Diversifying Startups and VC: Breaking Barriers

The Persistent Challenge of Diversity in Startups

Startups consistently grapple with a significant issue: a pronounced lack of diversity. Research demonstrates that founding teams exhibiting diversity achieve a greater return on investment compared to those comprised solely of white individuals. However, the venture capital (VC) ecosystem continues to display a notable underrepresentation of BIPOC and women in founder, investor, board member, and counsel roles.

Why Diversity Matters in Venture Capital

The importance of addressing this disparity stems from the pivotal role venture capital plays in funding groundbreaking and successful companies – including industry giants like Apple, Amazon, and Google. These organizations have fundamentally reshaped modern life, influencing communication, information processing, and commerce.

Considering that roughly one-quarter of U.S. professionals are employed within the high-tech sector, representing 5-6% of the total workforce according to the U.S. Equal Employment Opportunity Commission, the potential for increased innovation with a more inclusive landscape is substantial. We are witnessing legislative changes and corporate practice adjustments aimed at fostering this inclusivity within the public company sphere.

Current Representation Statistics

A prevailing pattern among founders of VC-backed startups is being white, male, and educated at Ivy League institutions or internationally. Companies led by women receive a disproportionately small share of VC investments when contrasted with those founded entirely by men. In 2020, only 2.3% of all venture capital funding was directed towards women-led startups.

As of June 2021, fewer than 20% of all VC deals involved a startup with at least one female founder.

BIPOC Representation in the VC Landscape

The statistics concerning BIPOC representation within the VC ecosystem are even more concerning. Only 3% of VC investors are Black, and a mere 1.7% of VC-backed startups are founded by Black individuals.

Representation of Latinx founders in VC-backed startups is similarly low, at 1.3%. From 2015 to August 2020, only 2.4% of funding was allocated to Black and Latinx founders. Furthermore, women currently occupy only 8% of board seats in high-tech companies.

Diversity Deficiencies Extend Beyond Funding

The issue of diversity isn't limited to funding allocation or boardroom composition; it also manifests in the executive ranks. In California, Asian Americans experienced lower rates of promotion to managerial and executive positions, and Black individuals comprise less than 2% of high-tech executives.

Addressing a Systemic Problem

The lack of diversity in the VC ecosystem represents a deeply rooted structural problem without a simple resolution. While some VC firms have initiated training and mentorship programs, further action is essential.

Legislative Efforts to Promote Board Diversity

Laws mandating board diversity have been enacted in several states, though these currently apply primarily to public companies and often focus on gender representation. These laws generally either require, encourage, or mandate the disclosure of board diversity information.

California’s SB 826, passed in 2018, was a pioneering effort, requiring public companies headquartered in California to have at least one woman on their boards by the end of 2019. This minimum threshold has since increased to two directors for boards with five members and three for those with six or more. The statute defines “female” broadly, encompassing individuals who self-identify as women.

This law has demonstrably increased female representation on boards, with a 93.6% increase in board seats held by women between 2018 and March 2021, though it is currently facing legal challenges.

Limited Legislation Addressing Minority Representation

While gender diversity legislation is gaining traction, fewer laws specifically address the underrepresentation of minorities on boards. Despite comprising 40% of the U.S. population, only 12.5% of board members of the 3,000 largest public companies come from underrepresented ethnic and racial groups.

Data from Deloitte and the Alliance for Board Diversity revealed that in 2020, Fortune 500 board seats were held by individuals identifying as African American/Black (8.7%), Hispanic/Latino(a) (4.1%), and Asian/Pacific Islander (4.6%).

California’s AB 979 and Expanding Legislative Action

To address this underrepresentation, California’s AB 979 mandates that public companies headquartered in California include at least one director from an “underrepresented community” by the end of 2021, with the minimum increasing by the end of 2022. This definition encompasses individuals who self-identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, or as gay, lesbian, bisexual, or transgender.

Beyond California, Colorado, Illinois, Maryland, New York, Pennsylvania, and Washington have also implemented some form of board diversity measure. Legislation is also being proposed in Connecticut, Hawaii, Massachusetts, Michigan, New Jersey, Oregon, and Ohio.

Non-Governmental Initiatives

Alongside legislative efforts, non-governmental initiatives are also emerging. NASDAQ has proposed new listing standards to the SEC requiring disclosure of board diversity. Goldman Sachs has announced it will only manage initial public offerings for companies with at least one diverse board member.

A Multifaceted Approach is Needed

Implementing these laws within the startup context may prove challenging. To truly shift the narrative on diversity in startups, change must extend beyond the boardroom and encompass a comprehensive strategy focused on diversifying employees in middle and executive management, directors, and the VC firms themselves.

Board diversity mandates similar to California’s may not be practical for early-stage startups due to their smaller board sizes. However, cultivating a culture that prioritizes diversity can be achieved through alternative means.

Strategies for Fostering Diversity

For instance, limited partners investing in VC funds could contractually require their general partners to consider diverse candidates for their firms and the boards and management teams of portfolio companies. VCs can also actively diversify their limited partner base, moving beyond their existing networks to engage with historically underrepresented groups within the startup ecosystem, such as Historically Black Colleges and Universities (HBCUs). Some VCs are already utilizing diversity riders in term sheets to promote this goal.

VCs must also critically examine the questions they pose to BIPOC and female founders, assessing whether these questions differ in ways that disadvantage historically underrepresented groups.

The Importance of Concrete Action

By failing to take more decisive action to enhance diversity within the startup ecosystem, we are missing opportunities to unlock further innovation. There is no single solution to address the lack of diversity. However, founders, VCs, and limited partners can all take meaningful steps in the right direction.