During tough times, people naturally seek out wisdom from their elders. And as today's financial crisis deepens, my thoughts have returned to Georges Doriot, a visionary French immigrant and legendary Harvard business school professor who pioneered the U.S. venture capital industry.
Venture capital has existed in one form or another since the earliest days of commercial activity. The Spanish monarchy and the Italian investors who financed the TransAtlantic voyage of Christopher Columbus were, in a sense, venture capitalists. But it wasn't until the second half of the 20th century that venture financing became a professional, large-scale industry. And the man who led that transformation was General Georges Frederic Doriot.
In 1946, after leaving the U.S. military, General Doriot became president of the first public venture capital firm: Boston-based American Research and Development Corporation (ARD). Over the next twenty-five years, ARD financed and nurtured more than 100 start-ups, many of which became huge successes that pushed the frontiers of technology and business. ARD's biggest hit: minicomputer maker
Digital Equipment Corp.
in 1957. By 1972, when ARD liquidated its $70,000 investment, it was worth more than $400 million.
While Doriot chided investors who chased short-term
returns, his philosophy of patient investing -- building for the long-term -- retains enormous value for today's investment community. My biography of Doriot,
, contains many of these lessons. But in this column, I have collected some nuggets from the book and other research materials to give you a taste of his ideas that have stood the test of time.
In the spring of 1961, Doriot articulated his vision when he addressed the Chicago Society of Security Analysts in a speech titled "Creative Capital." By that time, ARD had created an impressive track record: it had invested $11 million in 66 ventures that, by 1960, were worth about $30 million. Sales of 29 other ventures had yielded
capital gains of $3 million, offset by a capital loss of $850,000 from only nine failures.
It was an impressive performance. How did Doriot maintain such a high batting average?
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
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
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.
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