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Look to early stage to create a more diverse and inclusive portfolio

Making seed investments into founders from underrepresented groups would have a more material impact for diverse founders than quotas, writes Sarah Barber, CEO of Jenson Funding Partners.

All VC firms should be thinking consciously about the diversity of founders they invest in. Data shows that 90 percent of VC money in the US goes to men and 72 percent of founders are white.

Look to early stage to create a more diverse and inclusive portfolio
Sarah Barber

This is unfair to minority founders and is bad business for VCs. A fund’s success is predicated on finding and supporting businesses creating solutions for large addressable markets. If all of a VC’s portfolio companies are creating solutions for the same homogeneous group, it makes sense that opportunities are being missed. This is supported by research by Morgan Stanley, which has estimated investors may be losing out on as much as $4 trillion of value by not investing in diverse founders.

The venture community is beginning to acknowledge this deficit of diversity and the challenge of creating an inclusive portfolio. What is less forthcoming are solutions.

The quota question

A common – and controversial – suggestion is that VCs should commit themselves to quotas of companies they invest in with female or minority founders. However, while there is certainly virtue in VCs formalizing their commitment to increasing diversity, the actual practicalities of quotas are often unworkable and perhaps even undesirable.

The common rebuttal is that there are not enough investable companies run by female or minority founders. As a result, in order to reach quotas, funds are competing over a very small pool of potential companies. Furthermore, investing in businesses as part of a tick-box exercise and not because they have a brilliant idea or huge commercial potential leads to negative outcomes both for the VC and the companies it invests in.

However, what VCs typically fail to ask next is why there are not enough companies to invest in. This is where the potential solutions may be found.

Finding diversity at the early stage

It is important to note that the lack of companies available to VCs is not due to a lack of minority-founded businesses in general. The US is home to more than 2.5 million black-owned businesses, according to one estimate. The problem is that underserved founders struggle to raise initial investment and – without friends and family or seed investment – are unlikely to grow to the size that would get them in front of VCs.

VCs therefore need to move down the funnel to early stage investment. One way to do this is to ring fence money or create a fund specifically for seed investment into founders from underrepresented groups. This would have a more material impact for founders than quotas, as it gives them access to the initial investment that they are lacking today. It would also benefit VCs by increasing the pool of potential investments for later-stage investors.

Addressing approachability

VCs also need to consider the makeup of their own firms when they are wondering why they cannot find diverse founders. Recent research in the UK showed that 76 percent of VCs are white, 70 percent are men and 33 percent have a degree from either Oxford, Cambridge, Harvard or Stanford. These stats demonstrate the lack of diversity among investors, which leads to closed networks that are naturally difficult and daunting for minority founders to try to breach.

Bringing in investors from diverse backgrounds should not be forced and definitely should not be tokenism, but firms should consider what an asset a diverse investment board could bring. As well as offering new perspectives, a diverse board increases the ability to attract a more diverse portfolio of investments.

We have recently seen this in action. Figures released by PitchBook in November showed that investment into women-led businesses in the US increased significantly in 2021, with $40.4 billion raised in just the first three quarters, almost double what they had raised in the entirety of either 2020 ($23 billion) or 2019 ($24 billion). Significantly, this correlates with an increase in female general partners at VCs (15 percent in 2021, up from 12 percent in 2019).

It is beyond time that investors stopped shrugging their shoulders and making excuses around diversity and inclusion. The start-ups are out there. The VCs that meet them at the early stage and make an effort to connect with them will reap the benefits of a more diverse portfolio.

Sarah Barber is chief executive of London-based Jenson Funding Partners, which has invested £17 million ($22.4 million) in 110 entrepreneurial UK businesses. She may be reached at sbarber@jensonfunding.com.