Why Venture Capital doesn’t work (as well as it could)
TLDR: in Venture Capital, diversity of thought is either missing or not ‘in play’ in 90% of venture firms. In order to improve fund and industry performance, as well as for the benefit of society as a whole, this must be urgently addressed.
Despite talk of inflated valuations and bubbles, it’s a great time to be a Venture Capital investor, especially in Europe. Accel and Octopus have just announced new funds, following hot on the heels of Local Globe, Mosaic and others. Even investment from China is coming. From London to Berlin, Stockholm to Lisbon, Tel-Aviv to Athens, there are many reasons to feel optimistic.
However, Venture Capital is still a sector with one of the most homogenous workforces in the world. Until VCs address this issue properly, they will make worse decisions, they’ll be less likely to find innovative ideas, they’ll have an imperfect understanding of new markets and they will struggle to hire the best talent.
VC’s problem with diversity
This is by no means the first article about the lack of diversity in VC and it definitely wont be the last. The subject of diversity in tech is already a well-worn (and some might suggest wearying) theme, so much so that it is the subject of frequent parody by the excellent FOMO Capital.
However, there are good reasons why diversity in tech is still frequently spoken of, particularly with regards to diversity in Venture funds. Venture still lags behind so many other industries on diversity, tech companies included. A 2015 US Study (data here), that looked at 71 top firms, representing more than $160 billion in assets, found that at partner level, 77% were white and 91% were male. Only 2% were female and not white. A Fortune study from 2016 showed only 6% of VC professionals in larger US funds are women, and that has actually declined since 1999. It is still the case that if you’re from a different race, religion, sexual orientation, age or professional background from the industry norm of a white heterosexual middle-class male, you are going to find it more difficult to get a job in a VC.
There are many possible explanations for the lack of diversity in VC — hiring practices, feeder industries, life stage. However, there may be a more fundamental reason for why a lack of diversity persists in VC particularly. It may be because of a structural bias in the way that VCs make decisions. Most VCs practice “pattern matching”, where the investor searches for the same metrics, the same leadership qualities, the same network effects/ stickiness/ mission driven teams [/insert investment thesis here/] with which they have succeeded previously. While pattern matching is an important part of assessing dealflow and therefore can be useful, it can also lead to the VC surrounding themselves with similar companies, similar hires, similar investment committees and therefore similar thinking. This type of pattern matching is the enemy of innovation. It leads to group think and consensus around the median, the middle of the road — whether this be companies or people.
Data in VC mapping diversity to performance is hard to come by and where data on individual or fund performance does exist, for example the Midas List, it is hard to draw any conclusions because the composition of the list largely reflects that of the industry (with 5% of women in 2016 for example). A proven positive effect on fund performance is likely to prioritise the issue. So we desperately need to get a lot better at tracking and reporting data. The recently launched Project Include is a great place to start if you are at a fund and want to understand how to do this (or take a look at the real world example set by the team at Homebrew). Until we have access to this data it is impossible to say definitively that increasing diversity will increase returns. But the evidence from numerous studies across industries and stages that increasing diversity improves company and industry performance strongly suggests it should.
So apart from collecting the data on diversity statistics in your fund and portfolio, what else can you do today? To answer this question, we started Diversity.VC*, which launched a month ago in partnership with Kea Consultants and supported by EVCN and Astia. We held a discussion with some of the best known VCs, from the most highly regarded funds in Europe, exploring the question of whose responsibility it was to encourage diversity of thought in VC firms. What came out most strongly from the discussion was the desire for change and for practical advice on how to bring this change about, and quickly. So in that spirit, below are the five simple things you can do to increase diversity and therefore, we suspect, the ultimate success of your fund:
1. Acknowledge the issue and act on it. The first step to addressing the diversity challenge in VC is to acknowledge that it exists. There are some people working in the industry who don’t. Once acknowledged, rather than hand-wringing, it is easier than you think to take the first step towards addressing it (even if it might feel small to you).
2. Work out whether you’re sending the right (or the wrong) signals. Take a step back to see whether your firm is sending unconscious messages that discourage applications from certain groups. These resources are an excellent place to start, and people like Brittany have written and spoken on this subject for the start-up community but her tips can be applied everywhere.
3. Take proactive steps when hiring. If you are looking for your next intern, associate, principal, venture partner or partner, take these steps (many of these are taken from GV’s excellent video on unconscious biases):
a. Clearly define what you are looking for (i.e by writing a job description with specific roles, responsibilities), even if just for yourself. For help in writing job descriptions that are not biased, see here
b. Look beyond your networks (whether they be school, university or social)
c. Conduct a formal interview process where candidates can be fairly compared
d. Acknowledge your unconscious biases (you can take a simple test here)
e. Hire by committee (as diverse a committee as possible). It sounds counter-intuitive but having multiple viewpoints and perspectives will reduce the influence of unconscious biases
4. Create a supportive environment for everyone. Consider your maternity and paternity leave policy, flexible working policies, investment committee protocols and office environment and consider whether these might be biased or skewed to any particular group.
5. Help the community. Whether you are in a position to offer your time as a mentor, suggesting speakers for conferences when you see a lack of diversity on panels (for more on this see here and here), or whether you want to help with Diversity.VC, the community will benefit from your engagement.
*Diversity.VC has one simple aim: To increase diversity of thought in venture capital. Diversity of thought covers many types of diversity, educational, cultural, professional, gender, racial, sexuality, income and much more. We are doing this by:
- Building a network of diverse VCs. If you are a VC who is interested in being part of these events or in promoting diversity of thought within VC, please get in touch with us and we will add you to our mailing list. We’ll be running events throughout the year.
- Helping to connect VCs with more diverse applicants. If you’re responsible for hiring at a VC and are looking for more diverse candidates we can help.
- Promoting the broader organisations across the technology world who have similar objectives to ours to our community. This includes collaborating on conducting a piece of research to map diversity of thought against fund performance. If you’re aware of any research or organisations that you think we should talk to about collaboration, or you are doing something related yourself, please let us know.
Thanks to all those who have done studies in this area that we have cited here. Thanks also to everyone who has advised us on this journey or attended our event and our panellists.
Originally published at medium.com on May 16, 2016.