The Consequences of Homogeneity

4 minutes, 6 links


Updated February 11, 2023

For an industry which has for the last 80 years filtered which ideas and technologies reach the market and change the world, this is a disastrous picture. Not only is this group nowhere near representative of the population it makes decisions for, it has neglected to make the best investments to maximize financial outcomes. Increased diversity in investment teams has been shown to contribute positively to the performance of venture capital funds: an authoritative Harvard study based on over 20 years of quantitative data from the US VC industry, for instance, demonstrates the impact a lack of diversity in the investment committee of a VC fund can have. The more similar the investment partners in a fund are, the lower the success rate for acquisition or IPO. To the contrary, if a fund increased their share of female partners by 10%, they had on average a 1.5% higher overall fund return each year and 9.7% more profitable exits. McKinsey & Company have published several studies (“Why Diversity Matters”, “Delivering Through Diversity”, “Diversity Wins: How Inclusion Matters”) on diversity in more general corporate contexts, which conclusively find that having more women and people from diverse ethnic backgrounds as executives in companies leads to higher financial performance. According to McKinsey’s recent study, companies in the top 25% for gender diversity of executives were 25% more likely to report above-average profitability than companies in the bottom quartile. Similarly, companies in the top quartile for ethnically diverse executive teams have a 36% higher likelihood for above-average profitability.

The data and the business case are very clear but—in the converse of the 2020 NVCA report’s optimistic conclusions—very little progress has been made towards changing the numbers so far. This book looks both at the history and reasons we are in this position, and provides a first-of-its-kind overview of proven best practices to inspire action towards the change that is needed now.

There are four key reasons why the homogeneity of the VC industry matters:

  1. VCs are the kingmakers of our digital age. They filter who gets money to build companies and bring ideas to market. Venture capitalists have enabled the success of the world’s most highly valued companies, from Amazon, Apple, and Facebook, to WeWork and Theranos. Who these people are and what kind of decisions they make matters to us all.

  2. The VC sector has so far seen very little scrutiny. Both in terms of DEI but also more broadly within the ongoing “techlash,” VCs have been left out of the conversation. While VCs have paid lip service to #MeToo and Black Lives Matter, not much progress has actually been made. This a social justice issue, thus, more external pressure needs to be applied to VCs.

  3. We need to broaden the diversity conversation. When it is in focus, diversity is often limited to gender and, especially in the US, ethnicity. We need to widen the conversation to include other dimensions of diversity including educational background, socioeconomic background, disability, mental health, sexual orientation, and others—and, most importantly, shine a light on intersectionality, in order to understand the complex interconnections of being excluded in multiple ways.

  4. Data doesn’t drive change. While we see the need for data (and more precise data at that) to push the industry to embrace DEI, data so far hasn’t made a difference. In fact, data is not something that VCs have historically paid too much attention to in their decision making—“gut feeling” is the strong driving factor. What is key to inspiring change, as even economists have recently picked up on, are stories. This is the main focus of this book: first-hand accounts, best practice examples, and case studies.

Ripple Effects in Startups and Tech

The problem that begins with VC investors invariably extends to the founders of the companies and startups receiving crucial venture capital funding. In 2021, both “European Women in VC” and the State of European Tech reported that all-female startup founding teams received less than 2% of funding (with both reporting approximately 9% went to mixed-gender teams).* As Wired reported in late 2021, “In a Banner Year for VC, Women Still Struggle to Get Funding.” The conclusion: women received less money in 2021 than on average across the previous five years. In the US, only 1.2% of VC funding went to Black entrepreneurs in the first half of 2021; just 0.34% went to Black women. The numbers are even more devastating in Britain, where not-for-profit Extend Ventures found that 0.24% of VC funding between 2011 and 2021 went to Black entrepreneurs.* The Extend Ventures report also identifies a significant socioeconomic class bias in UK VC funding, with 43% of seed funding going to teams with at least one member from Oxford, Cambridge, Harvard, or Stanford.

Representation, or lack thereof, filters through the fabric of the entire industry, as investors are more likely to invest in those who look like themselves. Richard Kerby writes that the illusion of meritocracy is in fact “mirrortocracy,” resulting in adverse effects for diverse startups founders. This is based on similarity bias in investment decision making and the reliance on gut feeling. Given the very limited pool of VC decision makers—mostly white men with Harvard and Stanford MBAs—women, people of color, and those without degrees from elite educational establishments are often left locked out and unable to access the support of venture capital firms.

This is particularly surprising given how clear the business case is for DEI in VC and startups. As PlanBeyond’s recent “Bias in US Venture Capital Funding Report” makes clear: more diverse teams are more likely to financially outperform their non-diverse counterparts and work on making society better with their companies. As these startups are scaling up to become the next wave of tech behemoths, the biases we see in venture capital and founding teams are filtered downstream and reflected as biases within venture-supported companies. Research from the Kauffman Fellows Research Center similarly shows that while only 20% of capital is invested in ethnically diverse founding teams, those teams achieve 30% higher returns than all-white teams. Boston Consulting Group found that female founders generated 10% more in cumulative revenue over five years, and startups with at least one female founder generated $0.78 in revenue for every dollar invested, compared to male-founded startups that generated less than half that ($0.31).

You’re reading a preview of an online book. Buy it now for lifetime access to expert knowledge, including future updates.
If you found this post worthwhile, please share!