The venture capital (VC) industry has backed some of the most successful American companies and innovation. It is responsible for tremendous growth in pension funds and endowments in recent years and is considered one of the great American inventions, according to Doug Villhard, director of the entrepreneurship program at Olin Business School at Washington University in St. Louis.
It’s well known, however, that the industry does not work well for women, Black and Latinx founders. Despite increased scrutiny on the industry and pledges by VC firms to diversify funding portfolios, funding for women, underrepresented founders has remained persistently low. Just 3% of total VC funds were allocated to these companies last year.
Last fall, the Olin-Brookings commission — a partnership between WashU’s Olin Business School and the Brookings Institution supported by The Bellwether Foundation — assembled a commission of entrepreneurs, venture capitalists and public policy experts to analyze the problem and develop evidence-based solutions to drive more equitable VC funding.
The commission presented their findings and recommendations as outlined in the report, Bridging the Startup Funding Gap for Women, Black and Latinx Entrepreneurs, on April 20 at the Brookings Institution.
“The most important message we want to convey is that everybody — policymakers, venture capitalists, investors and entrepreneurs — has a role or part to play in increasing access to venture capital,” said Dedric Carter, vice chancellor for innovation and chief commercialization officer at Washington University.
“Access to capital is a complex problem, but it is solvable. I believe this report is positioned to help us all think about the role that we play in advancing a more inclusive and innovative set of companies coming out of the United States.”
The biggest hurdle to overcome will be convincing an industry that’s already working well to make a change, Villhard said. But the VC industry also has the most to lose if it doesn’t change.
“If the venture capital industry does not make a change, then someone is going to come in and disrupt this industry,” Villhard said. “It’s ironic because venture capitalists make bets all the time on disrupting industries. If they do not change, someone is going to figure out this tremendous opportunity that’s being left on the table today and they’re going to go after it. The old industry is going to be at risk of being extinct.”
Why everyone should care
The historically lopsided funding is a disadvantage to women, Black and Latinx founders, contributing to economic inequality. But that’s not all. Fixing this problem would have a ripple effect in the economy — creating more jobs, growing the overall gross domestic product and strengthening American innovation, commission members said. For the venture capital industry, the benefits of investing in more women and underrepresented founders is clear, Villhard said.
“This is not about quotas or lowering the bar. This is about recognizing that there’s a missed opportunity here,” Villhard said. “When you invest in women and underrepresented founders, in turn, you attract an audience that you’re not attracting today. That’s an opportunity, not a cost.”
Akeem Shannon, commission member and founder/CEO of Flipstik, agreed: “If we want to stay ahead and, more importantly, not fall behind the rest of the global economy, we have to invest in what we have. Let us show you what you’re missing. I think once VCs get a taste of this success, the sky’s the limit.”
How can we fix the system?
Commission members say these three recommendations have the potential to disrupt the venture capital industry for the better.
Increased transparency: When trying to enact change, the first thing you need to do is track where you are today so you can tell whether the strategies are working, Villhard said. Commission members recommended that data leaders like PitchBook and Crunchbase should create options for expanded self-reporting in leading databases and provide a straightforward way for researchers and stakeholders to access and analyze date through a secure platform interface or data sharing agreements. Additionally, investors and mentors should also encourage founders to self-report information in leading databases in respectful ways.
“If companies like Pitchbook and Crunchbase, which track venture capital funding, would be more intentional in this area, then we would have a tremendous baseline for which we can do research on, report on and tell if our efforts are working in the future,” Villhard said.
Government support: Venture capitalists’ one goal is to make the largest possible return for investors, said Morgan DeBaun, AB ’12, commission member and founder/CEO of Blavity Inc., a tech company for forward-thinking Black millennials. Therefore, the most promising solutions are those that incentivize venture capitalists for making diverse choices, she said.
For policymakers, that means creating a policy environment that doesn’t perpetuate the status quo but, rather, encourages an innovative community that is inclusive. The government already provides benefits to the industry today through “carried interest” incentives for VCs, favorable tax treatment for nonprofit foundations, pension funds and endowments, and grants through Minority Business Development Agency and State Small Business Credit Initiative (SSBCI).
To encourage more equitable distribution of VC capital, commission members recommended that policymakers explore a selection of both “carrots” and “sticks” such as:
- Promote transparency and equity in the granting process.
- Increase the use of tax credits to promote funding for underrepresented entrepreneurs. Commission members suggested tax credits on capital gains realized by VC organizations that can show that some portion — perhaps 30% or more — of their general partners are women, Black or Latinx and/or that their capital is deployed above some floor for the same population of founders.
- A voucher system for women, Black or Latinx founders that would create a new tax-deductible investment vehicle, giving VCs a risk-free way to invest in women-, Black- or Latinx-founded startups.
- Support and increase access to alternative types of financing such as loans and revenue-based financing — like WEPOWER — and provide incentives for lenders.
Increase public awareness: In the aftermath of George Floyd’s murder and the social unrest that followed, many firms acknowledged there was work to be done to create more equitable funding. We have to hold each other accountable to those commitments as an important first step, Carter said.
Commission members said an advocacy group is needed to not only hold each other accountable, but to also amplify data findings and influence public policy. Such a group would support future progress by maintaining ongoing media relations and social media campaigns, and hosting events and conferences to explore additional solutions. Additionally, an advocacy group could create a public dashboard for venture funds and their investors with diversity-based metrics.
How to disrupt the industry
In addition to the three recommendations proposed by the commission, members said these evidence-based solutions have the potential to transform the VC industry and bring about real change:
Be intentional: Venture capitalists tend to bet on solutions that look like what has worked before. But when it comes to women and underrepresented minority founders, pattern matching doesn’t work because there are few previous deals to compare to. To break this cycle, Carter said VCs need to intentionally look for deals in previously underserved communities.
Bring diverse perspectives to the table: The tendency for people to seek out others like themselves, is a major reason why VCs continue to underinvest in women and underrepresented minorities.
“Expand the pipeline by looking in places that may not be historically where you’ve looked to find the best innovation,” Carter said. “Also important is creating opportunities and recruiting people who look like the communities in which you want to invest. These actions make a difference.”
Expand focus: The commission found one reason VCs have not traditionally invested in women- and minority-backed companies is because they have focused on solutions for technology and the pharmaceutical industry. Those industries historically have not attracted women and underrepresented minority founders at the same rate. They create solutions for the industries they see — industries like beauty, entertainment, education and consumer goods, Shannon said.
“While VC has been hyper-focused on technology and high-growth startups, there’s a lot of wealth generation that’s currently being left on the table by looking at other sectors of the economy, which happen to be the sectors of the economy that women and minority founders are creating solutions for,” Shannon said.
Where do we go from here?
Commission members said there is a lot of work to do to encourage more equitable VC funding, but that should not deter stakeholders.
“This is something that is within our control. We as individual people can decide to take the power back and make a difference. We can use our voices and our unique skillset to solve this problem,” DeBaun said.
What will success look like? For starters, DeBaun said success in the future would mean that we do not need funds dedicated specifically to women founders or people of color.
“Success would be having funds that their entire portfolio is an accurate representation of the American population and are solving problems that are unique to certain interest groups,” she said. “Because at the end of the day, innovation is about having some sort of arbitrage of information. And I believe there are so many problems that are not solved because it’s just this giant monopoly. That’s an issue.”