By: Amity Shlaes
Amity Shlaes, senior fellow in economic history at the Council on Foreign Relations, is author of The Forgotten Man: A New History of the Great Depression (Harper Perennial). Gaurav Tiwari and May Yang contributed research to this article.
Back in 1959, the National Broadcasting Company, an American television network, aired a new series. Entitled Bonanza, the hour-long Western represented a technological innovation — it was the first series broadcast in color. The show depicted the Cartwrights, a father and three sons who made a new kind of life ranching at their homestead, the Ponderosa, on Lake Tahoe in Nevada. The Cartwrights were the opposite of salary men. They were pioneers — one son built the family ranch. They lived near a silver boomtown where hard work and sudden luck were transforming the occasional poor man into a wealthy one.
To many Americans, Bonanza symbolized the freedom to make one’s own life and own money one’s own way. The show became enormously popular, not only in the United States but worldwide. By 1969, Bonanza was broadcast in 80 foreign markets. President Richard Nixon expressed concern about pre-empting the show for a crucial policy address. Other Westerns such as Wagon Train, Gunsmoke, and Rawhide also found large viewerships.
The great popularity of the self-reliant Cartwrights and their counterparts on the other popular TV Westerns affords a key insight into post-World War II American culture. While standard histories of the period from 1945 rightly stress the Korean War, Vietnam, President Lyndon B. Johnson’s Great Society social programs, and the triumphs of the civil rights movement, they often fail to capture another important development: the arrival of financial techniques that helped to release and leverage Americans’ already robust creative and entrepreneurial energies. Even in the 1960s, often viewed as a period of social revolution, something we might call Bonanza America was moving forward. This was the America of the business start-up and of what we now call venture capital.
Starting a new business was not on most Americans’ minds as the country demobilized after World War II. One reason was that it did not seem possible because of the lack of access to capital. In those days there were only three places one could find cash to fund a new business plan: the government; big companies; or perhaps, if one were lucky, a bank. During the early 1950s, government loomed the largest. Defense spending averaged a full 11 percent of gross domestic product, about three times today’s share. Capital was in any case something people associated with the pinstripe-suited Establishment, not cowboys. Memories of the 1929 stock market crash and the Great Depression that followed were still fresh. Americans feared a repeat. If young professionals wanted to work in the new field of computers, they did not start a new company in their parents’ garage. They tried for a job at IBM’s Poughkeepsie, New York, research center, possibly to work on the 650 Magnetic Drum Calculator.
But even those on Wall Street or in the big companies wondered whether the nation’s financial system was too conservative. They understood that the traditional three capital sources could not make the nation grow fast enough, especially in peacetime. What’s more, they understood that when Wall Street financiers or Defense Department technocrats selected among competing applied research projects, they often backed the wrong ones. Finally, they recognized the most important thing — the incentives to launch a start-up were too weak. Why devote so much of one’s time and energy to a fledgling business when one likely would earn more as an IBM “Organization Man”? Talented men and women, it came to be understood, would work more creatively and with greater entrepreneurial zeal when they stood to reap a commensurate reward — their own bonanza.
The Dream Factory of Georges Doriot
A key figure in the story was a French-American named Georges Doriot. Doriot was himself an Establishment figure: A Harvard Business School professor, he joined the wartime army, rose to head the Quartermaster Corps’ Military Planning Division, and was appointed a brigadier general in recognition of the high quality of the military research effort he led. Afterward, Massachusetts Investor Trust Chairman Merrill Griswold, Massachusetts Institute of Technology President Karl Compton, and various politicians handpicked Doriot to head American Research and Development (ARD), a new firm that would invest in precisely those small, innovative companies that had been underserved by traditional capital markets.
Doriot explained to his students — and the world — that a more effective means of financing entrepreneurial start-ups was needed, one that matched venture capital to promising new ideas. In this system, the investor does not lend money to a start-up. Instead he buys a share of the new company — and then, at least sometimes, helps to manage it. Failure often results. But if the company succeeds, the returns for the investor can be enormous.
As his biographer Spencer E. Ante notes, Doriot started out relying on traditional sources of capital. ARD became a public company in which shareholders could buy stock. But Doriot also held a number of untraditional views. He understood that incentives were important to innovators and investors alike, and that classical business hierarchies might dampen those incentives. Better to devise methods of giving more people a stake in the start-up’s success. He liked the idea of ARD colleagues personally owning shares in companies that ARD invested in. He liked the idea of pouring more capital into a start-up when he felt like it. His suits were as far away from the cowboys’ denim jeans as you could get. But like cowboys, Doriot liked freedom.
When a Navy veteran and engineer named Ken Olsen decided that computers smaller and cheaper than IBM’s mainframes might represent the future, traditional lenders turned down his request for cash. Doriot and ARD stepped in, and Digital Equipment Corporation was born. So were scores of other high-tech start-up companies. ARD became known as Doriot’s Dream Factory. His inspiration and energy helped create the now famous technology parks and companies outside Boston along the (Route) “128 Corridor.”
The financial returns were enormous. An original $70,000 stake in Digital Equipment grew to hundreds of millions of dollars. But ARD’s success did not transcend the underlying competition between the public- and the private-sector models. As a publicly traded company, ARD was regulated by the U.S. Securities and Exchange Commission. SEC regulations made it hard for Doriot to put extra capital into his portfolio companies. The commission repeatedly opposed ARD’s allowing its employees to hold stock options in companies ARD invested in. The regulators could not see what Doriot saw — that those options were crucial incentives. A bitter Doriot learned a lesson that many venture capitalists then internalized — there is a cost to going public. Sometimes it is just better to stay private — on your own ranch, as it were. “While the SEC believes it is protecting our stockholders, they are actually suffering,” Doriot fumed.
Innovation: Boosts and Backsteps
It took the 1957 launch of Sputnik, the Soviet satellite, to break the policy logjam. Fearing that Sputnik signaled a U.S. inability to compete with the Soviet Union in technological innovation, President Dwight D. Eisenhower introduced and signed the Small Business Investment Act. This law allowed small companies to borrow from the government at a favorable rate — if they agreed to rigorous terms. The law did not yield many inventions, but it did send a crucial signal that government would be friendly to private start-ups.
Meanwhile there were other innovators and also young venture capitalists who, like Doriot, had trouble with traditional management. They were stepping forward to make their own visions real. Among the technical whizzes were eight brilliant engineers who worked for William Shockley at his Shockley Semiconductor Corporation. Shockley was a classic company head, demanding and hierarchical. Backed by private venture capital, the eight quit Shockley and founded Fairchild Semiconductor, a signal moment in the emergence of California’s “Silicon Valley.” There, Robert Noyce, Gordon Moore, and others invented the “integrated circuit” that is the basis of all computers today.
In time, a number of Fairchild employees attracted private venture capital and split off to found their own high-tech businesses. Intel Corporation, whose processors power so many of today’s personal computers, is just one of these “Fairchildren.” When we hear today about a West Coast company where no one is boss and where as many employees as possible get stock options, we think of Microsoft. But it was actually the Fairchildren who pioneered this format — and Silicon Valley as well.
The boundaries between the public and private sectors continued at times to impede the progress of the venture capital model. For example, federal spending on research at universities was enormous, but the research tended to stay on the shelf. Part of the trouble was that no one could confidently launch businesses based on ideas from such research, since the ownership of the ideas was unclear — the ideas might legally still belong to the federal government.
Congress laid another obstacle in the path of investors when in 1969 it increased the capital gains tax to 50 percent from 25 percent. The clear message that they might keep only half of the profit from their ideas daunted inventors. From 1971, new patents decreased each year. At some point in the 1970s, the staff of Senator Birch Bayh, a Democrat from Indiana, found that there were some 28,000 patented ideas languishing at the U.S. Patent and Trademark Office, with only 4 percent of that figure finding commercial application. People wondered whether the frontier period of American enterprise was passing. Even television seemed to confirm this: Bonanza itself lost viewers and was cancelled.
Bonanza Comes Back
In 1978, a concerned Republican congressman from Wisconsin, William Steiger, produced a plan that effectively cut the capital gains tax to the 28 percent level. This made it more worthwhile to develop commercial applications for patents. Another significant policy change occurred in 1979, when the U.S. Department of Labor changed its rules to permit pension fund managers to invest as venture capitalists in riskier firms.
In 1980, Bayh and his fellow senator Robert Dole, a Republican from Kansas, led passage of the Bayh-Dole Act. It allowed universities and small companies, within certain limits, to keep as their own intellectual property innovations funded by government research. Sure of a share in the profits, the research world now had an incentive to find practical uses for its inventions.
Venture capital activity immediately and dramatically increased. In the first half of the 1970s, there were only 847 venture capital investments nationwide. That increased to 1,253 in the period 1975-1979, and to 5,365 in 1980-1984. These figures represented a sevenfold increase in cash investment. Apple Computer was one of the start-ups that received a timely infusion of venture capital.
This rough roster of policy changes may be dry and legalistic — how many who wonder at the success of Andrew Grove at Intel or of Howard Schultz at Starbucks have heard of Bayh-Dole or Doriot? But the new laws facilitated the emergence not only of Silicon Valley and the Route 128 Corridor, but also a general culture of innovation. Today the Lake Tahoe where Bonanza was set routinely hosts conferences of venture capital firms. Those who had feared a tamer future for the United States after World War II would have been pleasantly surprised: The cowboy was still there after all.
The opinions expressed in this article do not necessarily reflect the views or policies of the U.S. government.