Open Book: Important Lessons from a Venture Capital Pioneer

The first rule: "The riskiest part of the spectrum has to date proved the most rewarding, and the greatest capital gains have been earned in companies which were started from scratch." In fact, ARD's first successful investment, High Voltage Engineering, was started by two MIT professors with little or no business experience, whose only product, an incredibly powerful generator used in cancer therapy, had no known market.

Second, in the case of venture investments, "it takes patience for the company's growth curve to develop and, the return to be realized." The stocks of some ARD companies, such as High Voltage and Ionics, took several years before the company's begin to fulfill their potential. "What the stock record shows," said Doriot, "is that many of these affiliates had serious crises early on in their lives when many an investor was tempted to abandon the long-range program." Most venture investing has not been "built on achievement of dramatic overnight successes, but on the steady growth of soundly based, well-managed affiliates."

Third, "technology has proved a rewarding field for ARD and is particularly well suited for creative capital investment." The reason? "In specialized technical areas with products protected by patents and know-how, it is easier for small companies to compete with large organizations," explained Doriot.

When evaluating an investment opportunity, Doriot relied on certain guideposts to base his decisions. Among the key factors:

Management: Doriot considered management as the most important business factor of success. Managers, wrote Doriot, should be "competent in their specialty and dedicated to the purpose of building a successful young company, even if inexperienced in many facets of business administration." The best managers have "technical creative competence," a "drive for recognition or monetary reward," and a strong work ethic "supplemented by a balanced personal life."

Innovation: Products or processes must be preferably beyond the developmental stage, protected by patents and know-how.

Growth: A field of business activity, usually technological, with growth characteristics.

Those are some reasons to invest in a company. But there are just as many reasons not to invest in a company. Sometimes it's the investment that you don't make that is the smartest decision. Doriot kept a list of reasons for not investing. After all, venture capitalists are in the business of saying no to entrepreneurs. Typically, ARD invested in 1% of the companies that came through its office. Among the reasons not to invest:

No proprietary products or abilities.

Product not yet developed -- feasibility can not be determined.

Low profit -- highly valued at too many times earnings.

Lack of growth potential -- competitive nature of business.

Unfavorable reaction from potential clients or distributors.

Recent association of principals with competing company. Fear of a poor ethical situation.

Let's say you've made an investment in the Digital Equipment of your generation. When should you sell the stock? The art of selling is one of the least-discussed but important investment decisions. Although Doriot invested mostly in private companies, he developed an expertise in investment management after taking public and managing the securities of many of ARD's portfolio companies. Among his reasons to sell:

Because hope seems gone.

The company is OK but not outstanding.

The best growth period has passed.

A new company often succeeds initially by showing superiority on one factor or product only. Trouble often comes when one fails to bring up other factors.

Lack of good succession in management.

Finally, Doriot's story is a reminder that all companies are involved in venture capital. Large companies must always keep a watch on disruptors. Digital disrupted IBM (IBM Quote). Then Apple (AAPL Quote) pulled the rug from underneath Digital. And on and on goes the creative destruction.

"Even in a large company, lack of attention to technical and commercial evolution, to aging methods, perception and decision-making ability, can make a company -- and sometimes without much notice -- shift from adventure to misadventure, and from stable capital to creative capital," Doriot once wrote. "Size and stability bring to a company a greater mistake-absorbing characteristic." But no company -- no matter how small or large -- is immune from change. Words of wisdom to keep in mind, when managing your investments.