Diversity in venture and by extension the startups that venture capitalists fund is not a new topic. By and large, partners at VC funds tend to be strikingly homogenous, not only in terms of academic background and network but also in terms of ethnicity. Finding a partner of non-white or non-male origin on Sand Hill Road is nearly an exercise in futility, as by and large, they do not exist. Less than 2 percent of VC partners (read: investors with decision-making power) are black¹ and less than 2% are Latinx² — nearly none of whom are women. Stats like these translate to black women only receiving .0006% of VC dollars since 2009, representing a funding-chasm that both dwarfs and contributes to the larger economic wage gap. After all, VC backed startups are both responsible for more than 11% of private-sector job creation³, as well as account for nearly 60% of all new public companies within the last 4 decades.⁴
Missing Alpha The lack of diversity is a question of fiduciary duty and a missed opportunity in diverse emerging markets. Diverse investors are capable of exacting due diligence on trends they’re uniquely familiar with by virtue of their cultural background and upbringing. Similarly, diverse founders encounter an entirely different subset of problems, inefficiencies, professional and consumer annoyances that, while they may be huge market opportunities, are otherwise invisible to founders of non-minority backgrounds.
A study at Harvard Business School showed that racial homogeneity among fund general partners decreased investment success rate by 18 percent.⁵ In a world where successful VCs compete fiercely over an ever-smaller number of ‘investable deals’, diversifying deal flow is essential. It’s not that founders of color aren’t founding startups, VCs just aren’t investing in them.⁶ VCs tend to invest in founders who look like them, which isn’t especially pernicious until you consider that VCs are categorically ethnically non-diverse. The requisite nature of warm introductions at many funds means that the lack of diversity is compounded. In other words, it is not a pipeline problem!
Despite diverse founders returning 30% more cash on the median to investors than all-white teams, diverse founders still struggle with restricted access to capital. This means that for two hypothetical funds, with otherwise identical characteristics, a fund invested in ethnically diverse founding teams is likely to return more to limited partners. Likewise, startups led by non-homogenous teams will likely generate more value for employees, in the form of equity appreciation — everybody wins.
If you were going to build a treehouse, and could only bring three tools, you wouldn’t bring three hammers. You’d bring a saw, a ladder, and likely some nails
While the reasons for the heightened success of diverse teams are many, it can be summed up by this: If you were going to build a treehouse, and could only bring three tools, you wouldn’t bring three hammers. You’d bring a saw, a ladder, and likely some nails — the hammer’s still an essential part of the equation, but your treehouse looks an order of magnitude better by virtue of a complete toolset.
Diversity = Disruption
There are many examples, but one of our favorites is Donnel Baird’s prop-tech startup BlocPower, which uses proprietary software to bring clean energy to urban revitalization projects (i.e. churches, schools and multifamily retrofits). Baird’s childhood was spent in a low-income neighborhood in Brooklyn, where his parents sometimes had to use the oven to heat their one-bed apartment. So when he got the entrepreneurial itch, solutions to problems like this one were top of mind.
This compelling value is a direct result of a founder with deep experience in inefficient circumstances. In this way, diverse founders can create emerging markets upside, if you will, but with a home-court advantage. In VC, an asset class with very high exposure to downside risk, funds that make diversity a mandate can gain access to portfolio hedging, by avoiding putting all of their eggs into a single homogenous basket.
Like diverse fund managers are a largely untapped source of above-hurdle returns for limited partners, diverse entrepreneurs represent an alchemistic source of high-quality deal flow for VC funds at all stages. Ultimately, diversifying venture isn’t just a moral imperative; it’s a financial must.
A cadre of emerging funds (Harlem Capital, Female Founders Fund, Backstage Capital) cater to historically disenfranchised founders and legacy VC funds are starting to test the waters. Even without a diversity thesis, other funds can be expected to help close the funding gap as a result of a more diverse general partnership (think hiring partners of color and women partners at established funds and investing in funds with diverse managers as LPs). Industry veterans like Andreessen Horowitz and Softbank (say what you will) have taken the first steps by creating special purpose funds for diverse founders but it’s important to remember, separate is not equal. Philanthropic token funds miss the mark by relegating diverse founders and their companies to the little leagues, when they’re just as qualified to play in the big game.
These are great starts, but ultimately much more work needs to be done. The good news: the only way to go is up, higher returns lay ahead for founders and funds who’ve committed to doing the work.
Open Source Deliverables for VCs and Founders
Use diversity as a component of portfolio construction -> boosting equity multiples
Pattern match for gumption, solutions-forwardness and a track record of overcoming real adversity
Use software, feedback and self-education to mitigate unconscious bias
Use board seats to advocate for infra-portfolio company diversity
Hire scouts, associates and partners from underrepresented backgrounds
Open up your network, warm intros dam the flow of diverse deal flow if you’re not connected to underrepresented founders
Iterate, if your impression of lack of diverse deal flow is a pipeline problem (debunked), then that pipeline is broken and inefficient
Written by Scott Smith, Matthew Fairbanks and Carlo Kobe
¹https://techcrunch.com/2018/11/08/81-of-vc-firms-dont-have-a-single-black-investor-blck-vc-plans-on-changing-that/ ²https://news.crunchbase.com/news/latina-vcs-are-optimistic-about-opportunities-in-their-industry/#:~:text=A%202016%20survey%20jointly%20conducted,percent%20of%20the%20venture%20workforce. ³https://www.accenture.com/_acnmedia/accenture/conversion-assets/dotcom/documents/global/pdf/technology_11/accenture-venture-capital-silicon-valley.pdf ⁴https://www.gsb.stanford.edu/insights/how-much-does-venture-capital-drive-us-economy ⁵https://hbr.org/2018/07/the-other-diversity-dividend ⁶https://www.kauffmanfellows.org/journal_posts/the-pipeline-myth-ethnicity-fund-managers