Chapter 79 - Creative Capital: Georges Doriot and the Birth of Venture Capital
Today’s Chapter is based on the book “Creative Capital: Georges Doriot and the Birth of Venture Capital” by Spencer E. Ante. This biography explores the life of George Doriot, known as the father of the venture capital industry.
Here’s what I have learned:
Not For Profit
“A business absolutely devoted to service will have only one worry about profits. they will be embarrassingly large.”
— Henry Ford
As we have learned previously from Henry Ford, it is wrong to assume that businesses only exist for profit. In his opinion, business exists to provide services. In fact, after working in business for so many years, he came to these three conclusions:
(1) That finance is given a place ahead of work and therefore tends to kill the work and destroy the fundamental of service.
(2) That thinking first of money instead of work brings on fear of failure and this fear blocks every avenue of business—it makes a man afraid of competition, of changing his methods, or of doing anything which might change his condition.
(3) That the way is clear for any one who thinks first of service—of doing the work in the best possible way.
As such, Ford reminds us to not be too greedy for money when running a business, as that is the surest way to not get any. He believes that when one focuses on providing great services, then money will abundantly takes care of itself. As he once said, “For the only foundation of real business is service.”
He explains that “The most surprising feature of business as it was conducted was the large attention given to finance and the small attention to service. That seemed to me to be reversing the natural process which is that the money should come as the result of work and not before the work. The second feature was the general indifference to better methods of manufacture as long as whatever was done got by and took the money.”
“ It is the function of business to produce for consumption and not for money or speculation.”
— Henry Ford
Similarly, Georges Doriot, also known as the father of venture capital, started his career as a professor at Harvard Business School. There, he taught a curriculum that was completely revolutionary for its time, emphasizing practical business knowledge and the importance of innovation in driving economic growth. In fact, instead of promoting the concept that business was about earning as much profits as possible, Doriot taught the concept that a business’ core purpose was to provide improvements to society. He believed that the purpose of business was not just to make money, but to create new things for the betterment of society. He wanted to produce leaders, not just managers.
Doriot’s career as a venture capitalist started when he was working in the army during World War II. He served as the Director of the Military Planning Division for the Quartermaster General, overseeing research, development, and planning efforts. His responsibility was to identify and to invest into new products and inventions that could save the Army time, money and raw materials. He was notably instrumental in introducing the following innovations to combat troops: water-repellent fabrics, L.L. Bean boots, cold-weather socks, saran wrap, K-rations, etc.
After the war, in 1946, Doriot co-founded the American Research and Development Corporation (ARD), widely recognized as the first publicly traded venture capital firm. ARD's establishment marked a significant departure from traditional forms of business financing, introducing a model that combined capital investment with active management and strategic guidance.
As a matter of fact, ARD's mission was to invest in companies that were commercialising new technologies developed during World War II. But Doriot had a grander vision: to create a new profession of professional venture capitalists who would play a critical role in the formation of new companies and industries.
ARD’s investment philosophy could be summarized into four key principles:
Focus on potential: Doriot looked beyond current financials to see the long-term potential of a company or technology. Profits were not a priority.
Patience: He understood that building great companies takes time and was willing to invest for the long haul. Once again, profits were not a priority.
Active involvement: ARD took an active role in its portfolio companies, providing management expertise and strategic guidance.
Emphasis on innovation: Doriot prioritized companies that were pushing the boundaries of technology and creating new markets.
One of ARD's most famous investments, and a testament to Doriot's foresight, was in Digital Equipment Corporation (DEC). In 1957, ARD invested $70,000 in DEC, a startup founded by two MIT engineers. This investment would go on to yield extraordinary returns, with ARD's stake valued at over $355 million by 1971. More importantly, it demonstrated the potential of venture capital to fuel technological innovation and create significant economic value.
Hands-on Management
“People and ideas are our assets; their measurement, our problem.”
— Georges Doriot
A crucial aspect and a big reason for Doriot’s success as an investor was his role as an active mentor and supporter of the entrepreneurs he worked with. This approach was revolutionary at the time. Unlike traditional investors who focused primarily on financial returns, Doriot saw ARD's role as nurturing and developing young companies, providing them not just with capital but with the expertise and guidance needed to grow and succeed. This hands-on approach to investment would become a hallmark of venture capital, setting the stage for the industry's future development.
As a matter of fact, this mentorship role was especially easy for Doriot considering he was a already teacher at Harvard Business School. He had a huge alumni of students that were potential entrepreneurs to invest in or potential mentors for his invested companies. Spencer Ante mentions that "Doriot believed that providing guidance and resources to the entrepreneurs he backed was just as important as the capital he invested. He saw his role as a partner and advisor, not just a financier."
"A good venture capitalist is a coach, not a player. He should be able to see the big picture and help the entrepreneur see it too."
— Georges Doriot
In my opinion, this approach makes sense in retrospective considering the fact that ARD often invested in companies that generated no revenues let alone any profits. In these circumstances, it must of been necessary for Doriot to be actively involved in the operations of the company in order to protect his investments. Doriot's genius as an investor was in recognizing that the key to successful investing was not just picking the right companies but helping to build them.
Oppositely, if you are investing in a company that is generating great revenues and that is highly profitable, perhaps a hands-off investment approach would be better. As Steve Jobs once said, "It doesn't make sense to hire smart people and tell them what to do; we hire smart people so they can tell us what to do."
As a matter of fact, Warren Buffett is well-known for his decentralised management system at Berkshire Hathaway. Charlie Munger, the ex-Vice Chairman of Berkshire Hathaway once described the system as “delegation just short of abdication.” While the capital allocation decisions are taken care of by Munger and Buffett, all operation decisions are left to managers in the company who are left alone to run their businesses.
As Buffett mentions, “At Berkshire, managers can focus on running their businesses: They are not subjected to meetings at headquarters nor financing worries nor Wall Street harassment... Our trust is in people rather than process. A "hire well, manage little" code suits both them and me.”
“Our managers are totally in charge of their personal schedules. Second, we give each a simple mission: Just run your business as if:
You own 100% of it;
It is the only asset in the world that you and your family have or will ever have; and
You can't sell or merge it for at least a century. As a corollary, we tell them they should not let any of their decisions be affected even slightly by accounting considerations. We want our managers to think about what counts, not how it will be counted.”
— Warren Buffett
Leverage
“Forget rich versus poor, white-collar versus blue. It’s now leveraged versus un-leveraged.”
— Naval Ravikant
As we have previously mentioned, Doriot’s success was further bolstered by his ability to leverage the credibility and resources he slowly acquired through his experience as a teacher at the Harvard Business School and as the founder of American Research and Development (ARD). Doriot was able to attract investors and entrepreneurs to ARD because of the firm's reputation and his own credibility as a respected academic and business leader.
As a matter of fact, Doriot was able to tap into a wide network of contacts and resources that he could channel towards the company he backed. By teaching at the Harvard Business School and later on with the founding of INSEAD, Doriot was able to build a strong network of students who later became future investors, entrepreneurs and industry influencers.
Furthermore, Doriot was able to leverage more investment opportunities through the success of companies among ARD’s portfolio. As a matter of fact, Doriot’s work as a venture capitalist was very difficult in the first few years. But everything changed with the success from one sole company which completely changed the reputation of both Doriot and ARD. That company was Digital Equipment Corporation (DEC), which captured the big majority of ARD’s investment return (From $700,000 in 1957 to $355,000,000 in 1971!)
As Charlie Munger once said, “The beauty of it is, you only have to get rich once. You don't have to climb this mountain four times. You just have to do it once.” And Doriot’s success at ARD is a perfect example of this.
This reminds me of how Jeff Bezos sees innovation. Usually, it only takes one bet to create outsized returns to make all other losing bets worth it:
“Outsized returns often come from betting against conventional wisdom, and conventional wisdom is usually right. Given a ten percent chance of a one hundred times payoff, you should take that bet every time. But you’re still going to be wrong nine times out of ten. We all know that if you swing for the fences, you’re going to strike out a lot, but you’re also going to hit some home runs. The difference between baseball and business, however, is that baseball has a truncated outcome distribution. When you swing, no matter how well you connect with the ball, the most runs you can get is four. In business, every once in a while, when you step up to the plate, you can score one thousand runs. This long-tailed distribution of returns is why it’s important to be bold. Big winners pay for so many experiments.”
— Jeff Bezos
The fact that ARD’s success is held into the performance of one sole company in DEC reminds me of the Pareto Principle, also known as the 80/20 rule. This principle explains that 80% of the outcomes are the result of 20% of inputs. As we have learned previously from Tom Monaghan from Domino’s Pizza, the Pareto Principle is an important mental model to master in business.
In Monaghan’s case, he wanted to make sure that Domino’s delivered quality pizzas to his customers under thirty-minute. To do so, he quickly realized that he had to reduce the amount of products he was offering in order to keep the kitchen much more efficient. As such, Monaghan noticed that even though he sold three different sizes of pizzas 80% of his sales came from 12-inches pizzas. Similarly, 90% of beverage sold were either Coke or Pepsi.
By consequence, he decided to reduce his products’ offering by selling only one size pizzas. This was a major revelation and breakthrough in Domino’s Pizza history. By doing so, the company was able to leverage its profits even further. It may seems counter intuitive that simplifying a business may increase its revenue, but here’s how Monaghan explains it:
“The main argument for having only twelve-inch pizzas was faster service. But quality would be improved, too. A pizza maker has to learn how to make each size pie. The twelve-incher is easier and larger ones are much harder. There would be fewer mistakes too both in taking orders and boxing them. With three sizes of pies and just two inches difference between them, it sometimes happened during a rush that a worker would ruin a large pie by trying to jam it into a medium size box. Then there were the saving we would make in purchasing. Having one size would cut our box inventory requirements by two-thirds.”
— Tom Monaghan
Beyond the Book
Watch "Berkshire Hathaway's decentralized structure" on Youtube.
Read "Leverage: Gaining Disproportionate Strength" by Farnam Street
If you enjoy reading my newsletter, please consider becoming a paid subscriber. You’ll be able to keep this newsletter going! Here’s what you get when you upgrade:
Voting on polls: you’ll get to vote on who I should write about next.
Requesting biographies: you can request a biography for me to read and write about next.
Supporting my next book purchase: all payments received will be used to purchase a new biography.