Investing in racial equality - BVCA Journal

Publish Date 19 Jul 2021
Categories BVCA Journal

How can venture capital firms improve their record on diversity?

The global Black Lives Matter protests of 2020 have forced the venture capital industry to confront its poor record on race. Barely any funding flows to black entrepreneurs and while venture capitalists are part of the problem, they also have the opportunity to make an outsized impact with their dry powder.

“The protests have shone a harsh spotlight on the entire investment ecosystem,” says Eric Collins, Co-Founder and Chief Executive of Impact X, which invests in companies run by or for underrepresented entrepreneurs. “For many investors, it has been a wake-up call.”

Just 0.5% of institutional capital went to start-ups with black founders last year in Europe. Unconscious bias is a key factor: more than 80% of venture capital firms do not employ any black investors, according to US-based Blck VC. Biases are holding ethnic minorities back from these jobs.

“People with African-sounding names have to send 80–90% more CVs than white people to get a job interview,” says Michael Tefula of Diversity VC.

Tefula felt it necessary to get an Oxford degree to break into venture capital. “You have to widen your network to break through doors if you’re an ethnic minority. That education is not accessible or affordable for everyone. It’s a privilege.”

Opening the door

Things are slowly changing, however, through initiatives to encourage industry diversity. Take, for instance, Future VC, an initiative that brings budding investors from underrepresented backgrounds together each year for masterclasses and mentorship. COVID-19 forced the paid internships online this year. The intake was significantly enlarged, with 500 remote participants, compared with 40 last year. “I was concerned diversity would take a back seat during the pandemic, but remote work has actually made the industry more accessible,” says Tefula.

Similarly, #100blackinterns is a new initiative to help investment firms source more black talent. It is bringing 170 of the leading industry players together with black students for internships.

However, with many of the UK’s black-owned companies clustered in sectors that have been battered by coronavirus (such as hospitality and transport), a swell of insolvencies could worsen the disproportionate dearth of investment in black entrepreneurs.

Of the UK’s 5.9 million businesses, around 40,000 are black-owned. It can be hard for investors to build connections with this relatively small and underserved community that has a healthy scepticism of financial institutions.

Faced with this challenge, some investors have innovated in order to unearth deal flow. One example is the crowd-based approach taken by Atomico, a European venture capital firm. It leverages angel investors in underserved communities to build stronger ties with underrepresented founders of early-stage companies (and underrepresented investors).

This model also raises the investment readiness of founders by providing a network that may otherwise preclude black entrepreneurs from institutional capital. Indeed, entrepreneur Richard Robinson says the biggest barrier he faced in raising funds was his network. “I worked in the City for years, but because I didn’t go to private school or Oxbridge, I didn’t know anyone who knew a VC.” Socioeconomic status is the primary barrier, he says, but wealth is often linked to race, with stark income inequality between white and black households in the UK.

Robinson raised funding for his legal technology start-up, Robin AI, through a VC fund that accepted pitches without an internal recommendation — an open-doors policy that is rare. But Robinson says venture capitalists weighing up companies without a strong track record may have a bias towards investing in entrepreneurs with a similar background to their own. “It confers a degree of trust and comfort, but investors must challenge their convictions.”

A lack of data on black founders compounds this problem. “Investors are pattern-matching pitches to previous successes,” he adds. “This disadvantages people from underrepresented backgrounds.”

Diversity pays

As well as being a moral imperative, there is a strong investment case for racial equality. The Kauffman Fellows Research Center in the US studied 260,000 executives at start-ups. It found that ethnically diverse founding teams returned 30% more capital to their investors through an acquisition or IPO than all-white founders. Similarly, research from Harvard Business School found the shared ethnicity of investment partners lowered an investment’s comparative success rate by 26% to 32%. The ‘diversity dividend’ was attributed to better creative thinking.

Ethnically diverse founding teams return 30% more capital

Rodney Appiah, Chairman and Co-Founder of Cornerstone Partners, says funds that do not invest in black entrepreneurs are forgoing returns for their investors. He believes that too much capital is currently chasing too few ideas, inflating valuations and diminishing returns. “This is not about being tokenistic,” he says, “It’s good business sense.”

Impact X’s Collins agrees: he sees it as his fiduciary duty to invest in black entrepreneurs. He specifically chose venture capital as his vehicle for social impact. He says that black entrepreneurs, who are well aware of the barriers in the job market, tend to hire ethnic minorities.

Businesses run by ethnic minorities already make an annual £25 billion contribution to the British economy. “Venture capital is a tool for positive change in society,” Collins says.

Maintaining a positive working relationship with black founders will be crucial to achieving a successful exit. Cornerstone’s Appiah highlights the importance of placing human capital at the heart of the investment and value add process. “It amazes me how few VC firms have a structured approach to developing the teams of the companies they back. Diversity of thought and team composition is often a critical factor in determining whether a business is likely to succeed or fail. For Cornerstone, that philosophy is core to our approach.”

Robinson says more immediate financial support is needed to help ethnic minorities who may come from less wealthy backgrounds. “I’ve lost count of the number of black entrepreneurs who said they are nervous because some VCs expect them to go without a salary for so much time,” he says. “The salary is the key thing.”

But he has also been inundated in recent weeks by statements from investors who are “disappointed and ashamed” about their poor record on race. Winds of change are blowing, but the investment sector has much more work to do.

This article is from the BVCA Journal Autumn edition, published October 2020. BVCA members can access the full publication here.

The autumn edition explores racial equality and what venture capital can do to improve its record; the ways COVID-19 is forcing retailers to rapidly evolve the shopping experience; and takes a look at the ‘Thrivers’, inspiring stories of companies innovating, evolving and rising to the challenge of the pandemic. This issue also features an interview with Sir Ronald Cohen, a deep dive into what makes Manchester an exciting hub for investment, and much more.

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