Father of Venture Capital

Venture capital is probably regarded as a relatively modern asset class, spurred by the billions of dollars raised for private investments in already valuable firms and the valuations conferred on growing firms in initial public offerings. However, venture capital investing, even early-stage venture investing, has been around since as long as risky new projects have been privately financed. Bridging the gap between the venture investing of old and the modern professional practice was the ‘Father of Venture Capital’, Georges Doriot, and his firm, the American Research and Development Corporation. Even outside venture investing, but perhaps nowhere more so than in it, the father of venture capital left a number of legacies.

Georges Doriot

The ‘Father of Venture Capital’ was born in Paris in 1899. Georges Doriot was the son of an automotive engineer and racecar driver for what would later become Peugeot Motor Co. He served during the First World War as an artillery engineer before coming to America to study at the Massachusetts Institute of Technology. However, he was convinced to study at Harvard Business School over MIT by the President of Harvard who recognized that Doriot really wanted to run an auto factory one day and not design car engines. In any case, he never graduated anyway. Nonetheless, after his time as a student, Doriot worked at the investment bank Kuhn, Loeb, & Company in New York before returning to Cambridge, Massachusetts to join the Harvard Business School faculty.

Doriot would serve as a Harvard assistant dean and a professor in industrial management for forty years. His course, more general than its name “Manufacturing” suggested, tested second year students’ general management skills. He also helped develop one of the first business management academic programs in Europe, the Centre de Perfectionnement aux Affaires in Paris. Closer to his adopted home, Doriot was involved in civic projects in Boston, including through the New England Council, a group aimed at reviving the economy of New England in the 1920s. His civic engagement extended to the military; Doriot taught classes at the U.S. Army Industrial College part time in the 1930s.

Soon after his naturalization as a U.S. citizen in 1940. Doriot served during the Second World War, overseeing research and development projects. He retired as a brigadier general in 1945 having earned a Distinguished Service Medal from the U.S. and honored with an Order of the British Empire and the French Légion d’honneur as well. He thereafter became known as ‘General’ Georges Doriot. Through his wartime service, Doriot developed a rolodex of industrial and scientific contacts in addition to his list of honors. His contact list was already vast from his time at Harvard, his position on the boards of several companies, and his work as a consultant to investment banks.

ARDC

Even prior to his foray into venture capital (‘VC’) investing, General Doriot was clearly an accomplished man. His entry into venture investing was enabled by his work before the war. Back at the New England Council, Doriot was a member of its ‘New Products Subcommittee’, which focused on addressing the issues faced by local firms in rising industries. Doriot and his future partners came to learn of the barriers faced by innovative new companies. Key among their issues was a low access to capital or more specifically, the lack of investment firms specialized in assessing new ventures which were usually engaged in frontier areas of science and technology.

Seeking to resolve this barrier to innovation, Doriot played an instrumental role in forming the American Research and Development Corporation (‘ARDC’) in 1946. The company has come to be regarded as the first venture capital firm open to public investors. Other contemporaneous VC investors were wealthy families who took no outside money to fund their investments and even these were few. ARDC provided an alternative investment vehicle to investment trusts that focused on safer investments and the company specialized in venture capital investing exclusively.

To be sure, ARDC was not established by Doriot alone. He was joined by other prominent New England academic and business leaders. These included Ralph Flanders, the President of the Federal Reserve Bank of Boston, a trustee at MIT, and a future U.S. Senator from Vermont. There was also Karl Compton, the President of MIT who served alongside Doriot at the New England Council. Further enhancing the expertise of its officers was Merrill Griswold, president of a different MIT, the Massachusetts Investment Trust, a large asset manager and one of the earliest mutual fund managers in the United States.

Investments

To fund its initial investments, ARDC raised just under $3.6 million by the end of February 1947. Participating institutional investors included investment trusts, life insurers, and university endowments and these provided roughly half of this initial capital. Individual investors provided the other half. Despite the relatively large size relative to the small investments the firm would make, the company was careful in putting this money to work. In no year did it fund more than 4% of business plans received. The firm’s focus also shifted in these early years. Though initially focused on chemical and industrial firms, ARDC gradually shifted towards electronics, data, and scientific instrument companies.

The firm’s most financially successful investment was that made in Digital Equipment Corporation (‘DEC’) in 1957. DEC was founded by an MIT student and Navy veteran, Kenneth Olsen, and had the goal of selling computers to businesspeople. This was an idea that was arguably ahead of its time, but the company still proved successful in marketing smaller and less expensive alternative to mainframes. Doriot’s firm acquired a 70% stake in DEC for $70,000 in equity funding and a $30,000 loan. ARDC liked to invest in both debt and equity.

The DEC investment proved enriching. The company’s valuation grew through the 1960s and DEC came to comprise an outsized portion of the ARDC portfolio following its IPO in 1968 which valued ARDC’s stake at over $38 million. The value of DEC shares continued to fly higher and by 1971, ARDC’s stake in DEC was worth $355 million.

“It should again be emphasized that American Research is a ‘venture’ or ‘risk capital’ enterprise. The Corporation does not invest in the ordinary sense. It creates. It risks. Results take more time and the expenses of its operation must be higher, but the potential for ultimate profits is much greater.” – Georges Doriot in ARDC’s Annual Report, 1951

Nonetheless, the company invested in other firms in other industries. ARDC had put $3.6 million to work across 18 companies by 1961. In his life, Doriot would invest in over 150 startups and even small investors got a piece of the action. ARDC was, after all, the first VC firm with publicly listed shares. This provided some early advantages. As essentially a publicly-traded closed-end fund, the firm could allocate capital to illiquid investments while still giving investors the ability to exit their investment at minimal cost. So, open-end investment trusts that could not feasibly invest in venture capital directly could invest through a firm like ARDC.

ARDC achieved a 14.7% rate of return between 1946 and 1971, beating the Dow Jones Industrial Average which delivered a 12.8% return over the same period. However, excluding the DEC investment, the firm generated only a 7.4% return per annum, trailing the index. Nonetheless, VC investing returns are naturally driven by the few top performers.

In any case, the formation of VC limited partnerships and small business investment companies (‘SBICs’) starting from the late 1950s meant ARDC now had real competition from firms that took advantage of these even more favorable legal structures. ARDC also struggled to retain employees who frequently left to start their own firms or seek higher compensation elsewhere. Many saw what was possible with the DEC investment and wanted to replicate that success for themselves. The end for ARDC drew near when Doriot retired in 1972. The company merged with the industrial firm Textron the following year.

Then and Now

Some things have changed little about VC investing since the days of ARDC and General Doriot. Investment approval rates remain low and few deals come from unsolicited sources; most of ARDC’s deals came from referrals. Then as now, VC firms have favored local investment targets in their geographic vicinity and the company spent much effort on monitoring and assisting portfolio companies. Georges Doriot and other ARDC staff typically served on the boards of firms they invested in.

That said, some things were unique about ARDC and this was not limited to its legal structure as a publicly traded corporation. ARDC also leveraged its university neighbors to a peculiar extent. Harvard and MIT faculty and administration sourced some of ARDC’s early deals. Further setting ARDC apart, the company sourced very few deals from other early VC investors, suggesting that firms co-investing in each other’s deals was rare at the time.

Legacies

Doriot left many legacies. One of these was his “Manufacturing” course at Harvard Business School and its students. These students included future CEOs of Ford and American Express. Other pupils tried their luck in venture investing, these included Arthur Rock, an early Apple Inc. investor and the founder of the VC firm Mayfield. Then there were another set of alumni at ARDC. Employees William Elfers and James Morgan left ARDC in 1965 and founded Greylock Partners, which was then based in Massachusetts. Other ARDC employees left to establish Flagship Ventures and other VC firms.

Through his civic engagement and ARDC’s effect on innovation in the Boston area, Doriot helped New England transition through de-industrialization and towards research and technology. Especially in the first half of its history, ARDC focused especially on Massachusetts based firms. Recall also that some of the firm’s alumni left to establish other Boston-based VC investment firms.

Doriot also contributed to education. Along with a French student of his, he founded INSEAD, the Institut Européen d’Administration des Affaires, in 1959. What is today one of the best business schools in the world had both humble and grand beginnings. INSEAD’s first home was the Château de Fontainebleau outside Paris, where an art school functioned in the summer; INSEAD borrowed the palace in the winter. Doriot’s former student Claude Janssen serves as the school’s honorary chairman to this day. His other major academic contribution, the Centre de Perfectionnement aux Affaires in Paris later became part of HEC Paris, France’s other great business school.

Lesson

An honored veteran of the two World Wars, the founder of two business school programs, a director in several large corporations, and a professor for forty years at Harvard Business School, ‘General’ Georges Doriot would have had an impressive list of accomplishments even had he never been associated with venture investing. However, through the firm he founded, led, and served for nearly its entire independent existence, Doriot earned the byname of ‘father of venture capital’. He stood in time between a VC industry that was nascent and the exclusive preserve of a small handful of wealthy families and the modern industry of limited partnerships and billion-dollar funds. ARDC’s success, even if not particularly long lived, helped transform this corner of the financial system.

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