The aim of venture capital is to bet on the long tail: Invest in many different start-ups, knowing most will fail but hoping at least one big success will more than offset the losses. For this reason, the business has always been focused on technology companies, which offer the greatest potential for fast growth and outsize returns. Most venture capital firms today are located in Silicon Valley, and nearly all the major tech companies, including Amazon, Apple, and Google, relied on venture capital funding to get off the ground. The playbook is simple: Raise capital from institutional investors such as pension funds and university endowments, buy an equity stake in young companies, and then oversee their operations until they go public and investors can cash out.
Tom Nicholas’s VC is a celebratory history of the evolution of the venture capital firm. The book opens with the industry’s origins in a uniquely American tradition of financial risk-taking that began in the early nineteenth century. It closes with praise for the “social value” the industry generates by sponsoring technological innovation. But the history Nicholas tells is not a simple story about smart investors betting on even smarter entrepreneurs and being rewarded by the market for their foresight. His account also shows how much the rise of venture capital has depended on the close relationship it developed with the American state: winning more and more privileges and concessions from it—tax breaks, cheap loans, and deregulation—while benefiting from government spending on research and the military’s insatiable desire for new weapons of war.
Wealthy individuals and families have always made investments in risky commercial ventures. But it was not until the 1940s, and only in America, that long-shot business ideas began to be funded by firms devoted to this purpose—ones that could tap not only personal and family riches, but also larger sources of income squirreled away in trusts and insurance funds. The first venture capital firm, the American Research and Development Corporation (ARD), was founded in 1946 by a group of Boston-area industrialists, financiers, and academics eager to profit from the new technologies developed for the war effort and worried that the onerous tax and regulatory strictures of the New Deal state were strangling entrepreneurial activity. The firm they created was headed by the Harvard Business School professor Georges Doriot, who had spent the war as a brigadier general overseeing the development of new military technologies, and who, at war’s end, would do more than anyone else to define what venture capital would become. Following a series of investments in bad ideas, such as a tuna-fishing outfit in the “South Seas” and a machine for deveining shrimp, ARD hit it big with a 1957 bet on the Digital Equipment Corporation (DEC), a start-up founded by two engineers from a federally funded MIT lab, one of whom had developed aircraft defense systems for the military. After bringing the first popular minicomputer to market, DEC became one of America’s largest computing companies. Its success, Nicholas argues, proved that the new style of “long tail” investing was viable.
In 1958, the US government started a program allowing for the creation of small-business investment companies (SBICs) that would receive cheap government loans and tax breaks in order to invest in other small companies. At a time when defense spending was being cut back, this helped to channel private capital toward investments in the new electronics needed for the arms race—it’s no coincidence the law was passed a year after the launch of Sputnik—in a way that avoided interventionist industrial policy and appeased the conservative fetish for small business. By the mid-1960s, there were hundreds of small investment companies, some with very close ties to the military-industrial complex.
Though it’s no secret that Pentagon money helped Silicon Valley to develop into a technology hub, Nicholas’s history sheds light on the less explored role of venture capital firms in bringing these new technologies to civilian markets. The military was the largest client of Fairchild Semiconductor, for example—the company that pioneered the silicon integrated circuit, which was first used almost exclusively in the manufacture of missiles—when it was set up in 1957. Many of VC’s early successes in Silicon Valley, Nicholas argues, came as former Fairchild employees worked to commercialize the new technologies the company had pioneered. He singles out the investment secured by Arthur Rock, the businessman who had raised the seed capital for Fairchild, in Intel, the computer memory company founded in 1968 by two employees of Fairchild, Robert Noyce and Gordon Moore (after whom “Moore’s Law” is named). In the 1970s, Silicon Valley firms and their financial backers struck gold as microprocessors, first commercialized in 1971, made possible a new wave of civilian computing technology. In a little over a decade, Don Valentine, founder of the leading VC firm, Sequoia Capital, went from selling Fairchild electronics to defense companies to making an enormously profitable 1975 investment in the gaming start-up Atari.
While Nicholas presents the industry’s growth throughout this period through individual stories of successful risk-taking, he acknowledges that, profitable as these gambles were, venture capital still operated only at the margins of American capitalism. It would take two significant changes in government policy in the late 1970s to catapult it to the center. The first was the overturning, in 1979, of the “prudent man” rule that prohibited pension funds from partaking in any risky forms of speculation. This change was largely the initiative of Texas senator Lloyd Bentsen, later Michael Dukakis’s running mate and Clinton’s first secretary of the Treasury, and was pushed by venture capitalists who had long eyed Americans’ retirement savings as an underutilized source of risk capital. Within a year of the law’s passage, pension fund investments in venture capital more than doubled. The other change was the reduction of the maximum capital-gains tax from 35 to 28 percent after heavy lobbying by venture capitalists and the heads of tech companies such as Intel. There’s only mixed evidence, Nicholas admits, that cutting the capital-gains tax encourages the formation of new businesses, but it’s clear the cuts made venture capital a much more profitable endeavor.
In the 1980s, venture capital firms were instrumental in launching the era of personal computing, betting on new start-ups like Microsoft in 1981 and Compaq in 1982. But the federal government still played an important role in financing the basic research that made VC so profitable. That same year, Congress passed a law to allocate government funding for risky technology start-ups that private venture capital firms could then invest in and bring public if they proved viable. By 1988, the federal government, led by the Department of Defense, had spent over $1.35 billion on such start-ups—nearly 10 percent, Nicholas points out, of all venture capital investment over this period. But while he mentions the importance of government policy in creating a healthy VC industry, Nicholas avoids exploring the implications of a system in which private firms profit from new technologies funded by public money. This is an arrangement, as the economist Mariana Mazzucato has argued, that socializes risk and privatizes gain.
In the 1990s, the commercialization of another technology first developed for military use—the internet—led to a bloom of software and Web service companies, including Amazon, Google, Netscape, Hotmail, PayPal, and Yahoo. Venture capital firms made historic returns. After the dot-com crash, the industry was criticized for fueling the bubble by investing in overhyped and underperforming products. But the transformations in digital technologies that were just beginning in the 1990s allowed it to quickly regain its stride. Today, with more money than ever to invest, VC is at the peak of its powers. The IPOs of Uber, Airbnb, Slack, and Pinterest will generate enormous riches for some of Silicon Valley’s biggest venture capital players, such as Andreessen Horowitz, Sequoia, and Founders Fund, which invested in these companies when they were founded in the wake of the 2007–08 financial crisis.
Though Nicholas avoids speculating on the future of the industry, there’s little reason to think other bets being made today won’t prove equally profitable a decade from now. As the high-tech arms race between the United States and China accelerates, Chinese venture capitalists have invested enormous sums in American start-ups and the Pentagon is racing to catch up. In 2015, Obama’s then–secretary of defense, Ash Carter, launched a Defense Innovation Unit that has provided seed capital for start-ups working on AI, autonomous vehicles, cybersecurity, and other far-out technologies like neurostimulation headsets. (It turns out there’s a lot of money in figuring out how to shoot down drones.) This was not unprecedented: In 2003 the Army opened its own venture capital operation, and in 1999 the former CEO of Lockheed Martin set up a venture capital firm, In-Q-Tel, that worked for the CIA. By last year, the Defense Innovation Unit had invested $300 million in nearly a hundred projects.
Compared to the money in private venture capital, this is chump change. But the Pentagon is also handing out enormous contracts to tech companies, and newer firms backed by VC funding are beating out traditional defense contractors. This March, Peter Thiel’s Palantir won an $800 million contract from the Army over Raytheon, and SpaceX is wresting the satellite-launching business away from Lockheed and Boeing, which have developed their own venture capital operations to keep pace. Despite the unease of many tech workers about getting involved in defense work, the money is hard for these companies to turn down. After Google dropped out of the running for a $10 billion cloud computing contract from the Pentagon in 2018, Amazon and Microsoft rushed in to win it for themselves. New start-ups are increasingly eager to get in on this lucrative business, since, among other things, winning a defense contract shows private investors that a company has a reliable revenue stream. In the name of beating the Chinese and the Russians, VC firms such as Thiel’s Founders Fund are looking to fund a new wave of start-ups to compete for government contracts in defense technology. As Nicholas’s history demonstrates, this would spell a return to the role played by venture capital at the height of the Cold War. After some time apart, Silicon Valley and the military appear to be rekindling their romance.
Jamie Martin is an assistant professor of history at Georgetown University.