J. P. Morgan and Edison: When Investor and Entrepreneur Fall Out

The investor–entrepreneur relationship: J. P. Morgan and Edison In the late nineteenth century, a specialist venture capital industry had not yet emerged. Inventors with a promising idea who wanted to start a business would seek support from wealthy people or approach bankers for loans. But there were two problems. First, loans generally required collateral, and not every inventor could offer a financial institution something valuable as security. Second, established financial institutions generally had little interest in small, early-stage businesses: they were too small and too risky. This was one reason specialist venture capital later emerged. ----- Likewise, in the nineteenth century, the Morgan group mainly served large clients, including governments and railway companies. Yet in 1878, Morgan made an exception and began financing Edison. At the end of 1878, Morgan told his partners that he was doing his best to arrange a deal. Though small, it was “probably the most important deal of all. It matters not only to the world but, financially, even more to us. The subject is Edison's electric light.” Edison made a simple incandescent light bulb in 1876. In 1878, he boasted that within a few weeks he would build an entire system to light Manhattan, at a lower cost than gas lighting. Gas stocks promptly fell by 25–50%. Yet Edison's system was not actually established until 1882. This was marketing and exaggeration by someone who wanted to change the world. Such behavior was hardly unknown before him, or after him. Edison entrusted his financing to Morgan. Changing the world through electricity and electric lighting required an enormous sum. This ambitious undertaking needed “the support of a businessman of the highest standing, someone not only cool-headed but also equipped with financial skill and power.” That person was Morgan. Morgan had already recognized that his strength lay not in taking a new venture from zero to one, but in taking an existing one from one to a thousand, or even ten thousand. Nevertheless, electric lighting and Edison captivated him. He believed not only that the project could change the world, but also that its risks were actually quite limited. He therefore continued financing Edison, even against his father's wishes. Edison's venture proved more difficult than Morgan had expected. Building a large central power station and turning a laboratory invention into a mature product for mass use was a very long road, costing far more than anticipated. Edison's other financial backers gradually lost patience. Like many founders needing capital today, Edison kept selling equity, borrowing from friends, and pledging his remaining shares to raise funds. Morgan, however, remained patient. At the end of 1880, he invested another US$1 million in Edison's company to help build the central power station in Manhattan. Morgan's support was Edison's greatest advantage over his competitors. It gave Edison “capabilities unprecedented in the history of invention.” Like any investor, Morgan had demands of his own, such as a timetable. Nevertheless, Edison ultimately concluded that Morgan was the best partner he could find. In 1884, Morgan helped Edison restructure the board of the Edison Electric Light Company. It was a victory for Edison: he successfully removed some investors who were dissatisfied with him. ---- But Morgan and Edison's honeymoon ended in 1892. The reason was strikingly similar to the conflicts between Silicon Valley venture investors and founders a century later: capital no longer thought the entrepreneur it had originally chosen was the best person to continue leading the company. By 1889, several companies Edison had founded, including the Edison Electric Light Company, had been consolidated into a new company: Edison General Electric. The merger was intended to meet competition from other companies. One of the strongest was Westinghouse Electric, founded by the entrepreneur George Westinghouse. The inventor Nikola Tesla was also on Westinghouse's side. (Robin: enter the War of the Currents.) Behind the competition between Edison and Westinghouse lay a disagreement between two great inventors over direct and alternating current. This was more than a contest between two companies; it was a contest between two systems. Another competitor was Thomson-Houston, which was also building central power stations. Villard, the president of Edison General Electric, proposed that the companies reach an agreement on electricity output and prices. Westinghouse rejected the proposal outright. Thomson-Houston made a different proposal: why not merge with Edison General Electric? Consolidation would create a larger company and reduce waste and destructive competition. Coffin, the head of Thomson-Houston, showed Morgan his company's financial statements. Morgan discovered that its profit margin was more than twice Edison's. He consequently began supporting a merger in which Edison General Electric would be the acquired party. The new company would control three-quarters of the electricity market. Its name became General Electric, with Edison's name removed. Edison, moreover, discovered that the company he had founded was to be sold without his having known anything about it. Repeated fundraising had reduced his stake to just 10%. At the time, he was mainly working in his laboratory on other inventions, such as the phonograph. When Edison heard the news, “his face turned so extraordinarily pale that it was painful to look at.” Morgan had not even thought to tell him. For more than a decade before this, he had firmly supported the inventor: financing him despite his own father's objections and being among the first to install electric lighting at home. Like Steve Jobs later, Edison was furious. He sold all his shares and withdrew completely from the company he had founded. Financially, this was not a good decision. ---- From Edison's perspective, it was a tragic story: an entrepreneur and inventor who wanted to change the world was driven from his own company by the power of capital. Yet in hindsight, General Electric went on to become the greatest company of the industrial age. For a time, it was America's largest company, and it was the first U.S. company with a market capitalization above US$200 billion. In hindsight, Morgan's judgment was correct. Edison was not the person to lead the electrical industry into the twentieth century. His determined obstruction of alternating current was evidence of that. He used every means available to oppose it, exploiting his celebrity to disparage it at every opportunity. History, however, showed that alternating current was the technological system appropriate for electricity at scale. When Morgan brought a company's stock to market, he was doing more than investing himself or selling shares. He also believed he had a responsibility to ensure that the company was successfully managed. Everything had to answer to investors. Wall Street's culture of maximizing shareholder interests was already emerging then, with J. P. Morgan as its guardian. Consider Morgan and Edison's conflict again. Morgan supported Edison's electricity venture for more than a decade, helping him stand out among many inventors. But when Morgan realized that Edison was no longer the most suitable leader, he decisively backed the sale of Edison General Electric and the creation of a new company unrelated to Edison. To an entrepreneur or inventor, this was a capitalist's cold-heartedness. In its outcome, however, it helped make General Electric one of the twentieth century's greatest industrial companies. #LiXiangTheRoadToGreatWealthMorgan ----- Robin: “Founders need a clear understanding of the limits of their own abilities. Doing it yourself is best if you can; if not, remain open to bringing in someone else. Success need not be led by me, but I should have a part in it.”