A couple days ago, I sat in on a course entitled, “The Coming of Managerial Capitalism,” during which the class discussed a case on Georges Doriot, commonly known as the “Father of Venture Capital.” Towards the end of class, comparisons were made between Doriot’s fund, the American Research and Development Corporation (ARD), and modern venture funds. The differing structures have significant implications on the types of investments they make as well as who invests in these funds.
For some background, in 1946, Doriot helped launch ARD, the first venture capital firm. ARD was formed as a closed-end fund, which meant it raised capital by selling a limited number of public shares. As opposed to VC firms today, there weren’t LPs, and the shareholders were primarily individuals — not institutions. Investors were given shares in this closed-end fund that could initially be traded over-the-counter and eventually, in 1961, on the New York Stock Exchange.
Over time, the LP / “2 & 20”structure that we’ve come to know and love came to the fore, ultimately forcing out ARD. But is there room for the Doriot-style fund today? And if so, are there enough benefits for it to be something worth pursuing?
Currently, venture funds tend to operate on a 10-year lifecycle with the first 5 to 6 years reserved for initial and follow-on investments and the last 4 to 5 years set aside for “harvesting” as well as beginning to raise another fund from LPs. This arrangement requires funds to return capital to LPs, implicitly meaning that they can’t always back the most revolutionary, and inherently risky, ideas. Certainly, today’s top funds back audacious entrepreneurs, but the current setup compels these investors to still place some relatively “safer” bets.
However, I’d argue that the closed-end structure, essentially a publicly traded venture fund, would incentivize more risk-seeking behavior. This style would allow for a focus on the more extreme long term, not just 10 years as we’ve grown accustomed to, as there would be no obligation to return a pool of capital to investors. Without this concern hanging over the heads of a fund’s GPs, I believe more SpaceX’s and Tesla’s would receive venture funding. Many VCs have disbanded their clean tech practices, while others have abandoned biotech, health care, or intensive hardware investing. While a lot can be accomplished in 10 years, as we’ve seen with Elon Musk, many of the most promising and significant advancements in the aforementioned sectors cannot. A closed-end fund would go a long way towards increasing the chances that these businesses get properly funded.
When it comes to some of the more practical questions, such as payouts to shareholders and evaluating the fund’s performance, this publicly fund could take a page out of ARD’s playbook. To return capital to its investors, it would issue dividends when possible. And just as today’s VCs must raise new funds from LPs, this publicly traded fund would simply issue new shares when it was running low on capital. Both types of funds are judged on prior performance when this fundraising occurs – it’s just a different method from different investors.
And speaking of investors, this stark difference between the closed-end fund and the now traditional venture fund carries some interesting benefits as well. A publicly traded venture fund would give retail investors, accredited and unaccredited alike, the opportunity to participate in this arena of (potentially) outsized gains. While the JOBS Act was supposed to allow unaccredited investors the opportunity to invest in startups, that still hasn’t come to fruition, and this model would be a safer way to let these investors participate in this sector. Moreover, their investment would be inherently diversified since they’d own a piece of an entire fund as opposed to merely a piece of one company.
The closed-end fund structure certainly has its flaws – no fees, which may lead to lower salaries, no automatic carry, which may lead to lower overall compensation, and difficulty around valuing portfolio companies, and thus the fund’s share price – but ultimately I believe there is a place for this structure in the current venture ecosystem given the aforementioned benefits, particularly if there is going to be sufficient support for an influx of truly world-shaking ideas.