“The truth is that one of the main problems—perhaps the main problem—of the time is that our world suffers from information overload, and can no longer handle it unaided,” wrote British futurist Christopher Evans in his prescient 1979 bestseller, The Micro Millennium. “The world needs computers now, and it will need them more in the future; and because it needs them, it will have them.”26
CHAPTER 12
Risky Business
As hundreds crowded into Homebrew meetings, long lines formed outside Byte Shops and Computer Faire booths, as subscriptions soared to Byte and tens of thousands of copies of 101 BASIC Computer Games flew off bookstore shelves, it certainly felt like a revolution was on its way. But as 1977 rolled into 1978, few of the rangy little companies sprouting out of the computer-club world had managed to do what Apple had done: grab the outside funding and management expertise needed to turn a neophyte’s garage start-up into a scaled-up operation aimed at a broader consumer market.
Instead of Silicon Valley’s nascent computer industry divvying up the market among itself, experienced and well-resourced operators barged in from elsewhere. At the same moment that Jobs and Woz were revealing the Apple II at the West Coast Computer Faire, a Pennsylvania calculator maker named Commodore was a few booths over, unveiling the Personal Electronic Transactor, or the PET. (The designer thought the gimmicky acronym made a nice play on the 1970s Pet Rock fad.) A few months later, Texas-based recreational electronics giant Radio Shack joined the game with a personal computer called the TRS-80. Both machines had less power and sophistication than the Apple II, but they were half the cost, and threw in a monitor to boot.1
An awkward fact remained: whether shoestring start-ups or well-financed electronics firms, the microcomputer makers were changing the world for a relatively small, nerdy group of very early adopters. The micros still didn’t have the computing power or the workplace applications to turn them into serious challengers to mainframes and minis in the office market. Personal computers were great for playing games, and playing around, but not a lot more. Even in Silicon Valley, Homebrew remained an after-hours sideshow to the main acts of semiconductors and other electronics. If the new generation wanted to make a market-disrupting commodity product like Andy Grove’s microprocessor “jelly beans,” they needed more speed, more software—and more investors to help them grow.
The venture capitalists, however, had other worries on their minds.
CASH CRUNCH
The problem began back in 1970, the year Wall Street’s ebullient Sixties gave way to tightened markets. “Has the bear market killed venture capital?” blared a headline in Forbes magazine that summer. A gush of public offerings slowed to a trickle. More than 500 new companies went public in 1969. Only 4 did in 1975.
By the time that OPEC’s oil embargo had American drivers stewing for hours in gas lines, capital-starved tech companies were slowing production and selling off technologies and licensing to foreign firms. In 1969, the national venture capital industry had raised more than $170 million in new investment. In 1975, it raised a paltry $22 million. What’s more, only one venture investment in four went to tech companies. The silicon revolution seemed to be stalling just after it had gotten going.2
Why had things suddenly gotten so tough? Electronics was a growth market! Microchips were going into everything! Its companies were dynamic and flexible, able to open and close plants as needed. They had already moved manufacturing elsewhere, into the Sunbelt, and availed themselves of cheap skilled labor in Taiwan and Singapore. They weren’t weighed down by giant pension plans and outmoded manufacturing processes like those that were waterlogging old-school American manufacturers.
Yet the shiny newness of tech start-ups became a liability when it came to raising money beyond the seed-capital stage. Tech entrepreneurs were beginning to get rich, but the vast majority of the big money still was old money: the endowments of Gilded Age fortunes, the pension plans of Big Labor, the in-house investment operations of giant corporations. The new economy depended on the old economy for financing, and the old economy played it safe, especially in a down market. Tech investment was called “risk capital” for a reason. While payoffs could be huge, the odds were steep. From Cupertino to Cleveland, tech VCs couldn’t get investors to buy what they were selling.3
The Valley’s money men were blindsided by the crisis, especially those who were relative newcomers to the investment side. After his first, modest fund with Melchor, McMurtry got together with Reid Dennis and set out to raise money for a new, much bigger fund—right at the height of the OPEC oil embargo. Despite Dennis’s connections and reputation, it took them the better part of a year to raise $19 million. Then the Dow Industrial Average plummeted, falling below 600 by the autumn of 1974. Even a preternatural optimist like McMurtry got spooked. “We were so terrified,” he confessed, “that we didn’t make an investment for fifteen months.”4
It was bad back East as well. Stewart Greenfield was a former IBM product marketer who had jumped into tech venture investment at the start of the 1970s, leading what was called the “Sprout” fund at New York City investment bank Donaldson, Lufkin & Jenrette. Going into 1974, he, too, was trying to raise a new fund and had already gotten promises for $12 million from his investors. He was optimistic he’d raise more than twice that much. Then, as he put it, “something strange happened.” One investor after another called him over that summer and fall, “withdrawing their interest.” Pension funds had been some of his biggest investors, but Greenfield wouldn’t see another dime of pension money for three years.5
The tech world still pulsed with young companies, but new entrants couldn’t get off the ground. A bad economy and high interest rates dampened investors’ enthusiasm, to be sure. And after the explosive growth of the chip business at the start of the decade, it wasn’t all that surprising that the industry hit a plateau. The next big thing, microcomputers, were still a niche market. But as the VC community saw it, the biggest thing scaring off investors wasn’t any of these things. It was the U.S. tax code.6
DEATH AND TAXES
The roots of their belief ran deep. In 1921, less than a decade after the passage of the Sixteenth Amendment creating the federal income tax, Congress responded to business-sector pressures to bestow special, lower tax rates on investment income, also known as capital gains. Through the Great Depression and New Deal, through wartime austerity and postwar prosperity, capital gains taxes remained low despite escalating levels of government spending and taxation. Effective tax rates hovered around 15 percent; the highest the rate ever got was 25 percent—even as taxes for the top bracket exceeded 90 percent.7
Even though rates were relatively modest, investors and their political allies hated the capital gains tax with a white-hot passion. In 1928, the American Bankers’ Association pronounced it “unfair and economically unsound” and blamed it for excessive stock market speculation. In 1930, President Herbert Hoover declared that the tax “directly encourages inflation by strangling the free movement of land and securities.” Throughout the 1930s, New York Stock Market president Dick Whitney—who, like Hoover, became a blistering opponent of Roosevelt’s New Deal—blasted the capital gains tax at every opportunity, asserting that economic recovery would come from “the initiative of private enterprise, the intelligence of private management, and the courage of private capital.”8
There was another reason investors fiercely resisted raising the capital gains tax, of course: it was a tax on a big chunk of their income. This was particularly true for the limited partnership model that became so prevalent in the tech VC world. Regular management fees were only a piece of their take; most of the upside came from their hefty 20 percent slice of fund returns—i.e., money subject to capital gains tax. Yet this was rarely mentioned in the battle cries that rang out every time rumblings of tax reform stirred at either end of Pennsylvania Avenue.
The bankers and investors made supply-side ar
guments decades ahead of the Reagan Revolution: cutting taxes would unleash investment in new industries, new companies, new waves of entrepreneurship. Any hit to the Treasury would be more than repaid in new tax revenues created by this growth. By the 1960s, maintaining the capital gains differential had become an unquestioned tent-pole of tax policy for politicians of both parties, despite scant evidence that capital gains tax rates had the outsized economic effects that Wall Streeters contended they did. A few brave investors hazarded the opinion that the low rate encouraged speculative investment simply for tax benefit, and a raise in the rates would move stock-pickers “back to fundamentals.” Yet the capital gains differential stuck.9
This changed in 1969. A Democratic-led Congress inched the rate up, arguing that the rich needed to pay their fair share. By 1972, the capital gains rate had risen to more than 36 percent, and the rhetoric on that year’s presidential campaign trail indicated it might go even higher. “Money made by money must be taxed at the same rate as money made by men,” declared Democratic nominee George McGovern. After his landslide victory, Richard Nixon remained focused on the “silent majority” of the middle class who might swing into the Republican column. Slashing capital gains taxes wouldn’t earn many of those votes.10
Swamped by the populist mood, businessmen once again rolled out arguments that capital gains and other corporate tax cuts were actually things that helped the little guy. The king of the venture capitalists, Ned Heizer, was outraged about Congressional inaction. As the economy soured, even the deep-pocketed Chicagoan had taken heavy losses. “This country was founded by entrepreneurs,” he declared, “but Congress is killing this process.” The future of the economy wasn’t a matter of propping up U.S. Steel or General Motors. “If we could assure a flow of capital to young companies, then if General Motors in time didn’t do a good job, new companies could compete against it.”11
In the middle of all of this came the Employee Retirement Income Security Act (ERISA) of 1974, which placed strict regulations and performance standards on private pension plans, including a “prudent man rule” that increased fund managers’ personal liability for how they invested retirees’ money. Here was the reason Stew Greenfield had suddenly lost all of his investors. A couple of years after ERISA’s passage, an industry survey found that most trustees had become “unwilling to invest in anything but blue-chip stocks and bonds.” VCs had lost one of the biggest sources of money out there.12
THE RED CARPET ROOM
As those clouds were gathering in early 1973, San Francisco–based VC Pete Bancroft found himself commiserating with some colleagues over lunchtime martinis. “Sending representatives of the Rockefellers, Phipps, and Jock Whitney to Washington to lobby Congress about the need for tax reduction would surely get us laughed out of town,” he lamented. They had to organize themselves differently, and they had to change the conversation.
That two-martini lunch led to an impromptu summit of the biggest players in the industry at a place that was an easily accessible middle ground between East and West, and that happened to be in Ned Heizer’s backyard: the United Airlines Red Carpet Room in Chicago’s O’Hare Airport. Out of that strategy session came a new, grandly titled trade group, the National Venture Capital Association, or NVCA. Not everyone agreed that politics should be the NVCA’s business; one member cheerily suggested that the group didn’t need to organize anything more formal than the occasional golf outing. But David Morgenthaler didn’t think that way. When Heizer called for volunteers to go to Washington to lobby for a tax cut, he stepped right up.13
Morgenthaler was only a few years into his second career as a venture capitalist, and he had been enjoying it immensely. He was in a different spot than the McMurtrys and the Greenfields of the world, having enough personal wealth in the bank to not worry quite as much about raising outside money. With a career that ran from the New Deal through the heyday of the military-industry complex, Morgenthaler was old enough to have an appreciation for what government intervention could do. Yet he’d been a corporate executive long enough to have a strong distaste for excessive regulation and high taxes. By the early months of the Ford Administration, Morgenthaler was regularly hopping on the short flight from Cleveland to pound Washington’s marble hallways. Pete Bancroft flew in from San Francisco to join him.
It didn’t go very well at first. The two didn’t understand the Byzantine hierarchies of the committee system, the legislative dance, and the fact that getting a meeting with a Senator or Congressman was no guarantee of getting legislation introduced. They didn’t have high-priced lobbyists; they did most of the talking themselves. They looked on helplessly as lawmakers pushed the rate up even further in 1976. The wealthiest now had to pay capital gains taxes of nearly 50 percent. “We were so green back then,” Morgenthaler recalled later. “We sort of mentally associated ourselves with the big boys from New York, until we got there and we found the congressmen were seeing us as these nice little guys from the country.”14
As it turned out, however, the country boys had landed in Washington at exactly the right time. The post-Watergate moment was all about reforming the system and embracing outsiders. The president had resigned. Manufacturers sheared off jobs. Big, liberal cities like New York were on the verge of going bankrupt. The Keynesianism that drove generous spending and high deficits from Roosevelt’s New Deal through Eisenhower’s military-industrial complex had abruptly fallen out of favor. Austerity politics—cutting taxes, cutting spending, balancing budgets—gained traction.15
With the new mood, the feds became more interested in how high-tech enterprises could give the economy the boost it needed. In early 1976, Ford’s Commerce Department released a study championing “technical enterprises” as powerful job creators, finding that young high-tech firms had job growth rates that were nearly forty times that of “mature” companies. Setting aside that the sample was tiny—only sixteen companies in all—and that it perhaps wasn’t surprising that tech jobs were growing like wildfire during the early-’70s microchip boom, Ford’s team saw a juicy election-year talking point.16
Morgenthaler and Bancroft had found their opening. If tech companies were job creators, then Washington must act to fix the horrible climate for venture investment. It was time for the NVCA to issue a white paper of its own. Emerging Innovative Companies—An Endangered Species landed on the Hill in November 1976, just a few weeks after another self-styled entrepreneur and Washington outsider, Jimmy Carter, won the presidency. Pete Bancroft had written most of it. Morgenthaler made sure every congressional office had a copy. The Republican electoral loss didn’t deter them. They had high hopes for the Georgia peanut farmer, a centrist reformer who’d sung the praises of small business on the campaign trail, and they took pains to point out that tech companies were small businesses too.
“It is the successful new small company of today which becomes the important innovative company of tomorrow,” the report declared. “They keep America at the cutting edge technologically and help our foreign trade balance.” Six months later, they published a follow-up featuring a comprehensive tax plan to combat the “erosion of capital investment” that was killing innovative companies. Just as bankers had been doing since the 1930s, the papers made a crisp argument for the supply side. Any investments made through tax cuts would be earned back in new jobs and “increasing revenues in the form of income taxes”—billions more, in fact, than from the “mature companies” of the manufacturing economy. America’s economic future depended on its high-tech companies, and tax cuts were the way to make sure these companies would thrive.17
DINNER IN WOODSIDE
Silicon Valley’s little Galapagos hadn’t been much involved in these first missions to the marble halls of Washington. The lobbying business wasn’t an easy sell for engineers-turned-chipmakers who considered themselves a breed apart from stodgy old-economy types. WEMA, the trade association co-founded by Dave Packard back in the 1940s, remained f
ocused mostly on military procurement policies—something with little relevance to the firms now ruling the Valley. Even though business lobbying was surging in the 1970s, WEMA had only just hired its first Washington representative. Headquarters remained in Palo Alto, three thousand miles away from the corridors of power.18
That suited the Valley just fine. The chipmakers were highly skeptical of people who looked to government for help. Beleaguered Detroit automakers might be going hat in hand to D.C., but the Valley wouldn’t ever stoop to that. Sure, they gave money to Republican candidates when Packard asked them to, but National Semiconductor’s Charlie Sporck summed up the sentiments of a fair-sized minority when he declared: “I was anti-government and viewed all politicians as a bunch of bastards.”19
The one exception to that rule might have been their Republican Member of Congress, Pete McCloskey. And that was largely because McCloskey didn’t give a rip about what the Washington establishment thought of him. The medal-draped Marine had been an early, vocal critic of the war in Vietnam, going so far as to run against President Nixon in the 1972 primaries as a protest against the bombing of Cambodia. He was an ardent environmentalist, hewing to the center-left at a time when the party had begun a sharp tack to the right. Governor Ronald Reagan and state party leaders tried and failed to find someone to challenge McCloskey in 1972 and 1974. In the aftermath of Nixon’s resignation, the congressman seemed a little less traitorous, but he still couldn’t get a decent committee assignment.20
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