The History and Future of Venture Capital Investing

Is venture capital a good investment? For long periods in the past, the best VC firms had spectacular returns, as their outside investors or “limited partners” – pensions, foundations, endowments, wealthy individuals – participated in the emergence of great companies such as Intel, Microsoft, Apple, and Amazon. But, going forward, can VC investors expect the same returns? Or are we in a new era of lower returns and a more challenging environment?

Innovation and the implementation of new technology, through the support of new businesses, has always been at the heart of economic progress. For centuries, this work was done by wealthy families, monarchs, and governments. But, starting in the mid-twentieth century in the United States, the VC firm, a wholly new type of investment management enterprise, began to seek and use capital from outside investors, as well as by the firm’s owners, to fund and nurture new business ventures.

Learning the history of this transformation helps us discern an answer to the questions I posed at the outset. The Harvard Business School professor, Tom Nicholas, has written a penetrating history of the industry that focuses on the early years and brings the story of VC up to the end of the last century.

By “technology,” of course, I do not just mean computers, rocket ships, or the latest whiz-bang smart-phone app. I mean whatever makes it possible to do more with less: railroads and telecommunications in the 1800s, the fruits of electrification in the early 1900s, the automobile and airplane shortly thereafter, and the thousands of lesser innovations that added up to a highly productive economy instead of a survival-based one. Nicholas fully appreciates this economist’s definition of “technology,” and shows how venture-oriented investors have helped to fund and shape all kinds of technological innovations throughout modern history.

(Don’t) save the whales

If they don’t study the past, leaders of businesses cannot begin to understand the future in which they will be operating. While no one can predict the future with accuracy, students of business history find that there are patterns that repeat, over and over, shedding light on today’s challenges. The Harvard professor Tom Nicholas’ book on venture capital, VC: An American History, reaches far back in time and into activities that are alien to us to find such patterns:

[N]ineteenth century whaling can be compared to modern venture capital... [W]haling was the archetypical skewed-distribution business, sustained by highly lucrative but low-probability payoff events... The long-tailed distribution of profits held the same allure for funders of whaling voyages as it does for a venture capital industry reliant on extreme returns from a very small subset of investments. Although other industries across history, such as gold exploration and oil wildcatting, have been characterized by long-tail outcomes, no industry gets quite as close as whaling does to matching the organization and distribution of returns associated with the VC sector.