By Anant Gupta
What do the biggest companies in the world such as Facebook, Google or Alibaba have in common? All of them were once backed by Venture Capital (VC) firms possessing a deep trove of funds, which enabled them to continue innovating despite not-so-promising results early on.
A venture capital firm provides equity capital and/or loan capital to promising ventures for returns that are higher than market interest rates. Most VC firms follow the Pareto principle when expecting returns – 20% of their investments result in 80% of their wins. Though venture capitalism seems like a recent blessing in disguise for young startups with new-age products, the idea of venture capitalism can be traced back to the latter half of the 20th century. The credit goes to Georges Doriot, who floated the idea of creating an investment fund to assist promising companies for their future growth. Known as the ‘father of venture capitalism’, Doriot paved the way for a legion of entrepreneurs whose firms stayed on top due to the rock-solid support from venture capitalists along the way.
Born in France, Doriot was an army veteran before he landed in the United States in pursuit of a management degree from MIT. However, his father’s friend’s close association with A. Lawrence Lowell, president of Harvard, led him to study management at Harvard Business School, an institute where he would go on to teach for over 40 years.
The dawn of venture capitalism
During World War II, Doriot, now a naturalized American citizen joined the military to aid the American army. Utilizing his rich army experience, he headed the Military Procurement Services and rose to the rank of General. Many of his students occupied numerous positions in the army, including his superior, who happened to be an MBA student of Doriot in the 1920s. At the time of war, many new technologies and military equipment were the need of the hour and his contribution to the same was very significant. Under his leadership, military uniforms and weapons for the troops were upgraded.
After the war, from a business standpoint, the serious demand for innovative technology did not go unnoticed under Doriot’s keen eye. “By partaking in the development of new technologies and industries during the war, the US government had assumed significant risk,” asserts Harvard Business School Professor Tom Nicholas. “The fact that several of these risks paid off–in ways that Doriot had seen firsthand–primed investors to take similar risks following the war.”
Doriot wished to leverage his managerial experience and well-spread network to create an investment fund which would support the growth of these new-age technology companies. In 1946, Doriot, along with Boston’s leading candidates formed the American Research and Development Corporation (ARD) also known as the world’s first publicly owned venture capital firm. The objective of the new firm was simply to, “…aid in the development of new or existing businesses into companies of stature and importance.”
Until the formation of the ARD only the wealthy families of America – the Rockefellers, Hiltons and the Vanderbilts were the benefactors of large funds for projects requiring such funds. This funding was few and too far in between, which according to Doriot, led to the unrealized potential of many companies. Through ARD, Doriot planned to support such companies, not only through funding, but also through expert management advice, support and guidance in making critical decisions. The credentials of its board was certainly worthy of such a cause – Karl Compton, president of the Massachusetts Institute of Technology (MIT); Ralph Flanders, president of the Federal Research Bank in Boston and later senator from Vermont; Merrill Griswold, head of Massachusetts Investments Trust.
How ARD viewed potential investments
At ARD, Doriot received hundreds of proposals but invested in only a small percentage of them. According to Doriot “It’s not just the lower valuations you get at the formation stage, but it’s also that you are working from a blank slate with respect to everything and you can work with the founding team to form the culture, the strategy, the team, etc.” After careful scrutiny, the firm’s prized portfolio companies included Circo Products (automobile tools), High Voltage Engineering Corp (high-powered generators and nuclear particle accelerators), Tracerlab, Inc. (analytical instruments and radiation detectors), Baird Associates (chemical analysis instruments) and Ionics (water purification).
Doriot did not believe in turning companies around for an instant profit but rather staying with them for the long term and through challenging periods. William E. Barbour, Jr., the founder and president of Tracerlab, recalled, “The general (Doriot) provides the two things that a young scientific organization most needs–enthusiasm and appreciation. Like all the others, I started out with a hatful of ideas and a lot of long-range plans. In a couple of years, I got bogged down in detail. Doriot stepped in just in time to pull me out of the rut”.
Hitting the home run – investment in DEC
ARD’s phenomenal success came single-handedly from its decision to support Kenneth Olsen and Harlan Anderson’s request for $70,000 to start up Digital Equipment Corporation (DEC). In its first year, DEC turned a small profit by making these Digital Laboratory Modules, but the real payoff came later. In 1968, following DEC’s initial public offering, ARD shares were worth $355 million (which gave him annualized returns of just over 100%) and massive returns on its initial investment. These returns were enough for enterprising people to hop on the venture capital bandwagon.
Giving back to France – the foundation of INSEAD
In the early 1920s, Doriot felt a strong desire to present to Europe a school which resembled Harvard; the globalist in him saw what other business leaders had not even started to visualize. Initially launched as a management program for the middle management, Doriot launched the Centre de Préparation aux Affaires (CPA) in Paris. The method of teaching was based on the case study method just like in Harvard, however here is where the similarity ended. With a vision to eventually build a global school from the ground up, CPA took some strict steps such as ensuring nationality of not more than 1/3rd of professors could be from a single nation. The CPA worked tremendously well, and it led the way for the establishment of the Institut Européen d’Administration des Affaires (INSEAD), a full-time business school with a European outlook. In 1957, he founded INSEAD in France, one of the world’s top global graduate business school.
Doriot’s impact on education and business
Top companies in the world have thrived because there was someone who was constantly backing them up, even when the chips were down. VC firms have tremendous importance in today’s age with, technology such as AI, machine learning and virtual reality bursting onto the scene. Doriot’s contribution in the world of business is undeniable, and so are his teachings. INSEAD was recently ranked the best business school in the world. Ever competitive, it was like Doriot predicted the future of our hyper-competitive world through his quote, “Someone, somewhere, is making a product that will make your product obsolete.”
Remember the Titans is a weekly ode to the inventors, geniuses, and business pioneers who left the world better than they got it. Check out stories of other Titans here.
Anant Gupta is an Analyst at KPMG. He graduated from Delhi Technological University in 2017.
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