This Article First Appeared on: Fastcompany.com
Written By: BÄRÍ A. WILLIAMS
The fact that African-American founders have limited access to investment has been well documented, but you might not know that that problem is replicated in the venture capital world, too. In recent years, several black-owned or -directed VC funds and firms have opened their doors, with a focus on minority- and women-owned businesses. But as it turns out, many VCs are hitting the same obstacle as the founders they’re trying to invest in: access to capital.
According to Pitchbook, American VC funds raised $40.6 billion in 2016, with this year on course to make 2017 the fourth consecutive year with more than $40 billion raised. But with less than 3% of VC funds employing black and Latinx investment professionals, only a small fraction of that sum will find its way to businesses owned or run by people of color. Here’s what several VC partners and fund managers say is at the root of that problem, and what they’re doing to adapt to it.
“DIVERSITY” INVESTING, OR JUST GOOD INVESTING?
To increase diversity in the startup world, some VC firms raise new funds or allocate a portion of their current funds to investing only in people of color; others hire diverse fund managers. But that’s not always a panacea.
VCs frequently have trouble convincing investors, typically in the form of limited partners (LPs), to spend their money this way. Marlon Nichols, founding partner at Cross Culture Ventures, has found that “there are well-intentioned LPs out there that haven’t quite figured it out yet, and I want to believe they’re working to figure it out.” In the meantime, Nichols says, “I’d like to see LPs legitimately put more capital into funds started by qualified, diverse fund managers.”
Monique Woodard has also had difficulty getting capital from investors to put into the types of companies she’s excited about–and that’s despite being a venture partner at 500 Startups, a name-brand firm. “Even after seeing the data, many LPs don’t understand this investment focus or see the opportunity for returns,” she says. “They think of it as ‘diversity’ and then decide they aren’t interested in investing with a diversity lens, and ignore the very real market shift and its ability to deliver returns.”
For Woodard, this isn’t just frustrating, it’s illogical. According to U.S. government data, black women in particular are one of the best-educated and most entrepreneurial groups in the nation; failing to invest in their businesses is simply bad investing. In Woodard’s view, LPs who overlook those founders “are skating to where the puck is, instead of where the puck is going to be, as we see a new multicultural majority in the U.S.”
KNOWING A SPACE WELL, AND LEANING INTO IT
The good news is that deal sourcing and deal flow remain plentiful, and VCs like Nichols and Woodard say they have their pick of companies to fund–not just because other firms keep their distance, but also because they’re personally familiar with the minority communities they invest in. That lived experience, coupled with Americans’ shifting ethnic and racial demographics and the buying power of communities of color, lets certain VCs spot talent that others overlook.
Ryan L. Smith, director of investments for Magic Johnson Enterprises, has found this to be true. Having invested in black-owned companies like Walker & Company, Super Heroic, and Jopwell, he believes “the best person to solve a problem is someone who truly understands it–someone who is of it . . . There will be a majority of the country with issues that need solutions. Who better to solve those issues than the people from those communities? Thus,” he explains, “there’s an opportunity to help facilitate that . . . provide capital, mentorship, relationships . . . all with the goal of helping solve those issues in the optimal fashion.”
To do that, many black VCs ask the same questions as any other would– scrutinizing the team, the product, and prior successes. But they’re also looking for grit and grind, often born of the challenges certain founding teams have faced through the types of personal experiences Smith refers to.
As Nichols puts it, “We’re looking for something that says this founder is more qualified than anyone else to build this business . . . [meaning] firsthand experience and a novel solution: Is this the right person to do it?”
THE NEED FOR MORE DIVERSE VCS
But for all the efforts of VCs like Woodard, Nichols, and Smith, there just aren’t that many who are thinking like them.
Indeed, for an industry based on informed risk taking, the VC world as a whole seems curiously uninterested in taking the risks needed to diversify and innovate their investment portfolios. In reality, the average VC invests only 1% of their own money, and tends to be much more willing to assume risk with their investors’ capital. So perhaps the most obvious way to encourage more experimentation is to diversify the largest, best-funded VC firms.
Associate and partner ranks are roughly on par with tech companies’ employee demographics. That means that those sourcing investment opportunities for the large VC firms resemble the companies they tend to invest in. Yet research shows that black founders who get a chance to pitch VCs succeeded at the same rate as all other founders; nonetheless, black founders account for just 1% of funding received. We need more people who can identify that talent and act on it, which is hard to do when less than 3% of the employees on VC firms’ full-time investment teams are black or Latinx.
As things stand, venture-backed businesses don’t reflect the current makeup of our consumer society. And if this imbalance isn’t corrected, the gap will only get wider, leading to a massive lost economic opportunity. Smith sums up her goals aptly: “We want to democratize the future, and our approach to doing that is by ensuring that historically underserved communities have access to quality goods, services, resources, and opportunities.”
In the meantime, black VCs like Smith and his peers are building the venture funds they want to see, in hopes that others will come along and recognize the same undervalued opportunities that they do.