WRG’s Diversity Paper featured in Forbes Magazine column by Lisa Stone
By Lisa Stone, Managing Director, WestRiver Group. C200 member since 2016.
It seems appropriate that in 2020, Our Year of Armageddon, creating better returns for investors, and doing the right thing for society are one and the same.
One year ago, I joined a venture capital partnership because I wanted to achieve both. My partners asked: Could I curate a paper with data showing how diversity drives better financial outcomes?
Sure, I said.
I should have said: How much time do y’all have?
In “The Power of Diversity: Why Homogenous Teams in Venture Capital Are Bad for Business,” I synthesize about 30 publications by established banks, consulting companies, investment firms, venture capital partnerships, industry associations and academic institutions, all of which had invested in the kind of robust, thorough analysis that defensibly and objectively informs and supports financial decision-making.
The data are clear: As with public companies, startup founder and investing teams that are diverse—specifically with more than one gender and/or one race or ethnicity represented—are more innovative and make more money. In fact, venture capital investing teams limited to any one gender and/or any one race damage innovation and risk limiting financial outcomes, wrote Paul Gompers and Silpa Kovvali in Harvard Business Review: “The difference is dramatic. Along all dimensions measured, the more similar the investment partners, the lower their investments’ performance.”
A steady stream of evidence published since 2013 indicates that when startup teams and venture investing teams embrace differences in gender, race, ethnicity, educational background, and/or professional experience, these heterogeneous teams outperform homogeneous teams. A sample:
Teams of diverse founders (more than one gender and/or more than one race or ethnicity represented) create more innovation and, on average, better financial outcomes at venture-funded startups, including 30% higher multiples on invested capital (MOIC) when companies are acquired or go public, plus better valuations for startups with at least one female founder (63% better than all-male teams) and/or with at least one ethnically-diverse team member reporting to the CEO (65% better than all-white teams).
The venture investing teams most likely to fund diverse founders also tend to be diverse. Many available data focus on gender-diverse investing teams, which are 2x more likely to invest in gender-diverse founding teams, 2.6x more likely to invest in women-led entrepreneur teams, and more than 3x more likely to invest in a female CEO.
In the end, better returns are correlated with putting money into the diverse venture investing teams that find and fund diverse founders, who in turn outperform homogeneous teams:
69.2% of the top-quartile-scoring U.S. funds and angel groups for the previous decade, (2009-2018), included female decision makers, while 30.8% were all-male, reported All Raise, Pitchbook and Goldman Sachs in 2019. As recently as last year, women represented only about one in every eight VCs, or 12% of venture investors.
When U.S. VC firms increased the proportion of female partners, they benefited with 9.7% more profitable exits and a 1.5% “spike” in overall fund returns annually.
Multiple studies even call out the negative effects of homogeneity on individual investment exits and overall fund returns, including 5.8% lower success rates for investments by VCs with shared ethnicity, and 11.5% lower success rates for investments by VCs with shared school backgrounds.
Based on these data alone, embracing diversity is a business imperative for U.S. venture investing teams, especially in the critical innovation sectors where my firm invests—healthcare, consumer experience and technology.
Since my partnership coalesced around diversity as a core value, a global pandemic, a U.S. recession, and the murders of George Floyd, Breonna Taylor, and uncounted others have re-surfaced how systemic racism and sexism continue to steal lives, dreams, and economic opportunity.
The ongoing, disproportionate suffering and inequality experienced by most Black Americans has forced a reckoning for the VC community, where the overwhelming majority of U.S. VCs are male and white. Even as venture capital has generated more economic and employment growth in the U.S. than any other investment sector in recent decades, Black and Latinx investors represent just 3% of venture capitalists, respectively; only 1.8% of venture-backed founders are Latinx and 1% are Black.
The resulting damage to the prospects of Black and Latinx entrepreneurs, who also are female, has been profound: At the same time that most new women-owned businesses in the U.S. are started by women of color (64% in 2019), of the $424.7 billion venture capitalists have invested since 2009, a mere 0.0006% of technology funding has gone to Black women and just 0.4% to Latinx women, according to digitalundivided’s ProjectDiane.
Against that backdrop, leaders in movements ranging from BLCK.VC to All Raise, have been calling for the U.S. venture capital community to diversify. Today VCs continue to be 80% white, 84% male, and investing the majority of venture capital funding into white, male founders (85% or $136.5 billion in 2019, according to Pitchbook and the National Venture Capital Association).
“Diversity, in fact, is not only a moral obligation; it is a fiduciary one—leading to fewer losses and better performance,” wrote Jennifer L. Eberhardt, one of seven authors of a 2019 Illumen Capital – Stanford SPARQ study. A fiduciary (like my company), is both legally and ethically bound to act in the best interest of the client, even when it’s not in the best interest of the fiduciary.
How, then, in the best interests of venture clients—private individuals, family offices, and institutional investors such as college endowments, foundations, pension funds and corporations— do we fix an industry so profoundly homogeneous?
A first step is to start with your own house, changing venture partnership DNA based on the guiding principle that diversity drives better financial outcomes, as the CEO of WestRiver Group did. In 2018, Founder Erik Anderson began approaching partners with a question: “Ninety percent of global financial capital is allocated by men. Shouldn’t half of the world’s intellectual capital—women—also be at the table?” Today WestRiver Group’s equity investment team is, by design, gender-balanced, with additional dimensions of diversity represented as well, including race, ethnicity, educational background, industry experience, functional expertise and personal networks.
A second step involves a “diversity inclusion rider.” The brainchild of Alejandro Guerrero, a principal at Act One Ventures, this language formalizes the intention that every term sheet, as an offer of investment is called, include at least one additional investor who is from an underrepresented group, to include but not be limited to Black, Latinx, LGBTQIA and/or women co-investors.
“I was personally shattered by the deaths of George Floyd and Breonna Taylor, and they were my inspiration for creating this rider,” Guerrero said. He described the diversity rider to WRG partner Anthony Bontrager and me as a virtuous circle in which everyone wins: Diverse investors gain access to deals and exposure to networks they previously had no invitation to join; startups and their founders gain access to new, diverse insights and networks to help them innovate toward better outcomes, as do the venture partnerships writing term sheets. “Our goal is to lead systemic change around the lack of diversity in the venture capital industry,” Guerrero said.
WestRiver Group’s partnership voted unanimously to introduce diversity riders for the same reason that we formed a diverse partnership of experienced investors and c-level operators: To win at what we do. As our white paper shares, we know from our 240 combined years of professional experience how well diverse teams work, and we see already how our intentionally diverse partnership has expanded our pipeline of opportunities and tapped new potential for fund performance, creating larger networks of former CEOs, C-suite executives and successful entrepreneurs, deal flow, and assistance for portfolio companies.
The data are in: Solving for better returns is solving for the greater good, too, so what’s the hold up? As investors, we are excited to find so many data demonstrating the financial value created by diverse leadership; as citizens, we believe these data chart a path to a more equitable world.