CHAPTER 1

Ford Motor, Detroit, 1956

When Bill Hambrecht visited a small electronics manufacturer in San Carlos in 1967, Silicon Valley was a very different place than it is today.

An energetic man who played football at Princeton, Hambrecht was head of West Coast corporate finance for Francis I. duPont & Co., one of the country’s largest brokerage firms and investment banks. Hambrecht had gotten his job on the West Coast because he was one of the few duPont bankers with technology experience. He had spent three years in central Florida arranging financing for defense technology and missile systems companies around Cape Canaveral.

Silicon Valley’s technology industry was then dominated by larger companies. Big government contractors. Lockheed had a big presence out at Moffett Field. Hewlett-Packard Co. started in a Palo Alto garage in 1938 and had grown by selling products to the government during World War II and the Korean War. It was a world in which it was still considered difficult to start a new company. Small players weren’t always taken seriously.

So when Hambrecht’s boss at duPont asked him to visit Farinon Electric, a small firm that was bringing in several million dollars a year in revenue, Hambrecht was initially resistant. He thought it would be a waste of time. Nonetheless, he drove out to San Carlos and introduced himself to Bill Farinon, the company’s founder. Farinon, whose firm manufactured microwave equipment used for voice communications, had successfully discovered how to sell into the notoriously closed Bell System. The collection of concerns led by Bell Telephone Company dominated the continent’s telephone networks.

After the two men had spent the better part of a day together, Farinon told Hambrecht that his father-in-law, who had put up most of the capital to get him started, wanted his money back. Farinon was thinking about an IPO. He didn’t want to have to sell the company to come up with the money.

“You’re really too small,” Hambrecht recalled telling Farinon. The banker listed several rules then used by Wall Street to judge whether companies were ready to go public. At the very least, they needed five years of earnings and roughly $1 million in after-tax profit.

“Who made up those rules?” Farinon asked.

“I don’t know,” Hambrecht answered. “They are the rules.”

The founder raised his voice. “Those goddamn rules,” Farinon said. “They were set up for you guys! So you could make a lot of money. They have nothing to do with me. How about looking at this from my point of view. I want my company to stay independent. I need some money.”

As Hambrecht was leaving, Farinon tried again. “Do you think I have a good company here?”

“Oh yes,” Hambrecht answered. “I think you really do.”

“Would you put in some of your own money?”

“Absolutely, I would love to buy stock,” Hambrecht said. “I don’t have very much money,” he told Farinon. But Farinon had something good.

“If you’re willing to buy stock for yourself, why aren’t you willing to sell it to the public?” Farinon demanded.

Hambrecht didn’t have a good answer. The following year, Farinon sold shares to the public for the first time in an IPO led by White, Weld & Co., one of duPont’s fiercest competitors.

Farinon’s parting question nagged at Hambrecht.

Not long after his visit to San Carlos, Hambrecht received word that he was in line for a job that would require him to move back east, where duPont was headquartered. It wasn’t the kind of opportunity that you turned down. But Hambrecht and his wife had come to enjoy living in California. If they were to stay in California, Hambrecht knew he would have to find a new firm to work for.

The dilemma was fresh in his mind when he heard about a promising technology company down the coast in San Diego. Hambrecht had befriended a banker with an outsized personality named George Quist. Quist ran Bank of America’s small business investment company, or SBIC, a fund set up after the 1958 passage of legislation intended to spur investments in startups. Bank of America used its SBIC to buy up stakes in nascent microwave and semiconductor companies. Hambrecht and Quist had already done a couple of deals together, and now Hambrecht asked his friend to join him on a trip to San Diego to visit the technology company. The gregarious banker soon agreed, and the two men booked a flight to Southern California for the sole purpose of looking into the company.

They arrived and visited the technology company, then went to the Kona Kai Club, a resort on a spit of land in San Diego Bay where they were staying before heading back the following day. Over scotch and not much food, Hambrecht told Quist about his opportunity at duPont. Did Quist know any firms that might be hiring?

Quist was looking for something new to do too. A CPA by training, he’d run a company that merged into Ampex, one of the early stars of the emerging technology industry. He followed a college friend to Bank of America and managed a portfolio of more than fifty companies. By the time of the San Diego trip, Quist was restless.

As the two men got deeper into their scotch and the night lengthened, they agreed that there wasn’t a firm doing what they wanted to do. Davis & Rock and Sutter Hill, two early venture capital firms, had formed just a few years before to make investments in promising technology companies. But no one was merging venture capital and investment banking—investing in startups and then supporting their public offerings as an underwriter once they’d grown big enough to attract public market investors.

It still seemed like a good idea the next day, and they sketched out a business plan on the flight home. The men thought that if they could find and invest in five new startups, they could establish a strong franchise. They soon raised $1 million from other investors.

“We got together and decided that if we could become not only a venture capital company but an investment bank,” Hambrecht later said, “we would be a welcome addition to the other venture capital firms on the peninsula.”

In 1968, they formed Hambrecht & Quist, focusing entirely on the technology industry. Farinon’s parting comment “really stuck with me,” Hambrecht later said. “That became the mantra at Hambrecht & Quist… became the quality screen for us. If we’d put our own money in it, we’d take it public.”

Hambrecht & Quist stepped into an IPO market steeped in rich history.

Investors had traded stakes in government projects or private enterprises for hundreds, if not thousands, of years. The Romans had partes, thought to have been used to finance public projects. The Dutch listed shares of the Dutch East India Company in the early 1600s and used the money to finance trading expeditions to faraway lands. Holland became a formidable center of trade in part because its relatively well-developed financial markets allowed businessmen to raise money for speculative endeavors.

Across the Atlantic, the first American public offering took place soon after the new country gained its independence. In 1781, the Bank of North America set out to sell 1,000 shares for $400 each. More than four months later it had only raised about $70,000. To ensure that the company would sell its shares and open for business, the United States government soaked up a majority of the shares. One early IPO investor was Benjamin Franklin, who purchased a single share to show support for what observers considered to be a critical step in the financial independence of the new nation. After its first year of operation, the bank paid out a dividend of almost 9 percent.

Over the next century, the capital needs of the companies developing the new nation’s industrial might only grew. The Civil War brought about an industrial revolution that gained steam in the second half of the nineteenth century. Railroads, oil companies, and steel concerns financed themselves by selling shares. In the early days, the process was often cumbersome and localized to New York or other large cities. Companies would offer stock to individual investors gathered around small brokerage offices. As the companies grew larger, so too did their need for investors with deeper pockets. Investment bankers, who acted as middlemen connecting companies to wealthy investors, took on greater importance.

Bankers took active roles in advising companies and in many cases even sat on their board of directors. Jay Cooke, the Ohio-born financier, is largely credited with founding the nation’s first modern investment bank. He helped finance the Union army’s operations during the Civil War by selling more than $800 million in bonds to various investors. He did so by recruiting a ragtag sales force made up of insurance agents, real estate brokers, and even tavern owners. He used the new technology of the telegraph to confirm orders, and developed “working men’s savings banks,” offices that were open late and offered bonds in small increments. Cooke showed that investors across the country could be counted on to buy an offering if it was marketed correctly.

In the following decades, John Pierpont Morgan, the mustachioed banking scion, gained fame for leading a corporate consolidation wave. In 1907, when the Dow Jones Industrial Index slumped 37 percent, Morgan staved off a financial panic by convincing other wealthy financiers to prop up failing financial institutions and brokerage houses. During his career, Morgan played a role in forming and financing such well-known companies as U.S. Steel, International Harvester, and General Electric.

The passage of the Banking Act of 1933, known as the Glass-Steagall Act, prohibited banks that accepted deposits from engaging in the business of buying or selling stocks and bonds. The First National Bank of Boston was forced to spin off a securities arm that became known as First Boston Corp.

By the 1950s, after two world wars had required a prodigious capital-raising effort from the now mature nation, investment banking enjoyed a golden era. Hundreds of retail brokers operated from offices on Main Street in small-town America. Those offices formed a network that the brokerages used to sell stocks and bonds to individual retail investors in the communities where they were located. Their clients were largely businessmen, lawyers, and other wealthy individuals in those communities.

As the middle part of the decade approached, Ford Motor Co. considered selling shares for the first time. One of the largest U.S. companies of the era, Ford was private largely because Henry Ford was notoriously against selling shares to the public, which he saw as a form of indebtedness.

In the 1930s, Ford transitioned much of his family’s shareholdings to a newly created nonprofit called the Ford Foundation so that he wouldn’t have to pay taxes to the administration of Franklin Delano Roosevelt. Ford felt that FDR was leading the United States into a war that he couldn’t support. Funded with nearly 90 percent of the automaker’s shares, the foundation was instantly one of the largest philanthropies in the world.

All those shares, however, were largely worthless to the foundation unless it could sell them on the open market for cash that it could use for its philanthropic efforts. So in the 1950s, members of the family began looking for a way to take Ford public.

Goldman Sachs’s Sidney Weinberg, known as “Mr. Wall Street” for his work ethic and financial acumen, had been a friend to the Ford family for years. Henry Ford had been a vocal anti-Semite and Weinberg, along with many of Goldman’s bankers, was Jewish. But Weinberg grew close to Ford’s son, Edsel, Edsel’s wife, and Charlie Wilson, a close associate who was by then helping to run the Ford Foundation. After Edsel died, Wilson approached Edsel’s son, Henry Ford II, about selling some of the foundation’s shares to diversify its holdings. The son soon agreed, insisting that Weinberg and Goldman Sachs work on behalf of the family’s automaker rather than for the foundation.

Weinberg planned the IPO in secret for nearly two years. The preparations revolved around a complex negotiation involving the competing demands of the Ford family, the foundation, the New York Stock Exchange, and the Internal Revenue Service. Weinberg ultimately came up with a scheme that satisfied the various parties and allowed the family to keep control of the automaker.

When it came time to sell the deal, Blyth & Co. Inc., a San Francisco–based investment bank, secured the lead banking role. Goldman Sachs was listed third on the company’s IPO filing, after First Boston Corp. and before Kuhn, Loeb & Co.; Lehman Brothers; Merrill Lynch, Pierce, Fenner & Beane; and White, Weld & Co. The seven firms each agreed to purchase 308,000 shares and sell them off to their network of clients.

Below those seven, Ford’s prospectus, the document that accounts for the bulk of a company’s submission to register stock with securities officials, listed more than 200 other investment banks and brokers on the front cover. They were part of a syndicate of 722 investment banks and over 1,000 total firms that were in a group charged with selling small lots of shares to retail investors.

Companies required large syndicates, or groups of banks acting in concert, because most investment banks at the time were structured as private partnerships made up of capital contributed by the firm’s senior bankers. That left them with limited funds to buy up large blocks of stock from industry titans like Ford.

Writing about the transaction at the time, the New York Times said that “probably never before in the history of the securities business has there been so much curiosity about the price at which a stock was to be placed on the market. And probably never before has the success of a public offering depended so little on the price. The underwriters say that the offering is sure to be oversubscribed by a wide margin.”

The Ford IPO was the largest of all time, raising $658 million by offering 10.2 million shares at $64.50. (Ford paid $15 million in fees to the underwriters.) The stock closed at $70.50 that day, representing a modest 9.3 percent increase.

The following year, 1957, Blyth once again led a high-profile offering, managing the IPO for Hewlett-Packard, then a maker of electronic measuring equipment. (It wasn’t until 1966 that the company began selling computers.)

“Wall Street in 1956 was a cottage industry,” said Bruce Foerster, a former navy officer who joined the Street fifteen years later and struck up friendships with older bankers who worked on Ford’s IPO. The industry’s private partnerships were mostly small affairs, while some of the larger ones, including Goldman Sachs, didn’t have large networks of individual investors that they could tap to buy a large stock or bond issue, Foerster said. “You needed all those firms.”

By the 1970s, the financial markets had begun to change dramatically. On February 8, 1971, the National Association of Securities Dealers, a self-regulatory organization that came out of the Great Depression to oversee securities markets, activated its National Association of Broker Dealers Automated Quotation (NASDAQ) system.

Initially, NASDAQ focused on stocks of companies too small to qualify for trading on the New York Stock Exchange (NYSE). Those stocks traded in the over-the-counter market, where it was often difficult to learn share prices at a given moment in time. Acting as a central place to collect those prices, the NASDAQ started by offering prices on 2,500 securities. It was the world’s first electronic stock market, and soon became the venue of choice for technology companies floating shares for the first time.

In October of that year, Intel listed on the NASDAQ by enlisting sixty-four underwriters to sell less than $10 million of shares. A maker of silicon computer chips, Intel was founded three years earlier by two former Fairfield Semiconductor engineers, Gordon Moore and Robert Noyce. More so than the Ford IPO, or the Hewlett-Packard IPO, which had happened years before the tech revolution took hold in Northern California, Intel’s IPO marked the region’s arrival on the national stage. Earlier that year, a writer for Electronic News christened the region “Silicon Valley.”

Investors were also beginning to change. In 1975, 426 mutual funds controlled less than $46 billion in assets. But with the September 1974 passage of the Employee Retirement Income Security Act (ERISA), mutual funds and other asset managers began to control a larger share of investment assets. ERISA set guidelines for pension funds to own dividend-paying stocks, and they scrambled to hire third-party firms like mutual fund companies to invest on their behalf.

As mutual funds proliferated, so too did the ranks of professional investors. And they demanded research about the markets or attractive investment opportunities. At first, smaller specialty firms like H. C. Wainwright and Mitchell Hutchins made a good business providing that research. The full service investment banks, like Goldman Sachs, dragged their feet. But it wasn’t long before the larger firms realized that they would need to offer research if they wanted to build deep, and lucrative, relationships with the growing class of professional investors.

“Goldman was a tiny little firm in the 1970s,” Foerster recalled. “They prided themselves among other things on being not the first to adopt new policies or new procedures or new gimmicks or new securities but the last, because they didn’t want to have any of their clients have something that blew up before people knew how it traded in the secondary market.”

That philosophy would be challenged the following decade when the bank set out to improve its standing in the rankings of stock underwriters, in the process redesigning how IPOs got sold.