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Done Deals: Venture Capitalists Tell Their Story: Featured HBS Arthur Rock

If anyone stands out as a seminal figure in venture capital, it is Arthur Rock (HBS MBA '51). The first venture capitalist to grace the cover of Time (in 1984), Rock garners respect among his colleagues and competitors, not only because he has made some of the most rewarding investments, but also because the companies he helped finance form the backbone of what is now known as Silicon Valley.
Arthur Rock

Excerpted from the book Done Deals, edited by Udayan Gupta, Harvard Business School Press

If anyone stands out as one of the seminal figures in venture capital, it is Arthur Rock. The first venture capitalist to grace the cover of Time (January 23, 1984), Rock garners respect among his colleagues and competitors not only because he has made some of the most rewarding investments, but because the companies he has helped finance have come to form the backbone of what is now known as Silicon Valley. Think of Scientific Data Systems, Teledyne, Intel, and Apple Computer, and Arthur Rock invariably comes to mind.

A private person, Rock has never been the media-savvy promoter that many venture capitalists have become. Rock made his first investments at a time when technology wasn't the Wall Street investment choice, a time when it took products and revenues and proven managers to go public. And although Rock himself confesses that he was never a very astute judge of technology, the people he brought together and the culture he helped influence have created a lasting economic presence in Silicon Valley. Even though Rock's partnership with Tommy Davis (who went on to launch Mayfield Fund) came at the very beginning of Silicon Valley, many of their covenants and practices became part of the partnership structure that Valley venture capitalists adopted.

Davis and Rock
The Venture Philosophy
The Internet

I finished Harvard Business School in 1951 and ended up at Hayden Stone, a New York investment banking firm that specialized in financing for companies. I was especially fascinated with smaller companies. We did quite a few deals, both public and private. Of course, the venture capital firms around then weren't called venture capital firms--they were just private family organizations, like the Rockefellers, or the Whitneys and the Phippses. There was a group of individuals who had been following the deals I had been making, and with them I invested in a few companies, the most notable of which was Teledyne.

You probably have read the story of the forming of Fairchild Semiconductor. Well, Fairchild Semiconductor was formed by eight scientists out of the Shockley Laboratory Division of Beckman Instruments. Shockley, of course, was one of the three people who invented the transistor. Shockley was a difficult man, but a genius. After he invented the transistor, he decided he wanted to change his life -- he got divorced then remarried, and then moved to California. At the time you couldn't raise the money you can today, but he did know Arnold Beckman. With Beckman's help, the Shockley Laboratory Division of Beckman Instruments was created. Of course, with Shockley's name he could recruit anybody he wanted. So he recruited a whole group of very young super scientists. That went on for around two years, but finally Shockley's difficult personality got to all of these guys, and some of them decided they wanted to leave. Seven of these scientists got together. One scientist's father had a brokerage account with Hayden Stone. So, he wrote to his father's broker and informed him that there were seven scientists who were going to leave Shockley, but before they did, they were wondering if anyone knew of a place where they could get a job together.

Lucky for me, this broker showed me the letter. I talked to this scientist, and it was decided that one of the partners at the firm and I would come out to San Francisco to meet with them. They needed $1.5 million. We thought about it for awhile, and I got the idea that we ought to see if we could form a company and then get one of the bigger companies to finance it. So we made a second trip out to California, at which time an eighth individual -- Bob Noyce -- joined us and we agreed to agree to form a company in which each of the eight scientists would own 10 percent of the stock, and Hayden Stone would own 20 percent. And between the scientists and ourselves, we selected about thirty-five companies to go talk to. We did zero with all of them.

This was 1957, twelve years after World War II, and all these companies were interested in expanding their technology, and they didn't know how to do it. They all liked the technology, but they couldn't see how it could be done without upsetting their organizations. They didn't understand how they could set up a separate subsidiary, and finance it, and how that would affect their organizations. All thirty-five of them passed. Then we came across Sherman Fairchild.

Sherman Fairchild was the single largest stock holder in IBM, because his father had financed Tom Watson Senior in forming the predecessor company to IBM. In any event, Tom Watson Senior had quite a few offspring. Sherman Fairchild's father had only one. So Sherman ended up as the single largest stockholder in IBM. He had a lot of money. In addition, he was an inventor. He invented the aerial camera -- and then he had to invent an airplane to hold the camera. That's how Fairchild Camera and Instrument and Fairchild Aviation came to be two separate companies. Sherman liked young people and he liked new ideas, and he had a lot of patents, so when we approached him, he liked our idea. So Fairchild Camera and Instrument lent $1.5 million to this company, in return for which they got an option to buy all of the stock for $3 million. That was how Fairchild Semiconductor came to be.

The reason I got so excited about Fairchild Semiconductor was because I'd already been in the semiconductor business through General Transistor. General Transistor was the first publicly held, independent company to make transistors. To show you what kind of money was involved, the company was started with $50,000. We did a small public offering for them, and eventually that company was sold to General Instrument, and became the semiconductor division of General Instrument.

In two years, Fairchild Camera bought the whole thing back. They exercised their option and paid us the $3 million, and created Fairchild Semiconductor. By the time everybody left, the subsidiary was making more of a profit than Fairchild Camera. Sherman Fairchild had died in the meantime, and the company was being run out of Syosset, Long Island, where Fairchild Camera and Instrument had its headquarters. Relations got pretty testy after Sherman died. The CEO didn't like the idea of stock options, and wanted to call the shots out of Syosset, and have everybody report to him. Finally people started to leave, and eventually Noyce and Moore left and started Intel.

It is entirely possible that there would be no silicon in Silicon Valley if Fairchild Semiconductor had not been established. The Fairchild Eight would probably have dispersed and the only other company working with silicon was Texas Instruments.

I moved to California in '61. We were doing a lot of deals in California, and it occurred to me that all of the energetic scientists were forming around Stanford. The reason for that, in my opinion -- although some people will differ -- is because of Fred Terman. He was head of the engineering school at Stanford, and he encouraged his students, especially the doctoral and postdoctoral students, to form companies and continue to teach at Stanford. That was an unknown concept at any other school in those days -- it certainly wasn't happening at MIT, Harvard, or Princeton, or any of the good engineering schools. People got fired from MIT in those days if they started companies. All these people were entrepreneurial, and yet there wasn't any money in California. The money was in the East, and Eastern companies weren't exciting. So I decided to try to get some Eastern money and move to California to set up a company to invest in these entrepreneurs.

I don't know that there was a term called venture capital when I started out. As far as I know, I was the first to use the term, but I can't claim that I coined it or anything. I suppose venture capital actually goes back to the days of the Medici. But in any event, institutions were not interested in putting money into these companies, because they were all Eastern institutions that invested by the prudent man rule -- it was just taking too big a risk. So we got individuals to invest.


Davis and Rock

I had met Tommy Davis through some mutual friends while I was in San Francisco. He was a vice president of the Kern County Land Company, which had decided they wanted to do some expansion, because they had all this cash flow coming in from their royalties. So, they hired Tommy to invest their money in corporate developments. He was responsible for the Kern County Land Company making an investment in Watkins Johnson. He had a couple more deals he wanted to do, but the Kern County Land Company said, let's wait five or six years and let's see what happens with the one deal we've done. Tommy didn't want to do that. So, we got together and raised $5 million -- mostly from Eastern friends of mine who had been in deals with me before -- and we formed the firm of Davis and Rock in 1961 with the princely sum of $5 million. In fact, we never invested the whole $5 million. We got pretty lucky, and made some very good investments, the most notable of which, of course, were Teledyne and Scientific Data Systems.

I suppose if I were starting out today I would do it the same way. I think venture capital today is made up of portfolio managers -- except for a few of them. You know -- I'll go into your deal, you go into my deal. We've raised all this money, we've got to get it invested. And if you divide up the number of companies they're invested in by the number of partners, you find that the partners haven't got ten minutes for any one company. We spent a lot of time with our companies.

As for the entrepreneurs, many of them were corporate creatures who weren't familiar at all with the outside world. We were successful in getting people who had been through it before. Henry Singleton was the vice president of Litton Industries and ran one of the big divisions. And Max Palevsky at Scientific Data Systems had successfully run the computer subsidiary of Packard Bell. But there were enough people around, and enough time for people to grow. You don't have that today. Everything is so fast and furious, and you've got to do things right away. But these people we invested in needed help. They had no idea of stockholder value.

Davis and Rock dissolved by its own terms in 1968 after a seven-year life. We had a big position in Scientific Data Systems, and the SEC laws were a little different in those days than they are now. So if we formed a new partnership, all the partners who were partners in the old partnership would be deemed insiders of SDS. I didn't want to resign from the SDS board, but we wanted to have our limited partners free to sell their stock if they wanted to. So Tommy went his way, and I went mine. We were very good friends, no problem there; it was just the way things worked out.

When institutions began seeing what kind of returns Davis and Rock had, they became more interested in investing in those entities. So, beginning in '69 and '70 -- maybe even '68 -- other venture capital firms were formed. SDS was sold in '69 to Xerox at close to $990 million. That was a humongous deal in those days.

I worked by myself for a year or so, and then I formed another partnership called Arthur Rock and Associates. That was successful, but nowhere near as successful as Davis and Rock. When that expired, I went out on my own.



It was the invention of the semiconductor and the microprocessor that really changed the world. And Intel was at the forefront.

It was Bob Noyce, Gordon Moore, and myself who incorporated Intel. Andy Grove was actually employee number two. As I said earlier, the Fairchild group became less and less happy at Fairchild Semiconductor after Sherman Fairchild died and John Carter became CEO at Fairchild Camera. John was not an easy man to get along with. He wasn't crazy like Shockley, but he was an Eastern CEO, and he ran everything by the book. He didn't want to give out any stock options, or to do the things that Bob and Gordon felt they had to do to build a business.

Fairchild was making transistors. When Bob and Gordon decided to leave they had the idea that they would make semiconductor memory. Now, you have to realize that all memory was made up of magnetic cores, and magnetic cores had to be strung by hand. So, if semiconductor memory didn't exist, but there were the same number of computers that are out today, my guess is that everybody in the world would have to be stringing magnetic cores. That's the business they went into, and they eventually replaced magnetic cores.

I was already involved in the memory core business, so I knew how difficult it would be to expand the business -- to get people to string those cores. And I had known Bob and Gordon since 1957 -- this was '68 -- and Intel is probably the only company I invested in that I was absolutely, 100 percent sure would be a success, because of Moore and Noyce.

We got lucky again with Busicom, a Japanese company that came to us wanting to make a calculator. One of our engineering gurus figured out a way to put together some semiconductors to make a calculator. From that we went into the microprocessor business. The memory business turned south because of Japanese competition, with their dumping in our markets and selling below cost. So, we couldn't make any money in the memory business. To Moore and Grove's credit, at that time we decided to bite the bullet and take our losses. We let go a third of our employees, and exited the memory business. That was probably, in my opinion, the single best management decision ever made in any company. It took a lot of guts.

The lesson from Intel? The necessity of having great management. Intel has been blessed with absolutely fantastic management, with the right managers at the right time. Noyce was the first CEO, and he was a visionary and a great scientist, but he was also a good salesman and a good marketing person. His interests were all over the place. He finally got bored. Then we had Moore for ten years, and he was the ultimate scientist and really drove the technology when the technology needed driving. Then when we started to have competition and needed someone to drive the business, Grove came on the scene. The Grove years were great ones for Intel, because Grove steered the business with laser-type vision. He just recently retired as CEO, although he's still active as chairman. Now we have our fourth CEO, and hopefully he'll be as good as the others. I don't know of many businesses that have had three generations of CEOs who were really fantastic.



Really, Mike Markkula should get most of the credit for my association with Apple. In those days, I was going to staff meetings regularly at all the companies I was associated with. I used to go down to Intel every week for staff meetings. One of the people I got to know in staff meetings was Mike Markkula. He was vice president of marketing and he retired early after he made quite a bit of money in his Intel stock options. Somehow or other, he had met Steve Jobs and Steve Wozniak. As I recall, he had guaranteed a bank loan of $300,000 to Apple, and became a third partner. Then Mike asked me to take a look at it.

Steve Jobs and Steve Wozniak weren't very appealing people in those days. I kind of wondered about this, but I trusted Mike. He asked me to come down to the Home Brew Computer Show. There were going to be a bunch of computer companies there, as well as a technical show. I had been going to shows all along, so, I said, "Sure I'll go." I went down to San Jose, and there was a big auditorium full of people with circuit boards and makeshift computers. No one was actually making a computer. Many booths were empty. I walked over to the Apple booth, and I couldn't get close to it. People were piled up behind the booth. I began to figure maybe there was something to this. I stood around there for quite awhile, and listened to people talking about it, and I thought, there's really something here, and if Mike is going to be really serious about this company, I guess I'll make an investment. The Rockefellers at that time also were making an investment. I invested the princely sum of $60,000. I went on the board, and lo and behold, it just took off. We got professional management in there. Jobs is an incredible person. He is very manipulative, very political, and has fantastic ideas, and can drive a process. But, he wasn't a manager, at least in those days. He had a falling out with Wozniak, and then he had a falling out with John Sculley, and much to his credit, he came back; maybe something will come of Apple now.

I had to get off the Apple board when IBM, Apple, and Motorola jointly developed what they called a Power PC chip. I really didn't pay much attention to it. Apple had always been a Motorola customer, not an Intel customer, and that was fine, that didn't bother me. I didn't see where I had any conflicts, because they had made that decision technically and had decided that the Motorola chip was better for their purposes. But, when this consortium developed the Power PC, they took an ad in all the newspapers -- a double-page ad -- in the Wall Street Journal, the New York Times, the San Jose Mercury News, and so on, announcing the chip, and saying that they were going to kill Intel. It wasn't two days later that I resigned from the Apple board.

The main help that I tried to give Apple was getting them some seasoned managerial people. Their first president didn't work out. Then of course we went out and hired John. Sculley did great for eight of the ten years he was there. Then things started to fall apart again, and that's exactly when I left, right at the end of Sculley's term.


The Venture Philosophy

There's a huge difference in a lot of venture capital firms. I think maybe Kleiner Perkins and a couple of the other older ones still try to give some management help. There's so much money around that they're fighting to get into deals, and decisions are being made over the telephone. People are calling up saying, I've got to be in this deal, without ever knowing anything about it.

I've been quoted fairly often as saying that I invest in people, not in technology, first of all because I'm not a technologist. I think you have to be a technologist today, because there are so many different technologies converging that you have to understand where everything is coming from. When I started doing these deals, there was no competition. You could make some mistakes, and still not get very far behind. Today, if you make any mistakes, you're dead. So, you have to understand the technology. A person with a general business background would not make it in the venture capital business today. But, in any event, I was always interested in investing in people. So, I spent a lot of time with would-be entrepreneurs to see whether they were motivated and whether they were intellectually honest. I don't see that as being possible in today's markets.

It just came out of people wanting to create something. I know I wanted to create something. I knew I couldn't do it by myself because, again, I wasn't technical. But I could sure help other people create things. And I really liked the engineers, scientists, entrepreneurs. Those are the people I enjoyed being with. I got my kicks out of helping to build big companies, creating jobs, and creating new technologies that would be helpful to people.


The Internet

I have this idea that there's been a major development of technology about every fifty years, 1850-1900 was the mechanical age with the development of the engine, 1900-1950 was the age of electricity, and then the big invention in 1950 of course was the transistor, which really is responsible for all of the technology we see today. Everything new in technology is a result of the invention of the transistor. I can't think of a single technology company that would have been able to exist without the semiconductor -- from medical instruments and software, to bio-tech, and so on. There is nothing that doesn't trace itself to the invention of the transistor. During the last ten years, I really began worrying about the future without a new seminal invention.

The new invention, right about the turn of the century, is the Internet. It's not an invention in terms of somebody getting a patent or developing a process, but it really is an invention where no one knows what's going to happen within five or ten years. You have no clue. Anyone who says he does is crazy. So that's the new invention, and I am just not up to it. I'm up to investing as an angel investor, and being of small help where ever I can, but not in taking the lead in doing what I did at SDS and Teledyne and Intel and Apple. I just don't see myself in that position.

As I said, the Internet is a new invention and a new platform. It's going to be a huge business, and big companies will come out of it as leaders. But in the meantime there is going to be more money lost than made before it sorts itself out.

I'm involved in a couple of companies that I think are quite exciting. One is a company called Education Partners, which is trying to change the way reading is taught in grammar schools. So far we've been successful and are profitable. I would guess we're probably the only profitable education company going. It's run by some very fine people -- in fact, the CEO is a Harvard Business School graduate, Adam Berman. There's technology involved, but it's not a cutting-edge technology. It's just a new method of teaching reading.

I'm involved in a very small medical start-up, which has developed a product that we're testing which will help people with Alzheimer's. It's quite exciting because it's such a simple thing to do. The theory is that part of the reason people get Alzheimer's is that their cerebral spinal fluid doesn't circulate fast enough in the brain, and builds up pressure. If you can relieve that pressure, the brain will become more normal. People call me about these little things and I get interested in them.

Things move so fast. Big profits and successes are made not only because the venture capital firms are choosing well, but because of the IPO market. I keep on telling people, wait until the IPO market dries up. I am a great believer in the regression to the mean. I don't know what's going to happen to all of these valuations. There are all these pension funds that are going into fund one, and fund two, and fund three, based on the profits of small amounts of stock that are sold in an IPO, which causes a shortage of them, so they trade hands at higher and higher prices. Some day that's going to stop. I don't know if it will be in my lifetime, but it just can't continue. What's going to happen to all these venture capital firms -- to all these investors who are investing blindly -- I just don't know.

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