Chapter Seven

Deucalion Venture Partners, Venture Capital and Its Present Scale

You can’t expect to hit the jackpot

if you don’t put a few nickels into the machine. —Flip Wilson

This chapter tells two related stories. One is about Deucalion Venture Partners (DVP), a venture capital partnership I formed in 1987 and ran for roughly thirteen years. The second is about the emergence and evolution of the venture capital industry. But in order to tell you the Deucalion story, I need to first provide some basic background on the venture industry. Later in this chapter I will more fully discuss the history and evolution of venture capital.

In the 1970s and 1980s, venture capital emerged in a big way and transformed the financing of startups and early-stage companies in the United States—and later in many other countries as well. There had always been private equity investing, particularly by wealthy investors, many of them with long experience in finance, but all of that would be eclipsed by venture capital. While there may have been thirty to fifty U.S. venture partnerships in 1980. By 1990 there were 650. Deucalion was one of them.

Wishing to spur economic growth during the 1970s and 1980s, the U.S. government enacted major tax law changes lowering tax rates for capital gains. This made such investments much more attractive. In addition, during those years, regulatory changes allowed pension plans to invest in venture funds. That significantly increased the amounts invested in such funds. Finally, the remarkable success of some very profitable high-growth technology startups, such as Fairchild Semiconductor, resulted in a huge surge of interest in venture capital partnerships and a dramatic rise in investible dollars.

In like manner, compensation packages for CEOs and founders of new ventures became more generous. Whereas in the 1960s a new CEO might hope to get stock options on 4 percent of a company’s stock (the state of California, for example, promoted a standard of “fair, just, and equitable” for such stock option awards), in the 1980s and 1990s, new startups typically provided much more generous awards if you were a founder or added substantial value to an early-stage company.

Most venture capital firms adopted the “carried interest” approach for partner compensation. It followed sixteenth- and seventeenth-century models in which ship captains would earn a 20 percent share of the profits from the goods “carried” on transoceanic voyages. Seventeenth- century whaling ship captains earned similar shares of a whaling expedition’s profits. Later, early nineteenth- century, American oil and gas partnerships did much the same, as have real estate partnerships in more recent times.

Thus, typically, 20 percent of the partnership’s profits have gone to the venture capital general partners in addition to the 2 percent annual fee earned on the assets being managed. Later, a few venture firms with superb track records were able to earn as much as 30 percent of the profits.

Most startup investments failed or underperformed and there were more losers than winners, but if you were a venture capitalist, you only needed one or two successes for total results to be excellent and partner awards to be very large. Kleiner, Perkins, Caufield & Byers first venture fund invested in Genentech, Tandem Computers, and one or two other successes while others of its investments were mediocre or failed. But the home runs made the partnership an immense success spurring yet more interest in investing in venture partnerships.

Deucalion Venture Partners

As described in an earlier chapter, my longtime friend Frank Caufield was an early venture capital pioneer as one of the four founding (general) partners of the legendary firm of Kleiner, Perkins, Caufield & Byers. I learned much from him and was intrigued. I had been doing some small-scale venture investing on the side and did well, so I decided I would try to set up a small $5 million boutique fund as a one-man band in 1987.

The investors included Frank Caufield, Charlie Crocker, Tom Ford, me, and twenty-five others. PLM also invested.

There is something to be said for the idea that venture investing is a career for dilettantes. You have to be willing to explore industries and situations in which you have little experience, and you must quickly master what you need to know and do in each unique circumstance to be successful. In the process, while you know that in any portfolio of perhaps 10 investments—just to pick a number—one or two will turn out very well and two or three will do fine. You also know the rest will fail or do poorly. That said, venture investors generally believe every check they sign for a new or follow-on investment will do well. They believe that despite the fact that they also know that it’s not true.

You also have to establish a source of potential investments—so-called deal flow. In my case, deals came largely from my investors, advisors, and friends; and as in many circumstances, one deal follows another. A lot of time is spent at the beginning digging up deals, doing due diligence on the ideas, the industry, and the people: evaluating their experience, their integrity, their strengths, and their weaknesses.

My first deal was mostly a bust. A clever inventor had a device to convert a conventional residential oven into a convection oven. It cooked food more quickly and more evenly with a uniform temperature. (We branded it the Zephyr, meaning “a soft gentle breeze.”) The foodies really loved the idea and so did the retailers. It looked like a sure winner, and we invested in the first round in late 1987. But the “sell-through” proved very difficult. Beautiful packaging and retailer displays could not offset customer fears that self-installation of the product would be unsafe and there was no practical way to have someone standing next to prospects to explain how simple and safe it was.

Ultimately, that and general ignorance about convection ovens led us to “show and fair” marketing (sometimes called “demonstration marketing”). It is used when a very convincing salesperson operates a booth at a show or fair and attracts prospects around the booth so he or she can explain the product’s benefits and show how they are delivered. Sales are made on the spot and the customer walks out with the product in hand.

We began working (and later merged) with Nationwide Marketing. It had a product that allowed customers to buy food in bulk at stores like Costco, divide it into smaller portions, and then wrap and vacuum seal all of the portions giving them much longer shelf life. The product was branded as the Food Saver. Originally, it could not sell itself on a retail store floor, but it was very successfully sold in fairs by good salespeople using demonstration marketing. Later it also sold on cable television, which became a great place to use demonstration marketing to reach much larger audiences. In the process, many prospective customers were quickly educated and, with that, the product began to sell well in retail showrooms.

No one was able to make the Zephyr a success, but the Food Saver was. While we did not get all of our money back, the Food Saver royalties we received returned two thirds of our investment. Today you can find Food Savers in any Costco and at other retailers or online. Our second deal did better. I met David Berliner over a dinner at Frank Caufield’s home. Born in Mexico, David met Frank while bailing out Paul Cook’s bad deals below the border. David was a Ph.D. physiologist, very smart, and a senior scientist on the Mexico-based staff of Syntex, one of the very early developers of birth control pills. David relocated first to Utah and later to Palo Alto when Syntex ultimately decided to relocate from Catholic Mexico to the United States where public attitudes were expected to be more accommodating toward this form of birth control.

David’s knowledge of biology and chemistry was extensive. He met a team of Ph.D. biologists who were developing techniques for inserting genes into living organisms to help recipient organisms deal with pests or diseases. Perhaps one day in the future, the technology might also be used to develop pharmaceuticals. This was state-of-the-art biotech in its day. The CEO and board originally named the company BioSource and Deucalion first invested in late 1987. Interestingly, one of the best vectors for transferring preferred genes into other organisms came from tobacco. As a result, R. J. Reynolds took a big interest in the company, invested in it, and provided access to their farms and facilities to develop and test the vectors.

It was a fascinating idea, and with R. J. Reynolds as an investor, Fortune magazine did a feature story on the company and its brilliant young scientists. The company went through great successes and failures. I invested in it over more than four years (1987 to 1991) in its different rounds of fundraising. I served on the board and received stock options, which I transferred to the partnership.

The company later changed its name to Large Scale Biology and went public at $17 per share. When we got out of the investment, our $447,849 investment was worth $4,632,927. Not a home run, but a ten-times return on our money was pleasing.

Siva was a company that could destroy (incinerate) hazardous waste, a major issue in the late 1980s. It did get off the ground, but not very far. Our $408,333 ended up yielding only $51,269 in royalties over the years.

Lease Partners had Neil Brownstein, a very smart and prominent venture capitalist who served as the lead investor. He thought I could add value based on my PLM experience in transportation asset leasing. I invested $251,925 but soon found my experience was irrelevant and the company was a poor judge of the value of its collateral. On more than one occasion when a leasee defaulted on the lease payments, Lease Partners found the underlying assets had little value. I wrote off the entire investment.

Erox and Pherin were two more ventures championed by David Berliner, drawing on his physiology and chemistry expertise. They arose from his interest in human pheromones and the existence of the little-known vomeronasal organ in our noses that sensed the pheromones. Quoting from a Medical News Today article:

A pheromone is a chemical that an animal produces which changes the behavior of another animal of the same species. Pheromones, unlike most other hormones,are secreted outside the body, and they influence the behavior of another individual. Many people do not know that pheromones trigger other behaviors apart from sexual behavior in the animal of the same species.

David recruited biologists to synthesize the chemistry of an attractant that might generate sexual interest in humans and, in his tests, he developed confidence it would work.

The first user for David’s pheromones was a new company we named Erox. Deucalion invested in 1988 and 1989 and I served on the board. We retained one of the leading “noses” in the perfume industry to formulate a fragrance into which we would incorporate the pheromones. A leading designer was retained, and he created a unique and beautiful bottle for the perfume. (I still have one in my office.) We also recruited Pierre de Chamfleury, who had previously served as general manager of Yves-Saint-Laurent Parfums in Paris. Erox became a publicly traded company in 1993 and when we sold our shares, our $152,400 investment was worth $785,418.

The second application for David’s pheromones involved a possible therapeutic use in treating social anxiety and depression. Pherin is still a private company. Despite David’s death some years ago, it continues to be funded by drug developers who believe the products are, or will be, safe and efficacious. We will see. This is more likely to be among the “living dead,” meaning a venture investment that continues to exist (now for nearly 30 years) but never succeeds or dies. The $72,600 we invested in 1991 was written off years ago, but I am still asked periodically to vote on certain company matters, which I do.

Real Estate Research Company (RERC) should have been a good investment since it involved real estate information. Its founder, a very smart and successful real estate investor, made a fortune converting a large warehouse on the New Jersey side of Hudson River into “back-office” space for Wall Street firms. It would save them serious money by paying much lower lease amounts to house their administrative staff.

Unfortunately, RERC hired too many people too quickly and was slow to generate revenues. I wrote off the entire $1 million investment.

Landbase was another wipeout. It contemplated building a library of geographic information but was unable to generate revenues. That one cost $291,385.

Applied Imaging was a decent investment. The original company had two genetic engineers who used techniques to identify the genes involved in certain kinds of ailments and hoped to produce and market equipment to do such work. It was more difficult than they expected but Applied Imaging acquired their technology making us shareholders in a company that had developed, made, and marketed automated image analysis systems. Its equipment was used by cytogenetic laboratories for prenatal, cancer, and other genetic testing in international markets. When we sold the publicly traded stock, we received $785,418 from our $525,079 investment.

Datis, our last portfolio investment to be sold, proved more successful. It was a spin-off from the Northern California Hospital Association and was led by the association’s former president, Mark Collins.

Datis collected information on patient discharges from all hospitals in selected states. The information included the zip codes of all patients (but no patient names or identifying information), the name of the hospital and its zip code as well as the diagnostic data and procedures that each patient received. It represented a complete market analysis, zip code by zip code, of all patients, ailments, and procedures. The reports gave each hospital a tool for knowing the total numbers for each kind of procedure in their market, that hospital’s share, the number of patients they got from people who lived closer to other hospitals, and the number of people from their market area that became patients elsewhere.

Datis was very well led by Mark and his team. When it was sold in 1993, we received $1,367,466 for our $279,361 investment. Collectively when all the investments were sold, we grossed $9,010,632 from our $4,089,990 invested in the companies.

The venture industry entity that collected results on all venture capital partnerships ranked us in the upper 25 percent of all VC partnerships formed in the mid-to-late 1980s. Not too bad for a first timer operating “solo,” but also not spectacular.

There was one wrinkle, however, that the industry group could not take into consideration in their ranking. Namely, when PLM went bankrupt, its chairman, Gene Armstrong, called. They had invested $1 million in the partnership and wanted to be bought out. I told him that we were nearly fully invested and did not have $1 million. I told him, however, that I would contact my advisors and see if they were prepared to support me offering $400,000 for PLM’s $1 million investment. He said, “Yes, he would accept that amount.” And we did that deal.

In effect, it meant that each limited partner received a benefit from their pro-rata share of the $600,000 discount that PLM forfeited to them. Said differently, each remaining limited partner got a 12 percent bonus in the value of his or her interests from the 60 percent discount PLM had surrendered to Deucalion Venture Partners.

Next?

As Deucalion Venture Partners came to a close, I decided I would not raise a successor fund. There were several considerations. While an upper 25 percent ranking would provide credibility for a first time VC’s results when stacked up against others, the thing I liked least about the work was the almost inevitable task of having to report on investments that did not work out.

I do not know of any VC who ever wrote a check to invest in a company he thought was likely to fail, but the industry results show most investments are losers or total busts, with one or two excellent outcomes. The overall results are dandy. And you are always enthusiastic when you write those checks and share that perspective with your limited partners, but when some of the “eagles” turn into “turkeys,” you hate to report the bad news.

Moreover, I had been well rewarded for my work at PLM, did fine with my profits from Deucalion Venture Partners, and I was interested in serving as a director of The U.S. Russia Investment Fund (TUSRIF) while perhaps also doing some research and writing about disproportionate Jewish achievements.

Evolution in the Venture Industry

There is one other aspect of my experience with venture capital that I find interesting. That is, I believe the era in which I participated, made money, and learned much is probably over. Namely, I liked the size and scale of the companies I invested in as well as those I ran. I wanted to run my own show, earn enough money that I could tell any difficult people who tried to control me to “go to hell” and I did not want to be pigeonholed or get slotted in a particular job or industry. I wanted variety in my life and for it to be interesting. I also hoped to make a mark, but immense wealth never appealed to me.24

These days almost no major venture capital firms do smaller deals. Such investments are mostly financed by so- called “angels,” typically individuals who operate in specific places—often a particular city or area where they work with other “angels.” Many of them made the money they now invest from their success as entrepreneurs. Returns are good but rarely exceptional. Interest in such deals by major VCs is limited. One reason is that there is so much money to be had by the large and successful venture capitalists with great track records. Their goal is to invest large sums to create huge companies and whole new industries. At that scale, the money to be made is enormous.

Why this is so arises from the evolution of private and venture investing from the end of World War II to now. From 1945 to the late 1960s, most startup investing was done by wealthy individuals and families such as the Rockefellers, Vanderbilts, Whitneys, and Warburgs. In addition, General Georges Doriot, the Harvard Business School professor mentioned earlier in Chapter Two, founded one of the first two venture firms, American Research and Development (ARDC) and J.H. Whitney & Company. In 1957, ARDC invested $70,000 in Digital Equipment Corporation (DEC) which grew to be worth

24 My friend David Nitka once said, “the perfect business to own and operate has $5 million in revenues, $1 million of profits, and two employees . . . but perhaps that is one employee too many!”

$35.5 million after DEC’s 1968 public offering. It was one of the first “home runs” in venture investing.

Whitney had been investing since the 1930s often partnering with his cousin, Cornelius Vanderbilt Whitney. Over time, they broadened their investor groups to include institutions and other wealthy investors. Minute Maid orange juice was one of their successful investments. They sold to

Coca Cola.

A vitally important

stimulant for venture investing was the creation and development of “research universities” coming out of the end of World War II. Technology was seen as vital for the defense and economic development of America and the West. Basic research was done at universities such as UC Berkeley, UCLA, Cal Tech, MIT, and others. And when the Soviets launched Sputnik and we thought we were

ARDC

American Research and Development

CFE

Center for Entrepreneurship

DEC

Digital Equipment Corporation

DARPA

Defense Advanced Research Projects Agency

ENIAC

Electronic Numerical Integrator and Computer— the first digital computer

ERISA

Employment Retirement Income Security Act

SBIC

Small Business Investment Company

UCLA

University of California Los Angeles

USRF

The U.S. Russia Foundation for Economic Expansion and the Rule of Law

“behind” in the Space Race, the research done in those research universities helped us regain the lead and put the first humans on the moon. In like manner, the Defense Advanced Research Projects Agency (DARPA) was charged with helping develop emerging technologies for use by our military.

In 1957, Fairchild Semiconductor was created as a division of Fairchild Camera and Instrument. Sponsored by Arthur Rock, a well-known fundraiser for technology startups, Sherman Fairchild listened to an impassioned presentation by Robert Noyce. Noyce envisioned using silicon as a substrate for an integrated circuit. Fairchild was very impressed. At its core the new division consisted of its eight “traitorous” founders25 who had resigned from William Shockley’s Semiconductor Laboratory to form the new company. In addition to Noyce, among the eight were Gordon Moore, Eugene Kleiner, and Jean Hoerni.

All of them, including Rock, became industry legends, and Noyce’s 1959 invention of the first monolithic integrated circuit on a chip of silicon has revolutionized high technology. In 1946, the first digital computer named Electronic Numerical Integrator and Computer (ENIAC weighed 30 tons. It was 100 feet long, 10 feet high, and 3 feet deep. Today our cellphones, iPads and personal computers are far more powerful and cost almost nothing compared to ENIAC.

25 So-called by Shockley, the Nobel laureate who recruited them all but proved to be an impossible boss. They rebelled and Arthur Rock helped them.

This is the reason we call it “Silicon Valley,” and its chips are the heart of why today we have those cellphones, personal computers, GPS, and much more. With support from Rock (who in 1962 formed a venture capital partnership with Thomas J. Davis), Noyce, Moore, Andrew Grove, and Les Vadasz would form Intel in 1968. Rock would later invest $57,000 (at nine cents a share) to buy 640,000 shares of Apple and serve on its board. Gene Kleiner would become a founder of Kleiner, Perkins, Caufield & Byers.

In 1958, the Small Business Administration licensed Small Business Investment Companies (SBICs) to help finance small companies. Clearly, our government wanted to encourage and provide financial support to small business.

In the 1960s, a few new venture capital firms were established in Northern California. They adopted the compensation model where limited partners paid annual management fees of 1 to 2 percent of total capital raised to the general partners plus a carried interest that paid 20 percent of the profits to them as well.

Draper and Johnson was formed in 1962, Sutter Hill Ventures in 1964, and Sequoia and Kleiner, Perkins, Caufield & Byers in 1972. Kleiner Perkins raised $8 million from limited partners for its first fund, and it scored big with Tandem Computers and Genentech.

The troubles and economic slowdowns of the 1970s served to prod efforts to promote entrepreneurs and start- ups. It was a difficult decade with Nixon’s resignation, the Vietnam failures, stagflation, malaise, and a stock market crash in 1974. That same year, the Employee Retirement Income Security Act (ERISA) prohibited corporate pension funds from “certain risky investments” such as investments in private companies. Only later (in 1978) did the Labor Department reverse itself and allow pension funds to invest in private equity. Economic growth continued to be slow; there was a broad sense that the government needed to do even more to stimulate entrepreneurship and economic growth.

Ronald Reagan defeated Jimmy Carter in 1980 and Congress began to sponsor legislation to stimulate the economy. In 1980, the Bayh-Dole Act (or Patent and Trademark Law Amendments Act) was enacted. It stimulated commercialization of government and university-sponsored research and a sharing of the profits with the inventors and the universities. Almost immediately, Stanford set up an office to encourage its technologies to be licensed. This caused entrepreneurs and venture investors to look for new ideas at those universities.

As discussed earlier in this chapter, one tax benefit for venture capital and private equity general partners is “carried interest” treatment for 20 percent of profits paid to the partners. As noted earlier, the gains are taxed at capital gains rates. The Internal Revenue Service affirmed this tax treatment in 1993 and again in 2005. In 1981, the Kemp-Roth tax cut bill was passed, lowering capital gains tax rates from 28 to 20 percent. This made high-risk investments more attractive.

Founded in 1966, the Kauffman Foundation, with its endowment of $2 billion, is a legacy arising from the success of one entrepreneur, Ewing Marion Kauffman.

They do this through philanthropic grants to organizations that support entrepreneurship and bolster the education of children and youth. It is the world’s largest not-for-profit supporting entrepreneurship. Kauffman, a superb salesperson, formed Marion Labs in 1950 after two years when his earnings from commissions at a pharmaceutical company paid him more than the salary of the CEO. The first year they cut his commission, and the second year they cut his territory. He decided it was time to go out on his own.

He began with no proprietary products, merely buying products in bulk from a large pharmaceutical company, repackaging them in his basement at night, and selling them during the day. In his first year, total sales were $39,000 and the profit was $1,000. He was a superb entrepreneur, and he treated his employees generously. Over time he developed a family of proprietary products. By 1959 sales were $1 million; he took the company public in 1965. By 1988 Marion Labs had revenues of $930

The foundation’s mission is to help individuals attain economic independence by advancing educational achievement and entrepreneurial success, and when Kauffman merged it with Merrell Dow Pharmaceuticals, he created more than 300 millionaires.

From inception his foundation was intended to be innovative and change people’s lives for the better. He strongly supported education and saw building enterprises as a way to realize an individual’s promise while creating jobs and building the economy.

I had personal experience with the Kauffman Foundation after our Center for Entrepreneurship in Russia adopted many of its training programs. The United States Agency for International Development (USAID) so liked the approach that they adopted our model, based on Kauffman’s in other countries they supported.

As suggested earlier, successes among the major venture capital firms spurred immense interest by pension funds and investors to become limited partners. Kleiner Perkins went from raising $8 million in 1972 to $15 million in 1978, $55 million in 1980, $150 million in 1982, and on and on. It simply kept growing. As of this writing, Kleiner Perkins has now raised $9 billion for its nineteen partnerships, made 1,308 investments, and had 306 exits.26

My point is scale. The coming together at this time of the development of new technologies and the companies that commercialized them, along with tax law and regulatory changes that spurred the enormous growth of limited partner investment have created an investing environment that has been simply phenomenal.

26 In this context, exits refer to the sale of the stock, either because the company is sold outright or because public stock can be sold.

As innovation and entrepreneurship flourished particularly from the 1990s on, governments around the world realized this was the engine of growth and employment. There was worldwide interest in free enterprise and individual initiative. Entrepreneurship and private enterprise proved to be critically important in moving a billion or more people out of poverty in most of Asia—particularly in China when Deng Xiaoping adopted programs to reform China’s economy.

Couple that with the emergence over the last forty years of remarkably talented entrepreneurs—Steve Jobs, Elon Musk, Jeff Bezos, Paul Allen, Bill Gates, and others— who have built companies valued in billions. We have all benefited from much of what they have created and achieved. Their companies now launch their own rockets to take astronauts to the Space Station. They hope to return to the moon and perhaps, before long, get humans to Mars.

From 1945 to 2010, missile and space technology was the domain of the United States and foreign governments as well as huge aerospace engineering firms such as Boeing, Airbus, Lockheed Martin, and others that had been in the business for half a century or more. Since 2000, Musk, Allen, and Bezos have all built companies that have exceeded much of what those pioneers achieved. It is a stunning story of human achievement.

At the same time, this huge scale means that unless you have an idea for a business that might quickly grow to $100 million or more, you probably should seek your money elsewhere. The world has changed, and the kind of life I aspired to is becoming a thing of the past. I would not change it for the world, but I am very happy I reached my maturity when there was room for someone with decent skills who could build, run, turn around and otherwise be involved in businesses that afforded me the opportunity to have a huge variety of experiences.

A codicil: I recall well when Monsieur Thomas Piketty went after the inequities of wealth around the world. He attributed much of it to inherited wealth that spanned the generations and the investment returns on their assets. My own conclusion is that he is correct about the disparities but completely wrong about the source, at least in the United States. At the time, I was doing research for my books on Jewish achievement (see Appendix I). I carefully studied the Forbes 400 at least for the years I worked on the books. The constant fact about the 400 was not the continuity of old money. Instead, it was by far about new wealth created by entrepreneurs. Nearly all of America’s richest have gotten their wealth in their own lifetimes. Thomas Piketty is simply misinformed. In the United States it has been the culture, the opportunities, and the people who have reached for the gold rings and gotten them.

More recently I am also moved by the speed with which the United States pharmaceutical industry developed COVID vaccines. Two men, both foreigners,27 who did

27 Stephane Bancels, CEO of Moderna, was born in France. Pfizer CEO Albert Bourla was born in Greece.

their work largely in and from the United States where most of their funding was raised, have led those endeavors.

One of my points is that we should not villainize successful high achievers. They accomplish much that benefits us all. Instead, we should encourage more of what they aspire to in terms of human achievement. We should not discourage what they do because they are successful.

Nonetheless, it is important to be mindful of Lord Acton’s famous insight that “Power corrupts and absolute power corrupts absolutely.” In this regard, I differ from America’s more recent approach to monopolies (based largely on whether consumers are injured by having to pay higher prices). Thus I believe that when a company becomes immensely powerful, we should praise the success but split it up into smaller entities. That does not destroy values, it divides that value among smaller entities which, in turn, provide more opportunities for multiple new leaders to take over and successfully build the various progeny while reducing the absolute power of the preceding entity and its leader who, if he wishes, can move on to start and build something else

As I was finishing the draft of this chapter, the November 27, 2021, Economist magazine ran a two and a half page feature story titled, “Adventure Capitalism: The Venture-Capital Industry Is Being Supersized. Good.” It is very well done and could be said to support much of the last half of this chapter.