At the start of 2020, I was asked for my insights about how to improve an initiative that sought to invest in and develop emerging venture capital fund managers, and to create a more diverse community of fund managers. Needless to say, 2020 has not been a great year for my writing habit. On account of a global pandemic, it’s been a bit more challenging to find the time and energy to write, but I finally wrote down my thoughts and proposals for anyone thinking about supporting first-time and non-incumbent fund managers.
But first, why even care about venture capital fund managers? It seems like every other hour someone is starting a new fund. Venture capital hot takes on Twitter range from myopic to inspiring. Do we really need more venture capital fund managers?
With my new book, Share Equity, I’ve been examining how we can have more diverse representation of people in senior leadership levels of the venture capital industry, share practical tools and resources, and shine the spotlight on role models – particularly women who have successfully founded their own firms and raised their own funds. Only 6.5% of the fastest growing firms as identified by Inc. magazine since 1996 were funded by venture capital, according to Kauffman Foundation. Personal savings, bank loans, and credit cards fund the vast majority of fast-growing firms. Marco Da Rin, Thomas Hellmann, and Manju Puri examined several research reports on venture capital and found, across many studies, less than 1% of startups raise money from venture capital.
Economic Activity and Innovation Attributable to Venture Capital-Backed Firms
Between 1980 and 2010, 35% of all US initial public offerings were by firms that had been funded by venture capital. And despite being the funding source for only 1% of startups, venture capital-backed firms accounted for 5.3% to 7.3% of employment (based on a study in 2011.) Venture capitalists tend to select more innovative companies to invest in and venture capital investors play a significant role in the commercialization of innovative technologies. Venture capitalists fund future public companies, support future employers, and help launch innovative technologies of the future.
Let me recap: although venture capital is the source of funding for only 6.5% of fast-growing firms and less than 1% overall for startups, the impacts of venture capital-backed businesses are more wide-spread. Venture capital-backed companies develop technologies that are implemented by non-VC-backed businesses and that are adopted by individuals. The jobs of the future are generated by VC-backed businesses or potentially eliminated or saved by them. Venture capital-backed companies disproportionately contribute to greater job creation, innovation, and companies of the future (including ones that eventually IPO). It is this outsized impact on the economy, the future, and our societies that has me really interested in ensuring a diverse group of people have decision-making authority in venture capital.
What Fund Investors Can Do Differently
As I was thinking about and writing Share Equity, I got really hung up on the things that were difference-makers for the fund managers who successfully started their firms and raised their funds. Privilege and advantage was a resonant theme, as was the importance of people and partners, in the form of networks, community, anchor investors, and mentors. You probably wouldn’t be surprised that being purpose-driven and persistence were difference-makers. You might be surprised that previous experience wasn’t really cited as a factor, but dig deeper and you realize all the fund managers I interviewed did have previous experience and exposure to the technology and innovation ecosystem in some way. A recurring theme was the opportunity for disruption at the fund investor level.
Beyond the scope of my exploration for the Share Equity book, I was Head of Investment Strategy at a non-profit, stewarding a $300M investment portfolio to fund grant-making to women’s rights organizations. There, I explored a strategy to invest with a gender-lens in private equity and venture capital funds.
Based on my conversation with fund managers, asset allocators, and my own experience on both sides of the fund raising table, here are my ideas for fund investors to really effect change and support a diverse, next generation of venture capital investors.
- Recognize their potential and performance. Recognize that investing in women, emerging, and a more diverse community of managers helps you achieve your financial goals and that diversity is more sustainable in the long run. Research from Cambridge Associates indicates that “new and developing fund managers consistently rank as some of the best performers”.
- Follow their lead. Embrace new models and fresh perspectives from emerging managers. They are innovating in their industry. Don’t try to make them conform to old models or you’ll risk losing the innovation and creativity that you valued in them in the first place.
- Reflect on what’s stopping you. You’ve seen the data, you’ve read the research yet you still find a reason not to invest in emerging managers. Think about the emotion behind that decision. Is it fear? Change is unsettling, creates instability and insecurity, but in the long run not changing introduces risk and obsolescence. Feel the fear and do it anyways.
- Carve out an allocation. Maybe you’re not ready to make a big shift in your portfolio and asset allocation strategy. Take a small step, make some room to allocate capital to emerging managers, and build the muscle memory.
- Integrate these principles and concepts throughout your portfolio and strategies. Don’t create a silo of diversity, equity, and inclusion. Figure out how to integrate a mindset for diversity throughout your entire investment business.
- Embrace innovative fund managers’ ingenuity and resourcefulness. Raising a fund requires a lot of capital and resources. Some managers may need to continue generating income from other means to bootstrap and support the build period of their firm and fund. To interrupt the reinforcing loop of privilege and unearned advantage in venture capital, celebrate the entrepreneurialism of fund managers to be resourceful to make ends meet during the fund raising period and early years of the firm when the economics of a first fund may be lean. Be open to changing your terms, structures, and constraints, otherwise you risk only the privileged and financially advantaged being able to contribute in the venture capital industry and you miss out on entrepreneurial, capable, new perspectives.
- Support your champions. There are already champions of diversity, equity, inclusion and emerging managers within institutions. Support the champions internal to your organization that are already supporting innovation in the investment industry.
- Add value. Make connections for your emerging managers. Support them with mentorship and connect them to peers. Listen more, embrace empathetic leadership, and help them grow as leaders by removing barriers and creating the conditions for them to be creative and innovative.