The Evolution of Venture Capital: Part 1 The first fund

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The First Fund

In the architecture of modern global finance, no asset class has achieved a more violent asymmetry between the capital it consumes and the power it commands. Today, the global economy is anchored by a handful of sovereign-scale technology monopolies, from the silicon dominance of Nvidia and Intel, to the digital infrastructure of Apple, Google, Microsoft and Amazon. Together, venture-backed companies account for roughly 75-80% of all US public market capitalisation created since 1979, a $15 trillion industry that dictates the pace of economic industrialisation. Yet, annual funding required to sustain this engine still represents less that than 0.5% of U.S. GDP while generating over half of all new public companies of the last five decades. 

If you strip away the Silicon Valley mythology, the dorm rooms, the hoodies, and the garage-bound folklore, what remains is not a cultural miracle, but one of the most ruthless and effective pieces of legal and financial engineering in human history. From Fairchild Semiconductor’s 1957 birth via a $1.4 million loan and an equity call option, to Kleiner Perkins' calculated bet on biotechnology with Genentech, to the $25 million Series A check that built Google’s advertising monopoly, venture capital has quietly industrialised the translation of extreme technological risk into exponential wealth.

Yet, in 1946, the financial machinery required to execute this translation simply didn’t exist. There was no standardised mechanism to industrialise scientific risk, and innovators faced a fundamental structural puzzle: How do you finance high-risk, illiquid laboratory breakthroughs without quarterly earnings reports or the corporate tax code crushing them? 

The answer was engineered not by entrepreneurs, but by an unlikely assembly of academics, corporate defectors, and tax lawyers. Together, they designed the blueprint of modern technology finance: the ten-year limited partnership, the tax-transparent pass-through structure], and the "two-and-twenty" carried interest model. 

Over the course of the next four episodes of The Unsophisticated Investor, we take apart the evolution of venture capital, from its origins, to the modern day. 

• Episode 1: The first fund (1946–1978) begins in post-WWII America, the era that forged the blueprint of private venture capital and set the stage for the greatest explosion of private wealth in modern history.

• Episode 2: Capital influx (1979–1990s) looks at the maturation of Silicon Valley. When regulatory shifts unlocked America's massive pension funds, the industry transformed almost overnight. We explore how venture capital multiplied from a sub-$500 million industry into a multi-billion-dollar financial engine in just under a decade.

• Episode 3: The era of disruption (2000–2019) what happens when an asset class engineered for scarcity is drowned in liquidity. Zero-interest-rate policy erodes board governance and installs the cult of the founder; its purest expression is Masayoshi Son's $100 billion SoftBank Vision Fund, whose brute-force "kingmaking" produced ByteDance and WeWork in the same breath.

• Episode 4: The new frontier (2020–Present) capital itself becomes a commodity, so the industry splits. At one pole, sovereign-scale platforms like a16z turn media and podcasting into proprietary deal flow and influence. At the other, a counter-revolution of emerging managers and solo GPs strips out the institutional bloat to compete on speed, precision and founder alignment.

But long before the mega-funds, the media engines, and the oceans of liquidity, there was simply an institutional void. To understand how the venture machine commands the global economy today, we trace back to the shadow of the Second World War, with a surplus of military research, a French-born Harvard professor, and a financial system entirely unprepared to fund the future.

Section 1: Post war capital and the ARDC experiment 

In 1946, American capital and innovation were structurally misaligned. The Second World War had demonstrated the nation’s capacity for rapid, industrial-scale technological deployment, leaving laboratories around MIT and Stanford overflowing with defence-funded breakthroughs ripe for commercial application. Simultaneously, the East Coast was awash with private liquid wealth. Yet, the bridge connecting the two, a systematic market for financing high-risk, early-stage innovation, was virtually non-existent.

The reigning financiers of the era were industrial family offices such as the Rockefellers, the Whitneys, and the Phippses. These dynasties funded bespoke projects without standardised terms, reserved follow-on capital, or a repeatable mechanism for transferring a prototype from a university lab to a factory floor. Industrialising risk-capital demanded a formal legal and operational architecture, and that arrived courtesy of Georges Doriot.

Doriot was a French immigrant with a Professorship at Harvard Business School. During the war he had run technology procurement for the Army Quartermaster Corps, responsible for items such as cold-weather boots, water repellent fabrics. Doriot’s ingenuity was that he realised funding technology could be made a repeatable process, with the money just being one part of making it a success. In addition to funding, he focused on mentoring, hiring and managing the people on the other side of the table to him. Then, in 1946, with the backing of MIT’s President and the Head of the Boston Federal Reserve, he took charge of a new post-war organisation, the American Research and Development Corporation (ARDC).

While ARDC was a genuine triumph of free-market innovation, the first non-family fund dedicated to commercialising high risk. Doriot made a series of structural mistakes that his successors would spend the next three decades learning from.

The first mistake was the structure of the fund. He set it up as a publicly traded, closed-end investment company, a fund whose shares traded on the open market like any stock. That created a structural conflict. Public shareholders demanded liquidity, dividend yield, and predictable quarterly earnings, whereas early-stage hardware development required the exact opposite: years of patient, illiquid reinvestment before generating a dollar of revenue. Consequently, ARDC suffered a chronic liquidity drag, with its public stock trading at a persistent, severe discount to the underlying value of its portfolio. 

The second problem was valuation. Because ARDC was public and SEC-regulated, it had to report what its holdings were worth on a quarterly schedule. The challenge was putting a valuation on a pre-revenue, illiquid hardware startup under 1950s accounting rules. There is no market price, no earnings, nothing to compare it against. In 1964 the SEC raided ARDC's offices and informed Doriot that ARDC’s valuation was wrong, without being able to say whether it was too high or too low. 

The third mistake proved the most destructive. ARDC's investment staff had little financial stake in the outcomes they produced. As a public corporation with a public-service ethos, the firm paid its people salaries rather than a share of investment gains. An ARDC employee who helped take a portfolio company public might see the founder's net worth climb into the millions while his own compensation barely moved. Without a link between the fund's success and the staff's pay, ARDC struggled to retain investment talent. Another lesson for future venture capitalists, was the use of carried interest for their staff, a share of the profits that ties the investor's earnings to the fund's performance. 

Doriot's investment judgment, however, was sound. In 1957 ARDC backed Digital Equipment Corporation, a computer company founded by two MIT-affiliated engineers, Ken Olsen and Harlan Anderson. ARDC invested roughly $70,000 for about 70% of the equity, alongside a small loan. The stake became the defining position in the firm's history: by DEC's 1968 IPO it was worth in the hundreds of millions, and DEC accounted for the large majority of ARDC's total returns over its lifetime, reported to represent a near 5,000-multiple of its initial investment. 

That outcome illustrated a pattern central to venture investing, a single successful investment can generate the bulk of a fund's returns. ARDC could not fully capitalise on it however. Because the firm was a publicly traded corporation, its shares traded at a discount to the assessed value of its holdings, a sign that the market did not reward the structure for the value it held. By 1972 ARDC was worth more to its owners broken up into its constituent parts than intact, and it was merged into Textron that year.

What Doriot had demonstrated however was that technology investing could deliver returns far above conventional equities. The limitation was structural, not analytical. It was the structure, rather than the investment approach, that the next generation of West Coast investors would set out to fix.

Section 2: The Traitorous Eight, Fairchild, and the west coast catalyst 

Three thousand miles west on the California coast, a bitter corporate dispute was about to trigger the industrialisation of Silicon Valley. While Boston financiers were wrestling with the public market structures of ARDC, a workplace revolt near Palo Alto established the fundamental structural rule of modern technology finance: durable wealth requires uncapped equity.

In 1956, William Shockley, co-inventor of the transistor and a newly minted Nobel laureate, established a laboratory near Palo Alto and recruited the most talented young physicists in America. Yet Shockley’s technical brilliance was paired with an erratic and paranoid temperament. Within a year, his controlling behaviour and insistence on subjecting employees to polygraph tests had driven his research team to open mutiny.

In the summer of 1957, eight of those engineers resigned en-masse. The group, which included Gordon Moore, Robert Noyce, Eugene Kleiner, and Jean Hoerni, was sourly dubbed the "Traitorous Eight" by Shockley.

These engineers did not initially intend to become founders. Their objective, outlined in a letter sent by Eugene Kleiner to a New York brokerage house, was simply to be hired as a collective unit by an established corporation that would grant them operational autonomy. As Gordon Moore later reflected, he was an "accidental entrepreneur" who stumbled into company creation rather than actively pursuing it.

That letter landed on the desk of Arthur Rock, a young corporate finance banker at the Wall Street brokerage firm Hayden Stone. Rock proposed a radical alternative that the scientists had not considered: rather than seeking an employer, they should incorporate their own firm and retain equity ownership. Rock approached roughly thirty-five potential institutional backers and industrial corporations to underwrite the venture. Nearly all declined. Traditional investment firms were wary of backing a scientific team with no commercial track record. Established corporations were willing to fund a fully owned subsidiary, precisely as Beckman Instruments had done for Shockley, but they adamantly refused to let outside engineers hold equity in an independent entity. To grant stock ownership to scientists risked setting a dangerous precedent within their own corporate hierarchies, as employee equity was entirely foreign to 1950s industrial culture.

The sole financier willing to take the risk was Sherman Fairchild, an inventor and the largest single shareholder in IBM. Through his enterprise, Fairchild Camera and Instrument, he agreed in 1957 to bankroll the new venture, which was incorporated as Fairchild Semiconductor.

The deal mechanics were deceptively simple, yet structurally flawed. Each of the eight founders purchased $500 of stock, and together with Hayden Stone, the group put up $5,000 in equity. Fairchild Camera supplied the primary capital of roughly $1.4 million, structured as a loan rather than direct equity to prevent initial dilution of the founders. That loan, however, carried a binding call option. Fairchild Camera retained the right to purchase the entire enterprise for $3 million if the venture succeeded. This contractual structure effectively capped the founders' upside, leaving them with ownership only until the business proved its commercial viability, at which point the parent conglomerate could expropriate the enterprise at a fixed, predetermined valuation.

Technical and commercial triumph followed rapidly. Jean Hoerni invented the planar process, a revolutionary method of fabricating transistors in flat layers of silicon. Utilising this technique, Robert Noyce developed the monolithic integrated circuit, placing multiple electronic components onto a single silicon chip and laying the hardware foundation for the modern computing age. Order volume exploded, growing thirteen-fold by 1959. Recognising the immense value of the breakthrough, Fairchild Camera exercised its call option that same year and acquired the company for the contractually agreed sum of $3 million.

Each founder received approximately $300,000, representing a 600-fold return on their initial $500 investment. Yet the parent conglomerate captured the overwhelming majority of the economic surplus. At Fairchild Semiconductor's prevailing growth rate, an independent open-market valuation would likely have exceeded $100 million. The transaction provided a stark financial lesson: the passive financier had absorbed the lion’s share of the upside, while the creators of the technology were bought out at a fraction of their market worth.

This asymmetry permanently altered how Silicon Valley engineers viewed risk and reward. It established the foundational tenet of modern venture capital: generating durable wealth requires holding uncapped equity in an independent firm, rather than accepting a salary, a bonus, or a capped buyout. In 1968, frustrated by diminishing stock options and bureaucratic interference from corporate headquarters in New York, Noyce and Moore departed Fairchild to found Intel, repeating the exact pattern of their earlier exodus from Shockley. Over the subsequent decade, legions of former employees departed to establish dozens of rival semiconductor firms, including AMD and National Semiconductor. Known collectively as the "Fairchildren," this diaspora became the human capital engine that transformed the Santa Clara Valley into the epicentre of the global technology economy.

Section 3 How Davis & Rock built the blueprint of the 10 year fund

Rock's firm earned close to $700,000 on the Fairchild deal. But the episode had shown him two structural weaknesses: at Fairchild, the passive financier had captured most of the gains while the founders' upside was capped, and at ARDC, the public-corporation structure had held the fund's value below that of its holdings. 

In 1961 Rock left Hayden Stone and moved to San Francisco, where he partnered with Tommy Davis, who had been making technology investments for the Kern County Land Company until the firm directed him to stop. Together they built what became the template for the modern venture fund. 

They did not originate the limited partnership structure; an earlier firm, Draper, Gaither & Anderson, had used it first, but Davis & Rock applied it at a scale and with a result that established it as the industry standard. 

A limited partnership divides its participants into two roles. The limited partners (LPs) provide the large majority of the capital and remain passive, taking no part in operating decisions. In exchange, they have limited liability: their loss is capped at what they invest. The general partners (GPs), in this case, Davis and Rock, contribute a small share of the capital, make all investment decisions, and bear unlimited liability for the fund's obligations.

Removing the LPs from operational control is a condition of their protection. By staying out of decisions, they preserve their limited-liability shield; involvement in management would otherwise jeopardise it. The arrangement allowed institutions such as pension funds and university endowments to commit large sums without taking on management responsibility or open-ended risk.

The fund was also time limited. Davis & Rock committed to liquidating the fund after seven years; the industry later settled on a ten-year term, typically with one or two-year extension options. A fixed life imposes discipline on the manager: capital must be deployed, invested companies developed, and holdings sold within a defined window, after which the proceeds are returned and the fund's performance is settled. This addressed a weakness of ARDC, whose open-ended structure allowed capital to remain tied up in underperforming companies indefinitely.

Tax treatment was another decisive feature. A corporation is taxed on its profits, and its shareholders are taxed again on dividends they receive, two layers of tax. A partnership is not taxed as an entity; its profits pass through to the partners and are taxed once. ARDC, as a corporation, carried the entity-level tax; the limited partnership avoided it. For a fund whose returns depend on compounding a small number of large gains over many years, eliminating a layer of taxation was a substantial structural advantage.

The GPs were compensated primarily through carried interest, a share of the fund's profits, often set at 20%, paid on top of a management fee. Carry aligns the manager's pay with the fund's investment performance: the GPs contribute little of the capital but receive a fifth of the gains, while their downside is limited to their own modest stake. This asymmetry, limited loss, large potential upside on capital largely supplied by others, is what makes running a fund attractive.

The 20% carry figure was not drawn from thin air; it has deep roots in the profit-sharing mechanics of high-risk maritime trade. It traces back to the medieval Mediterranean commenda, a legal contract where passive financiers underwrote merchant voyages while the travelling trader took an agreed percentage of the profit. A similar economic structure governed 19th-century American whaling. In an industry where most voyages lost money and rare successes generated immense fortune, crews were compensated in "lays": fractional shares of the ship's final harvest. Economic historians frequently cite these maritime contracts as the direct antecedents of venture carry. A one-fifth share proved sufficient to motivate extreme entrepreneurial risk-taking while remaining palatable to conservative capital providers, and the ratio has remained remarkably stable ever since.

The federal government had previously attempted its own structural solution, with disastrous results. Spurred by the Soviet launch of Sputnik, the U.S. Congress passed the Small Business Investment Act of 1958, establishing Small Business Investment Companies (SBICs). These federally sponsored funds were designed to borrow low-cost government debt to finance early-stage enterprises. Yet their statutory design guaranteed their failure. To qualify for federal leverage, individual fund sizes and check caps were severely restricted (capped at roughly $450,000 and $60,000 respectively), rendering them too small to scale ambitious industrial technology. Furthermore, SBICs were prohibited from compensating their investment staff with stock options, stripping away the primary incentive for elite talent. 

Most fatal, however, was the underlying debt mechanics. Borrowed capital requires mandatory, regular interest servicing, which inevitably pushed SBIC managers toward mature companies capable of generating immediate cash dividends. Early-stage technology ventures cannot service debt; they must aggressively reinvest every dollar of revenue into research, development, and market expansion. The federal debt model was fundamentally incompatible with high-growth technology compounding. By the mid-1960s, most SBICs had abandoned technology entirely, leaving the field open for private limited partnerships to capture the market.

Davis & Rock raised about $3.4 million: Davis and Rock each contributed $100,000, and roughly thirty limited partners, including six of the eight original Fairchild founders, supplied the rest. They kept the number of limited partners under one hundred to avoid the securities regulations that had constrained ARDC and the SBICs. The fund invested in companies including Scientific Data Systems, where a $257,000 investment grew to a position worth about $60 million.

When the fund was wound up in 1968, its $3.4 million had grown to nearly $77 million, a 22.6-fold return over seven years, and each partner received close to $10 million. The result demonstrated the advantages of the limited-partnership model over the corporate, public-company, and government-backed alternatives, and the ten-year, tax-transparent, "two-and-twenty" structure became the industry standard, which still largely remains.

Section 4: The 1972 Class and the Sand Hill Road Standard

By the early 1970s, the scaffolding of modern venture capital was firmly in place. Two firms founded within months of each other in 1972, both operating out of Sand Hill Road in Menlo Park, did much to establish the industry's operating norms. Yet their founders held sharply divergent views on how the work should actually be done.

Kleiner Perkins and Sequoia Capital represented two competing philosophies of capital allocation. Tom Perkins came from an operating and engineering background. Trained at MIT, he had run Hewlett-Packard’s computer division and subsequently founded a laser company. He believed that a venture capitalist should act as an active builder of the business: shaping the product, recruiting and replacing executives, and driving strategy from the boardroom.

Kleiner Perkins deliberately targeted companies where the primary hurdle was technical rather than commercial. Its most prominent early investment, Tandem Computers, built fault-tolerant systems. Perkins helped develop the concept internally, injecting an initial $50,000 to resolve the core engineering question before the company was even formally incorporated. Genentech followed the identical logic in biotechnology. The firm funded the commercial development of recombinant DNA, a speculative bet that depended entirely on whether the underlying science could be forced to work at scale.

Don Valentine approached the market from the opposite direction. Having come up through sales and marketing at Fairchild Semiconductor and National Semiconductor before founding Sequoia, Valentine prized the size and velocity of a potential market over the elegance of a technology or the pedigree of its founders. His working thesis was simple: a massive, expanding market could carry even a mediocre company to success, whereas a brilliant team faced impossible odds in a market that simply did not exist.

These divergent philosophies dictated the firms' portfolios. Perkins concentrated on technically ambitious ventures across lasers, computing, and biotechnology. Valentine backed the video-game pioneer Atari, spotting a massive consumer market in the making despite the company’s notoriously chaotic operations. When Steve Jobs pitched Sequoia, Valentine was decidedly unpersuaded by the young founder as a manager, but he recognised the sheer scale of the personal computing opportunity. He referred Jobs to Mike Markkula, a former Fairchild and Intel executive who became Apple's early chairman, and Sequoia secured its stake. When evaluating a pitch, Perkins invariably asked if the technology could function; Valentine asked how large the market might become.

To understand the era, one must strip away the mythology surrounding venture economics and look at the actual numbers of the 1970s.

The first structural difference lies in the management fee. The now standard "two and twenty" model, a 2% annual levy plus 20% of profits, was not originally a vehicle for generational wealth. Kleiner Perkins raised roughly $8.4 million for its early fund, while Sequoia assembled about $5 million. A 2% fee on pools of that size generated between $100,000 and $170,000 a year. This was just enough to cover office rent, basic overhead, and the salaries of a lean staff. The fee merely kept the lights on, the partners’ wealth was tied entirely to carried interest, meaning their personal compensation depended on genuine investment performance. 

The second difference involves the simplicity of the deal structures. Early financing rounds were priced without the elaborate spreadsheet modelling common today, and capital was deployed through straightforward common stock or convertible debentures. Investors routinely took substantial equity stakes, claiming between 30-50% of a company per round. The complex, layered liquidation preferences that dominate modern term sheets, which guarantee investors priority claims on proceeds ahead of founders, only emerged as an industry standard from the late 1980s onward. In the 1970s, Sand Hill Road investors protected their capital through a much simpler mechanism: a large equity position and a seat at the boardroom table.

Section 5: The end of the beginning

By 1978, the machinery of modern venture capital was fully assembled, and it would remain structurally frozen for the next fifty years. The ten-year, tax-transparent limited partnership was standard. The two-and-twenty fee structure, borrowed from New England whaling expeditions, was set in stone. The West Coast habit of aggressive boardroom intervention had taken root, alongside a gradual drift toward preferred stock. The instrument was complete.

And it barely mattered, because in 1978, the entire apparatus was economically irrelevant.

If you added up every fund, every partner, and every dollar under management across the entire United States venture capital industry, the total came to less than $500 million. On Wall Street, that was a rounding error. The most potent vehicle for capital allocation of the twentieth century had been engineered to perfection, yet it remained an obscure sub-sector of finance. It was run by a few dozen men in a cheap California office park, scraping together five-million-dollar funds from university endowments and the occasional eccentric industrialist.

The problem was certainly not the returns, which were already outperforming almost every other asset class in finance. The problem was regulatory.

The industry was cut off from the largest, deepest pools of capital in the world: American pension funds. Swelling with the retirement savings of ordinary workers, these funds were governed by a strict federal doctrine called the "prudent man rule." This legal standard effectively barred pension managers from allocating a single cent to anything as volatile and speculative as a private venture partnership. The world's biggest reservoir of capital sat right next to Sand Hill Road, but the federal valve was locked tight.

Then came the quiet bureaucratic tweak that changed the global economy. In 1978, US lawmakers slashed the capital-gains tax. The following year, the Department of Labor issued a subtle reinterpretation of the prudent man rule. It was an obscure adjustment buried deep in trust law, noticed at the time by almost no one outside a handful of specialized legal offices in Washington.

The reaction was immediate and violent. Pension fund managers were suddenly legally permitted to pour retirement cash into high-risk private partnerships, and the floodgates broke. In the five years before the rule change, the entire US venture industry had been scraping together roughly $42 million a year. In the five years after, that figure exploded to $940 million, an increase of more than twentyfold.

Overnight, five-million-dollar partnerships swelled into fifty-million-dollar funds, laying the groundwork for the multi-billion-dollar asset managers of today. And this is where the law of unintended consequences bites: when you direct a raging river of institutional capital into a legal structure designed to skim 2% off the top every year, the fragile alignment of pay and performance crafted in 1972 begins to dissolve.

Next Week

Capital Influx of the 80s and 90s. We follow the pension billions as they pour onto Sand Hill Road and watch the VC industry of small partnerships swell into a multi-billion-dollar financial engine in under a decade. It is the era that mints the first technology behemoths, Apple and Genentech to Cisco and Sun, and turns a handful of Menlo Park partners into some of the most powerful capital allocators on earth.

But as the money multiplies, so does a tension the founders of 1972 never had to reckon with: what happens to the fragile balance of pay and performance when there is simply too much capital chasing too few deals?

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The Unsophisticated Investor is brought to you by Mark, Head of UK Expansion & Operations at Shuttle. Shuttle's mission is to break down the barriers to private markets and make wealth-building opportunities accessible beyond the ultra-wealthy elite. To do it, we're building Europe's private market infrastructure platform for running investment operations. By stripping away the legal friction and admin for deal managers, we make it easier than ever for high-performing opportunities to open up to a wider, modern network of investors.

Mark
Shuttle’s Head of UK Expansion & Operations