Friday, March 30, 2018

How big money can drive diversity in venture capital

The world’s largest asset manager just called for more corporate responsibility in governance. Twenty-one countries already legislate diversity on corporate boards or mandate practices that enhance diversity in the workplace. The United States has avoided proactive rules, often citing adverse results from implementing quotas. But in the USA, money talks. And the money behind venture capital funds is starting to take diversity seriously.

When Larry Fink, CEO of BlackRock (with $5.7 trillion under management), says, “We also will continue to emphasize the importance of a diverse board,” that is a lot of votes for diversity. Similarly, the largest private foundation, Bill & Melinda Gates Foundation, just backed Aspect Ventures, a women-led venture fund, to help change the ratio in technology.

Someone working on behalf of a LARGE pool of capital recently asked me what actions would help it produce strong returns with diverse venture capital investors and diverse entrepreneurs. Their investments to date had all been with middle-aged white guys — literally — and they worried about both social justice and business relevance and returns.

Diversity is important for investment performance, both for better financial outcomes and for ameliorating risks. The trend toward requiring more diverse governance bodies, whether investment managers or corporate boards, spans from early-stage startups to public company boards. At the largest scale, governance advisers such as Glass Lewis will start to advise voting against boards that are not diverse (see page 23.) Women- and minority-owned venture capital (VC) firms are flourishing, partly driven by public employee pension funds. Strong performance in venture capital is tied to access to the best companies, many of which are now founded by a diverse range of entrepreneurs: young, racially diverse and not all male.

In the post-Binary Capital era, limited partners (LPs) are increasingly concerned with the downside risks present in non-diverse investment firms, where old-fashioned monocultures may foster illegal or undesirable behavior. Astute LPs are asking their general partners to document their diversity statistics — inside the firms and among their portfolios — and to document their policies that foster a diverse and inclusive workplace, such as policies on sexual harassment, fraternization, maternity leave, etc. The National Venture Capital Association (NVCA) provides model HR documents for free to the community for use in firms and portfolio companies.

The large pool of capital (let’s call them “LPOC”) was aware of all these trends, but sought advice on how to influence their investment portfolio of firms and their broad ecosystem. I gave LPOC these simple recommendations:

  • LPOC to track and publish its diversity stats and those of its partner firms, including the results of Rooney Rule usage in searches

  • LPOC to adopt a diversity pledge, including implementing the Rooney Rule in hiring and in considering firms for investments

  • LPOC’s partner firms to adopt a diversity pledge, including adopting the Rooney Rule in the pledge

  • LPOC to consider a broad range of managers for partnership mandates, including open solicitation of proposals for partnership

  • LPOC to encourage startups to develop diverse executive teams and to consider employing the Rooney Rule and/or other efforts to recruit diverse talent

  • LPOC to create an advisory committee to provide guidance on diversifying its investment strategy

These suggestions don’t include a capital allocation to women-owned or minority-owned firms — in other words, no quotas. But they do require LPOC to measure where it invests its money and staffing, and requires its investment partners to do the same. I believe their returns from measuring their actions will move them to the top quartile in every metric they care about — financial and social.