Venture Forward’s mission is to shape the future of venture capital. But in order to shape the future of our industry, it is important to preserve and understand our past. The history of modern venture capital (VC) does not go back as far as most other industries; however, in just a short time, the VC industry has had an outsized impact on our economy, innovation, and society. By taking account of our past, the VC industry today can learn from the legacy of previous luminaries, and current and future VC leaders will add new chapters to the industry’s history, continuing to shape the narrative of VC and helping to fuel our economy for the next 50+ years.
A Brief History of Modern Venture Capital
- 1946 & the early days of modern VC
- Notable public policy for VC in the 1970s & the formation of NVCA
- Venture capital establishes itself as an asset class
- Early successes for VC-backed companies
- Rise in venture capital, the Dot-com boom & bust
- Venture capital + services model
- Proliferation of Micro VCs, growth in corporate venture capital investing & non-traditional investors
- Focus on a healthy ecosystem & increasing diversity among investors, founders, geographies
- What’s next?
1946 & the early days of modern VC
The first modern VC firm was formed in 1946 – American Research and Development Corporation (ARDC) – 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. The latter is often referred to as the “father of venture capital.”
ARDC was a public company that raised capital from sources other than families (i.e., universities, insurance companies, mutual funds, and investment trusts) to make private investments in companies leveraging technologies developed during World War II. ARDC’s major success came from its investment Digital Equipment Company (DEC) in 1957 for $70,000 and a 77% stake in the company. The company’s value increased to $355 million over the next 14 years, thereby setting the mark for the potential high returns that risk capital could achieve through VC funding.
Prior to ARDC, wealthy families such as the Vanderbilts, the Rockefellers, and the Whitneys were the main source of risk capital for private companies, forming the early roots of both private equity and venture capital investing in the United States. ARDC proved that there was interest from institutional investors (not just family money) to invest in VC firms, and that risk capital could provide hand-on, active management, not just money.
ARDC’s and Doriot’s impact remains in the fabric of the industry today through former employees or students who went on to form VC firms including Greylock, CRV, Mayfield, and Venrock.
Arthur Rock was also a student of Doriot’s and is tied to several notable milestones in the VC and technology sectors. As a banker in the 1950s, Rock helped secure funding from serial entrepreneur Sherman Fairchild to help eight founders in the Bay Area form transistor company Fairchild Semiconductor in 1957. The eight cofounders then invested in new startups and helped Rock start the Bay Area’s first VC firm Davis & Rock, which went on to fund successful startups Teledyne and Scientific Data Systems. Rock also went on to provide early funding to iconic American companies Intel and Apple. Before 1957, the country’s VC firms were primarily in the Northeast region (Boston and New York).
The VC industry’s roots are also traced to the year 1946 through the formation of two VC firms: J.H. Whitney (still in existence today) by the Whitney family and Rockefeller Brothers, Inc. (now Venrock) by the Rockefeller family.
Notable public policy for VC in the 1970s & the formation of NVCA
Small Business Investment Companies (SBICs) – As the interest to investment in small businesses emerged in the 1950s, the Small Business Investment Act of 1958 saw the U.S. government give the Small Business Administration authority to create new SBICs to finance early-stage companies in a manner similar to venture capital. In its early days, SBICs controlled most of the risk capital in the U.S. However, SBICs proved to be mainly a source of capital, not the active management that VC firms were providing, and other challenges surfaced for SBCIs based on their structure. The SBIC program still exists today but has scaled back since the mid-2000s.
Revenue Act of 1978 – This legislation reduced the capital gains tax rate from 49.5% to 28%, increasing the tax advantage of capital gains to 42%. This advantage was later reduced to 30% with the Economic Recovery Tax Act of 1981.
Changes to the Employee Retirement Income Security Act’s (ERISA) “prudent man rule” in 1979 – Pension funds are an important source of capital to VC funds today, but there were limitations on pension fund commitments to VC, a high-risk asset class, as a result of ERISA passed in 1974. With the relaxation of the “prudent man rule” in 1979, pension funds were allowed to allocate up to 10% of their capital to VC funds. As a result, a large and important new source of long-term capital opened for the growing number of VCs in the country.
With the growth and maturation of VC in the 1970s, it became clear that the industry would need to have a lobbying voice in Washington, DC. Venture Forward’s supporting organization, the National Venture Capital Association (NVCA), was formed in 1973 as the trade organization advocating on the federal level on the behalf of VC firms and their portfolio companies.
Venture capital establishes itself as an asset class
In the 1960s, the common structure of venture capital funds used today—limited partnerships—emerged (see Venture 101). Other notable West Coast firms, still in existence today, were founded in the 1960s: Sutter Hill Ventures, Asset Management Company, Mayfield, Norwest, and Venrock. Also, Morgenthaler Ventures, based in Cleveland, OH and Menlo Park, CA, was founded in 1968 by David Morgenthaler. Several VC firms in the Boston area also formed in the 1960s, most notably Greylock, Charles River Ventures (now CRV), and Fidelity Ventures.
Venture capital emerged in the 1970s as an asset class with a growing number of firms on both the East and West Coasts, public policy changes that saw more capital flowing to VC, and an industry transforming into a more institutional structure. Several of today’s largest VC firms formed that decade:
- Sequoia Capital, founded in 1972 by Don Valentine, who was a salesman at Fairchild Semiconductor.
- Kleiner Perkins Caufield & Byers, was also founded in 1972. One of its four founders is Eugene Kleiner, who was one of the eight co-founders of Fairchild Semiconductor.
- Bessemer Venture Partners was created as a VC firm in 1974 though Bessemer Securities pre-dated the formation of the VC firm as a family office.
New Enterprise Associates, Menlo Ventures, Sofinnova Ventures, Matrix Partners, and Oak Investment Partners were formed later in the decade.
Early successes for VC-backed companies
The 1970s and 1980s brought successful exits for VC investors and created some of today’s biggest companies: Apple, Genentech, FedEx, Microsoft, and Electronic Arts.
More new firms emerged on the coasts in the 1980s. As of 1985, there were more than 290 active VC firms in the U.S., managing more than $17 billion and 530 funds.
Rise in venture capital, the Dot-com boom & bust
The rise in personal computer usage and the internet becoming more mainstream led to a boom cycle in the 1990s. Companies like Netscape, Amazon, eBay, Netflix, Paypal, Yahoo, Google, and Salesforce hit the market, among others, with VC backing. The VC industry ended the decade with more than 700 active firms managing $143 billion, more than 5x the capital the industry started the decade with. 2000 brought the end of the dot-com bubble though VC firms still managed about $225 million by the end of that year.
Venture capital + services model
The post-Dot-com period ushered in a new wave of VC firms, many with a more targeted focus on certain sectors or stages. Whereas personal computers and broader access to the internet were core to the previous VC investment cycle, software, services, and social media headlined the mid-2000s to the mid-2010s. Going back to the roots of VC from its early days, VC investors expanded on the value they brought to the table for entrepreneurs, beyond capital. A new meaning for active management formed as VC firms created new ways to help entrepreneurs through additional “platform” services like marketing, recruiting talent, and business development.
In addition, accelerators and incubators, also offering services beyond capital, emerged to shake up the traditional lifecycle of investing in early-stage companies. Pitch competitions and accelerator “batches” entered the VC vernacular, as companies at the seed stage had additional resources and sources of capital to turn to.
The VC industry reached another peak in number of active firms (~900) and capital managed (~$230 billion) before the 2008 Global Financial Crisis brought another correction to the U.S. economy and the venture ecosystem.
Proliferation of Micro VCs, growth in corporate venture capital investing & non-traditional investors
The 2010s brought new types of VC investors to the mix, diversifying the sources of capital available to startups. Notable among these has been the creation of micro VC firms, almost as a sub-asset class of VC. These firms invest small amounts of capital into a large number of seed or pre-seed stage companies. Though the risk is higher for firms at these very early stages of a company’s growth, the return potential is commensurate. The sheer number of firms that began operating in this space transformed early stage investing from what it looked like pre-2010. A seed stage investment today looks like what a Series A investment was before, as the cost of starting a company in many cases has also fallen. The number of angel and seed deals completed reached a record peak in 2015 and has since subsided but remain elevated compared to early 2010 levels.
An influx of corporate venture capital groups and more participation from private equity funds, hedge funds, mutual funds, and other non-traditional investors coincided with the micro VC shakeup on the early stage side. Traditional, institutional VC firms continued to control the private capital available to startups, but these non-traditional sources of capital began to play an increasingly important role for startups.
The 2010s also brought a new term, “unicorn,” to the VC vernacular, coming to mean an elite status of VC-backed companies that reach a valuation of $1 billion or more while still private.
Focus on a healthy ecosystem & increasing diversity among investors, founders, geographies
Venture capital has been a cottage industry, and activity for both founders and funders remains concentrated in the hands of certain geographies (California, Massachusetts, and New York), though healthy emerging ecosystems have emerged across the country recently. At the same time, investment partners, i.e., decision-makers at firms, and founders have been predominantly white and male. Similar to how the VC industry banded together in the 1970s to create NVCA, several firms, individuals, and organizations in the last few years have prioritized expanding VC to other parts of the country and to those who have traditionally been underrepresented in the industry. Efforts like Venture Forward, Rise of the Rest, All Raise, BLCK VC, and Latinx VC are working to break some of the barriers that have existed for new entrants to the industry. The momentum of these initiatives and the ecosystem’s support are important to ensuring people of all backgrounds and from all parts of the country have access to VC and the opportunity to thrive in the industry.
The VC industry rode the heels of an 11-year bull market until early 2020 when the U.S. entered a recession and the global pandemic stemming from COVID-19 surfaced. The industry started 2020 with about 1,300 active firms, $444 billion in assets under management, and $120 billion in dry powder (i.e., capital still to deploy to startups).
It is still too early to forecast how the industry will shake out from the current macro environment, but a recent NVCA white paper highlights what we might expect in the coming months. The VC industry has proven its resilience through tough times, and some of the most successful companies formed during downturns. The next big startup is in the works right now!
Source: SVB State of the Markets Report