FIGURE 1 : Distribution of New Bedford Whaling Voyage Profit Rates and Venture Capital Net Internal Rate of Return ( IRR )
Source : Tom Nicholas , VC : An American History ( Cambridge : Harvard University Press , 2019 ). Whaling voyage profitability based on voyages from 1817 – 1906 ; venture capital net IRRs based on data from 1981 – 2006 .
from skilled whaling agents was in short supply . For example , the most successful agents shared lessons obtained from prior voyages ( both successes and failures ). They also helped assemble the most experienced and reliable crew members . High-quality venture capital firms function in a similar capacity today .
2 . Incentive-based Compensation for Agents : Whaling agents possessed unique skills , which enabled them to command a premium for their services . This explains why they typically received incentive-based compensation that was much like the carried interest of modern venture capital funds . In fact , the share of profits for whaling agents was even more attractive than the typical 20 % share commanded by venture capitalists . On average , whaling agents received 39 % of the profits from voyages .
3 . Incentive-based Compensation for Crews : Whaling voyages were risky and grueling . Not only did crew members face the high likelihood of returning empty-handed , but they also faced a real possibility that they would never return at all . Whaling agents also had little control over the behavior of captains and crews after the voyage commenced .
It was critical , therefore , to align the interests of investors and crew members . The solution was allowing crews to share in the profits of the voyage . The percentage share , which was referred to as a “ lay ,” was greatest for the captain , but all members of the crew participated to a degree . The profit-sharing system was similar to the use of stock options at start-up companies .
Venture Capital Resuscitates a “ Risk-Less ” Economy
“ We cannot depend safely for an indefinite time on the expansion of our big old industries alone . We need new strength , energy and ability from below . We need to marry some small part of our enormous fiduciary resources to the new ideas which are seeking support .”
— Ralph Flanders , president of the Federal Reserve Bank of Boston ( 1945 )
The great whaling partnerships of New Bedford disappeared by the turn of the 20th century , but innovation in the United States persisted . A relatively small community of wealthy individuals supplied capital for entrepreneurial ventures . For example , Thomas Edison received funding from wealthy financiers , such as J . P . Morgan and William H . Vanderbilt . While it is conceivable that economic progress was held back to a degree by the absence of an organized industry to fund new ventures , advancements in the United States still far outpaced economic rivals in Europe in the early 1900s .
It was not until after the end of World War II that the scarcity of capital posed a threat to entrepreneurship in America . The first problem was extreme risk aversion among potential capital providers . Banks were still recovering from the scars of the Great Depression , and funding new ventures in unproven markets was considered too risky . Insurance companies and pension plans , which had amassed substantial pools of capital during the war , were equally risk averse . Trustees rarely ventured much beyond high-quality bonds . Another problem was that demand for capital skyrocketed after the war . The US had won an unprecedented global war on two fronts , and much of the success was attributable to the inventiveness of academic institutions and industrialists . Many inventions had compelling commercial applications , but there was insufficient capital to bring them to market .
Several leading financiers and academics feared that the capital shortage threatened the nation ’ s economic progress . They described the post-war business climate as the “ risk-less economy ,” and they feared the United States would lose its technological edge if innovation depended entirely on large companies .
In 1946 , a group of leading academics , financiers and industrialists in New England formed a closed-end investment company to address this problem . The company was called Advanced Research and Development ( ARD ), and its mission was to provide a new form of financing for early stage ventures . The famed Harvard Business School Professor , Georges Doriot , took the helm soon after ARD ’ s formation , and the financing model pioneered by the whalers of New Bedford returned .
ARD ultimately proved the viability of venture investing , but it took more than a decade of struggle . The greatest challenge derived from the structure of the fund . As a closed-end investment company , ARD was subject to SEC oversight . This created
16 FINANCIAL HISTORY | Fall 2023 | www . MoAF . org