Venture Capital 101 – The Origins of Venture Capital

October 14, 2023

A few years ago, around 2016, I remember stumbling onto an old lecture from Don Valentine. For the uninitiated, Don Valentine founded Sequoia Capital VC firm in 1972, before the terms “Silicon Valley” and “venture capital” had even been coined. I can go on and on about how iconic Don was, but his lecture left a deep imprint on me. While the world of Venture is quite complex, it’s the complexity that Don spoke so much about with fervor. It was impossible not to get influenced—so, long story short, I now work for Rainmatter, the investment arm of Zerodha. And I felt it would be helpful to share what I learnt about this industry over the past few years. Let’s start with the historical context, shall we?

Origins of Venture Capital

In his book, VC: An American History, Tom Nicholas discusses the history of VC and mentions the whaling industry as the identifiable starting point of how modern VC works today.

Similar to modern venture capital, whaling in the 1800s demonstrated Power Law, basically highly lucrative but low-probability payoff events. Both whaling and VC are similar in that they relied on extremely high returns from a very small subset of investments.

But if you were to look closely, Power Law or long-tail outcomes go back to 12th-century Venetian merchants and their trade agreements and partnerships. Here is an excerpt from a paper with more context if you want to learn more.

But the modern VC era, of course, began with the iconic American Research and Development Corporation in 1946. And then, Arthur Rock happened. He was one of America’s first venture capitalists. In the 1950s, Arthur Rock took it upon himself to shape the industry. Legend has it that Arthur received a letter from 8 scientists working at Shockley Semiconductor Laboratory. These eight scientists subsequently left Shockley Semiconductor to start Fairchild Semiconductor and, in the process, got named the Traitorous Eight. Rock pioneered de-risking entrepreneurship. By 2014, ~100 companies and several VC firms could have been traced back to Fairchild.

There was no looking back after that. Following in the footsteps of Rock, a plethora of VC firms like Matrix Partners, Sequoia Capital, Kleiner Perkins, Bessemer, and others started operations between 1960 and 1980. 2.5B $ VC funding in 1977 quintupled by 1983 to 12B $.

The 1990s brought with it the advent of personal computing. VCs in the decade funded companies like Google, eBay, Amazon, Yahoo, Netflix and Salesforce. Companies that are behemoths of the US public markets today. But the dot com bust brought carnage – $9.5 billion of venture-related losses were written down in the second quarter of 2001.

2010-2020 saw the rise of micro VC since many larger VCs were reluctant to a large extent to take bets on early-stage companies. Small firms investing around $25-$100 million in funding heralded the democratization of private capital. They invested small amounts in a large pool of companies at the pre-seed and seed stage.

And that brings us to today – since 2020, a lot has happened in the world of venture. Record amounts of capital found its way to the venture world due to the age of ‘free money.’ While 2023 feels like a reset, time will tell if the venture cycle highs will return over the next few years.

This is a guest post by Dinesh Pai. Dinesh heads investments for Rainmatter and is an avid blogger. In a series of multiple blogs, he will discuss all things Venture Capital.

Investments @ Zerodha

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