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Excerpted from the book Done Deals, edited by Udayan Gupta, Harvard Business School Press, 2000
Charles Waite got his venture capital education at Harvard Business School, at the feet of Georges Doriot, the master.
For Waite, the excitement of what Doriot taught was all-pervasive. But Waite simply didn't believe that others should make all the money while he did all the work, so when the opportunity to join a start-up fund came, he jumped at it. He co-founded Greylock in 1965 with $10 million from six wealthy families including the Watsons of IBM and Sherman Fairchild, the founder of Fairchild Semiconductor. Greylock has gone on to become one of the most venerated East Coast venture institutions, and Waite was involved in many of the fund's major successes.
We obviously weren't going to back cocaine traffickers. But we were open to most anything else. | |
Charles Waite |
Waite isn't active as an investor anymore, but he continues to be involved with some Greylock investmentsboth as an advisor and as a board memberas a Greylock limited partner. Here Waite recounts not only his days with Doriot, ARD, and later Greylock, but also the early days of venture investing on the East Coast and the early values and practices at one of the most storied firms on either coast. He talks about the venture capital industry that was and how it is changing as greater infusions of money, higher expectations, and greater successes leave the industry with an embarrassment of riches. His narrative is a candid description of how the venture business found an identity and how quickly it can lose it.
I was a student of Georges Doriot at Harvard Business School. He probably had more to do with the formation of this business than any other single person. Doriot had the practice of asking a high performer in his class to be his teaching assistant the following year. He only asked you to assist for one year, because he thought there was valuable exposure if you did it for one year, but he wasn't attempting to make you into a teacher. I took that post for the school year of '59 to '60. It was a grand yearthe pay was low, but I had a lot of exposure to his students. It was a large class with 150 students, and there was a lot of activity. Doriot then asked me to join his venture firm, American Research and Development Corp. I liked him, and I had learned a lot about venture capital from him in his class. So after finishing at the Business School I went to work for him. I stayed there for nearly seven years. Then with Bill Elfers and Dan Gregory I founded Greylock in 1965.
Doriot took the first steps toward institutionalizing venture capital. As a young professor at Harvard, he knew a lot of powerful people including the president of MIT, the head of Mass Investors' Trust, and the head of John Hancock. They met in 1939 to define what was to become venture capital. In other words, they were asking if it wouldn't be useful if there were money and advice available to support the entrepreneurial effort. They actually held their meeting, as I recall, the night the Germans invaded Poland. With the war, they put the whole program aside for seven years. They met again after World War II and got the process started in 1946.
When I came to ARD in 1960, venture capital had been around for fourteen years or so. But it was still an academic experiment in some ways, because Doriot was head of it, and he was more than anything else a teacher. He was in the business to test a thesis. Making money wasn't really a very high objective. He wasn't opposed to it, but the salaries were modest. There was no ownership in the company for anybody. When others began to make serious money, ARD, unless it changed itself, would be unable to continue. At one time he tried to give options to ARD employees but the SEC wouldn't allow him to do that in the investment company format. He then tried to give options in the companies we invested in to ARD employees, and was able to do that in a start-up we did called Digital Equipment Corporation. But the SEC didn't like that either. There was really no way of having employees participate.
ARD started out being owned by John Hancock, Mass Investors' Trust, and a number of wealthy families, and then became one of the first publicly traded venture capital vehicles. It was founded under the 40 Act, and did a public offering in 1960. It raised $18 or $20 million, which was sizeable at the time, and was traded on the New York Stock Exchange. We invested our money as it is invested today, with a lot of legal hooks, a lot of careful analysis going into each investment, and a lot of time and effort put into the directoral, strategic, people-finding, and financial advice support areas. Doriot believed in working very hard at your investment portfolio.
Investing in Digital Equipment Corporation
Ken Olsen came to ARD two years before I got there. As I remember the story, he was working in the Computer Lab, or whatever it was called then, at MIT. Something was published about the work the lab was doing, and the youngest guy at ARD picked up the phone and called him. That fellow, very interestingly, never became a well-known venture capitalist or an industry legend. But he did find and help create one of the most successful companies ever. His name was Wayne Brobeck. He was a very studious person who didn't spend a lot of time at ARD. He found Ken Olsen and a couple of other ARD ventures, and then joined one of ARD's portfolio companies and moved out of the business. However, there were a number of people at ARD who were pleased to take credit for the Digital investment.
The investment made in Digital was $70,000. That bought 68 percent of the company. So in the early years, before subsequent financings, ARD owned 68 percent of DEC for $70,000. We subsequently lent $150,000 to DEC for no further equity position. But that was not risk capital. We did that because it was easier to lend the money to them than go to the bank, but it really wasn't capital at risk. So, it was a $70,000 equity investment. The end of that investment came many years later when ARD was sold to Textron and the DEC investment was distributed to the shareholders. It had a value at the time of between $400 and $500 million. Now, of course, there are many $400 or $500 million successes. But that was a time of different equity valuations, and a less inflated dollar. It was a huge win by any measure. Several of my then colleagues had a 1 percent interest in DEC that they'd received in options before the SEC closed that window to ARD and other investment companies. So those positions totaled $50 million to $60 million at the peak.
One other thing people have forgotten about DEC is that Ken Olsen had a partner who was every bit as important in the early days as Ken was. His name was Harlan (Andy) Anderson. Andy is still a private investor, living in Connecticut. He was a very, very valuable partner of Ken's. They had a falling out, a technology falling out some years later, and Andy left. But, of the founding equity, Ken had 60 percent and Andy had 40 percent. So, they were nearly equal partners.
Bill Elfers was the driving force behind the launch of Greylock. I think it was to prove himself, to see if he could do it on his own. He'd been in Doriot's shadow all these years. He was very important to ARD. He was the number two guy, and had been the number two guy for a long time. Doriot, being the professor, relied heavily on Bill for the everyday decisions. Are we going to make this investment or aren't we? Are we going to advocate the change in management in company X? Are we going to sell this investment? Are we going to put more money into this investment? Those were the kinds of things that Bill Elfers did on a day-to-day basis. I think Bill wanted to try his own game.
He left in 1965 and put together a group of investorsprivate familiesand then asked me a few months later to come and join him. There was a third fellow who he had met along the way, Dan Gregory, that joined him. So there were three of us, essentially, from the beginning. Bill and I had already been working together for a number of years. So, we just did what we had learned how to do.
The first fund began at just under $5 million with five investors. Subsequently another family came in, and then several years later the same group put in some more money. That first partnership became a $10 million partnership that took us six years to invest. My colleagues now are putting money to work at a far more rapid pace. It's changed a little bit. We were investing $250,000 and $300,000 at a crack, and we looked at everything very, very carefully.
We did a wide range of deals at first. At ARD we often backed scientists that left MIT or elsewhere to make scientific instruments, often related to defense or to the space effort. There was pattern for many of these companiesthere would be a professor who was working for the Air Force, or NASA, with an agreement that they would get a $50,000 or $75,000 research contract for some technology effort. After getting that contract, they would come to us for some operating money to get started. That would be the initial step of the companyfunded with some research money from Washington and some venture capital. They would do the research and if it was successful, it would turn into some instrument they would sell to the Air Force. Then if the instrument had commercial applicationas we always hoped it wouldthey would commercialize it. That sounds easy, but it was very difficult, because the markets were different, the configuration of the product had to be different, and it was often a very costly and time-consuming transition to make. But I'd say that was more of what we did than anything.
At Greylock, we said from the very beginning that we would do anything as long as it was legal and honorable. We obviously weren't going to back cocaine traffickers. And we wouldn't have backed a cigarette maker. But we were open to most anything else. Among the first investments we made at Greylock were a cable TV company, an insurance company, and a grocery retailer. Those weren't necessarily one, two, and three, but they were three of the first seven or eight investments. We were looking very opportunistically at a wide variety of things.
At Greylock in the early days, we weren't oriented to start-ups. That was basically because Bill Elfers felt much better, much more at ease, when there was more information to go on. And, of course, if a company had been around for a couple of years, there was more to analyze. One could be more confident. The risk was lower. That was one of the early tensions between Elfers and me, because I always believed that the odds of a great win were only there if you did start-ups. So I pushed very hard, and eventually the firm came around to doing start-ups, but it was not an easy transition.
The nationparticularly in Boston at that timewas beginning to develop an entrepreneurial culture. There was a company that ARD founded or supported called Tracer Labs. That's a name many people don't know. But, Tracer Labs was an early model for Fairchild in California. How many companies came out of Tracer Labs? You could make one of these branching maps today. It was a big number. Tracer Labs was never a great company. It was one of these companies that started making analytical instruments. But some scientist inside, some researcher, would come up with a new instrument. He couldn't sell it to his boss, so he'd leave and come to us, or others, and get funding to start his own company. That happened repeatedly.
High Voltage Engineering was another early success of ARD's after World War II. And by the late '50s, early '60s, those companies were producing an interest in high-technology capital gains, as well as an entrepreneurial interest. The companies were also the source of people who were leaving to start their own companies. It's nothing like the wave of today, but it was there. And, of course, the semi-conductor companies started. We had Transitron, which was the early one in Boston. The people poured out of Transitron by the '60s, and were starting little companies, either in California or Boston. And if they weren't coming out of these companies, there would be professors at MIT or Harvard, or elsewhere, that read the stock sheets and could see that there might be opportunities.
We started with around $10 million in '65 and '66, and the three of us went for about three years. We then added Henry McCance, who runs the firm today. This young person we hiredhe's still a young guy to meis in his mid-fifties now and has been with the firm about thirty years. We added Howard Cox a couple of years after that. They had both worked in an analysis group at the Pentagon. Henry was a civilian employee at the Pentagon. As a matter of fact, he worked there for a guy named Charlie Rosatti, who we later backed in a venture and who is today Commissioner of the IRS. The five of us went along for a while, and our next hire was David Strohm. One of the interesting things about Greylock is that no one on a partner track has ever left the firm. Not one person in thirty-three years.
Today there are ten partners. That doesn't include the three founders, who are all in one form of retirement or another. I still sit on boards of companies, but I'm not looking for deals on a day-to-day basis, or integrating with my partners on a day-to-day basis.
The size of the last partnership that we raised, which was done early in 1998, was about $250 million. We have a different philosophy than some about raising money. We've been one of the successful firms, so raising money has not been a problem for us. If we were to have a few bad years it would become a problem for us like anybody else. We're not alone, of course. A number of good firms have no problem raising money. We try to raise as little money as we can. I mean that sincerely. At the same time we want to be thought of as a player by other people in the industry, because the source of a lot of investments is other people in the industry. We don't want Sutter Hill or Kleiner Perkins to say, "We can't take this deal to Greylock, it's too big for them." So, we have to have enough money to qualify to be a member of the real club, but that's all the money we want.
Actually, we've disappointed some potential investors by saying, "we're sorry, we don't have any room." "Well, of course you have room," they say. We don't. We've turned down many families and university investors, because we want to keep a lid on capital so we have a higher confidence of our ability to create returns. Greylock was very successful with a $10 million fund, then with a $12 million fund, then with a $30 million fund, and so on, but there are some different things you must do when you start managing a $250 million fund, and still different things when you raise $1 billion. The people that are true venture capitalists, and are really working on these companies, aren't necessarily good at managing huge amounts of money.
Venture Capital, a Small '60's Community
When I started in the business, there were very few other players. If there were fifty people in the business in 1960, that was a lot. Today, I don't know how many professionals there are, but I think it's 7,000 or more. I used to know everybody in the business quite well. You didn't really compete with one another. I mean, if Venrock had a deal, it was Venrock's deal. If you really wanted in, you'd call Peter Crisp and ask him to let you in. But you wouldn't put another term sheet on the table. That was not very gentlemanly. If somebody was going to start a company, they wanted $250,000 or $300,000 and they gave up about 65 percent of the equity. The deals that we offered were all about the same. So unless you were some great manunless you were Dwight Eisenhower wanting to start an infantry divisionthere wasn't much hurry to do the deal, which gave us plenty of time to research the market, the competition, and the quality of the people.
The president of a proposed company in these early days didn't have all the experience in high-tech firms that most entrepreneurs have today, but he had an education, and he had worked somewhere. So we looked at his performance, and talked to his boss. We didn't do that on the telephone. We would get on an airplane and go to Youngstown, Ohio. Which I've done. I've been most everywhere. And we would sit down across from the entrepreneur's boss and talk to him. It does make a difference. It is very hard to get a read on people today. People won't be honest with you. If there's anything negative to say, they won't say it, because they're afraid they'll be sued, and for good reason. And if you do it on the telephone, there's no way you're going to get any negatives. So if you are really interested in this entrepreneur, you better go and personally talk to the people who he's worked for. But people frequently don't do that. It's too time consuming, and it's too much work. The business has gotten too easy, even though it is very competitive.
There was time to do your due diligence, and we did our due diligence. We would make a lot of visits and calls, and really do our homework before we made an investment. And when you'd made that investment, there typically weren't five other companies created by your competitors to do the same thing.
We genuinely believed that companies benefited greatly by our serving diligently on their board. That diligence has been lost along the way by some firms to some degree. Our reason is that the numbers don't work anymore. You start out by raising a whole pot full of money, say $500 million, because it's available. How many boards can one person serve on effectively? Six, seven, eight, nine? That's about it. Beyond that it's a joke, because you don't know what's happening. You don't have time. You miss meetings. You try to do it by telephone, and it doesn't work, at least not the way that it's meant to work. So, what people can do to solve this problem is either raise less moneywhich they don't door make larger investments, which at some point in time aren't really efficient venture capitaltype investments anymore. Or they kid themselves that they can handle a lot of boards by not really being on the board, just being available as an advisor, and so on. That's not what the classic entrepreneurial-venture relationship used to be, and I think still should be. So a lot of ventures don't work because they're not getting proper attention from somebody who has the relevant experience. Just because some young person has been to Harvard Business School and is now a fresh twenty-six years old, and smart as hell, really doesn't mean that he's much use to an entrepreneur. He probably needs four or five years of experience to be helpful. A lot of these entrepreneurs get young guys foisted off on them because there isn't anybody else in the firm to do it. In our early days at Greylock, and at the other good firms at that time, we wouldn't put a new hire on a board without his having first served with one of the partners. That substantially reduces the amount of money you can manage, as well as the rapidity with which you make investments. That's all been speeded upnot necessarily for the betterin recent years.
People today are placing high values and betting that these companies are going to achieve great success, and then the market value will be there, the performance will catch up to the market value, and it will be okay. But, in most cases, they probably won't be great successes, and those numbers will get punched back substantially.
Early Venture Capital: A Mission to Create
There was a kind of a missionary quality in venture capital years agoor at least a feeling of doing something that was different and goodthat remains to a lesser degree now. One reason for that was Doriot's philosophy. Many of the people in venture capital have some connection to him. For example, Tom Perkins and Peter Crisp were his students, and I'm sure there are many others. And he stayed in touch with these people. Not only were they students of his, but he had substantial influence on them.
Doriot's thesis was that if you took a team of people with business experience and a willingness to expend time and effort as well as money, and mixed them with an entrepreneur they could invest in, it would be greater than just the entrepreneur raising money from his uncle Fred. This pool of knowledge, money, and time would add materially to the mix. Back in the '50s and '60s, this was a new idea. Entrepreneurial efforts in the past had been done by wealthy individuals who would invest in a start-up now and then. Doriot would pick the entrepreneur he wanted to back, invest the money, and go away. A year or two later, he'd hear whether it worked or not. So this was a new idea. And, yes, there was a missionary zeal about itthat's how Doriot got away with underpaying us all, because we believed were doing something for the greater good, making America a better place. And it was truewe were doing something. I had a lot of good times, and felt like I was making the contribution that the great man wanted me to make.
Optical Scanning Corp.: A Turning Point
There was one company that changed my mind about this, or made me at least change the way I did it for a living. We had at ARD a company called Optical Scanning Corporation, which was a '60s company that was involved in optical scanning technology. It was a troubled investment for ARD, and some of my colleagues had lost confidence in it. Doriot kept trying to force them to put more money into it. He didn't want to be responsible for writing the checkhe wanted them to want him to write it. The way he responded was to get me involved with it. I was still pretty green. I went on the board of this company, and I was the one that he used to get the checks written over the next few yearsI was responsible for putting a lot more money in this company and working very hard with it. Optical Scanning eventually went public and was a large success. ARD went from an exposed capital position of about $3 million to having a gain of over $20 million, which was a lot of money at that time. It went from being a burden to a big win in about three years. I had made a very substantial contribution to that company. The way I had done it was by getting along with the entrepreneur. The other guys didn't do that. He and I had a lot in common, and he had confidence in me, and I in him. We made it work together. The CEO's net worth went from zero to $10 million, and I got a $2,000 raise. I agonized a lot over that. I loved what I was doing, but I thought I should be somewhere where I was compensated adequately. And, so that was what eventually led to my leaving the firm and moving to Greylock.
My partner Bill Elfers had been in the business by that time for nineteen years, and I had been in it seven. I had a good reputation. I was thirty-five at the time, Elfers was in his middle to late forties, and we knew everybody that was in the business. We knew Peter Crisp's Rockefellers and we knew Bessemer and Peter Brooke, and the people out here on the West Coast. So although Greylock was a new name, we had a continuing flow of opportunities.
We've had a very good record over the years, but in the early years we weren't doing start-ups, so we didn't have the huge wins. We were investing a little further along the spectrum, and were seeking to make four or five times our money. One of our investor founders was the Watson family. They asked us not to invest in the computer industry. If somebody said that to you today, you'd laugh about it. But we were willing to accept it in 1965 and 1966.
The Watsons were IBM. They viewed it as a conflict for Greylock to invest in the computer industry and it may even have been a written IBM policy. They didn't make us sign anything, but they didn't want us to invest in the business. Thus, we weren't looking at deals in the computer industry in the late '60s. Many thought at the time that the computer industry was overit had been done, and IBM controlled it. And there were a bunch of other little companies like SDS that became XDS, and DEC.
Prime Computer really changed us. Prime came to us through one of the investor directors, who was also the father of my son's girlfriend. I was invited to his home one night. I thought it was a social function, but they were actually raising money for Prime. I ended the night with no dinner but a favorable introduction to Prime and its chief technology officer Bill Poduska. In order to invest in that company, we had to form a special partnership that excluded the Watsons. We thought enough of the opportunity to do that.
We've since followed Poduska through his entrepreneurial career. We did Apollo Computer, and, unfortunately, Stardent. He's still a great friend, having made a lot of money for us with Prime and Apollo. We gave some of it back in Stardent, but we're still way ahead with J. William Poduska.
How has Greylock evolved? We've gone from a $5 million partnership that became $10 million, to what is most recently a $250 million partnership.
We've tried to maintain the culture of the firm as much as possible. We expect people to stay. When we bring an investor on board we expect them to stay. In bringing people into the firm we've been careful. We don't want a bright person whose culture is all wrong for ussomeone who wants the toughest, harshest, sharpest deal he can possibly make, who's going to be a little too sharp. Even though in the short term we might make a lot of money, we just don't hire those kinds of people. We try to hire mannerly, personable people with a good education who honestly want to make a contribution to the companies they're involved in and are not focused only on making money. Most firms say they do the same but my experience is that many don't. They'll hire the smartest people they can get, people who have a reputation for making money but are often devoid of people skills and the ability to help entrepreneurs. I'd say this is a principal element of our culture. And that leads you to a number of other places. For example, we've never lost an investor. We've now raised nine partnerships, and not one of the original investors or of the other investors we've added along the way has ever dropped out. Where people have died, their sons or daughters or trusts are writing the checks today. That's part of the same culture and we're very proud of it. The last time we made a major change in our investor format was in 1978, when Harvard University, in the person of Walter Cabot, came to us and asked to invest in Greylock. Walter was a classmate of mine, and a close friend of Gregory's. He told us he had just taken over Harvard's money management and wanted to try to get some push in it, and had decided that venture capital might be a place to put some capital. At that time, universities, with a few small exceptions, really weren't investing in venture capital.
Once Harvard expressed a serious interest in Greylock, MIT, which had been exploring an interest in us for years, wanted to investas did Duke and Dartmouth. From this time in the late 1970s on, 50 percent of our new capital in each partnership has come from these universities, along with Stanford and Yale, who joined us later.
We have subsequently had to limit participation in new partnerships because the appetite of our present investors exceeds our need for new capital.
We've had one of those recently. A company called Ascend Communications, here in San Francisco. The Ascend investment was made for Greylock by Roger Evans. Some years before, Evans was COO and CEO of a very successful Greylock investment, Micom Systems. I worked on that company for Greylock with Roger. We sold the company after much success and some trials for about $400 million. Roger, a Brit with a liberal arts degree from Cambridge, was rich, forty-two years old, and trying to figure out what to do next. We persuaded him to join Greylock. He sponsored Ascend and contributed enormously to its success in terms of getting the right people in the right slots and defining strategy. The company was recently sold to Lucent for about $23 billion. Greylock's share of that counts on our records at about $800 million because of time of distribution. At any rate, Ascend proved to be Greylock's largest win ever.
Firms in our business have carried interests of 20 percent or 25 percentsome even have 30 percent. And there are all kinds of different formulas. Alternatively, I can write a check for as much money as I want to give to Ned Johnson at Fidelity Investments and he'll manage all the money that I give him for somewhere between 0.5 percent and 1.2 percent. Think about that. Why should an investor give Greylock, or Kleiner Perkins, or anybody else money and pay them 25 percent if I can get Ned to do the same thing for 1 percent?
The only reason for investors to tolerate high carried interests is to receive superior returns. In the past, venture capital operators providing value-added services have shown, on average, higher returns than mutual funds or other investment vehicles. Recently, however, S&P average returns have been very high, placing pressure on venture firms to provide still higher returns. One of my concerns for the venture industry is that as capital pools get larger there is some tendency to provide less value added and over time I believe this will reduce returns. Not many people believe S&P or other similar yardsticks will continue to show such high returns. Nonetheless, the venture industry needs to remember that its investors are there for the returns. They also need to recognize that my friend Ned Johnson is always there to manage money for 1 percent.
Would I personally do a venture capital partnership again at this time? If I were twenty years younger, I would. I wouldn't do it at my age largely because it is a young person's business. I would get together two or three other people, and I would raise about $100 million. I wouldn't want more, because I think $100 million is about the right size today to create the best returns. It is easiest to work with three or four guys. Working with eight or ten is more of a management burden. For example, my partner Henry McCance has to be a manager now. Henry loves deals. He loves to be on boards. And he hasn't stopped doing that. But he principally has to manage the firm. Everybody has an opinion. Someone must decide what we need to do now. Otherwise you have eight or ten guys running around doing deals on their own, with little coordination and no benefit to being together and having a culture and a management structure.
I think the venture business is still a good business. There is still an opportunity for experienced, motivated people to help entrepreneurs create wealth. There are probably, at this point in time, too many people in the business and there's too much money available to allow ideal venture returns, but adequate returns are still available. Young people are paid too much at the front end. They don't have the incentive to work hard enough to create the successes that will make them money when they become partners. Additionally, firms are pressured to make associates partners sooner than is ideal. There's also the problem that the business is much more competitive. That's good overall, but less attractive for each individual firm.
There's another factor. There are other classes of competitorsthe Ciscos and the Intelswhich are motivated somewhat differently than the Greylocks and the Sutter Hills. They are able to put $50 million into a company at extraordinary valuations if it has potential importance to their mainline business. That's very tough for us to compete with. You find that the prices make no sense. We lose often to this class of competition.
Today there is a significant advantage to having specialist experience in one or more of the areas in which venture capitalists concentrate. In the past, the investment spectrum was much broader and we generalists perhaps had an advantage. But today, if your firm doesn't possess software experience and talent, you should probably stay away from this lucrative area because the best and the brightest are already there.
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