Dec 7, 2023
 in 
Venture Capital

Journey Through Time: A Comprehensive History of Venture Capital

Author
Ivelina Niftyhontas
V

enture capital, a term that is often unanimous with startups, has become a critical component of the entrepreneurial ecosystem. It’s not only for the finance folks anymore, it seems that everybody and their uncle wants to get into VC or work at a startup. 

Since 1974, 42% of companies that have undergone initial public offerings (IPOs) have had venture backing. But how did venture capital become a “thing?” How has it evolved over time?

Let’s take a look at the history of venture capital.

1800s-1900s 

Banking on Whales

The origins of VC are debatable, but some say it goes as far back as when Christopher Columbus got sponsored by Queen Isabella of Spain to voyage to the Americas (after many other monarchs turned him down). In return for funding his high-risk venture, she got 90% of the profits after he accidentally discovered the West Indies and propelled Spain into a Golden Era of exploration.

In fact, the term “carried interest” comes from that time, as noted by Andrew Powell. 

“As exploration continued to Asia and the Americas over the next century, the captain of the ship would eventually take a 20% share of the profit from the carried goods, which is where we get the term “carried interest.”

However, according to Harvard professor Tom Nicholas, the history of venture capital goes back to the 19th century. In his book, VC: An American History, he traces the origins of the contemporary American venture capital model to whaling expeditions, highlighting the inherent risk-reward dynamics. 

By the middle of the 1800s, nearly 75% of the 900 whaling ships in the world were American, and that was mostly because American whaling agents had figured out how to finance and make money from these risky ventures.

A financial backer would invest capital in the journey without assurance of profitability. The sailors involved in capturing whales received a modest living stipend and a share of the venture's profits. Notably, this profit distribution occurred after the financier recouped their initial investment along with a predetermined profit percentage. What’s interesting is that this early era already saw a distinction emerging in individuals who could consistently and effectively deploy capital, while others could not.

In the book, Nicholas also compares the distribution of returns for the whaling industry during the 1800s versus the VC industry from 1981 to 2006, and the results show they are incredibly similar.

Nineteenth century whaling can be compared to modern venture capital… Whaling was the archetypical skewed-distribution business, sustained by highly lucrative but low-probability payoff events… The long-tailed distribution of profits held the same allure for funders of whaling voyages as it does for a venture capital industry reliant on extreme returns from a very small subset of investments. Although other industries across history, such as gold exploration and oil wildcatting, have been characterized by long-tail outcomes, no industry gets quite as close as whaling does to matching the organization and distribution of returns associated with the VC sector.” 

Banking on Electricity 

Then there was another important moment - Thomas Edison vs. Nicholas Tesla and George Westinghouse. Edison clashed with both of them over which lighting system would be the winner to light up the world. 

Luckily for Edison, good ol’ J.P. Morgan was a huge believer in Edison’s lighting tech and placed heavy financial bets on him, to the point of going into legal battle against Westinghouse and Edison.

Morgan was an investor and a “beta tester” of Edison’s tech as he installed 400 electric lights in his own home. His investment turned out to be extremely lucrative as General Electric went on to become one of the original 12 publicly-traded companies on the Dow Jones.

1940s - 1990s

The Birth of Modern VC - 1946

1946 was a pivotal moment for modern venture capital with the establishment of the American Research and Development Corporation (ARDC). ARDC was founded by MIT president Karl Compton, Massachusetts Investors Trust chairman Merrill Griswold, Federal Reserve Bank of Boston president Ralph Flanders, and Harvard Business School professor General Georges F. Doriot. 

They became what you could call the “superheroes” of raising money and supporting exciting, new ideas. The idea was not just to create a firm; they wanted to create an industry. That industry soon became what we know today as Silicon Valley.

Often hailed as the "father of venture capital," General Doriot played a central role in steering ARDC toward innovation. Before ARDC, wealthy families such as the Vanderbilts, Rockefellers, and Whitneys were the main source for risk capital, but ARDC changed the game.

They started sourcing funds from institutions like universities, insurance companies, mutual funds, and investment trusts. The firm strategically directed these investments into private companies harnessing technologies developed during World War II.

One of ARDC’s biggest wins was their investment in 1957 in a company called Digital Equipment Corporation. They invested $70,000 for a 77% stake. Over the next 14 years, the company's value increased to $355 million, a 500x on ARDC’s initial investment and validating the potential for high returns through VC money.

After ARDC, more and more people got interested in venture capital. Some of the people who worked with ARDC went on to start their own groups, like Greylock, CRV, Mayfield, and Venrock.

Another prominent name in the development of venture capital is Arthur Rock and founder of the first VC firm in the Bay Area. It’s thanks to Rock that the VC industry really took off.

He was a student of General Doriot and helped eight founders in the Bay Area secure funding from serial entrepreneur Sherman Fairchild to start a company called Fairchild Semiconductor in 1957.

The successful eight co-founders then started investing in new startups and helped Rock start the VC firm in the Bay Area called Davis & Rock. Later on, Rock went on to fund iconic American companies like Intel and Apple.

Another two notable VC firms which were formed around that time were J.H. Whitney by the Whitney family, which still exists today, and Rockefeller Brothers, Inc., now called Venrock, by the Rockefeller family.

The Iconic Sand Hill Road is Born

It was in the 1960s and 70s that the VC industry truly found its footing, with VC firms focusing on starting and expanding companies instead of investing in existing ones. The 60s also saw the emergence of the common structure that venture capital funds use - the Limited Partnership.

Sand Hill Road in Palo Alto rose to fame as some of the most prestigious VC firms started to pop up, the likes of Sequoia Capital, Kleiner Perkins, and New Enterprise Associates, etc.

Fun fact: Sequoia was founded by Don Valentine who was a salesman at Fairchild Semiconductor, and Eugene Kleiner of Kleiner Perkins Caufield & Byers was one of the eight co-founders of Fairchild Semiconductor. All thanks to Mr Arthur Rock!

In 1973, the National Venture Capital Association (NVCA) came to life in the United States in support of  venture capital in Washington. Even today, they're still speaking up for venture capital firms, the companies they invest in, and the whole system of entrepreneurship.

Overall, the 80s were a superb time to be in VC since many risky companies that were backed by VCs started to provide big time returns. But, the 90s is where things got really interesting, with the emergence of the internet and personal computers.

1990s - 2000s 

Dear Internet,

Oh the Internet. And how that changed everything.

In the early 1990s computers started appearing in more and more people’s homes, whereas before they were generally only found at work or in classrooms.

This decade ushered in a wave of new companies, which are now the most iconic companies in the tech world, the likes of Google, Amazon, Yahoo, Netflix, PayPal, eBay, etc.

It was a glorious time to be a tech entrepreneur and a VC investing in tech. Investors became millionaires overnight as some of these companies went public, and everyone wanted their share of the pie. Whereas in 1991 only $1.5 billion had been invested in tech, by 2000 that amount had risen to more than $90 billion. The hype was real.

But then…

The Dot Com Bubble Goes Poof

Not everything good lasts, and the same applies to the VC world. A bunch of companies closed down during the dot com bubble burst, taking many VC dollars with them. And when we say companies closing down, we’re talking about massive ones, not just a few small startups.

Some examples of companies that shut down at the time:

  • Boo.com, an online clothing store which couldn’t make it even though it went through $135 million in 2 years.
  • Pets.com, an online pet supply store in which Amazon owned 50%, closed down 9 months just after its $82.5 million IPO.
  • Webvan, an online grocery store, was liquidated after its glorious $1.2 billion valuation.

That’s a lot of money lost right there, and a shock to all the VCs that had joined the bandwagon and were waiting for their big returns.

However, not all bad things last either, and it’s often in the toughest moments that the real gems are created.

The Era of Apps and Accelerators 

Although a lot of money was lost, VCs were still excited about the tech sector as innovation was booming. There was also a shift in the way VCs invested, as they now focused their portfolios and funds on stages and industries. This era gave birth to companies like Airbnb, Uber, Facebook, Reddit, and Dropbox.

Simultaneously, accelerators were popping up everywhere. Y Combinator, the most popular accelerator for startups (which backed companies like Airbnb and Dropbox), was started in 2005 by Paul Graham, Jessica Livingston, and several others.

YC's first batch: Summer 2005

Around the same time, Seedcamp was launched in the UK, and other renowned accelerators like Techstars and 500 Global were created. It’s now common practice for startups to participate in accelerator programs because of the cash injections, mentoring, and connections they can get access to. Along with the rise of accelerators, a whole new startup culture started forming around pitch competitions, conferences, hackathons, and startup courses.

Not only that, but startups were becoming a part of pop culture with shows like “Silicon Valley” and movies like “The Social Network”. 

For the first time ever, entrepreneurs such as Mark Zuckerberg and Jack Dorsey held the same celebrity status as movie stars.

Now

The world of venture capital has continued evolving in the last decade, and it will keep changing as technology evolves, especially with the rise of AI and the increasingly lower costs and accessibility to starting a startup.

A notable change in the way VCs invest has been the emergence of micro VC funds. Micro VC funds invest in early-stage companies and typically invest smaller amounts of money than traditional VCs, focusing on pre-seed or seed stage startups. 

They usually invest between $500,000 and $5 million in a company and fund sizes tend to be anywhere between $20 million and $100 million.

Some popular micro VC funds are:

  • Baseline Ventures
  • Wischoff Ventures
  • Cowboy Ventures
  • Forerunner
  • Homebrew
  • Draper Associates
  • Initialized Capital
  • Spark Global,
  • SignalFire

See the full list at EQVISTA.

The last decade has also been marked by the emergence of what is known as “unicorn” startups. The term unicorn was coined in 2013 by Aileen Lee, founder of Cowboy Ventures. It first appeared in a TechCrunch article called “Welcome to the Unicorn Club,” celebrating startups with a valuation of $1 billion and above.

At the time, only 39 companies were part of the unicorn club. Since then, 2,700 startups from around the world have achieved unicorn status. There are now also several decacorns - private companies with a valuation of $10 billion or more, such as SpaceX and Stripe.

There will always be ebbs and flows, but overall, VC remains an active source of capital for startups, and it will keep adapting and evolving alongside the tech sector. Investors will always have an appetite for high risk ventures, and there will always be innovators and entrepreneurs who need that initial pay check to get things off the ground.

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