â€œShould private equity, venture capital and other investors invest in underrepresented minorities and women simply because itâ€™s the right thing to do?â€
Â·Â Â Â Â Â Â Itâ€™s an appropriate question. The funding gap for women and multicultural entrepreneurs is very real and remains huge when compared with men and white founders.
Â·Â Â Â Â Â Â Itâ€™s asked frequently. And itâ€™s asked with increased frequency, largely due to the impact of the Black Lives Matter (BLM) movement. The specific query: Has the recent raised awareness generated by BLM changed the investment habits of the PE and VC sectors?
Â·Â Â Â Â Â Â And it isnâ€™t adequately addressed with a one-word answer. There obviously are those in both the â€œyesâ€ and â€œnoâ€ camps. It isnâ€™t that simple, however.
The reality is stark.
The U.S. population is 13 percent Black, but just four percent of the venture capital industry is Black, according to 2018Â dataÂ from the National Venture Capital Association. Two years earlier? The number was three percent.Â Â
Only one percent of venture capital investments were committed to Black founders in 2018. And, only one percentÂ of VC-backed foundersÂ are Black, with less than two percent Latinx. And thereâ€™s this: 82 percent of fund commitments were to all-male teams, with 12 percent to mixed teams and six percent to all-female teams. Finally, more than 75 percent Â of all funding rounds went to all-white founding teams.
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It should surprise to no one, then, that the number of Black decision-makers in venture capital in 2018 dropped to one percent â€” representing just seven Black people at the 102 largest venture capital firms (at least $250 million under management) in the country, according to an annual survey by the Information, a technology-news outlet.
â€œThe lack of access to capital is the single highest driver for business failure, and Black founders are less likely to gain it,â€ says Melissa Bradley, Georgetown McDonough School of Business Professor. â€œAccess to capital is limited not because of demand, but due to pattern recognition by investors, different social capital based on educational and social choices (e.g. golf clubs), and a limited number of sponsors … who can vouch and validate the entrepreneurs.â€
But the reality of venture capital and private equity investing is this: investors canâ€™t simply modify their investment thesis and start investing only because of how someone looks or what their background is. Investorsâ€™ fiscal responsibility is to adhere to their thesis and be prudent. It has to be about the idea, the opportunity and the teamâ€™s experience.
In doing so, however, investors clearly need to be more aware of how their evaluation, experience and criteria are biased. They just are. Full stop. Partner/decision-maker demographics, dollars invested and the evaluation process demonstrate this each and every day.
Changing the Process
Investors simply must broaden the pool of where their investment dollars can flow.
Itâ€™s tricky, though. Simply targeting more investments for underserved communities may appear to be a start, but it isnâ€™t the needed fix. And hereâ€™s why â€” talent, good ideas and competence are evenly distributed among race, gender and geography.
â€œWe should be well beyond this idea of separate but equal,â€ says Monique Woodard, a venture capitalist who created early stage investor Cake Ventures. â€œBut in venture it seems as if we are moving right back there. Black entrepreneurs donâ€™t need a separate water fountain. You have to fix the systemic issues in your funds that keep Black founders out and keep you from delivering better returns.â€
Â·Â Â Â Â Â Â According to research by Kauffman Fellows and the Kauffman Foundation, diverse founding and executive teams generate higher median realized multiples on acquisitions and IPOs than all-white founding and executive teams (3.3 to 2.5 and 3.3 to 2.0, respectively).
Â·Â Â Â Â Â Â And, a study by First Round Capital found that its investments in companies with at least one female founder performed 63 percent better than its investments with all-male founding teams.
So, broadening the pool to include more women and people of color makes sound business sense.
For their part, investors largely havenâ€™t noticed.
â€œOver the last decade, U.S. venture capital investmentsÂ quadrupled, the number of businesses started by women grew to 40 percent, and weâ€™ve seen growth in the number ofÂ entrepreneurs of color,â€ writeÂ Ilene H. Lang andÂ Reggie Van Lee in the Harvard Business Review. â€œHowever, the percentage of venture capital dollars going to women-founded companies hasÂ barely budgedÂ since 2012, and the numbers are even worse for Black and Latinx founders.â€
The reason, they add, is â€œwell-documentedâ€: gender and racial stereotyping, unconscious bias, systemic economic barriers, and Silicon Valleyâ€™s preference for serial entrepreneurs.
Itâ€™s a foolâ€™s errand to believe quick fixes â€“ especially those focused simply on â€œchanging percentagesâ€ â€“ can permanently and adequately remedy a systemic problem. Instead, solutions need to be better thought out, better targeted and implemented more consistently across the industry. This will broaden the pool and ensure all opportunities are evaluated with the same criteria.
A productive starting point is deal sourcing.
â€œVenture capital is driven by relationships and many investments are sourced via personal referrals, usually through oneâ€™s direct networks,â€ Kimmy Paluch, founder and managing partner ofÂ venture coaching and services firm Beta Boom, writes in StartupNation. â€œGiven the homogenous and elite nature of most partners and investors in firms, this yields a proclivity to investing in homogeneous and elite groups.â€
Going forward, then, the VC/PE industries need to address the following:
Â·Â Â Â Â Â Â Expand your networks. Opportunities are driven by networks. Commitments are influenced by networks. Barriers are constructed by narrow networks.
Fix: Proactively and intentionally expand your networks to groups that include more people of color and women.
Â·Â Â Â Â Â Â Increase size of prospect tent. VC/PE firms shouldnâ€™t increase commitments to Black, Hispanic and women entrepreneurs just because they are Black, Hispanic and/or women. But they shouldnâ€™t leave them out in the cold either.Â
Fix: The attractiveness of underrepresented founders can only be supported if they are included in the evaluation process. VC/PE firms must create internal protocols to broaden the pitches they hear and evaluate.
Â·Â Â Â Â Â Â Change the discussion paradigm.Â Studies show VCs ask more preventative questions highlighting potential losses and risk when meeting with female founders.Â The same happens with underrepresented minorities.Â When the conversation focuses on negative areas, investors walk away with a negative gut feeling and canâ€™t â€œget excitedâ€ about the deal.
Fix: VC/PE firms need to be aware of this trap and consciously change their approach.
Of course, these steps are only a start: There are steps founders can take to improve their funding odds as well. Weâ€™ll address those in Part Two.