Money  /  Book Excerpt

Venture Capital Builds The Modern World

The American method of high-risk, potentially high-reward investments has fueled innovation from New England whaling ventures to Silicon Valley start-ups.
Tom Nicholas

The first stage saw early investors deploying risk capital into high-risk and potentially high- reward activities in ways that established historic precedents for VC-style investing. The risk capital deployment in the New England whaling industry in particular has especially striking parallels with modern VC in terms of organization, payoffs, and more. Whaling was one of the largest and most important industries in America during the early nineteenth century. In it, New England whaling agents looked a lot like modern venture capitalists.

There were wealthy individuals able to supply finance and there were captains and crew willing to initiate and manage voyages, and whaling agents intermediated between the two groups in much the same way that today’s venture capitalists intermediate between entities like pension funds that supply risk capital and entrepreneurs capable of applying that capital to profit-making opportunities.

Like venture capitalists, whaling agents charged fees and received a share of the profits in return for intermediation; they engaged in repeat business with the best captains; they sometimes syndicated to spread risk; and the most capable of them, along with the most capable captains, enjoyed returns that were persistent over time. Flexible partnership structures worked because of strong compensation incentives. And the reasoning behind profit splits on whaling voyages still persists today in the conventions regarding how equity should be allocated to the various roles in entrepreneurial startups.

The deployment of risk capital in this first stage in the history of venture capital, is evident in the financing of leading-edge cotton textiles innovation in Lowell, Massachusetts — essentially the first Silicon Valley-type cluster in America. As New England financing elites redirected capital from merchant trading to industrial production, their need to access high-tech know-how compelled them to develop new heuristics to guide their contracting. Examining the structure of contracting, it is clear that tradeoffs between cash flow and control rights were being made in ways similar to the contracting strategies venture capitalists use today as they interact with entrepreneurs.

The intersection of entrepreneurship, technology, and finance was powerful. In 1820, Lowell had a population of only two hundred citizens. There was not much in that location but land and fast-moving water on the Merrimack River as a source of power. By 1836, however, Lowell’s population had exploded to 17,633, and by 1845 it had topped 30,000. The financing of new innovation hot spots further west gave rise to additional Silicon Valley–style clusters. Most notably, Cleveland and Pittsburgh became high-tech hubs between 1870 and 1914 in such areas as electric lighting, chemicals, oil, and steel. The industrialist and politician Andrew Mellon became a pivotal venture capitalist as he devised ways to finance local enterprise in this region relying on syndicated lending, governance, and equity participation.