Colin Barry

Georges Doriot and American Venture Capital (CMC, Friday, Week 9)


Why did the VC model arise post-WWII?
-- Hard for small, risky firms to access capital => banks won't lend
-- Revenue Act of 1940 => higher taxes, probably doesn't deter investment but greater need for individual investors to pool risk
-- US Government funding for war R&D => de-risks follow-on investment
-- US Government created wartime partnerships between universities and industry
-- GI Bill => higher ed is more broadly accessible

Georges Doriot: HBS professor, American soldier, visionary investor
-- Firm believer in possibility of managing entrepreneurship
-- Dispenses money AND advice
-- Already had created a pool of analysts (HBS students)
-- "Central node" => deep industry connections, networker
-- Portfolio theory

American Research and Development Corporation (ARD) -- founded in 1946
-- Shifts industry focus with the times: chemicals => diverse sector choices => electronics
-- Access to capital: lots of individual investors, permanent fund (closed-end)
-- Portfolio management: takes controlling stake in enterprises and actively manages (board seats)
-- Capital gains and consulting fees (looks more like contemporary PE, but they also started off with less risky investments/more hits than modern VC)

The big deal about ARD: foresight to invest on an unproven thesis
Digital Equipment Corporation (DEC): ARD invests in 1957, IPO in 1961, 81% IRR/375x returns over 10 years.
Proves the model...

Subsequent evolution in VC firm structure:
-- sells shares at Net Asset Value on public markets (like an ETF)
-- investors have liquidity via secondary market
-- General Partners are salaried

Limited Partnerships:
-- 10 year fund lifetime (usually), limited liquidity
-- GPs earn fee (2%) and carried interest (20%)
-- Unequal distribution of fund upside among GPs (older GPs make more, usually)
BUT hard to retain good GPs; easy to break off and start another fund once you have a reputation...

Increasingly, trend away from "royalty model" of compensation and towards "insurance model"
-- Junior partners see a piece of the upside
-- Decreases attrition of good GPs, allows VC firms to build a brand. Helps explain persistence of returns??