPOs elevated venture capital from the ranks of a boutique business, thanks in part to a group of specialized investment banks — Alex. Brown & Sons, Hambrecht & Quist, Montgomery Securities and Robertson, Stephens Co. — known as the Four Horsemen. Well connected to the technology centers in Silicon Valley and on Boston’s Route 128, the banks often invested their own capital in the venture rounds for many tech companies. This familiarity became part of their pitch as they took many of these companies public and touted their prospects to investors.

The research these banks provided, clearly identified as partisan and sales-driven, was a critical tool in the marketing of venture-capital-backed companies. Research analysts, partnering with the investment banks, who helped promote successful stocks shared greatly in the profits that successful IPOs generated.

This funding at astronomical prices brought even more money into the venture capital industry. And a host of advisers and funds of funds were feeding the frenzy. By the mid-1990s venture funds were raising hundreds of millions of dollars. In 2000 the industry raised a record $100 billion.

Then the bubble burst.

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