editione1.0.2
Updated February 11, 2023Since we met and started this project in 2019, it feels like the world has fundamentally changed. The impact of COVID-19 is still not fully decipherable; the markets, including venture capital funding, reached record heights in 2021 and then dipped drastically in 2022. Russia’s invasion of Ukraine continues to have far-reaching impacts on the global economy, as has the rise of central bank interest rates. A cost-of-living crisis has taken a stranglehold on those least wealthy in society, as everything from energy, to food, and fuel have risen in cost exponentially. Cryptocurrencies and the associated technologies of decentralization, or “Web3,” have moved from a fringe interest to a mainstream phenomenon, and environment, social, and governance (ESG) principles have begun to make waves in startup fundraising and VC.
What does all this mean for the aim of this volume, to increase diversity, equity, and inclusion (DEI) in venture capital and startups? The unfortunate truth is that the numbers of diverse entrepreneurs accessing capital have receded in the last two years. The overall share of female VC partners is stagnant at around 15% (in Europe and in the US), while women manage an even smaller share of money than these numbers would suggest (5% in Europe). We still don’t have a good overview of how much money is being managed by Black GPs globally, though we do know that Black-led funds in the US represent around 3% of total funds,* and that Black fund managers are raising significantly smaller funds (46% smaller) than the industry average; we know even less about any other overlooked group mentioned in this book. What is clear, however, is that we are a long way off—even further away than before COVID—from approaching equity!
While funding for mixed-gender teams has grown to over 15% of total funding in 2021 (up from just 7% 10 years before), funding to all-female teams has shrunk to 2% (down from 2.4% in 2011), while 2021 happened to be a record-setting year for VC funding overall. The funding allocated to Black entrepreneurs has also fallen dramatically in 2022 so far (by at least 25% in the US, for instance) at 1.2% of total VC dollars (as of June 2022).
Two explanations for this lack of improvement are systemic: on the one hand, women were more likely to step back during the work-from-home times of COVID and take the lead on caregiving responsibilities. On the other hand, much of the funding boom of 2021 has been deployed to later-stage funds, which are still much more likely to be managed by white men. To inspire some hope, the longer-term trend is slightly better: the number of rounds of funding received by female-only teams has risen slowly but steadily over the last decade according to Pitchbook data, from only 3.7% of deals in 2011 to 6.5% in 2021, the highest percentage reached so far. Similarly, the deal count percentage for mixed-gender teams has risen in parallel, from 10.9% in 2011 to 18.8% in 2021.
Dramatically, however, we have also seen new research undermining some of the core tenets of recent efforts to put more money in the hands of female VCs. So far, the assumption was that more money managed by female GPs would automatically lead to more female founders getting funding. While this might be true to an extent, taking female GPs’ funding makes those female-led teams two times less likely to receive money from male investors, who control 95% of venture capital, in future funding rounds.* As a result, a team’s chance of building a successful VC-backed business is in fact smaller if they take early-stage funding from female VCs, while there is no pipeline of diverse funding that sees that startup through to escape velocity. While no comparative study exists for Black founders and Black investors, or any other of the groups we address in this volume, we fear similar biases might hold true.
This finding sheds new light on what we should ask for to increase DEI in VC and tech. The authors of the research paper, who are based out of the INSEAD international business school, have a proposal: we need more inclusive money rather than homophilic money, meaning investment teams that have a balance of genders rather than, say, six men and one woman, or the reverse. The insights from our panel on allyship become particularly crucial with this in mind: we need men, especially white men, to step forward and take decisive action, as they currently hold the majority of money in their hands, and the data clearly shows that startup success is more likely when the teams behind them are diverse (see Boston Consulting Group and McKinsey for more evidence on this front).
In the event we continue to see levels of investment in diversity recede rather than advance, we will need to think at a more senior level. Given that data shows* that diverse fund managers can identify investments traditional fund managers overlook, we need to create funds focused on diverse founders that span the entire lifecycle of a company. Currently, there are mostly smaller pre-seed and seed funds run by GPs from overlooked backgrounds.
There are three fundamental levers we believe will be crucial in changing the way investments are made, all of which were touched upon in Part III: Best Practices and Part IV: New Ideas:
LPs must allocate money with DEI in mind. Well-versed portfolio theory states that resources should be spread across a variety of categories and managers to minimize risk. We also know that investing in diverse VC teams has financial benefits. To this date, however, most LPs appear to be stuck in legacy relationships and haven’t taken decisive action when those funds continue to invest homogeneously. This must change dramatically so that money is distributed more equally across a larger diversity of managers. LPs are arguably neglecting their fiduciary duty in not taking DEI more seriously. Lawsuits may follow.
GPs need to acknowledge their biases and change their investment behavior. A first step to overcome common human bias—preferring or being more likely to trust people who are similar to yourself—is to recognize it. This can be a lot to unpack when it comes to VC, but there are clear starting points for investors:
Make it easy for people to pitch you without a warm introduction. For example, have a form on your website which you check regularly.
Run serious office hours, open to everyone, where you allow for pitches and track outcomes. If there are no investments made from office hours, either stop running them or commit to making an investment from the next one.
Undertake effective DEI training and actively diversify the funnel of startups that you monitor.
We all need to work together to create new flywheels. We are still hopeful that some of the existing ecosystem whales and lions will be willing to push for change, but at the same time, new players may have an easier time writing different playbooks and building new flywheels. Our conversations with the Zebras Unite and New Mittelstand founders made this very clear in particular; with a different ethos and a new kind of startup idea in mind, change follows. LPs need to take a chance on these players that come from alternative backgrounds, without a track record, and who are unable to pay a large GP commitment. There is a strong role here to be played by state-funds, like the European Investment Fund, the British Business Bank, or KfW Capital, who can take “risks”—evidence has shown these investment decisions are actually less risky—under the banner of “inclusive development.” It is important that these institutions lead from the front and make these important decisions now. At the same time, we need established managers to be friendly: sponsor new ecosystem players, take personal responsibility for their success by co-investing with them and forming syndicates, or by writing LP checks (like the Screendoor GPs-turned-LPs or LocalGlobe in the UK, who are heavily invested in Black Girl Fest).
Notably, this list does not include continuing to put the DEI responsibility on the few Black female VCs and CEOs; it does not include continuing to ask for more DEI data that only serves to stall real action; it does not include hiding behind charitable, DEI-focused side funds. It’s time to stop talking and start wiring checks to diverse funds and founders. If you look at your portfolio and there is only one type of diversity, as in you have invested in either one white woman or a few men of color, there is a problem that requires your urgent attention. Single dimension diversity in 2022 just isn’t good enough. The 30% Club taught us that to make seed change and truly feel the benefit of diversity, the diverse talent in the room need to feel as though they belong and have a voice. That tends to be best achieved when there is a quorum of 30% or more.
We began this project in 2019 with a rush of hope and exhilarating energy amid what was supposed to be our “real work”—Erika was running her startup Kinhub (then Kami) and Johannes was writing an academic book on VCs. We saw a big opportunity to combine our knowledge and networks to raise awareness, elevate voices, and finally define the agenda for concrete action. The first interviews, focused on broadening the definition of diversity, were eye-opening for us. The problem was even bigger than we had thought, and so much of it was hidden behind the industry’s closed doors.
After the initial push, things began to slow down as interviewees were sourced and scheduled, and the pandemic brought new concerns and changes to the industry. A new series of wins were the wind behind our sails that we needed to make it through the dip; we were able to connect with people we thought would be out of reach, like Mitch Kapor, who we reached via Twitter, and who was incredibly kind and giving. Success usually reproduces itself, and the next phase of interviews flew by, propelling us through the VC world.
The second phase of interviews focused on people who had launched initiatives and taken action within the system’s predefined parameters. We heard from many of the people on the VC, LP, and operator sides, learning that much of what we thought had revolutionary potential from the outside turned out to be localized, small-scale, or merely cosmetic. To complete the interview series and meet the promise we had set out with—to create a handbook on how to fundamentally change an industry—we decided to cast a wider net. We reached out to people who we thought had less power and influence because of their position outside of the “power centers” of tech. We connected with people like the founders of Zebras Unite and the New Mittelstand; we spoke to investing organizations embedded within companies; accelerators who aren’t copying Y Combinator, such as Village Capital; and individuals who thought (and acted) fundamentally differently about what needed to be done, like Ed Zimmerman and Nicola Corzine. Looking back at these conversations, we believe that in the long run, they hold the biggest promise. Building new flywheels—being true disruptors and contrarians—holds a lot of hope. How quickly and in what way exactly this hope will materialize into systemic change remains to be seen.