A lack of diversity is a problem that startups face. Despite the fact that diversity in founding teams has a higher rate for return than white ones, there is one thing that startups have in common: a lack of BIPOC founders and investors as well as women board members and counsel within the venture capital (VC).
Why is it important? Venture capital has been a source of early funding for some of the most innovative and lucrative companies in our time, such as Apple, Amazon, Google (now Alphabet), to name just a few. These companies have revolutionized the way we live, work, and play. They have made a difference in how we communicate, process information, and buy goods. According to the U.S., the high-tech sector employs approximately 25% of all U.S. workers. It accounts for 5% to 66% of total U.S. workforce. Equal Employment Opportunity Commission imagines how innovation could be made with more diverse people who have different perspectives and life experiences. We already see states passing laws and companies changing their ways to make this happen in public companies.
Many founders of VC-backed startups tend to be white and male. Women-founded businesses receive a fraction of VC investment than all-male-founded ones. Women-led startups only received 2.3% of all VC money in 2020. Less than 20% of all VC deals were made to startups with at least one female founder as of June 2021.
The numbers for BIPOC representation in VC ecosystem are even worse. Three percent of VC investors in the US are Black, and 1.7% of VC-backed startup founders are Black. Even lower is the 1.3% Latinx founders of VC-backed startups. From 2015 to August 2020, 2.4% of funding was given to Black and Latinx entrepreneurs. Women hold only 8% of the seats on high-tech company startup boards.
The problem of lack of diversity is not limited to who gets funding and who sits in the boardroom, but it also affects the executive ranks. California's Asian Americans were the least likely to be promoted into managerial or executive positions. In California, less than 2% high-tech executives are Black.
This structural problem of a lack of diversity within the VC ecosystem has no easy solution. Some VC firms have already begun to allocate funds for mentorship and training programs. However, more steps must be taken.
Although laws regarding board diversity have been passed in some states, they only apply to public companies. They typically emphasize gender diversity. They generally fall under one of three categories. California was the leader in 2018 with SB 826, California's board gender diversity law. This law required all public companies located in California, regardless of where they were formed, to have at least one woman on their boards by 2019. The minimum threshold rises to two for boards with five or more directors by the end of the year. It is three for boards that have six or more. (Female is defined in the statute as someone who self-identifies as a woman and does not consider the birth gender.
This law already has an impact: Between 2018 and March 2021 the number of women on boards increased by a staggering 93.6%. However, the law is currently being challenged by the courts.
Although legislation has been passed in some states regarding gender diversity on public company boards, very few laws address the issue. Even though these groups make up 40% of the U.S., only 12.5% of the largest public companies' board members are from underrepresented ethnic or racial groups. According to Deloitte's data, the Alliance for Board Diversity found that Fortune 500 board members were held by individuals who identified themselves as African American/Black or Hispanic/Latino(a) and Asian/Pacific Islander at rates of 8.7%, 4.1% and 4.6% respectively in 2020.
California's AB 979 mandates that public companies based in California have at least one director representing an underrepresented group by 2021. The minimum number will increase by 2022. This includes anyone who self-identifies to be Black, African American or Hispanic or Latino, Asian or Pacific Islander, Native American or Alaska Native, as well as someone who self-identifies to be gay, lesbian or bisexual.
California, Colorado and Washington are not the only states that have enacted diversity measures for boards. Connecticut, Hawaii and Massachusetts have also proposed legislation.
Other initiatives are also being looked at. NASDAQ proposed new listing standards for the SEC that required disclosure of diversity on the board. Goldman Sachs stated that it will only manage initial public offerings for companies with at most one diverse board member.
However, these laws may not be easy to implement in startups. To change the narrative about diversity in startups, it is not enough to just change at the board. Instead, a multi-pronged approach should be used to diversify (1) middle and senior management, (2) directors in boardrooms, and (3) VC firms and other investors.
Due to the small size of startups, mandates for diversity on boards similar to that in California won't work in the initial stages. But, it is possible to create a culture that values diversity in other ways.
Limited partners that invest in VC funds may contractually obligate general partners to look for diverse candidates as well as board members and managers of portfolio companies. VCs have the option to diversify their limited partners who invest in their funds. This can be done by avoiding their immediate networks and actively reaching out to historically underrepresented groups in the startup ecosystem such as HBCUs. Some VCs even use diversity riders in their term sheets to accomplish this. Also, VCs need to examine the questions they ask to their BIPOC or female founders. This will help them to consider whether they are excluding people historically underrepresented in startup ecosystems.
We are missing out on opportunities to encourage further innovation by failing to take more concrete actions to increase diversity in the startup ecosystem. There is no one-size fits all solution to the problem of lack of diversity within the startup ecosystem. There are steps founders, limited partners, and VCs can take to move in the right direction.
