The defection of 1957 was made possible by a new form of finance, what we call venture capital today. The idea was to back technologists who were too dicey to get a conventional bank loan but who promised the chance of a resounding payoff. The funding of the “Traitorous Eight” and their company, Fairchild Semiconductor, was arguably the first big venture deal in the Valley; and from that moment on, teams possessed of grand ideas and stiff ambition could spin themselves out, start themselves up and generally invent the organizational form that best suited their fancy. Engineers, inventors, hustlers and artistic dreamers could meet, combine, separate, compete and simultaneously collaborate, all courtesy of this new finance. Talent had been liberated. A revolution was afoot.
In its modern incarnation, venture capital involves a series of transactions. When a start-up is formed, “seed” investors might advance $1 million to help it develop its first prototype, receiving shares in exchange. If the start-up makes progress, it will raise a “Series A” round: This time, venture capitalists might advance $10 million so the company can hire salespeople and reel in the first customers. At each stage in the journey, a fresh round of financing depends on the attainment of an agreed milestone, and at each stage, the investors provide capital for shares. Of course, most start-ups fail, with the result that these shares turn out to be worthless — building companies is tough. But the few start-ups that make it often have exponential stock rises, delivering gains to venture capitalists that offset multiple losses.
The invention of this liberating finance explains more than most people still realize. Today, venture capital has morphed from a niche specialty into a global juggernaut, spreading far from the Valley to China, Israel, Europe and beyond. Venture-backed start-ups have changed how people work, socialize, shop and entertain themselves; how they access information, manipulate it and arrive at quiet epiphanies — how they think. But the significance of venture capital goes further. The liberation of the Traitorous Eight, and the countless entrepreneurial liberations since then, explain how Silicon Valley came to dominate innovation. Policymakers the world over have tried to understand the Valley’s secret sauce and bottle it. They must begin by understanding venture capital.
This, to be sure, is not what the standard history teaches. But the rival theories of what established the Valley’s preeminence — that it was home to Stanford University, that it benefited from military contracts, that it was blessed with a certain countercultural irreverence — have never been especially persuasive. After all, Stanford was no more distinguished than the Massachusetts Institute of Technology, which was itself a short drive from Harvard, creating a research cluster more powerful than anything Silicon Valley could muster in its early days. And though Stanford did benefit from military research dollars, the famous military-industrial complex of the 1950s was primarily an East Coast alliance between the Pentagon and Cambridge, Mass. If military ties had determined the location of applied science, Cambridge should have been the center of the universe.
Meanwhile, the cultural explanation for California exceptionalism also falls short. The anti-materialist hacker ethic, championed by communalist nerds who obsessed over code and declined on principle to monetize it, is often cited as the source of California’s peculiarly inventive culture: “We Owe It All to the Hippies,” a Time magazine essay claimed in 1995. But the hacker ethic actually originated at MIT — with the Tech Model Railroad Club, a group of undergrads enthralled by the technology behind model trains before their attention shifted to computers. Similarly, Tim Berners-Lee, the British-born and Geneva-based inventor of the World Wide Web, combined creative imagination with an anti-materialist disdain for business: “If you’re interested in using the code, mail me,” he wrote in a public announcement, refusing to profit from his invention. In Finland, Linus Torvalds created the bare bones of the Linux operating system and gave it away for free. In short, there has been no lack of inventiveness outside Silicon Valley and no lack of countercultural anti-business prejudice outside it, either.
The truth is that the distinguishing genius of the Valley lies not in its capacity for invention, countercultural or otherwise. The first transistor was created in 1947, not in Silicon Valley but at Bell Labs in New Jersey. The first server software was from Minnesota. The first graphical browser was co-developed by Marc Andreessen, the billionaire entrepreneur who was then at the University of Illinois. So, too, early versions of the search engine, Internet-based social networking and smartphone all emerged outside the Valley. No single geography dominates invention. Yet all these breakthroughs have something in common. When it came to turning ideas into blockbuster products, the Valley was the place where the magic happened.
And the magic sprang from venture capital. By freeing talent to convert ideas into products, and by marrying unconventional experiments with hard commercial targets, this distinctive form of finance fostered the business culture that made the Valley so fertile. In an earlier era, J.P. Morgan’s brand of finance fashioned American business into muscular oligopolies; in the 1980s, Michael Milken’s junk bonds fueled a burst of corporate takeovers and slash-and-burn cost cuts. In similar fashion, venture capital stamped its mark on an industrial culture, making Silicon Valley the most durably productive crucible of applied science anywhere, ever. By the 21st century, an astonishing 70 percent of the publicly traded tech companies in the Valley could trace their lineage to Fairchild Semiconductor; and every hoodie-wearing innovator owed something to that crucible moment when it raised venture finance.
The investor behind the Traitorous Eight was a 30-year-old MBA named Arthur Rock. Slight, taciturn, his eyes often clouded behind large glasses, Rock was not an obvious founding father, especially not of a swashbuckling innovation in finance. He had grown up poor in Rochester, N.Y., the child of Yiddish-speaking immigrants, and had worked as a soda jerk in his father’s small grocery store. He had suffered from childhood polio, performed miserably in athletics and been brutally victimized by antisemitic classmates. During a wretched stint as an Army conscript, he had bridled at reporting to superiors whom he considered “not too bright.” Perhaps because of these experiences, Rock was reserved to the point of being prickly. He suffered fools impatiently, and the fools always knew.
The pivotal moment in Rock’s still-early career arrived in the summer of 1957, in a letter mailed to the New York brokerage where he worked. The sender was Eugene Kleiner, one of the Eight and later himself a venture investor. Because venture capital barely existed at this point, Kleiner and his comrades had not thought of starting a new enterprise. Rather, they asked Rock’s firm to identify an alternative employer — “a company which can supply good management.”
Rock understood that the researchers wanted to escape the tyrannical Shockley, the semiconductor inventor whose scientific brilliance was matched only by his prodigious arrogance. Rock also understood that they wanted to keep their team together, believing they could be most inventive as a group. Rather than seeking out a new employer for them, Rock flew to the West Coast and proposed an unexpected alternative.
“The way you do this is you start your own company,” he told them. By striking out on their own, the scientists would capture the rewards of their creative wizardry. A self-made loner from outside the establishment, Rock felt strongly that a certain kind of justice would be served.
Rock’s idea shocked the researchers. “We were blown away,” recalled Jay Last. “Arthur pointed out to us that we could start our own company. It was completely foreign to us.”
Gordon Moore, another of the Eight, who would go on to achieve fame as a founder not only of Fairchild but also subsequently of Intel, characterized his reaction even more directly. “I’m not the sort who can just say, ‘I’m going to start a company,’ ” he told an interviewer later. “The accidental entrepreneur like me has to fall into the opportunity or be pushed into it.” In that summer of 1957, Rock was pushing firmly.
Rock promised the scientists at least $1 million, an ungodly sum of capital at the time. He also stressed that they would each own shares in their start-up.
The scientists duly launched Fairchild, and the results soon proved more raucous, and more glorious, than even Rock had imagined. This was the era of “The Organization Man,” of managers who marked their status with carved paneling, fake fireplaces and dressing rooms. But at Fairchild Semiconductor, the formality and hierarchy of 1950s business culture were tossed out the window. The team worked out of utilitarian cubicles. Company strategy was hashed out at collaborative bull sessions. Sales meetings featured brownies and whiskey. New hires straight out of grad school were empowered to make decisions.
Within a few months of its founding, Fairchild was pushing the frontiers of innovation at a pace that the suffocating Shockley never would have permitted. The scientists were trying out new products: innovativeswitches, a revolutionary scanner, new combinations of metals in semiconductors (those critical components of most electronic circuits). And the whole effort was self-consciously commercial. At other companies in the 1950s, researchers wore white smocks and were generally confined to the laboratory. But at Fairchild, they were out talking to the customers even before developing their first transistors, determined to discover what kind of device would sell. The goal was to make stuff that the market wanted — stuff that would cause the value of their personal equity to grow.
Sure enough, it did grow. At the formation of the company, Rock had ensured that each of the Eight bought $500 worth of stock. Two years later, Fairchild sold to its main backer, and each founding scientist received $300,000, a bonanza amounting to around 30 years’ salary at the time.
And Rock had a feeling this was only the beginning. More important than the gratifying payout, Fairchild’s success had demonstrated the liberating power of venture capital. It was about unlocking human talent. It was about sharpening incentives. It was about forging a new kind of applied science and a new commercial culture
Over the next decade, Rock took his idea to the next level. He quit his East Coast brokerage, moved to San Francisco and raised a dedicated venture fund. Along the way, he solved one of the most intriguing puzzles in investment history: how to back risky start-ups that normal investors shun.
To begin with, Rock acknowledged the sound reasons why start-ups are so hard to fund. According to the standard rules of finance, allocators of capital should seek collateral. Creditors back companies with physical or financial assets, so if the business hits the skids, they can recoup their loans by selling buildings, stock portfolios or land. Equity investors analyze “book value,” a measure of the capital that can be extracted if the company is wound up. Rock announced cheerfully that he was seeking something different. In backing start-ups, he was betting on “intellectual book value” — the dreams and determination that lay hidden inside the heads of entrepreneurs. If the venture failed, he would not get his money back.
Another standard financial practice, then and now, is to forecast company profits. Investors like to compare the price of a share with projected earnings, combining these numbers into a price-to-earnings ratio. But this reassuring quantitative benchmark was also of no use to Rock: He was backing start-ups whose earnings existed only in an imagined tomorrow. The few props that Rock could grab on to were, again, intangible: the character of the start-up founders, the quality of their ideas. Judging such variables was necessarily subjective. Investment decisions about tech start-ups originated, as Rock put it, “either from ‘the seat of the pants’ or the ‘top of the hat.’ ”
When Rock raised $3.4 million for his first venture fund in 1961, most contemporaries regarded such pronouncements as reckless. But over the next seven years, Rock confounded them. The chief cause of his triumph lay in what venture capitalists came to call “the power law”: the idea that, while most start-ups end up being worth zero, a handful take off exponentially. “Venture capital is not even a home-run business,” Bill Gurley, the venture capitalist behind Uber remarked a few years ago. “It is a grand-slam business.”
Thanks to the power law, Rock’s difficulty in evaluating start-ups was not fatal. The subjective nature of his methods meant he would be wrong much of the time, but a tiny number of winners could make up for the losers. Sure enough, Rock’s first venture fund multiplied his backers’ money an extraordinary 22-fold, largely on the strength of one astonishingly successful bet. Defying the conventional wisdom that taking on IBM, the giant computer incumbent, was bound to be a losing strategy, he backed an upstart challenger, Scientific Data Systems. When SDS became the fastest-growing computer company of the 1960s, Rock’s $257,000 investment generated a jackpot of $60 million.
When word of Rock’s returns spread, the taciturn investor became a business celebrity. In 1968, Forbes posed the question on the minds of many readers, “How do you get to be like Arthur Rock?” After the Forbes article was published, ambitious imitators rushed to copy Rock’s methods. The following year, $171 million flowed into private venture funds, fully 50 times more than Rock had raised in 1961.
The boom set the stage for Silicon Valley’s takeoff, its eclipse of the rival tech cluster around Boston and, ultimately, the Valley’s enduring dominance of innovation over the next half-century. Strangely, Rock’s role in this story is seldom recognized. The prevailing narrative about the Valley lionizes inventors and company founders, neglecting the financiers who liberated them.
Today, Rock is a self-effacing nonagenarian active in philanthropy. “I never wanted to be the richest corpse in the cemetery,” he says of his charitable giving. But his business legacy is obvious. His “power law” approach to risk management has freed generations of VCs to back high-risk, high-potential start-ups, knowing they could absorb the cost of failures because the winners would be so profitable. The result is a financial specialty so influential that it demands a new framing of how capitalism works.
The economics profession has long recognized two great institutions of modern capitalism: markets and companies. Markets coordinate activity via price signals and arm’s-length contracts. Companies coordinate by assembling large teams led by top-down managers. But economists have focused less on the middle ground that venture capital inhabits.
Venture capitalists channel capital, advice and talented recruits to promising start-ups; in this way, they replicate the managerial direction and team formation found in corporations. At the same time, venture capitalists have the flexibility of the market. They can get behind a start-up with a fresh business idea; they can shape it, expand it, murmur its name into the right ears. But when a round of funding is exhausted, the market will decide what happens. If there are no enthusiastic buyers for the next tranche of the start-up’s equity, it will be forced to close, avoiding the waste of resources that comes from sticking with doomed speculative ventures. This blend of corporate strategizing and respect for the market represents a third great institution of modern capitalism, to be added to the two that economists traditionally emphasize.
Venture capital challenges economists in another way as well. A huge amount of energy in government and the private sector is spent on economic forecasting; without a clear view of the future, committing resources would seem irresponsible. But extrapolations from past data anticipate the future only when there is not much to anticipate; if tomorrow will be a mere extension of today, why bother with forecasting? The revolutions that will matter — the big disruptions that create extreme wealth for inventors and great anxiety for workers — cannot be foretold because they are so thoroughly disruptive. Rather, they will emerge from the murky soup of tinkerers and hackers and hubristic dreamers, and all you can know is that in 10 years the world will be excitingly different. The future can be discovered by means of iterative, venture-backed experiments. It cannot be predicted.
Of course, venture capital is far from perfect. The very success of the industry has attracted incautious investors who shower money on young companies without overseeing their founders. The result is multibillion dollar “unicorns” with inadequate governance. In a few celebrated cases — the office-space company WeWork; the ride-hailing giant Uber; the blood testing sham Theranos — entrepreneurs who thought themselves accountable to nobody cut ethical corners, with investors, employees and customers alike paying the price. The underrepresentation of women and minorities is another failing. Women account for only 16 percent of investing partners at VC firms. Black investors account for only 3 percent. An industry that involves subjective judgments about start-up founders is wide open to bias and should stress diversity all the more. Without progress on this front, people of a certain type will fund people of a similar type. The venture industry is a meritocracy, up to a point. It is also what its critics call a “mirror-tocracy.”
Despite these important reservations, venture capital is a positive force for societies and economies. Only a fraction of 1 percent of firms in the United States receive venture-capital backing, yet this tiny minority accounts for fully 47 percent of the nonfinancial companies that do well enough to go public and 76 percent of the market capitalization of these firms. Venture-backed companies have delivered more progress in applied science than any kind of rival: more than centralized corporate research and development units, more than isolated individuals tinkering in garages and more than government attempts to pick technological winners. Studies repeatedly find that start-ups backed by good VCs are more likely to succeed than others.
Even as the public mood has turned against the tech-industrial complex, this positive case for venture capital needs to remain front and central in policymakers’ minds. As Silicon Valley’s origin story demonstrates, venture capital liberates talented people to be their most effective and creative. The United States needs the innovation that results if it is to compete with China’s rising tech complex — and this competition ranges from civilian technologies (pharmaceuticals, medical robots) to military ones (artificial-intelligence weapons and surveillance systems) and dual-use hybrids (Internet routers, drones). For the past generation, Americans have celebrated entrepreneurs such as Steve Jobs and Elon Musk. But think of Arthur Rock and remember: Without the venture capitalists who helped them get started, Jobs and Musk might have remained unknown.
21 Replies to “The Creation of Silicon Valley”
A good read, thanks.
So much of Schumpter’s “creative destruction “ depends on risk-taking, free association and above all, property rights with an inclusive set of constraints.
Acemoglu and Robertson do a discussion of this in their 2012 book Why Nations Fail.
As posited in that book, extractive elite regimes will ultimately fail. In that sense I see a connection between the UN’s IPCC and the reception you endured with your atmospheric CO2 analysis.
Never forget the bomb curve.
Thanks for letting me enjoy your work.
Hi John. You’ld not be surprised to hear that I have written at times about the origin of Silicon Valley and commented on much of what is said in the article. Shockley among them, and Stanford, (in fact recently I used Stanford, out in the whoop whoop as it was initially, as an example for keeping the UTas campus where it is in Sandy Bay and not in the city). It is always a topical question as economies everywhere ubiquitously try to emulate SV with their own Silicon Allies. Being a Tasmanian and having lived and worked in Silicon Valley, I’ve also commented on the similar climate to Hobart, same parallel, big harbour, big bridge, big mountain, oranges instead of apples, but hey! And UTas and others here pioneered technology in radio telescopy, optics, organ transplants, robotics, civil engineering. Back when we had leadership. But hey!
When I add what Allan says here to my experience explained below, the idea comes to me that they corroborate the idea that cultures are shaped by beginnings, with our Big Governmental penal societal beginning sharply contrasting with the US West Coastal beginning. Hence, largely, their being Open to Silicon Valley, our being Closed.
Our being partially Open comes after this beginning, so is mostly muffled, slowed down by ours being less entrepreneurial.
That later settlers and farmers were highly entrepreneurial also mattered less here than in California for this same reason.
This difference between California and Tasmania has also been a good demonstration of how leadership works, how it succeeds and fails, and the proverb :
“When a clown moves into a palace, he doesn’t become a king. The palace turns into a circus”
The Tasmanian success stories you mention could never have had the massive commercial success of the semi-conductor industry. The semiconductor revolution is comparable with the industrial revolution. Wherever it happened first would have become the Birmingham of the new technology and it happened in the southern bay area of San Francisco.
And thanks for prompting me this morning, waking me up to this important article STRONGLY SUPPORTED by my experience on two trips there from Sweden, in 1969 & 1970 :
Mostly from my sense that something very unusual was going on in the minds of West Coastal tech workers, starting with my having to attend a Pep talk the day I arrived. IBM had been doing world leading work developing the world’s first drum and then disk storage computer memory in San Jose, and the best half of its team had quit and formed a new company called Memorex. Only now do I understand this to have obviously followed THE example of Fairchild, represents a spread of it as a proto-Silicon Valley from Palo Alto, through Sunnyvale to San Jose where it has since been centred. “Since” is a big word here, because the Memorex “white ant”-ing of IBM was BIG, and how I have since been thinking Silicon Valley started. Still do, only now I see that it clearly started with Fairchild. “BIG” because IBM had invested hugely, bigger than most people know. They’d bought an orchard in San Jose because this was where land in the Valley was cheapest, through a string of 17 agents so that nobody would know it was them. They filled it with several groundscapers, one for each IBM Division. I worked in the SDD groundscraper, Systems Development Division as an Associate Writer: Research, Development and so on, plus several other buildings. Where we ate was a great place, luxurious. “Low-fat” was strongly encouraged.
It was NOT just that pep talk that woke me up to West Coasters being onto something I should know about : Unlike IBM-ers everywhere else in the world, most of my fellow writers were there “on contract”, NOT IBM employees. What got me was how PROUD they were about this . . . and not at all envious of . . . “old-fashioned me”. The quotes here are NOT what they said, only what I now clearly see !?! Until I read this article, I have long been simply assuming it grew out of Western experience, the UNIQUE experience of making an America on the Western land frontier AHEAD of Big Government, like what happened in Australia and Siberia. This is still true, it did so grow. All that’s changed is that we now have a focus on the Silicon Valley form that we know now, a revelation of the detail of the “extreme event” of its origin. “Forms are created by extreme events.” “White ant-ing [of IBM]” back there were my words, my idea, my way of understanding what I was observing there. IBM’s reaction was extreme. By the time of my 2nd visit, IBM had made the decision to MOVE their entire San Jose complex to Boca Raton in Florida, including as many staff as possible. Their usual anger at this, reluctance to move and so on, added to my sense of West Coasters being unusual. So too the Spanish and other special flavours so evident there in this Other, almost-antipodeal Home away from Home, on the Other side of the Pacific Ocean. Cold ocean currents instead of Warm like on both sides of Australia.
There are a couple things.
I agree that the semiconductor factor was key. However the end of WWII and the reduced need for the war effort manufacturing machine, jeeps and planes and jets and radar and communications and computers and such, left the smartest people out of work, and once acclimatised to Silicon Valley’s climate, (alliteration deliberate), they did not want to leave, so those people were the talent pool in the right place at the right time. There were no 101 traffic jams then, a population of maybe 5m in CA.
And much of the technology lent itself to the demand for consumer products of the burgeoning population, radios, appliances, hot cars. Also most US companies, not just large ones, invest heavily in R&D, whereas we rely on grants. US entrepreneurs, and investors, are not scared of failure, whereas we are petrified of it. I remember that I was told I could get some funding only “once I was successful”. Similarly when I started my first high tech venture in Hobart, everyone, I mean everyone, said it was impossible, so I just did it anyway.
Yet another factor, the US, at least back then, never hesitated to accept the best brains in any field, (to the point at times of covering the history of German rocket scientists), whereas we were still in the White Australia Policy, still are in my opinion. Another factor was the unimaginable availability of money. I remember sometime in mid 1970’s I think it was, with shock a news article that the UK had finally repaid its war debt, presumably lend lease payments to the USA. Not to mention that business in the USA is aggressively wild west in culture and practice. It was they who found the need to invent anti trust laws to stop collusion and price fixing monopolies. Not working with today’s tech behemoths.
We are all in awe of Silicon Valley one way or another.
I have long been thinking along similar lines following my experience there. It truly was a great place in those days.
“No 101 traffic jams” rings a big bell. It was like a race track.
I used to think nothing of looping the Bay after my usual weekend trips into San Francisco from San Jose. Nobody would dream of doing this today.
I stayed in a motel with a pool on the SW corner of Monterey and Cottle Roads. I am so glad I did this now. The IBM complex filled what had been an orchard in the NE corner, so I got a great impression of it every day, also of poor local farmers left out of the IBM deal. ALL now gone and forgotten locally . . . by locals . . .
A “forgotten” I feel as deliberate, reflecting a cover-up of a “White Ant-ing” of that Eastern institution of my earlier Comment. Key Western leaders have been seeing in IBM what they’d seen earlier in Shockley . . . an imperious Easterner . . .
I am greatly respectful nevertheless, of these people striking me as extremely generous. NOT mean the way Europeans often are, beliefs I continue to hold to. Extremely courteous car drivers also.
I have also been impressed by what Allan mentions about how failure is NOT seen there as the permanent stain it is here. I learned this when I tendered my resignation, by their wanting to hang onto me when I thought they’d be glad to be rid of me. A big surprise. Yes, US Americans, especially in Silicon Valley, are very much into seeing the glass as half full . . .
I too have fabulous memories of living and working in Silicon Valley, SF proper to Sunnyvale to San Jose, at various times, along side giants like Nolan Bushnell, Jack Tramiel, Steve Wozniac (showing my age a bit).
I’ve enjoyed this discussion with you. We seem to have similar reminiscences.
Thanks Allan, I agree, our impressions are tellingly similar. Important, as two of few Tasmanians witness to this important start to Silicon Valley VC culture.
The “I am so glad I did this now” in the following that I wrote earlier, is only since reading the above article making this icing on the cake of my experience of the huge, transient, IBM investment there, important, valuable :
“I stayed in a motel with a pool on the SW corner of Monterey and Cottle Roads. I am so glad I did this now. The IBM complex filled what had been an orchard in the NE corner, so I got a great impression of it every day, also of poor local farmers left out of the IBM deal. ALL now gone and forgotten locally . . . by locals . . .
A “forgotten” I feel as deliberate . . .”
For all of the 50+ years prior to my reading the above article, I had been envious of an Irish workmate who happened to be there about the same time as me, only instead of locking himself into a boring motel like I did, he had a room in a very impressive old French hotel in the San Jose CBD impressing him and me as having surely been a high class brothel. All of its wood work was superb with a beautifully smooth dark polish.
I used to love visiting him there, sharing drinks in dark, Wild West-ish bar . . . He was amazed that I’d never heard about the many Irish patriots, heroes who been sent to Van Diemans Land.
I believe I found this French-style hotel on the Internet ~20 years ago after its obviously great Heritage value had seemingly been destroyed in a usual commercial way . . . Economic Growth.
I now cannot find it . . . The Bad side of the Good of . . . what we have been talking about, how San Jose became the Silicon Valley center.
That “old French hotel” would have been an extension of this. In https://www.francetoday.com/learn/history/paris_of_the_pacific_celebrating_san_francisco_s_founding_french_community/ :
‘”. . . the French were the largest minority in San Francisco . . . They came over for the Gold Rush, but got rich from providing the tools to mine gold.”
. . . the French immigrants invested their lives, fortune and expertise in the city itself, creating a “Frenchtown” that influenced shops, businesses, food, saloons and culture. One of San Francisco’s nicknames was the “Paris of the Pacific”‘.
Related. As the Industrial Revolution outgrew Britain, so the new driver of Change, Venture Capital, has long been outgrowing California, mostly by doing whatever it can to evade Governmental and other controls : https://www.wsj.com/articles/venture-capital-becomes-a-tech-battleground-between-china-u-s-11643202001
The end of the US Venture Capital boom is indicated by the Theranos debacle: https://en.wikipedia.org/wiki/Theranos .
“The end of the US Venture Capital boom is indicated by the Theranos debacle:”
On the contrary; I think it maybe just part of the wake-up call required to put research back on a balanced risk basis rather than big ticket hype.
I’m an optimist by nature..
The” boom “part of the comment may have more to do with easy money looking for a parking spot. Fertile ground for hype.
To me Theranos could just as well indicate a lack of adequate benchmark diligence ( by a lot of people who one would expect to know better, but here we are).
The related story of Ian Gibbons, Theranos’s chief scientist who died by suicide in 2013 https://en.wikipedia.org/wiki/Ian_Gibbons_(biochemist)?wprov=sfti1
Tragically this story rings the alarm bell to late of a structural problem in the innovation system in this case.
How sad. Poor bugger. Had he been American he may have jumped ship earlier.
Thanks Rob. I have always said: “You can’t generalize from a sample of one” so maybe Theranos was a one-off. We would need to know other cases where “adequate benchmark diligence” was lacking. My guess is there are a few. As systems mature/age/decline human judgement tends to be replaced by formulae and box-ticking.
Reflecting on Theranos, as you know I turnaround companies, mostly tech startups that have stalled due to lack of funding, lack of sales, technology does not work, and such. About 4 years ago I was in Pittsburgh with my old friend Jon Jarvik, prof of genetics at CMU, brother to Robert Jarvik of artificial heart fame. Jon made me aware of Theranos which I had not heard of before, they were starting to get into really deep trouble for fraud. I contacted Elizabeth Holmes directly offering to clean up the company, make the technology which she was faking actually work, but she said no. Similarly more than a decade earlier I contacted Meredith Hellicar directly offering to clean up James Hardie (through honesty and transparency and a fund), but she said no.
In reply to Admin’s comment about adequate due diligence (6 Feb), it brings me back to 2000, at the heart of the dotcom crap.
My experience with venture capital, (apart from the usual “vulture capital” comparison) is that they are ultimately quite conservative and only superficially appear progressive. The image is created because all new ventures are presented to them, dozens each day, so they have the luxury of choosing the choice ones. Those of low risk. VC does not take risk in my experience.
Yet there is a herd mentality even there. Most psyches fail to avoid a stampede. I am always amazed how competing movie houses seem to bring out similar themed movies at the same time. One learns of a project at another studio and jumps on the bandwagon too. Same happened during the dotcom boom. (Funny how a “boom” precedes then succeeds a bubble!) Like sheep, money was thrown at rubbish projects with next to no due diligence. I have seen some of those business plans. Projects where the CEO’s were making comments like, “The rules of markets no longer apply to us”. Well guess what? The few that survived had television ads, so traditional marketing supplemented the new digital media marketing that was emerging then. Now of course digital/social media marketing is mainstream. And those that survived had products or services that people wanted to spend money or time on.
It also reminds me of the flippant comment I make sometimes, “… everyone is lining up to be second”. The real successes of the new economy were those that learned from the dotcom failures and mistakes and came along shortly afterwards. We know some of them because we use them every day.
I have mentioned privately how much I have enjoyed this particular discussion.
A great article. I would argue mining finance of high risk projects shares many attributes of venture capital, but they’ve been doing that since the gold rushes of the 1850s. Canadians and Australians know how to harness expertise and finance in mining. The Aussie ” Penny dreadful shares” remind me of IT start-ups. Of of the 100s of IPOs listed you will get the odd spectacular success.
I like David’s input about mining companies. Technology and mining are similar in that they are both entrepreneurial. (Interesting that originally entrepreneur referred to someone putting on an entertainment venture with unknown risk.)
The difference is that technology startups have something to run with, an invention for example, whereas mining startups, called junior explorers, have unknown potential. The discovery is yet to be made.
They both have risk. The risks in a tech startup are well known and legally obligated to be spelled out in the prospectus. The risk of mining exploration are similarly well known. Investors look to the management and growth potential of a tech startup and the geologist and the tenements in the mining company. So in both cases it comes back to people talent. Investors will follow a successful geologist and a successful technologist.
My statements are a bit black and white, and of course there are exceptions. For instance the current thing in mining is lithium and rare earth metals, so the risk is more acceptable than say zinc when these are the projects. Social media, electric cars, are hot in the tech sector, so these are assessed on a different scale to say recycling ventures or organic vegetables.
I’ve had experience in both advanced tech and mining and there is another difference I’ve noticed. Most exploration startups go straight to their IPO, while tech companies start off privately and go public once they have some runs on the table. That means that there are two types of investors in mining companies. These in for the long haul, banking on the company making discoveries and becoming a mining giant, and those investing in the ups and downs as the company’s daily fortunes progress, not caring about the end game, only the profits from short term trading. This makes mining much more speculative in my mind than technology. That applies not only to investing as a VC or IPO participant, but in the day by day tracking of share prices looking for trends to lock onto.
(I’m sure Admin would have something to say about looking for trends in share prices. I have smart friends who lost family fortunes not realising that is is easy to find a trend working backward on random data, believing that is a predictor for the future.)
So I agree with David’s post that there are examples of risky venture capital, for instance in mining.
Comments are closed.