Creating Modern Venture Capital: Institutional Design and Performance in the Early Years

Abstract

This paper presents a range of new evidence on the development of the US venture capital industry in the 3 to 4 decades following World War II, the period in which modern-style venture capital was created. The paper reveals details of supply and demand for venture capital services and underscores the critical roles that individual entrepreneurs played in creating a viable venture capital industry in the United States: On the supply side, entrepreneurial financiers like Georges Doriot, William Elfers, and the many founders of SBICs; on the demand side, the pool of qualified and interested entrepreneurs that appeared in the aftermath of World War II.

The paper also provides new measures of the aggregate supply of and demand for venture capital finance in the era before large-scale databases were collected. In addition, by examining the personal papers of Georges Doriot, the driving force behind the first public venture capital company, as well as the recollections of a few venture capitalists of the 1960s vintage, the paper provides some qualitative corroboration to the quantitative results.

The paper also offers new results on comparative performance of firms backed by early venture capitalists, ARD, Greylock, and the publicly traded SBICs. The findings suggest strong performance among venture-backed firms overall, even at this early stage of the learning process, with common stock returns consistently outperforming those of the broader market (S&P 500) on average. In other words, investors at the time would have fared significantly better by investing their funds in a comprehensive portfolio of venture backed firms starting as early as the first such investments went public. While there is some evidence that the privately-backed venture capital firm offered the greatest advantages to its portfolio firms — or at least selected better performers — the differences are statistically weak. These firm-level returns also demonstrated higher variance, and therefore risk; so higher returns, as expected, came with a cost. Indeed, for the narrower time frame of the 1960s and 70s, Greylock firms performed below the ARD and SBIC-backed firms on average, but they also grew more rapidly over that period.

Keywords: venture capital, Small Business Investment Companies (SBICs)

JEL Classification: G24, N22