VCs are *still* ignoring Black founders. What can we do now?
The authors of a new book on the history and future of diversity in venture capital break some of the industry’s biggest secrets and reveal its most entrenched problems
In many ways, diversity, equity, and inclusion have become empty buzzwords, a box to tick off on an human resources to-do list after enough employees attend a few well-chosen trainings. Erika Brodnock, an entrepreneur, researcher, and PhD candidate at the London School of Economics, and Johannes Lenhard, a lecturer and researcher at the Max Planck Cambridge Centre for Ethics, Economy and Social Change, want nothing to do with this kind of vague nod toward “progress.”
Their research focuses on why it matters that venture capitalists themselves are such a homogenous group. By funding people whose experiences and backgrounds are similar to their own, investors are not just leaving better returns on the table, they’re missing huge opportunities to solve societal problems. The type of world-changing innovation that Silicon Valley and other tech hubs claim to want just can’t exist without a wider, deeper, and thornier set of challenges—and a more diverse group of problem solvers.
In their forthcoming book, Better Venture, Brodnock and Lenhard explore how the economic and structural history of the VC world have led to a lack of diversity in the industry. Their research, data, and interviews with industry insiders like such as partners at Kapor Capital, Precursor Ventures, Balderton or Atomico, representatives from AllRaise, Diversity.VC, and the BVCA as well as LPs in big endowments and state funds, show again how founders who fit a certain pattern (white, male, from a privileged background) are far more likely to get funded, regardless of the strength or weakness of their idea or business.
Sherrell Doresy and Annaliese Griffin talked to Brodnock and Lenhard about risk and reward, entrepreneurship, and new, alternative investing models that make equity possible.
Sherrell: I live in Miami, where we’re currently experiencing an influx of founders and investors from Silicon Valley. When I talk to the transplants, they want to turn it into the next utopia for tech unicorns. And then when I speak to the locals, their deepest fears are being realized by the way in which the Silicon Valley folks are coming in—they're staying insular with one another and funding each other's companies. They're not looking outside of their bubble to look at the infrastructure of the city and who has equitable access to investment and opportunity.
This industry is organized around the idea that adopting a “high risk, high reward” philosophy will change the world, but there are obvious flaws in the funding-and-founding structure that leave out some of the most challenging, impactful work that could happen. How are you seeing this sort of replication of Silicon Valley values playing out as tech hubs spread to new cities?
Erika: From my perspective, the notion of “high risk, high reward” is directly linked to the failure and actually the mediocrity of the people who are being invested in at the moment. The investments are made into mediocre males who have, for the most part, been to the right schools—the schools the investors also went to. The failure rate for most startups receiving investment is exponential—that's why it's deemed “high risk, high reward.”
There could be an option of creating less risk and higher rewards by investing in more females and in more people of color, who have been shown to return anything up to 43% more than their white male counterparts. Most funds are at an IRR of less than 15% when places like Kapor Capital have shown that they can get an IRR of up to 29% by making investments in a more diverse set of founders. This data and experience is all being ignored, in favor of sticking with the status quo. People are choosing not to take that course of action, instead preferring to stick to the status quo of who gets funded, and then replicating that status quo in terms of the rate of failure and impact.
We can't pretend that people aren't making deliberate choices, and that certain groups aren't being actively locked out, rather than overlooked, or it being a mistake anymore.
Sherrell: Which is very contradictory to “let the best ideas win.” How do you get these folks who've been doing business one way to make the transition? Do you actually feel that they are willing to make that change?
Erika: So from my perspective, the answer is no, because if they were, I think we would have started to see it already. I'm not entirely sure how we can start to see the change.
We called some of these people out in 2017 with #metoo, and we started to see some hope. And then last year, we saw the investments in females recede as we went through the COVID crisis. If the change was really going to be substantial, why did it go away as soon as it appeared that we were busy with things like Covid?
The investment in Black entrepreneurs in the U.K. is around a quarter of a percent of the total capital that's invested. In the U.S. it's 1% of the total capital invested. And that's been the same for, well, since the beginning of venture capital. It's stagnant. It's in no way, shape, or form reflective of the population.
And so I don't know that people are actually willing to make the change. The more that we say that data is required, or that we need to be patient for the change to occur, the more we enable people to continue on in the system that serves them and doesn't really serve anybody else.
Johannes: The question is not one of a single actor or a single class acting in unison. It's a multi-stakeholder systemic problem that we're dealing with. So looking at the VCs alone, or looking at the founders alone, or looking at the LPs alone, or looking at the regulators, which is something that the U.S. doesn't think about too much but that play a much bigger role here in Europe—looking at any one of these alone doesn't make any sense.
Within a year, very little change can be done in this industry. This is actually a very, very long-term industry, particularly if we're comparing across financial asset classes. The average stock is held seconds in anyone's portfolio, because there's billions and billions of dollars flowing through different stocks through automated trading algorithms that the banks use. A venture capital asset—a startup—is held for several years, sometimes over a decade. So the speed is very different. That in and of itself places enormous constraints on what can actually happen. Fundraising takes months for the startup, but even longer for GPs in a VC fund.
So for a $100M Black-led or majority Black fund to be raised, that's an insane undertaking that likely took them a year, 18 months, possibly longer than that. Only last month, three big firms announced their raises in the U.S. that were all majority Black, or led by Black VCs, which is a very good sign. We're seeing bigger sums of money going to women and Black investors. But that is still the exception. VCs continue to be predominantly white men.
In Europe, big funds that are able to make massive changes, because they can write a $5M, $10M, $15M check when it really matters haven't been raised by overlooked or underrepresented VCs yet. What we're seeing is a $5M fund, a $10M, $15M, $20M, maximum $30M fund. That makes them often actually too small to take money from big institutional LPs.
That takes us into a whole other conversation, which makes this even more complicated, where a lot of the big, institutional LPs say, Can’t give you money yet—you first have to prove that you're able to generate these returns. What we're looking at the moment, I think, is a generational shift. We are building, slowly, this pillar of people who have decided we need to build our own flywheel, and that's the funds that start with the $5M, $10M, $15M, $20M, and then go up to $100M funds. But within the big firms, for instance, like the Accels and the Sequoias, as well as the big LPs, that's going to take a generation or two of GPs. Unfortunately, they are by far the most powerful actors here.
So who really matters for now are the people who have proven that they are generating these returns over several funds, and those are the funds that are still all white men, or majority white.
Erika: But have they proven that they're generating the returns? Some have. And then there are others who have no track record and pop up overnight with a fund. And because of who they are, they're able to do so.
Johannes: That’s the bullshit! In the U.S., only 10% of VCs reach above market rate returns for their LPs.
Erika: That’s the whole point! So what track records have we proven?
Johannes: These 10% of funds happen to be the Accels and Sequoias of this world.
Erika: The other funds exist, and people have invested in them. So what did they prove?
Johannes: That's the ex-analyst who goes out, or some founder who has an angel record, of being at the right place at the right time—normally in a dorm room at Stanford or Harvard—and has the right friends that he wrote some small checks for.
Erika: That's the truth. It's actually built on nonsense anyway. But the nonsense excludes people who don't have the right background. And that's the problem, is that it's set up to exclude people. Lots of the story that you'll hear is that actually, we can't invest in you as an LP unless we can see that you have the GP commit. But where do you get the GP commit [to put down between 1-5% of the fund size as a general partner out of one’s own pockets] from if you didn't come from wealth? You end up in this situation where the wealth begets wealth and begets wealth and begets wealth.
Sherrell: One example of this is Calendly, a company that was started by a Nigerian immigrant to Atlanta, who had tremendous credentials, but ultimately ended up having to bootstrap and leverage his pension to build his company. And it wasn't really until he had crazy mass adoption and traction that investors would even take a look at him, which is not how it works for white male founders.
Erika: Him having to bootstrap all the way to pretty much becoming a unicorn is not a rarity for non-white, non-male founders. It's what all Black founders are facing on a day to day basis. The rarity is that against all the odds that were stacked against him, he was able to overcome them. According to the data, most startups that make it to unicorn tend to have around $27M as a minimum pumped into them. So the fact that he did it without that is insane.
Annaliese: So VC and the tech industry, innovation is supposedly their thing. And yet in terms of who makes decisions, who signs checks, and who they are building for, it feels very homogenous, very stuck and stagnant. Why is this industry so cautious in this way? Especially after all the promises made by corporations and investors of all kinds last year after the murder of George Floyd and the Black Lives Matter movement came to the forefront.
Erika: I can't help but really take stock and look at the industry and what has actually changed over the last year. And I would say, not that much. What is happening in the industry is quite performative. People will make gestures, there's a lot of gesticulation about wanting to be diverse and wanting to make change.
In reality, the change is only ever one step removed. And by that I mean that if somebody is a founder of color, then they must be a founder of color who has had, for instance, an elite education, that means that they are the same as the people that are sitting in the room, apart from the skin color. And if somebody is female, then that must be the only difference, if you see where I'm coming from. When you look at things through an intersectional lens you see that there isn't that much change at all. So if somebody comes from a working class background, and hasn't had the educational opportunity of those that are sitting in the room, or they are female, or they're a person of color—and God forbid, if they're all three—then they still stand literally zero chance of being able to break into the industry that is shaping the future.
That's problematic for a number of reasons. One of the things that we'll hopefully do with the book is is start to both analyze and prove with evidence that lots of this dates back to slavery. A lot of the historical wrongs could actually be put right with venture capital, and the opportunities that it could create for certain communities, and that is actually being ignored in favor of keeping wealth exactly where it is.
Johannes: As you say, these people are investing in innovation, but not their own innovation—we mustn't be mistaken about that. VCs are ultimately a financial investor of other people's money, which makes that a systemic issue. The excuse is often, Yeah, but this is not really us making these decisions. We are tasked with one exact thing, which is to make as much money as possible for our investors (limited partners). The model that they've been following, and this is a very young industry, which only started in the 1940s and 50s has recently been one often called ‘blitzscaling unicorns.’ And financially they've been doing very well with that model, so as with everything, why change?
The LPs are the people that are the actual asset owners, which includes lots of our money. This is, at least in Europe, a lot of state money, which will include a lot of taxes, and in the U.S. it’s pension schemes, and big foundations, and endowments that invest in VCs. Particularly given the macro environment of zero interest rates, they are keen on somebody making them some returns. So they say to these VCs, You're doing exactly what you did 10 years ago, no changes, please, because I'm reliant on your returns.
There's a much bigger structure in place in this way that keeps the system the way that it is. Ultimately, I think these people are much more risk averse in their own doings in the industry than when they're investing into startups, if they're willing to take risks at all.
Erika: The other thing that I would say is that, actually, it's the perception of risk, because in reality, it's less risky to invest in diversity. That's been proven through data, and time and time again, [and we lay this all out in the book]. But it's consistently ignored. And I think that that in and of itself is indicative of the problem here—if the data isn't convenient, then it's brushed aside. We keep the status quo as the status quo is.
Sherrell: How are you thinking about the wealth gap and how that informs who gets to be an entrepreneur?
Johannes: The craziest thing is you're not even allowed to talk about that. Because class is a word that doesn't exist, particularly in the U.S. and even more so among people that so strongly believe in meritocracy. Everyone's middle class, right? Class is a concept that is almost not talked about, so you always address it through proxies, like education.
The statistics are reasonably thin when it comes to who is doing what in the industry beyond the fact that education is a good indicator of class. That’s something we know a little bit more about when it comes to the entrepreneurship class, even more so when it comes to the VCs. It's mostly people from the Ivies in the U.S.—we have Oxbridge, plus a couple of London schools in the UK. These are the majority of people that start companies, too, which again, goes completely against this idea, which people like Peter Thiel still hang on to, of the meritocratic American dream that anyone can make it from poverty to riches by becoming an entrepreneur.
It’s something that's even more perpetuated right now with the stupidity of the gig economy, which I would call a servant economy. That's what we're producing here, not a class of entrepreneurs that can become rich. I don't know how many Uber drivers you've met, or any other person that is engaged in the gig economy, who is really on a path towards that.
So this narrative is structurally perpetuated in all kinds of directions, and entrepreneurship is almost hailed as this holy grail that can help you out of poverty, which I absolutely have not seen an awful lot of proof of, beyond exceptions. [Founders get, on average, $30K from friends and family to start a business, before they raise a VC round or bootstrap the rest of the way.] There are stories about this, but that, for me, is almost the counterintuitive example that proves that for the majority of people, this is not an option, and it doesn't work.
Erika: I don't know if I 100% agree with that, mainly because I know that in communities that are South Asian, and indeed Black, they have turned around and created the mom and pop stores, which is still entrepreneurship, just not the kind of scalable VC route, and that has educated their children and enabled them to buy asset classes that they otherwise wouldn't have been able to attain. So it's elevated people from abstract poverty to the working and lower middle classes. I do agree that it doesn't enable working class people to transcend into the upper class, or become those billion dollar unicorns.
Sherrell: What are some of the solutions, or guidance that you all are aiming to share as part of some of this research that folks like myself or other founders or business owners can tap into? Otherwise, it just feels like we're waiting on an industry that has to be forced to change.
Erika: One of the things that we hoped to do when we set out to write the book was to turn around and share best practice across the industry that was already being undertaken. In the book, which consists mainly of such interviews, we will feature some amazing practices that are going on out there, and some shining lights in a very dark and dingy corridor. But we spoke with a lot of people, and I don't know that there is enough going on across the entire industry to really say that things are really changing.
I think that we may need to start to look at shaping interventions from an evidence base, and turning around and seeing whether there are ways that we can start to trial and test some of these things. If we look at the 80-20 rule, in terms of who's speaking about what could be done and what should be done, versus who's actually doing it, it was 80% speaking and 20% actually walking their talk. I am not sure how we get to a place where we switch that around, because we thought that we were speaking to the people that would be walking their talk.
Johannes: I was just going through a lot of the interviews and thinking about if I was a founder now, and I was in a position where I wanted to raise money, what did we learn from these conversations that would make that easier? Let me perhaps share a few takeaways.
Don't just think about venture capital as your only option. I think we are too focused on that being the one and only idea that can get you from zero to one. I think there's very interesting, much more inclusive, participatory, and collaborative ways that are being built up as we speak that can get you to the same endpoint. Aunnie Power’s book Adventure Finance on this topic is particularly illuminating and she gave us a fantastic interview.
There are people doing what some call revenue-based finance. So you actually end up with much more of your company—so if the company works out, you end up, quote unquote, much richer. They give you a little bit of startup finance in the beginning, and help you as much as possible, and there are no questions about being able to raise more money. They keep it as much as possible with you. Two examples of that are Earnest Capital (Now called the Calm Company Fund —Ed.) and Village Capital. They're doing VC, but they are doing it very differently, and I think it's much more founder friendly. It's definitely a much more inclusive approach.
Then there's another whole breed of investors that I would call venture capital investors, but they've raised money very differently, and they are distributing money very differently. I'm thinking specifically about Mac Conwell, who we have interviewed for the book, and Lolita Taub, who is in the process of really rolling out what she is calling Community Fund, who also contributed to the book. They are both raising money and distributing money following very different principles, much more about a group of people working together.
So here are two ideas of thinking outside of the box when it comes to venture capital, when it comes to raising money, that I think are reasonably concrete, that we definitely would propose as, not a solution to the problem—which I don't think exists at the moment—but as approaches to dealing with it at the moment.
Erika: The other thing that the industry needs to do is really start to look into the regulations around this and the fiduciary duty, not just to investors in terms of actually being able to invest their money fairly, but also the fiduciary duties of pension funds, for instance, that are invested in venture capital funds that don't have diversity.
They're investing everybody's money. And everybody who's putting into the pension fund has a right to see themselves reflected in the investments that are being made on the other side. I think that there may need to be some collective bargaining and collective action that starts to force people to make decisions differently, because actually, it should be criminal, that the pension money that is taken out of my wages every month is only being used to create wealth in a very homogenous group of people.
Annaliese: We've touched on this—Erika, you named it mediocrity earlier in this conversation—but what is not getting funded because of who is not getting funded?
Erika: There are solutions to problems that are being ignored because the problems are just not going to be experienced by the current investor class—climate change is a good example, or innovation specifically focused on female problems (menopause, female fertility) is only now getting started to get funding. In reality, those problems are being experienced by the majority of the world, or large populations. We’re just not giving enough people who are at the center of these problems the opportunity to come up with solutions. In terms of the value creation that could be added, it's huge. We're missing out on an awful lot.
Then there are the clear returns that are being left on the table. When Kauffman Fellows conducted their research, they found that Black entrepreneurs return up to 30% more to their investors than their white counterparts, so we're leaving returns on the table as well as ideas.
Johannes: Perhaps an abstract point to close on, but lots of what the VCs have focused on funding, because it's an easy market to begin with, and then there's a trickle down economics theory to tag on to that, which usually doesn't work. So the kind of products that lots of VCs have been funding are targeted very explicitly at rich people, because their money is easier to get to. They're also their buddies. They're the first person that will try what they're putting out there.
Then the idea is that once Group A, of .001% of the earners has adopted it, it will be pushed down into the rest of the world, which usually doesn't work out. That has to fundamentally change and will fundamentally change if the VC investors change.
We don't necessarily need to get rid of all the buyers, we just need to expand the buyers that we have in the system. At the moment all the buyers are basically white rich men. We need some other buyers so that other people look at some ideas that they can resonate with. One good example, which is not just a venture capital problem and goes much, much longer back, is female health. Research was not done on female health for centuries, because doctors happened to be mostly men. So nobody really cared about women's problems, and that's only very, very slowly changing. Fortunately, some startups and VCs are catching on to this kind of problem. That's very powerful.
This was a conversation between Sherrell Dorsey, Annaliese Griffin, Erika Brodnock and Johannes Lenhard, edited for length and clarity by Annaliese Griffin and Rachel Jepsen. Reply to this email if there's someone you'd like to see us interview in the future.