Creative Capital

When Georges Doriot shepherded Digital Equipment's IPO in 1966, he changed the rules of entrepreneurship and laid the groundwork for tech giants like Apple and Google

Editor's note: This is an extended version of a story published in the Apr. 14, 2008, issue of BusinessWeek magazine.

Creative Capital: Georges Doriot and the Birth of Venture Capital is BusinessWeek editor Spencer E. Ante's chronicle of the life of Georges Doriot, a visionary French immigrant who pioneered the venture capital industry from Boston, sparking the transformation of America into a high-tech startup nation. A 20th century Renaissance man, Doriot revolutionized the military as a U.S. brigadier general during World War II by applying science to research and development; in 1959 he founded the first European business school, the Institut Européen d'Administration des Affaires (INSEAD); and he was arguably the most influential professor at Harvard Business School during the postwar period. In this excerpt, Doriot and American Research & Development (ARD), the landmark venture capital firm that he joined in 1946 as president, orchestrate the initial public offering of Digital Equipment Corp. It was the venture industry's first blockbuster offering, creating the paradigm of entrepreneurial success for venture-backed companies such as Intel (INTC), Apple (AAPL), and Google (GOOG). In the words of F. Warren Hellman, a former president of Lehman Brothers (LEH), which took many ARD startups public, including Digital: "Doriot was at the forefront of fundamentally changing our economy."

The annual meetings of American Research & Development were always festive affairs. Over the last 20 years, Doriot had transformed a normally sedate event into a three-ring circus where entrepreneurs could network, trade ideas, and show off their wares to hundreds of stockholders, friends, and fawning members of the press.

But ARD's gathering in the spring of 1966 was an unusually raucous occasion. Pressure had been growing on Doriot to address its problems with the U.S. Securities & Exchange Commission (SEC), and to take public its rising star, Digital Equipment Corp., a Massachusetts startup that had spearheaded the market for minicomputers. The SEC had begun to question a number of ARD's practices, including its issuance of stock options to company officers and the seemingly rich valuations that ARD placed on the small private companies it financed.

On the meeting's first day, Doriot took on the SEC, highlighting the rigorous process by which ARD sought to value these young companies. To determine the worth of a startup, ARD evaluated many factors, including the company's product evolution, financial results, management, problems, plans for the future, and its willingness to accept advice. "Our valuations when securities are not traded are worked out very carefully, with great desire to give stockholders an idea of trends, but also with an obligation not to give false hopes," said Doriot.

It was a convincing argument, but one investor did not buy it. Otto Hirschman, who owned 14,600 shares of ARD stock, stood up and criticized the company's management—the first time it had been publicly faulted in its 20-year history. Hirschman argued that ARD treated its stockholders unfairly by undervaluing the company and not paying out enough in dividends. "A new board of directors should be elected to better represent the interests of all stockholders," declared Hirschman. "The stock is worth $150 a share if we had another board."

Behind the Scenes

Had Doriot confided in Hirschman his future plans, the activist investor probably would never have attacked the ARD board. For Doriot was laying the groundwork for a stock offering that would delight Hirschman and other shareholders like no other IPO had ever done before—the IPO of Digital Equipment.

In the fall of 1965, in fact, Doriot had already secured an underwriter. On a trip to New York, he persuaded Longstreet Hinton, an ARD director who was executive vice-president of the powerful Morgan Guaranty Trust Co., to buy 20% of Digital's offering. With this valuable promise, Lehman Brothers President Robert Lehman happily agreed to take Digital public.

The task for building Digital's investment case fell to a 31-year-old junior banker named Arnold Kroll. "No one at Lehman had the slightest interest in doing an offering for a minicomputer," says Kroll. "No one knew what a minicomputer was. There was a prejudice that IBM was the only company that would ever do good. It was a throwaway, and it was thrown at me."

ARD had helped Digital in countless ways since its inception. Doriot invested money in Digital when no one understood the importance of computers, he stocked the Digital board with ARD staffers to help guide its business, he rejected many takeover offers for his precocious child, and Doriot himself became the chief mentor of Kenneth H. Olsen, Digital's co-founder and president.

Doriot's orchestration of the Digital IPO was a crowning achievement that perfectly symbolized his philosophy: He believed in building companies for the long haul, not flipping them for a quick profit. And now, nine long years after his first investment in Digital, Doriot had decided it was time for Digital's coming-out party. Kroll grabbed the ball that no one wanted and ran up to Digital's headquarters in Maynard, Mass. Burrowing into the company, he analyzed Digital's management, its products, and its market. Olsen stood in the background while Doriot guided the entire process, articulating the value and uniqueness of the operation to Kroll and the staff of Lehman Brothers.

Kroll wrote a report strongly recommending the Digital offering. The biggest concern was competition from IBM (IBM). But Digital executives and Doriot convinced Kroll that Big Blue couldn't move quickly enough to catch up to Digital's innovative band of engineers. "I came away with the feeling that the company would be able to make its internal projections, which were very high," says Kroll. The firm green-lighted the IPO.

Perfect Pitch

Over the summer, Lehman bankers pitched the deal. Back in the mid-1960s, there were no "road shows." The sales process consisted primarily of meetings between Lehman associates and potential investors in New York and Boston. Olsen made a few appearances. But Doriot played the leading role, infusing many investor meetings with his vision, charm, and gravitas. "People got very intrigued by it," says Robert Shapiro, who as part of Lehman's syndicate desk was responsible for identifying a nucleus of long-term investors. "It was because of Doriot and the reputation that he enjoyed. He was highly respected as a man of a scientific mind who also understood the business aspects."

Ultimately, the deal attracted far more demand than supply. Lehman Brothers wanted to price the shares at $17, but Digital's board held out for $22 a share.

As the summer drew to a close, it was time for ARD's Cinderella to put on her glass slipper. On Aug. 19, 1966, Lehman led an $8 million offering to sell 375,000 shares of stock in Digital Equipment under the ticker DEC. It easily sold out. In nine years, ARD's $70,000 investment had skyrocketed in value by a factor of 500, to $38.5 million, validating Doriot's vision and proving the shortsightedness of the SEC in one dramatic transaction.

But there was no celebration inside the Civil War-era woolen mill that served as Digital's headquarters. "I don't think anyone viewed it as a way to get rich quick," says Digital executive Winston R. Hindle, one of about 30 employees who owned IPO shares. "It was a quiet sense of enthusiasm and pride" that "reflected Ken's and the General's style," said Digital executive Jack Shields.

After the IPO, Digital offered stock options to a wider group of its employees. Many of them seized the opportunity. But Digital shares got dragged down by the falling stock market, bottoming out in October at about $17. "Some of the people tried to give the options back," says Ted Johnson, Digital's head of sales. "People felt that they had been had."

The stock market recovered. And as shares in Digital began to rise, more and more people grew intrigued by this fairy tale.In February of 1967, James F. Morgan, a consultant with Booz Allen who joined ARD as an assistant vice-president, picked up Kroll and drove out to Maynard, where Digital was holding its first-ever meeting with financial analysts in the mill. Kroll and Morgan sat in Digital's dingy cafeteria and listened as Ken Olsen scared the heck out of Wall Street. "The first meeting with security analysts was a disaster," says Morgan. "You had this monosyllabic CEO who didn't want to speak with them. They were grunting at each other. Half of the people went home and sold their stock."

The shrewder analysts realized that Digital was sitting on a gold mine. The company's PDP-8, a small but potent machine that sold for $18,000, quickly became Digital's best-selling product. By expanding the promise of computers beyond the handful of large companies able to afford an IBM machine, the PDP-8 foreshadowed the personal-computer revolution 15 years later. The market exploded as tens of thousands of machines were sold to labs and industrial companies.

By March of 1967, Digital shares topped $50. Over the summer, they hit $80, and in September they crossed $100. In October, just as Otto Hirschman had hoped, ARD's stock reached a record high of $152, its stake in Digital now worth around $200 million. Digital was the venture capital industry's first home run, single-handedly proving that venture capitalists could generate enormous wealth by backing the winners of a hot new business. "I'd say it was a sea change in the attitudes toward venture capital investing," says ARD's Morgan. "There really had never been a phenomenal, enduring success. If a klutz like Ken Olsen can do that, why can't I? Digital blew open the restrictions that anyone had ever applied to entrepreneurial ventures. It was really mind-blowing, that you could take such a small amount of seed capital and get ownership of a company that was worth more than IBM in a fairly short period of time."

During its 26-year existence, ARD financed 120 companies. But it was the rise of Digital Equipment that allowed Doriot to accomplish his ultimate goal of forging a nationwide movement of entrepreneurs. "Doriot was very important because he was the first one to believe there was a future in financing entrepreneurs in an organized way," says Kroll. "He [and ARD] really created the venture capital community."

Reprinted by permission of Harvard Business School Press. Excerpted from Creative Capital by Spencer E. Ante. Copyright © 2008 Spencer E. Ante; All Rights Reserved.

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