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Innovation might seem magical, but magic comes with a steep price tag. Venture capital provided a superior way of funding entrepreneurship than what existed before.

Paul Matzko
Tech & Innovation Editor

Margaret O’Mara is the Howard & Frances Keller Endowed Professor of History at the University of Washington and a contributing opinion writer at The New York Times. She writes and teaches about the growth of the high‐​tech economy, the history of U.S. politics, and the connections between the two.

O’Mara is the author of Cities of Knowledge (Princeton, 2005), Pivotal Tuesdays (Penn Press, 2015), and The Code: Silicon Valley and the Remaking of America (Penguin Press, 2019). She is a coauthor, with David Kennedy and Lizabeth Cohen, of forthcoming editions of a widely used United States history college textbook, The American Pageant (Cengage). In addition to her opinion pieces in The New York Times, her writing also has appeared in The Washington Post, the Los Angeles Times, Newsweek, Bloomberg Businessweek, Foreign Policy, the American Prospect, and Pacific Standard.

At the University of Washington, she teaches undergraduate and graduate courses in U.S. political and economic history, urban and metropolitan history, and the history of technology. She is the Washington co‐​chair of the Scholars Strategy Network, a co‐​founder and current faculty affiliate of Urban@UW, and a board member of His​to​ryLink​.org, the online encyclopedia of Washington State history. In addition to her teaching, she speaks regularly to academic, civic, and business audiences.

O’Mara is a Distinguished Lecturer of the Organization of American Historians and a past fellow of the Center for Advanced Study in the Behavioral Sciences, the American Council of Learned Societies, and the National Forum on the Future of Liberal Education. She received her MA/​PhD from the University of Pennsylvania and her BA from Northwestern University. Prior to her academic career, she worked in the Clinton White House and served as a contributing researcher at the Brookings Institution. She lives outside Seattle with her husband Jeff and their two daughters.

Spencer Ante is a Managing Director in the Strategic Communications segment at FTI Consulting based in New York City. Spencer serves as the head of the Content and Creative team in the Digital and Insights practice in the Americas, an interdisciplinary team that leverages data, creative, editorial and digital media capabilities to create integrated campaigns and content programs that enhance corporate reputation and drive business results.

Spencer E. Ante has been writing about technology, business and digital culture and developing digital products since the first dot com boom. Starting in September 2013, he was named a senior special writer on The Wall Street Journal technology team, where he hunts for big stories with a focus on how companies use technology. He left the WSJ in July 2014.

He is the author of the book, Creative Capital: Georges Doriot and the Birth of Venture Capital.

While fans of the show Silicon Valley might not have much regard for the role of venture capital in technological innovation, the reality is that venture capitalists do more than act as ATMs for startups. They provide crucial business, marketing, and legal expertise, all of which are necessary to actually get a product to market.

But while venture capital might seem obvious to us today, it was a radical idea in the mid‐​20th century. Paul interviews Spencer Ante about his biography of the founding father of venture capital, Georges Doriot, a French immigrant who revolutionized the way startups are funded.

What is the relationship between venture capital and start‐​up owners? Who was Georges Doriot and how did he change the world of venture capital? How is venture capital regulated by the SEC? What barriers do venture capitalists face?

Further Reading:



00:06 Paul Matzko: Welcome back to Building Tomorrow for part three of our exploration of the origins of Silicon Valley. Well, so far we’ve covered two key elements in that story. Innovation requires gathering smart people from around the globe in hubs of knowledge, this case universities, where they are supported as they research and tinker. But innovation also requires money. Lots and lots of money. It’s impossible to imagine Silicon Valley existing in anything like its current form were it not for the invention of modern venture capital. Fledgling startups need significant money to develop their product and to bring it to market. But given that three quarters of startups fail, giving them that money, it’s a pretty high risk business. However, it’s also got high reward potential if you happen to be fortunate enough to invest in the next Google or Amazon, and you can weather the major failures that will come in between. But that’s not all venture capital firms do, they’re not just ATMS for startups. I asked Margaret O’Mara, author of The Code: Silicon Valley and the Remaking of America, who we heard from last episode, about the role venture capital plays within startups.

01:13 Margaret O’Mara: Yeah, well, what the high‐​tech venture capital model is different in that it is not just money, it’s also mentorship, and it’s expertise. ARDC, Doriot comes into being in the ‘40s, seeing that there are all these eager, young men, smart guys graduating from MIT and Harvard that have these great business ideas, and banks aren’t gonna loan it to them, and the electronics industry is exploding in size because of government contracts and then the Cold War, and so they see an opportunity to get in the ground floor. But of course, when you have a young 22‐​year‐​old engineer, who’s maybe smart as I’ll get and can do wondrous things technically, but they have no idea how to run a business.

02:06 Margaret O’Mara: And so, what these VCs bring, and we really see this, particularly in the venture firms that emerge in the Valley whose founding partners by and large come from industry, they are guys who were in industry and then who are trained engineers originally, and then they go and they become become investors. But they are really shepherding and mentoring these young guys. They are showing them, “Here’s how you build a business. Here’s how you bring a product to market. You may have this really cool thing, but what are you gonna do? How are you gonna commercialize it? How are you gonna market it?” They link them in with marketers, with PR people. They link them on with lawyers who can do the contracts. One of the other distinctive service firms that emerges in Silicon Valley that again is distinctive to the Valley, and it helps explain its ability to produce generation of generation of companies is the specialized high‐​tech law firm. The original pioneer was Wilson Sonsini, which is still one of the big, big players. Now a global law firm but based in Palo Alto and doing, really focused on helping these brand new electronics companies incorporate, and then go public and do all the things in between.

03:23 Margaret O’Mara: And so that, the VC is it’s not just writing a check. It is really showing the entrepreneur how to do what they do helping… And oftentimes, what’s happened until relatively recently is you had the young founder and then with the VC’s help, they would find someone who was more seasoned, who has adult supervision, who would kind of come in over the young person, and actually run the joint and sometimes just ask that young person to go along their way and leave it to the pros to run the operation. So that is something that can fall out of the start‐​up story a bit, and really helps explain the really distinctive role that venture capitalists in this industry play in a way that is different from investors in other moments, other industries, other places.

04:19 Paul Matzko: There’s an excellent description of this relationship between venture capital and start‐​up founders in the book by another one of our guests today, Spencer Ante, who we’ll talk to later on. He writes, “Venture capital firms are organizations with enormous fiduciary resources, but the seasoned operators running them were not daredevils skilled in the art of invention. Conversely, inventors were struggling creative types with no money trying desperately to become poor business men.” Now, you could illustrate that point picking almost any startup at random. Odds are, it’ll be a story about a software developer or an engineer with a brilliant idea but little sense of how to turn that idea into a successful product. Perhaps the most famous example of this comes from the largest tech company in the world, Apple. Now, unless you’ve been living under a rock for the last couple of decades, you’ve heard about how a pair of Steves; Wozniak, the genius programmer and jobs, the visionary, built Apple computer in their garage. But their company might have easily remained a footnote in computing history were it not for Apple employee number three. Venture capital investor Mike Markkula. Back to Margaret.

05:32 Margaret O’Mara: Yeah, so Mike Markkula, it’s a great story. He was an Intel guy, so he’s… Again, the earlier generation feeds into and shapes the, makes the next generation possible. So, Intel is the great business story of the early ‘70s. And Markkula is in his mid to late 30s. He’s retired. He’s made a lot of money, he’s gonna just go skiing, he hasn’t figured out what he’s gonna do next. And Apple shows up, and Don Valentine, who was another semi‐​conductor industry veteran who has agreed to put some money in. And he is one of the people that connects Markkula into the two Steve’s Wozniak and Jobs.

06:11 Margaret O’Mara: And yeah, he showed Apple how to get out of the garage and actually build a business organization. Apple is a company that has always very successfully positioned itself as kind of a countercultural think different, we’re different than other companies, but you look at the org chart and Apple got out of that garage because it decided to grow up and run like a business. And it had seasoned business professionals like Mike Markkula, it had the best marketing guy in the Valley, Regis McKenna. It had all of these people who are kind of the older generation who brought seasoned business expertise and connections to more established business institutions to get it done. And yes, you have to have a charismatic founder and an amazing technical co‐​founder. Jobs and Wozniak were that. They were extraordinary and that is one reason Apple emerged from the pack, but it also was because one of the things that made Steve Jobs extraordinary is he saw from the very beginning that he needed to get these seasoned pros on board and working for his company.

07:20 Paul Matzko: Clearly venture capital plays an important role in the startup economy that goes beyond simply bankrolling needy founders. But to show just how important that role is, it’s worth considering what startup financing was like back before the rise of modern venture capital. Back before you could go put your hand out at any one of dozens of outfits on the famous Sand Hill road in Palo Alto. I asked Margaret to describe what that world was like. So what is the funding model for research prior to that and prior to the rise of modern venture capital?

07:54 Margaret O’Mara: Yeah, well it was a lot smaller pool. I can tell you that much, but it was private. It was when you go to before World War II where the money for the big players in research of any kind, it was industrial research labs. It was companies like General Electric or AT&T that were funneling some of their profit into research laboratories that were developing next generation products. It was a very different model. At the university level the money was coming from private foundations, from private individuals and in industry you saw instances of what was in some earlier eras called adventure capital where you had say in the early auto industry in Detroit and other cities in the upper Midwest in the 1890s, 1900. The very first were people like the Dodge brothers and Henry Ford were getting their money from rich people that aren’t them and who are willing to be investors in these new high tech ventures building these automobiles, these crazy horseless carriages that don’t really have a market yet.

09:04 Margaret O’Mara: So you have seed investors that are operating in a very similar way. You also, we have venture capital of some kind playing, you could take it back all through human history, how do young, untested entrepreneurs who want to bring a product to market, they gotta go to someone who made money in an earlier generation in order to do that and is willing to take a risk. And oftentimes they aren’t going to conventional banks. These aren’t guys who can go to get bank loans. They have to go find someone else. So venture capital, high tech venture capital as we know it really comes into being kind of at the same time as the growth of the high tech electronics industry in the postwar period as we know it. And it comes into being in some of the same places, Boston and the Bay Area. And it is, the Venture Capitalists are, really they’re the middlemen in some… Originally they are the people who are finding connecting old money with new deals. And some of the money that funds the earliest commercial ventures, early startups in both Boston and the Bay Area is coming from families like the Rockefellers and the Whitney’s. They’re the old money of the gilded age is then funds the new ventures of the electronic age.


10:30 Paul Matzko: At the time, it was much harder to get access to one of the handful of wealthy dynasties able and willing to invest in so risky an asset as a new venture. You had to know somebody who knew somebody who may be worked for Cornelius Vanderbilt or Andrew Carnegie or someone of that like. It was a very limited, opaque and privileged process. But all of that began to change in earnest in 1946 when a man named Georges Doriot founded the first modern venture capital firm, The American Research and Development Corporation. It was a radical idea, a publicly traded investment firm that would give ordinary investors the ability to back startups. I’ve asked Spencer Ante, a managing director at FTI Consulting and the author of the definitive biography of Doriot titled Creative Capital, Georges Doriot And The Birth of Venture Capital to tell us more about this really quite fascinating individual.

11:25 Spencer Ante: Yeah. So basically one of the main things I write about in my book is how Georges Doriot was the founding father of modern venture capital. And what I mean by that is that he’s the first person who essentially ran an institutional venture capital fund, not a family office. And he also played a key role in getting the venture capital community to see itself as a real industry. So he was both a pioneer in founding the institutional model for venture capital, which made a lot more money available over time to entrepreneurs. And he was also, this is another thing that attracted me to him as a book subject is he was kind of the leader of a social and an economic crusade. And he saw himself very intentionally as that voice as that leader who would articulate the principles of the industry, the practices of the industry, why it’s important?

12:29 Spencer Ante: And he of course, he didn’t do this alone, he was coming out of World War II, just when ARD was founded he was supported by some prominent industrialists in New England, the President of MIT was a backer Ralph Flanders was a senator from Vermont who was the guy who later went on to criticize Joe McCarthy for the first time in public, all these individuals came together to realize that after the war, the economy needed a way to… Way to get back, to get a boost essentially ’cause essentially the economy had been taken over by the war machine, so they saw this need for raising money and funneling it into these small companies that through their experience, they’d observed were the really the main engines of economic growth and job creation in New England, and they thought they could apply this to the larger country after the war and that was the impetus for American Research and Development, which Georges Doriot was the first founder and President of.

13:37 Paul Matzko: Now, Doriot really is a fascinating figure and you do a great job in the book, telling his story, but for our audience where does he come from, where does he get the idea for ARD or the American research and development corporation and give us a better sense of what’s that vision that he has for venture capital as an industry?

13:58 Spencer Ante: Yeah, it’s a great story. Everything kinda goes back to your family in a sense So, when I researched him, I learned that his father first of all, he was born in France so his father was an engineer, and his father built one of the first automobiles for the Peugeot Motor Company in the early ‘20th century he was when he was growing up, he would literally go to the automobile factory and he worked in the automobile factory and he would learn about how to make stuff, how to build stuff. And in addition to that his father also was an entrepreneur so his father Auguste left the Peugeot Motor Company and founded his own car company called Doriot’s Flandrin and he created some of the fastest most innovative automobiles in France, and the European market in the early 20th century, unfortunately, World War I broke out and it destroyed the company, and that’s what led Georges to come over to America to seek a better future, where he gained acceptance to the Harvard business school.

15:14 Paul Matzko: That’s pretty cool. Okay, so he has his father’s kind of interest in entrepreneurial activity he’s getting business training at Harvard and my understanding is he was not, it was not intended for him to stay in America, he was supposed to come and study and learn and then go back and I guess join back up with new family Ventures, is that correct?

15:39 Spencer Ante: Well, it wasn’t clear. He definitely was very serious about realizing that there was really nothing to do in Europe after World War I it was decimated. So he came here, and he basically just fell into the, he fell into the culture he fell into the country and it was a boom time it was the ‘20s he was attending HBS in the ‘20s, so he quickly realized America was the place to be at that point in our history and the global history and he just was very ambitious and he started to work on Wall Street, and he got a job in an investment bank at [16:24] ____ which is one of the most prominent successful investment banks in the early ‘20th century and he built his career from there, he went on to become a professor at Harvard business School and not only was he a professor, but as he gained more prominence in the business community, he started becoming a director of many corporations, so the combination of his business school training and Wall Street experience and then his academic background coupled with his experience on the boards of these companies gave him a very well‐​rounded and deep and solid understanding of how business is run, and that was the basis of his becoming a venture capitalist.

17:13 Paul Matzko: And this idea, for American Research and Development Corporation was my understanding is pretty radical at the time and a lot of folks were skeptical. They told him, this was a fool’s errand it was gonna fail. So I guess, where does he get the idea from? He’s on these boards, and he thinks there’s a better way to do this. And then what kind of pushback did he get at first?

17:39 Spencer Ante: Yeah, it’s interesting, the idea and this is a big revelation in my research, a lot of this early thinking about venture capital grew out of the Great Depression. So like I said, there was obviously the boom time, then the big crash, and then there was a depression in the ‘1930s and he was observing all of this and I mentioned those other individuals in New England, they were all trying to figure out how do we get out of this Depression, what do we need to do and what they observed was that the way to do it was to start small businesses, so there was a lot of industry that came up in New England during the Great Depression, like the shoe industry was incredibly important to New England. There’s other examples of industries that early manufacturing, that grew out of the Great Depression, and so these people that I mentioned realized that the way to… The Way to jump‐​start the economy was to invest in, figure out a way to invest in more of these small businesses eventually. They put together a plan to start what was ARD in the late 1930s, and they were actually about to do it but then history, intervened again World War II broke out and that pretty much put it on the shelf for a few years.

19:15 Spencer Ante: But when the war… And this is another thing that the other big revelation in my research was that war in a sense, World War II is credited with Helping effect many changes in our American culture, and industry and society integration between races, the invention of the nuke the atom bomb and what I learned is that venture capital the idea of applying technology and money towards towards innovation really grew out of World War II ’cause Doriot, was the head of the Quartermaster Corps which was the branch of the military responsible for developing equipment, for the soldiers.

20:06 Spencer Ante: And he was a genius at logistics and manufacturing and product development, and he figured out a way to marshal all these resources and these incredibly smart people in the country to essentially invent a whole new series of products for soldiers so they invented famously bulletproof armor for soldiers and for pilots in the Air Force, they invented keratin they did a whole bunch of research around science and nutrition they invented new types of shoes for the soldiers because they were fighting in incredibly brutal winter conditions and they were getting, a lot of soldiers were getting frostbites They had to figure out how to build new shoes they had to develop sunscreens and the list goes on and on and on. And so that’s where he learned how to become a venture capitalist as a general. He left the military as a general in World War II, and he just applied all those lessons that he learned in the military to the peacetime economy.

21:20 Paul Matzko: It’s fascinating to think of, so far, we’re not even into the part where he starts ARD yet but he’s an immigrant, who goes to Harvard Business School, who works on Wall Street is a corporate executive centre on corporate boards and now he’s a military general, and that’s… That’s all just in the first half of his life, that’s pretty impressive. Okay, so the war is done. And he wants to apply the skills and the venture model that he learned as a Quartermaster to the private sector afterwards and he starts ARD. It’s considered this kind of risky venture. You mention in the book the venture I forget his first name But Kettering tells him he’ll go bust in five years, so he expects him… This to be a [22:13] ____ rusty venture. They’ll lose all their money. It’s just not gonna work. But ARD holds in… Holds in there for a few years, and it is a few years before they get their big, their big hit, they’re betting on a bunch of companies, one of them goes gangbusters, and it’s kind of the proof of concept for the model. Tell us a little bit more about that.

22:34 Spencer Ante: Yeah, so what they were trying to do had never been done before, so obviously people were very skeptical of it rightfully so, but he was a visionary, so he kind of saw into the future and what he saw was that the economy was really going through a major transformation from in the early 20th century, the economy was dominated by these large conglomerates like Standard Oil and US Steel and coming out of the war You saw that the shift towards these startups and that the startups are gonna be the ones that really power the economy. In the second half of the 20th century so but it took time to prove this out. So like you said, they invested in a number of companies, they actually incorporated ARD as a publicly traded company, and so they were getting a lot of scrutiny by public shareholders who were watching them spend a bunch of money on these companies and invest in them, but they didn’t see a lot of fruits, but that was one of the things that people didn’t understand back in those days was that, it actually takes time to build a business and the business model will shift numerous times over the course of five, six, seven years.

24:00 Spencer Ante: And so what ended up happening is they invested in this company called Digital Equipment corporation, which was founded by two engineers who, to help develop computer technology for the US military. Okay, again, comes back to the military. Ken Olsen work in MIT in a very well‐​known computer lab. He saw an opportunity to start a new computer company that would challenge the mainframes of IBM he wanted to build these smaller easier‐​to‐​use computers to compete against IBM so, Doriot and ARD funded the company they invested $70000 in it I think it was 1957 like any other start‐​up, they had a lot of fits and starts, but they actually ended up of making a really good product started catching on with scientific, technical, communities. And five, six, seven years later, the company was actually starting to make some serious revenue and then everything kind of like turned they had a lot of other good investments in companies that made nuclear atom smashers and they invested in George Bush’s oil development companies and had like a lot of interesting medical device companies that were very innovative, but Digital Equipment was the star of the portfolio.

25:38 Spencer Ante: And it went public in the ‘60s and the $70,000 investment became worth over $400 million when Digital went public. And that’s really when the whole thing exploded. That was, what I’d say, was the first home run in venture capital. And it proved that you could take small amounts of money, invest in them and these companies, combined with this management advice we talked about. And over time, you nurture and you build. He was a builder, that’s how he saw himself. He wasn’t a speculator. He was very vocal about the dangers of flipping things for profit in the short term. He was a really big believer in building things for the long term. If you work hard, you build great products. Financial rewards will come over time. This has all become kind of almost conventional wisdom now. But in the ‘50s and the ‘60s, it was nobody knew what the hell they were doing. And he was the guy who really helped pioneer that. So after Digital Equipment went public, all of a sudden people woke up. The general public woke up. The financial community, Wall Street woke up. And they realized, “Wow, this could be a big deal for people and for the economy.” And so that kind of kickstarted a whole another era of innovation.

27:08 Paul Matzko: But Georges Doriot didn’t get American research and development up and running without a fight. Indeed throughout the entire history of the company, it was locked in a series of running battles with the Securities and Exchange Commission, that’s the federal regulator for the stock market and investors. The SEC is after all a political creature. And so every four or eight years, a new raft of presidential appointees would take charge and cast their bleary eyes towards ARD, wondering what shenanigans this novel style firm must be up to. Let’s go back to Spencer.

27:41 Spencer Ante: Yeah, so going back to the theme of nobody knew what this whole venture capital thing was, the regulators were part of that too. The SEC was a constant source of anger and frustration for Doriot, because he felt like they didn’t understand the business, and they were constantly trying to muck around in the business and kind of… Which would cause a lot of problems. So one, there was two main issues. One issue was around valuation. The SEC wanted, ’cause they were publicly traded, the SEC had regulatory authority over publicly traded companies. They wanted them to disclose more information about the valuations of these companies, and essentially proprietary financial information, which would never be disclosed today. So that was one battle they fought. But the bigger battle was over what the SEC thought were conflicts of interest over ARD giving its employees stock options in both its portfolio companies and ARD. The SEC believed that that presented a potential conflict of interest. So that was really the main issue that led to the demise of ARD. And we can get into that, but those are the two big battles they fought. And at one point, the SEC did a surprise raid on the ARD offices in Boston, which really pissed off Doriot.


29:25 Paul Matzko: Sure, yeah.

29:26 Spencer Ante: As you would imagine.


29:28 Paul Matzko: I can imagine, yeah. So, there’s that battle, which, and well let’s get to that in a second where it really does lead to the decline of ARD and the rise of a new style of corporate structure for venture capital. But before we get there, I was struck real early on that there was actually this law passed in the aftermath of the stock market crash and The Great Depression that banned investment companies from owning more than 3% of another company. And ARD had to get that, they actually lobbied to get that law changed to like 9.9%. Why was that law such a barrier to venture capital? And why did they have to have it changed?

30:11 Spencer Ante: Yeah. When a company is gonna get an investment from a venture capitalist, the typical stake that they give up today in an initial rounded venture capital is like usually 10% or 20%. But by the time a company goes public, the majority of its stock is owned by outside shareholders. ARD famously got gruffed for its initial investment and in Digital Equipment, ’cause that’s $70,000 investment, they got 70% of the company. That would never happen today. A company would never give up that much equity. But if you’re gonna invest all this money in a company, you wanna have a significant stake in it, otherwise it doesn’t make sense to do it. You’re not gonna benefit from it when it does do well. So that was really the problem there.

31:09 Paul Matzko: So, let’s jump now to the big showdown between the Securities Exchange Commission and kind of the death nail for ARD. And my understanding, and correct me if I’m wrong here, it had to do with whether or not a venture capital officer sitting on start‐​up boards, whether they were allowed to have stock options in client companies. Is that right? Is that what the SEC had a problem with?

31:26 Spencer Ante: Yeah. They thought that the employees of ARD, if they had stock options in their portfolio companies that it could potentially present a conflict of interest between their duty as employees of ARD and their duty as fiduciaries of the portfolio companies. They never really gave a great example of how it could sort of present a real conflict of interest. And that was one of the things that kind of angered Doriot. And they never, Doriot felt like they never really took the time to understand why they were doing this, and how they operated and so it was a long running battle and there were times in which he was close to actually cutting a deal with the SEC over this, but various things kept getting in the way, like there was one individual who ran the SEC that actually did invest time in trying to understand the business, but then he left the SEC.

32:45 Spencer Ante: So then a new guy came in and he had to start over from scratch. And he basically just ran out of time because in addition to not… The reason why the stock option issue was so real… Was because before the SEC brought the hammer down there was a few people who actually got stock, in Digital Equipment corporation, they ended up becoming really rich. Okay and the ARD employees who didn’t get stock in Digital Equipment were jealous of course, an envious And then when they stopped the ARD from being able to give out more options, all of a sudden some of the people, the investment professionals were like forget about this, I’m gonna go start a limited partnership and run, but my venture capital firm is limited partnership and that became a competing structure in the late ‘60s.

33:50 Spencer Ante: And so when you had a limited partnership, the SEC didn’t regulate you, and so you could give options to your employees and they could benefit from their participation in helping to grow these companies because if you were a VC, and you were helping to grow XYZ startup and they went public, the founders of the companies, would do incredibly well, but you felt like you got screwed because you didn’t get really anything out of it other than your salary? So essentially, some people, in the industry realized there was a better way to structure venture capital companies through limited partnerships, it would became a compensation problem, and so the best talent at ARD when they realized that Doriot wasn’t gonna be able to develop a solution to this, they started leaving the firm. So famously, there was a guy named Bill Elfers who was his number two guy ARD he left and he started a company called Greylock which is one of the most successful venture capital firms operating today in Silicon Valley.

35:06 Spencer Ante: He started as a limited partnership Doriot actually tried to recruit Tom Perkins, who went on to found Kleiner Perkins and one of the reasons Tom Perkins didn’t wanna join ARD although he respected Doriot enormously and said Doriot was the second most important mentor in his life after Dave Packard and Hewlett Packard. He didn’t wanna do it ’cause he knew he tried to make a lot of money, so he started Kleiner Perkins as a Limited partnership, and that’s kinda what happened with a couple other employees too. They left and they went on to start other venture capital firms or run other venture capital firms like Fidelity Ventures was run by ARD alumni, and went on to do very well for itself.


35:50 Paul Matzko: You can think of this revised venture capital structure that’s now the universal norm as a kind of regulatory arbitrage. Arbitrage is the word economists use to describe how say companies will move across state lines to find more favorable regulations or lower taxes. Las vegas is a famous example. Regulatory arbitrage means that we built a city, in the middle of a literal desert it’s crazy Well, that was the only state where casino gambling was legal at the time. But in the case of venture capital their need to arbitrage around a backwards SEC had huge unintended consequences. That’s because, while both ARD, and its successors both gave money to start‐​ups, there was a fundamental difference between them. Anybody could buy a share of ARD on the stock market, but only the already wealthy the millionaires whom the SEC calls accredited investors were allowed to invest in the new venture capital firms. Now, the SEC thought it was protecting ordinary Mom and Pop investors. But What It actually did was cut them off from the highest possible investment returns in the American economy, over the past half century.

37:00 Paul Matzko: Yes, it would be foolish for retail investors, as folks like you and I are called to put all of our money in venture capital, but these high‐​risk, high‐​reward investments should be a slice of our retirement funds and the like, that’s because the returns over a 30‐​year period annualized at perhaps 20 to 25% are significantly higher than what you’d expect from a vanilla index fund, which runs approximately half of that. It’s hard to quantify what that means, but I think it’s suggestive that if you look at a graph showing wealth inequality, the moment when the rise in inequality starts to Soar is in the late 1970s, early 1980s, which just so happens to be exactly when venture capital investments really took off with the help of the new style venture funds. Also the moment when it was access to that venture capital was barred to retail investors.

37:51 Paul Matzko: This cuts against a common narrative about inequality that’s the natural result of too much capitalism. Instead, it suggests that ill‐​advised government policy led to too little capitalism, cutting off the entire middle class from the most profitable capital investments. Indeed, on that point, we can look at how well a certain segment of investors did with venture capital. Because just as venture capital became gated, these institutions were given access. Talking here about university endowments and pensions, both of which were barred from significant investing in venture capital until the 1970s when Congress passed a relatively obscure law called the Employee Retirement Income Security Act or ERISA for short. I asked Margaret to explain.

38:38 Margaret O’Mara: Yeah. So ERISA was passed in 1974. And its chief purpose, again… Like high‐​tech wasn’t the chief reason that the law was passed, by any means. But it had to do with employee pension funds. And in 1974, again, not a great year, for the American economy. And so it was trying to protect… As the stock market is just in the tank, trying to protect employee pension fund investors, or pension funds from being kind of squandered by bad investments. And what it did is it really limited, it kind of created this category of risk investment that pension funds weren’t allowed to invest in. And into that category of risk investment fell most early stage electronics, and computer hardware, and software companies. And so actually, this is a story where… Often times we think of Valley people and venture capitalists, as not having… Kind of doing their own… Doing their own thing out in California, and not messing with the halls of Congress, but this is a great lobbying story. [chuckle]

39:45 Paul Matzko: Yeah.

39:45 Margaret O’Mara: Where the newly formed National Venture Capital Association, the trade association of venture capitalists. Which was, again, a community so small that the first meeting of the association occurred in the Red Carpet room of O’Hare Airport. [chuckle]


40:03 Margaret O’Mara: It was like about 30 guys.

40:04 Paul Matzko: Classy, alright. [chuckle]


40:06 Margaret O’Mara: So there just weren’t that many people. And they decided, look we… This is… We have this really inhospitable environment for all these laws in Washington. Not just this restrictions on pension fund investment, but also the capital gains tax rate. Which at the time was really, really high, were kind of quashing, really making it hard for them to raise funds. And so they go to Washington and they start lobbying Congress. They really did not know what they were doing. They were told, there’re some of people who were instrumental in that. Ed told me later, “We just had no clue. If we had any idea, what we were doing, we would have, we would have been embarrassed to… I look back on what I did in the beginning. I just didn’t know which congressman to go to.”

40:52 Paul Matzko: Yeah. [chuckle]

40:53 Margaret O’Mara: Didn’t have any kind of professional lobbyist that were helping them out. They just were showing up, and be like,“Can you just cut this tax rate for us please?” And they were like,” What we don’t… [chuckle] You know, who are you?”


41:04 Paul Matzko: Yeah.

41:04 Margaret O’Mara: But anyway, long story short, this kind of dedicated lobbying effort, that also kind of helps sit in the mind of lawmakers, who it’s the late ’70’s, they were trying to figure out, how do we get the American economy out of the tank? And you have these venture capitalists, and you have electronics industry executives too, that are also going and lobbying Washington, and saying, “Hey we are the new… We’re the future. And what can you do, policy‐​wise, to make this future happen? What you can do is you can lessen the restrictions on what pension funds and other institutional investors where they can put their money, you can free up capital for us. And you also can lower the capital gains tax rate, so that there isn’t this huge penalty for investing, and getting ahead…

41:51 Paul Matzko: Yeah, yeah.

41:51 Margaret O’Mara: Like you wanna create an incentive for capital to flow. And so over… That kind of… The combination of that and kind of the timing of law makers of both parties really, really wanting to do something to jump‐​start the economy helps… In 1978 and ’79 changes a decrease in the capital gains tax rate, and the new ERISA Law that allows pension funds and other institutional investors to invest in “risk capital” including electronics. A lot of the VCs I talked to were like, “Yeah, the capital gains tax reductions were absolutely instrumental.” I think that they’re… I think the jury is kind of… The evidence doesn’t totally stack up in terms of how that did. But I’ll tell you what it did. It was a huge psychological shot in the arm. And look, the market’s all about psychology, right? But on the pension funds, that was absolutely critical, it’s pretty clear, and there’s been a… The research that has been done on what affect this deregulation had on the kind of opening up a pool of venture capital. Really, I think, there’s some pretty strong strong correlation there. And again it kind of just changes the atmosphere. It kinda creates this, “Okay, these are really… These are good investments. These are sound investments. Let’s go for it.” And then, is of course, what happens in ’79-’80-’81, it’s the personal computer. [chuckle] Apple goes public in 1980, like boom, and off to the races we go.

43:21 Paul Matzko: I also asked Spencer about ERISA reform. And he gave me some startling statistics about, just how large, and how quick an impact the rule changes had.

43:32 Spencer Ante: Yeah, so what happened in the late ‘70s, is that after some lobbying by pension fund managers and entrepreneurs, the US Labor Department certified what it called the Prudent Man Rule of the Employment Retirement Security Act. Basically, what it meant was the old rule held that pension fund managers could only make investments that “a prudent man would make.” So that meant a lot of pension fund managers, avoided venture capital. When they were softened the fund managers could take into account things like the diversification of an entire portfolio, when determining the prudence of an investment. So that did open up the floodgates of venture capital, I’ll just give you one data point. In 1978, there were 23 venture funds that managed about $500 million. Five years later, there were 230 firms overseeing 11 billion.

44:24 Paul Matzko: Were it not for ERISA, pension funds would be in even worse shape than they currently are. And university endowments would be much smaller with all kinds of significant knock‐​on ramifications. It’s no accident that Harvard’s endowment was funded in 1974, but it’s cumulative, rate of return, since then is approaching double the return of the S&P 500. Not because the managers are some kind of geniuses but because they have access to investments that ordinary investors do not. The state restricted access to venture capital investing to the already wealthy contributing to the rise of wealth inequality but without receiving any of the blame for these disastrous policy decisions. Do I sound angry? I hope so. I’m feeling real punchy right now.

45:08 Paul Matzko: There have been efforts to reform the accredited investor rules at the SEC by the Obama administration, most notably the jumpstart our business startups Act in 2012, get it, “jobs” which will allow small dollar investors to crowdfund startups kind of like kickstarter but for angel investing. However the rules only went into effect in 2016 so the jury is still out, and it was only a partial reform, it still comes with a raft of restrictions and how much crowdfunding a company can accept and all kinds of regulatory hurdles to jump through. Still, it was a step in the right direction, baby step though it may be.

45:44 Paul Matzko: And we are desperately in need of reform, modern style venture capital used to be a uniquely American phenomenon but that has been changing as other countries change their investment laws to try and match our success. Venture capital is offshoring, we reached a tipping point in just the last few years where the US is no longer the destination for majority of the world’s venture capital, it’s flowing at much faster rates to China, Singapore, Canada and all over the globe. So I asked Spencer what he thought the global future of venture capital would look like.

46:16 Spencer Ante: Yeah, it’s a good question. I think this is another area where Doriot was a visionary. He had a lot of famous quotes that people would always raise here and there. One of them was, “creativity knows no boundaries,” he saw early on that good ideas can come from anywhere. And so he was a leader in what I would call globalization, so two things he did that were significant in that regard. He helped found INSEAD just like the first global business school in Europe. Doriot was one of the first people to understand the importance of globalization and this notion that good ideas can come from anywhere, and he sort of acted on that by founding INSEAD an early European venture capital firm. And so, but in some ways, he was too ahead of his time, which is another theme of Doriot like, it’s great to be a visionary but timing, if you get too far ahead of the world that it kind of blows up in your face sometimes.

47:27 Spencer Ante: I think what we’ve seen over the last decade is a realization of the power and the potential of global innovation, you see a lot of new companies popping up on the scene that aren’t based in America that are really having a big impact on the global economy. I think Alibaba is a really good example of that. Skype was founded in Europe. India and China are founding a lot of interesting companies. Brazil is another emerging area of innovation, and so I think that’s a long term trend. Silicon Valley will always be the epicenter of innovation, but it doesn’t mean that over time more and more interesting companies will be coming out of different places and I think we’ll see that play out in the coming years.

48:23 Paul Matzko: We will see indeed. I hope you’ve enjoyed this three‐​part series about the origins of Silicon Valley. I know I have. There is a key under appreciated thread running through all three stories, the importance of deregulation. You see, it was the liberalization of our immigration laws in the 1960s that led to a wave of global talent from around the world choosing to come here, giving us the knowledge and expertise needed to build Silicon Valley. It was the decision the government made to fund the private researchers and universities like Stanford university, instead of clustering them at government run research labs as other countries did that built Silicon Valley. And deregulatory reforms like the Bayh‐​Dole Act of 1980, which got the government out of the innovation stultifying patent holding game. And the ERISA reforms of 1974, 1979 they resulted in massive venture capital investment in these fields like biotech and the internet. Without these changes it’s hard to imagine Silicon Valley having become synonymous with innovation and creative disruption. Until next time, be well. Thanks for listening. “Building Tomorrow” is produced by Tess Terrible. If you enjoyed “Building Tomorrow,” please subscribe to us on iTunes or wherever you get your podcasts. If you’d like to learn more about libertarianism, find us on the web at www​.lib​er​tar​i​an​ism​.org.