Heart of Silicon

The fact that Silicon Valley has emerged as the leader in both tech and venture capital in the world is disputed by very few people.

Specifically for VC, it is common knowledge that if you’re serious about building or working for a startup, being an angel investor, or working for a VC firm, the best move is to pack up your bags and head to the Bay.

However, SV was not always synonymous with embracing risk, fearlessly starting companies, and moving from job to job.

The Northeast dominated the tech space, as it had both the technical expertise from Boston (Harvard / MIT) and the capital from New York City.

A variety of factors like the warm weather, emergence of Stanford and Cal’s engineering departments, founding of HP by William Hewlett and Dave Packard, and the Shockley and Fairchild Semiconductor fallout (which could easily be its own memo) played an essential role in the rise of Silicon Valley.

Additionally, the West Coast was more meritocratic than the nepotistic northeast; the idea of young engineers building companies with young bankers funding them lured East Coast talent across the country.

More important than all of these, however, was the creation of the Small Business Investment Act of 1958.

The catalyst for the law was the launch of Sputnik 1 by the Soviets which gave the perception that America was falling behind technologically. 

The law allowed the SBA to license private small business investment companies, known as SBICs, to help with the financing and management of small entrepreneurial businesses in the US.

The SBICs were far from perfect, as due to their ability to borrow four dollars for every one to invest, it led to unnecessarily risky investing, as there was a clear misalignment of incentives.

Government guarantees for the debt meant that it was the taxpayers who were subsidizing these questionable deals.

The government ultimately lost most of the $2B it invested in the SBIC firms. However, the initiative served its purpose, laying the foundation for partnership-based venture firms that remain popular to this day.

The first official VC firm, Draper, Gaither, and Anderson, was founded in 1959 by General William H Draper Jr., a former U.S. Army general and diplomat, H. Rowan Gaither, a lawyer and businessman involved in Cold War-era policy, and Fred Anderson Jr., a retired U.S. Air Force general with a background in aerospace and defense.

The company in its original form did not last long, as Gaither and Anderson left the firm, and was as Draper & Johnson Investment Company in 1962 after Draper connected with Franklin “Pitch” Johnson, a young and ambitious Stanford MBA grad.

The firm started with $150K of family money + $300K of SBIC money and was able to significantly grow its AUM after successful investments like Apollo Computer Dionex, Integrated Genetics, Quantum, Activision, Measurex, Hybridtech, and LSI Logic.

Arguably its most lasting contribution was its fund structure, as its 10 year limited partnership with a 2.5% annual management fee and 20% carried interest rate have remained nearly the same to this day.

Additionally, Draper was the first to vocalize his opinions on the founder versus product-market fit battle, as he believed if you back the right person, “he’ll get you out of a bum business, a bum product idea, a bum service idea, and move you into a better one. But the wrong person with a great idea would never get anywhere and just instead bumble and fumble.”

The second notable venture firm from the early days was Davis & Rock, founded by Tommy Davis and Arthur Rock.

Rock was a banker at Hayden, Stone & Co in NY that found himself frequently flying to and from California to do tech deals.

He had previously helped scientists who left Shockley Labs, due to its lackluster culture, create the company Fairchild Semiconductor after securing financing from Sherman Fairchild. After about four years of flying back and forth, he decided to permanently move to California and start the investment firm with his former banking co-worker Davis.

The company’s first big investment was in Scientific Data Systems, an emerging player in the growing minicomputer market, as they were one of the earliest investors and backed the company in 1962, the year after it was created. The company was acquired in 1969 for more than $900 million, netting Davis and Rock’s investors an impressive return.

The other notable investment from Davis and Rock was Intel, as the company was founded by Gordon Moore and Robert Noyce, who were both scientists from Fairchild that Rock had previously helped.

In addition to underinvesting in research and development, Sherman Fairchild had just passed away, and the new CEO refused to pay the scientists options or give them the appropriate authority over their division.

This prompted Moore and Noyce to exit and found their own company.

SDS, Intel, and other investments led to an extremely impressive track record for Davis and Rock: they were able to return nearly $100 million to their investors after initially investing $3 million.

Despite this success, differences in investment approaches led to the company’s dissolution in the late 60s.

More specifically, Rock enjoyed making highly concentrated bets on a few companies while Davis preferred a more diversified strategy, spreading risk across numerous companies.

The next big venture firm was Kleiner Perkins, founded by Eugene Kleiner, another alum of Fairchild Semiconductor, and Tom Perkins, an apprentice to David Packard from HP.

In 1972, the year it was founded, Kleiner Perkins became the largest VC partnership, as it quickly raised $8 million, with half of that coming from billionaire Henry Hillman.

The duo approached venture capital with a hands-on mentality, as the company was known for organizing its portfolio companies in a keiretsu—a Japanese word that represents a group of companies with interlocking business relationships—as well as distributing audited quarterly and annual reports to investors.

The fund also had very investor-friendly terms like an eight year fund life, a clause mandating capital to be returned in full to LPs before GPs received any compensation, no reinvesting of profits, and a prohibition of GPs investing in outside deals for personal benefit.

After investing in a few flops like a tennis shoe resoling company and a snowmobile-to-motorcycle conversion kit company, they decided to focus their efforts on what they knew best: computers.

The partnership also played a pivotal role in revolutionizing incubation, as Perkins collaborated with an old colleague Jimmy Treybut from HP to create the company Tandem Computers in 1974. The company, with Perkins as chairman and Treybut as CEO, saw immediate growth and its IPO in 1977.

Because Perkins understood that a venture capitalist was in the business of selling money to entrepreneurs, he knew that providing tangible value to a company was a surefire way to differentiate himself from other VCs.

Last, but certainly not least, is Sequoia Capital, created by Don Valentine in 1972.

Valentine had moved to California due to military service and worked at a handful of tech companies, with his last role being the head of marketing at, you guessed it, Fairchild Semiconductor.

He was approached by Capital Group, a large Los Angeles based mutual fund company, in the early 1970s with the request help build a VC subsidiary after its clients requested exposure to the emerging asset class. Rather than work within a large and bureaucratic framework, Valentine declined and decided to start his own firm.

His first win came in 1975, when Sequoia invested in Atari, and the company was quickly sold the next year to Warner Communications for $28 million.

The next home run was arguably its most famous, yet infamous, investment in the company’s history until this day: Apple.

Nolan Bushnell, Atari’s founder, suggested to Steve Jobs and Steve Wozniak that it would be a good idea to meet with Valentine.

Valentine recommended them to allocate more resources on marketing and, more importantly, to “think big.”

Valentine also introduced Jobs and Wozniak to Mike Markkula, a 30-year-old marketing manager, who would become the company’s first chairman.

After investing roughly $150K in January of 1978, Valentine sold his stock in the summer of 1979 for “tax reasons” and to provide distributions to investors.

Valentine’s co-investor Arthur Rock, the aforementioned co-founder of Davis & Rock, saw his $57K stake balloon to $22 million by 1980.

You win some, you lose some.

And Sequoia would win plenty.

The list of other notable Sequoia investments include Cisco, Google, YouTube, WhatsApp, Airbnb, LinkedIn, Instagram, and NVIDIA.

Valentine’s investing philosophy differs from Draper’s, as although Valentine acknowledges the importance of competent founders, he places a higher emphasis on potential market size, momentum, and the product / application itself.

I guess the founder versus product-market fit debate will live on forever.

Headlines

• These are the investors funding Musk’s $97B OpenAI bid. TC article

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• Plaid is working with Goldman Sachs on a $300M+ tender offer to give liquidity to early investors and employees. TC article

• Goldman Sachs’s exclusive investment club is a powerful draw. Bloomberg article