From a Queen to Crypto: The History of Venture Capital

In March 2020, as the pandemic hit, Sequoia Capital warned of a “Great Unwinding” in the world of venture funding. Startups trimmed their workforces, delayed IPOs, and prepared for a long winter. But just a few months later, the clouds lifted, and now we sit in the midst of a historic boom. In 2020, the 103 venture-backed companies that went public accounted for 22% of all US IPOs and represented $222B in value. This is projected to grow to $500B this year, and thus a 50-year long trend continues. Since 1974, 42% of all companies to go public have been venture-backed.

Venture capital today provides the funding that powers the vast majority of positive innovation in the world. VC is part of the zeitgeist. The business of funding disruptive businesses, once a niche activity performed by a select few, is now a global institution. But how did we get here?

Let’s start at the beginning.

Queen Isabella and Christopher Columbus

At its core, venture capital is a capital investment in a high-risk company (or venture) with the hopeful promise of extremely high returns. Silicon Valley financiers might come to mind, but they were far from being the original architects of this business model. For that, we have to take a trip back in time.

The story begins with a morally questionable and controversial figure. In the 1400s, Christopher Columbus (our entrepreneur) saw an opportunity. He was in possession of a map that proved it was possible to sail west and access the valuable treasures of the Far East. The voyage (or venture), however, would be extremely risky, and the scholars of his day laughed the whole thing off as wildly impossible. In addition, this was far too expensive for a mere Italian sailor to fund alone.

Undeterred, he went looking for investment — a monarch’s investment. After eight years of trying to convince the top European courts, Queen Isabella of Spain (desperate to reach the Indies) finally greenlit the trip in 1492, and the rest is history. In return for funding the entrepreneur and his high-risk venture, the Queen (and OG venture capitalist) got a major return on her investment. Columbus’s accidental discovery of the West Indies catapulted Spain into a Golden Era of exploration and solidified the Spanish Empire as a powerful force on the global stage. And on top of that, she received 90% of all the profits.

FUN FACT: As exploration continued to Asia and the Americas over the next century, the captain of the ship would eventually take a 20% share of the profit from the carried goods, which is where we get the term “carried interest.”

The Whaling Industry

Fast forward a few centuries, and we start to see examples of how the structure and ideas of the VC system began to form.

Since Neolithic times, whaling was conducted to obtain valuable resources (blubber, oils, food, keratin) from nature’s largest mammals. In the 1800s, the industry was one of the most dangerous in the world, but for some reason, an unassuming coastal town — New Bedford, Massachusetts — was the most successful whaling hub in the US. How? In an industry where the wins were few but monumental, a group of agents figured out how best to maximize their success. The basic structure is summarized here:

“Agents” (the equivalent of today’s venture capitalists) would encourage these whaling expeditions (the “startups”) by raising capital from corporations and wealthy individuals (the equivalent of today’s limited partners) to fund the ship captains (the entrepreneurs).

This resembles the structure of VC as we know it today. What’s even more intriguing is that to ensure success, these agents often invested in multiple expeditions at the same time — a strategy that has become a core value of modern VC. In the end, New Bedford was highly successful with some agents making returns of up to 60% a year.

Edison and Disruptive Technology

It was during the “War of Currents” at the end of the 1800s that technology entered the picture with none other than America’s Greatest Inventor — Thomas Edison.

Edison clashed with fellow inventors, Nikola Tesla and George Westinghouse, over which type of lighting system would be the one to light up the world. While Tesla and Westinghouse were fans of high-voltage alternating current (AC), Edison was convinced that it was too dangerous and promoted the use of low-voltage direct current (DC) instead.

While Edison, Tesla, and Westinghouse fought it out publically and intellectually, one finance titan of the era — J.P. Morgan — threw his (financial) weight solely behind Edison’s DC tech. Morgan was so convinced that Edison’s tech would be the future that he became an evangelist investor and directed Edison to install 400 electric lights in his own home–becoming the first “beta tester” and true investor in the technology.

Westinghouse, on the other hand, was an entrepreneur himself, and he underbid Morgan for the contract to light up the 1893 Chicago World Fair. It ultimately was an overwhelming success that put the abilities of AC on literal display, but unfortunately, Morgan would soon lead the charge in takeover attempts and legal battles against the AC inventors. In the end, Westinghouse and Tesla had their brief, shining moments but were mostly written out of the history books, and Morgan definitely capitalized on his investment in Edison’s tech. General Electric went on to become one of the original 12 publicly-traded companies on the Dow Jones.

FUN FACT: This edition of the World Fair took place 400 years after Columbus had sailed the ocean blue, and so it was aptly named the World Columbian Exposition.

The Birth of Silicon Valley and the Limited Partnership

Heading into the 20th century, private equity and venture investment were the domains of well-known, wealthy families such as the Morgans, the Vanderbilts, and the Rockefellers. However, with the Depression and the New Deal in the early 1900s, these families weren’t investing in small businesses. Then, at the end of WW2, everything changed.

In 1946, the “Father of Venture Capital,” Georges Doriot, and a group of educated minds on the East Coast decided to form the first official venture capital firm — American Research and Development Corporation (ARDC) — that used money invested from other sources besides rich families. These men correctly predicted that entrepreneurship was vital for the future of the economy and held the belief that research and development could provide both economic growth and capital appreciation. The idea was not just to create a firm; they wanted to create an industry.

And soon enough… an industry arose in what we now know as Silicon Valley.

During the 60s and 70s, VC firms began to focus primarily on starting and expanding companies (rather than investing in existing ventures). It was the official beginning of the Limited Partnership, the corporate structure that now governs almost all VC firms. Sand Hill Road in Palo Alto saw a number of well-known firms emerge (e.g., Sequoia Capital, Kleiner Perkins, etc.), and by the end of the 70s, the “Prudent Man” rule came into play. Passed as part of the Employee Retirement Income Security Act (ERISA), this rule allowed pension funds to invest in VC for the first time. This allowed institutions for the first time to invest into venture funds at scale, and unprecedented surges of capital began funneling into the industry.

The Invention of the Internet

Over the next few decades, the VC ecosystem continued to thrive, and there were large public successes of VC-backed companies such as Apple and Genentech. But it wasn’t until the invention of the internet in the early 1990s that VC kicked into hyperdrive. Naturally, VC firms saw huge potential in world wide web technology, and some of the biggest names in the business (Netscape, Amazon, AOL, E*Trade, C/NET) were founded around this time. Almost all were backed by venture capital.

Investors saw unprecedented returns as these companies went public, with millionaires being made overnight. FOMO kicked in. A huge rush of capital began flooding into VCs from those wanting a slice of the .com pie, and by the end of the 20th century, the amount of money committed to the sector went from $1.5B (1991) to more than $90B in 2000.

What could go wrong?

VC Goes Mainstream

The Dot Com Bubble burst in early 2000. Tech startup valuations were decimated. Many firms, along with retail investors, lost their capital. But despite a period of instability, the promise of revolutionary technology in the form of enterprise software, mobile, GPS, and social media meant the industry remained bullish into the 21st century.

This is the era of Google, Facebook, Airbnb, Uber, and other highly successful ventures that (whether acquired or gone public) made enormous amounts of money for their investors. Beyond that, venture capital was becoming a part of pop culture with the emergence of movies like “The Social Network’’, TV Shows like “Silicon Valley”, and a podcast and content craze that focused on the space. We saw incubators such as Y Combinator flourish, and founders and investors like Mark Zuckerburg, Jack Dorsey, Elon Musk, and Adam Neumann reach a level of fame and infamy previously reserved for politicians and entertainers.

As we move into the 2020s, we’ve seen valuations and investments continue to grow exponentially. Masa Son’s $100B Softbank Vision Fund changed the game, entering the market in 2017 at a time when the entire US VC industry was worth $82B. Meanwhile, Andreesen Horowitz’s employee count is nearing 300 as they approach their 60th fund. VC firms, previously manned by relatively small teams, now more closely resemble large financial institutions.

The industry continues to thrive, but where do we go from here?

Challenges of the Future — Web 3.0

While venture capital investment continues to boom, arguably the most revolutionary technology movement of 2021 has been in crypto and blockchain-based systems — an area not traditionally associated with venture funding. This includes decentralized finance (DeFi) applications, nonfungible tokens (NFTs), crypto-centric gaming, and increased adoption of cryptocurrencies as investment and payment tools. In addition, Decentralized Autonomous Organizations (DAOs) now allow communities to raise significant sums of money and govern themselves outside of a traditional VC company structure.

All of this has venture capital firms scrambling to be evolved in “Web 3.0,” with many firms raising crypto and blockchain-based funds. While venture funding continues to power more traditional companies, as we move forward, firms will have to learn to adapt and invest in new asset classes to continue to thrive. We’ve already seen this in action with A16Z’s Crypto Fund III now investing in DAOs and taking part in their governance structure.

There are real questions about whether the current valuations and volume of venture funding are sustainable, and it may be likely that a reckoning, so long promised, is due. Meanwhile, an evolving secondary market and alternative funding methods, such as revenue-based financing, are providing a real alternative to startup founders.

Whatever the case, innovation is accelerating faster than ever before, and it will be fascinating to see how VC adapts.