Bankrolling Creative Destruction

Abstract

Bankrolling Creative Destruction Robin Wolfe Scheffler (bio) Tom Nicholas, VC: An American History. Cambridge: Harvard University Press, 2019. vi + 382 pp. Figures, appendices, notes, and index. $35.00. In the aftermath of the Great Depression, Harvard economist Joseph Schumpeter hailed entrepreneurs as the vehicles of capitalism's renewal. Unlike sclerotic corporations or government bureaucracies, entrepreneurs were agents of "creative destruction"—their risk-taking fostering ongoing technological transformation. At the close of the twentieth century, the high-technology startups of Silicon Valley appeared to embody this hope, promising the "disruption" of whole industries. However, these enterprises and the bold futures they promised could not have come into being without the support of a new form of financing: venture capital. In VC: An American Story, Tom Nicholas charts the history of venture investing from the nineteenth century through its modern ascendency in four phases. Venture capital is a species of "risk capital"—investments in enterprises that are likely to fail but may occasionally be extraordinarily profitable. Venture capital managers promised investors expert guidance, or "intermediation," to select and structure their investments to minimize the risk of losing money while preserving the potential for large gains. This strategy stands in contrast to a more conventional method of selecting investments that are thought likely to produce modest profits and shield capital from loss. In the first phase, from the nineteenth to mid twentieth centuries, Nicholas seeks the historical antecedents of venture investing. Whaling voyages, for example, had a payout structure similar to venture capital investments. Voyages were too expensive and risky to invest in individually, so wealthy merchants within the Quaker communities of Rhode Island and Massachusetts invested through agents, who offered superior knowledge of the outfitting and crewing of ships. This included not only selecting the right crew but also transferring a share of the financial risk of failure to them by paying via shares of profits (if any) rather than wages (pp. 33–34). A generation later, groups of businessmen in New England towns such as Lowell, Massachusetts pooled money to back engineers who claimed that they could construct improved textile looms based on purloined British technology. This was similar to the style of more [End Page 470] recent high-tech venture investing—investors gained equity stakes in the mills rather than promises of repaid debt (p. 56). Geographic and social clustering was a hallmark of these early investment efforts. With information about entrepreneurs hard to come by, clusters allowed investors to draw on a broad range of technical expertise to evaluate proposals, often provided by local universities. Firms could draw on networks of investors tied by mutual trust to raise more money. Often investors would also take a role in managing new firms they backed—far easier if the firm was in the same city. These dynamics drove clusters of investment around the automobile industry in Detroit and the electronics industry in Cleveland (pp. 62, 86). Not all high-technology-based businesses were appropriate for these approaches. Capital-intensive railroads, for example, turned to issuing bonds (p. 57). The modern outlines of venture investing were suggested by the strategies developed by trustees of the immense family fortunes created during the Second Industrial Revolution (pp. 100–101). Without the need to follow set rules or even generate substantial returns, family funds were often drawn to exciting new technologies such as aviation or electronics rather than more prosaic investments. They also had the ability to structure their investments in more sophisticated ways to address the substantial risks—establishing tiers of financing and taking a role in the oversight of companies. Laurence Rockefeller, one of the heirs to the Rockefeller Oil fortune, popularized the idea that investing in "pioneering projects" even served philanthropic ends by producing industries that would shape the future (pp. 91, 99). During the second phase in the development of venture capital, from the 1940s to the 1960s, the legal structure and regulatory environment of venture funds shifted to tap into larger pools of capital controlled by fiduciary bodies—institutional investors such as insurance companies and pension funds. These organizations were bound by law to avoid risky investments, which foreclosed their support for many entrepreneurs. Seeking to address this challenge, the...