Venture capitalists are in the business of picking winners and losers. Without their early financial backing, companies like Google, Facebook and Microsoft might never have taken off.
By definition, venture capital is early-stage funding for start-up companies that are high on risk but also high on potential. A venture capital fund reaps profits by acquiring an equity stake in the company, netting a percentage of businesses’ earnings based on the venture capitalist's percentage of ownership.
The investment game, however, is all about taking calculated risks while mitigating others. Venture capitalists gain the confidence to gamble on a company’s future when they see the potential for that company to succeed.
Regrettably, it seems that there is a pervasive, systemic problem throughout the venture capitalist community, where it seems distinctly risk averse when weighing investments in companies founded or led by women and minorities.
A study conducted by CB Insights in 2010 examined the disparity in the amount of venture capital funding for Silicon Valley companies founded by minorities and women as compared to companies founded by Caucasians.
The study found that while less than 1 percent of venture-capital-backed company founders were African American and 12 percent were Asian, 83 percent had a racial composition that was entirely Caucasian.
The impetus for the study was to determine what was behind venture capitalists’ investment strategies, which CB Insights suggests is a “critical lever in the United States to spur innovation, entrepreneurship and economic growth.”
In the preface to the report, CB Insights writes:
“When we ask venture capitalists what gets them excited about the young, emerging, and often unproven companies in which they invest, we never hear about deals and dollars. Rather, the first answer is frequently ‘the team’ or ‘the founders’. This demonstrates just how crucial human capital is in VC (venture capital) investment decision-making.”
The report showed that, four years ago, ethnicity and gender were disproportionately factored into that crucial “human capital” valuation equation, leaving minorities and women at a distinct disadvantage when seeking early investments.
Since the report was published, there have not been any follow-up studies to determine the extent to which the playing field has either been leveled, or whether the imbalance remains.
To determine whether or not this industry problem has persisted, I conducted an informal study using CB Insights to identify companies that received a round of funding from March 18-19. Analyzing 120 companies that ranged from start-ups to established business, I found that approximately $1.92 billion was invested in that period alone.
Discouragingly, the findings, which are admittedly unscientific, nevertheless suggest that the racial and gender problem in venture funding is stubbornly persistent.
Of the $1.92 billion invested, companies that had a Caucasian CEO or founding team received 61 percent of the total investments, which equates to substantial majority at nearly $1.41 billion.
Asian-led companies, as defined by the original CB Insights report to include individuals with South Asia and East/Southeast Asia ethnic backgrounds, earned a 17 percent share of investments at slightly more than $383 million.
Investments received by Latin American and Middle Eastern-led companies, which comprise the group labeled “other,” cleared $460 million, or 18 percent, while mixed-race leadership teams received $96 million in investments, or 4 percent.
Earning the lowest share of investments for all minority groups were companies led by African Americans. Only one such company acquired capital funding in the time period during which data was collected, totaled at $1.9 million, which factors to less than 1 percent of the total share.
Figure 1: Data collected from 120 capital investments that occurred from March 18-19, 2014, totaling approximately $1.919 billion
For female entrepreneurs, the news is even worse.
Companies headed by male executives received 98 percent of all investments, totaled at nearly $1.88 billion. By comparison, female executives only received $32.2 million in funding, while mixed-gender leadership teams took in $9 million, or less than 1 percent.
Figure 2: Data collected from 120 capital investments that occurred from March 18-19, 2014, totaling approximately $1.919 billion
Women make up roughly 51 percent of the US population, yet the total number of women holding an executive officer position in Fortune 500 companies has stagnated over the past five years. That number currently stands at about 14.6 percent, according to Catalyst.org, a nonprofit organization that works to expand opportunities for women in business.
Minority executives are similarly rebuffed.
In a tech-driven economy, where Internet-specific companies received $7.1 billion in 2013, the highest level of Internet investment since 2001, African American executives in the tech industry still struggle to garner investors, despite the fact that African Americans are among the most zealous consumers of technology.
According to a Nielsen report published last September, African Americans wield a buying power valued at more than a trillion dollars, which is rising rapidly. In October, the Pew Research Center reported that more black adults used smartphones than white adults, and last year, found that 26 percent of black Internet traffickers used Twitter, compared to 14 percent of white Internet users.
Yet, the diversity of tech consumers remains unaccounted for in the Silicon Valley venture capitalist funding projects.
Tristen Walker, the founder Walker & Company, which produces haircare products and other goods specifically geared towards African American men, said in an interview with The New Yorker that he believes black culture is under-appreciated and underrepresented in Silicon Valley.
“I do fundamentally believe that, really, global culture is influenced by black culture in the US,” he said. “This region doesn't know enough about the most early adopting culture.”
William Bradford, former dean and endowed professor of business and economic development at the University of Washington Business School, believes that the reason minorities are under-financed by venture capitalists is that they do not have the same access to them as do white men.
"There is evidence that venture capital markets are not race-neutral or race-blind," said Bradford in a 2001 interview with the Seattle Post-Intelligencer.
"Venture capital is quite often doled out through a system that is partially old-boy, partially not. But in either case, you have to be connected to the right people to get the best access, and quite often minorities just are not connected to the white decision makers." He continued, suggesting that "if we look at the practicalities of it, there are biases. Quite often those who are looking for this type of financing do not know where to look because they do not hang out in the same cocktail set as many of the white entrepreneurs."
In spite of obstinate inequality in venture funding, there are minority- and women-centric investment firms and angel investor networks that are intent to close the disparity.
The Marathon Foundation, a Washington-based philanthropic organization that strives to provide greater “access to capital” for minority- and women-run businesses, suggests that there is an immediate need for venture capital to invest in diverse business.
“By 2050, the United States will be a majority-minority nation,” writes the organization on the webpage for its Venture Capital Access Program. “Without the development of a robust pipeline of minority and women entrepreneurs and businesses, our economy will face a significant shortage of world class talent and innovation for economic growth.”
They go on to suggest that diverse businesses outpace non-diverse businesses in revenue and hiring, saying that they “are an engine of job creation with paid employment growing by 24 percent compared to a decrease in employment of 1.1 percent for non-diverse businesses.”
Other groups, like Women 2.0, a media brand that works on behalf of women entrepreneurs in technology, are trying to open avenues to capital funding for women by creating networking opportunities for them.
“With 30 percent of tech workers being women, 10 percent female founders, 10 percent female investors, 24 percent women sourced in news — something had to change,” says Women 2.0 in its mission statement. “We became passionate about catalyzing this change. We saw how important it was to have more women in technology as leaders, founders, investors.”
Regardless of these efforts, the fact remains that venture capital funding overwhelmingly goes to white men over any other demographic. Given the fact that the country is growing evermore diverse, one must wonder whether these business executives who receive the lion’s share of venture capital are in the best position to build a business that caters to a consumer audience that looks nothing like they do.
Photo credit: Merrick Morton/Columbia Pictures