A Case Study of the Diversity in the and Startup Ecosystem

Prepared by: Joseph Chen

Assisted by: Catherine Ulrich

For: REL597: Silicon Valley Ethics: Case Studies in the World of High Tech

Pre-class homework: (40-45 min) What is venture capital and how much does it drive the US economy? (7 min read) https://www.gsb.stanford.edu/insights/how-much-does-venture-capital-drive-us-economy This source clearly demonstrates the prominence and importance of venture capital on the economy and on the tech industry.

Interview with Monica Dodi, Co-Founder at Women's Venture Capital Fund [5:38 - 15:38] (10 min) https://www.youtube.com/watch?v=2EXYtDO1EF8 This video is informative on the benefits of diversity in VC and helps frame a discussion question on whether VC should base their investments on merit and performance, or focus on promoting greater diversity like Women’s Venture Capital Fund?

Chamath Palihapitiya on state of tech, politics, diversity, picking investors & our changing morality [35:00 - 39:48] (5 min) https://www.youtube.com/watch?v=Njj6HZvixK8 At 2016 LAUNCH Festival, Jason sits down with Chamath Palihapitiya, Founder and CEO of Social Capital. It's classic, candid Chamath sharing his insights on the critical importance of diversity in venture capital // Talks about the disparity between entrepreneurial class and investor class and how the current investor class has to change

How LPs Conduct Due Diligence on Venture Capital Firms (4 min) https://blog.darcmatter.com/lps-venture-capital-due-diligence/ This source presents information on the mindset and workings of LPs (limited partners), which is necessary to know for the case study.

The Role Of Limited Partners In Investment Inclusivity (4 min) https://news.crunchbase.com/news/the-role-of-limited-partners-in-investment-inclusivity/ This source provides more information about LPs in a lens of diversity and inclusivity.

Do female founders get better results? Here's what happened on my quest to find out (5 min) https://pitchbook.com/news/articles/do-female-founders-get-better-results-heres-what-hap pened-when-i-tried-to-find-out

Research: The Gender Gap in Startup Success Disappears When Women Fund Women (6 min) https://hbr.org/2016/07/research-the-gender-gap-in-startup-success-disappears-when-wo men-fund-women This source shows why a diverse team running a venture firm would be beneficial; provides argument that LPs should be responsible.

Background: V​ enture capital​1​ plays a significant role in Silicon Valley and the tech industry; some notable VC-backed companies include Tesla, Apple, Starbucks, Uber, WeWork, and Facebook. While less than 1% of total startups seek funding from venture capital, VC-backed companies make up almost half of all public US companies founded between 1979 and 2013; in 2018 alone, VC investors deployed nearly $131 billion across US companies with software being the largest industry.1 These investors — typically small partnerships of white men — determine the types of entrepreneurs that are backed, which in turn shapes the types of products that we use in our daily lives.

The capital that flows into venture capital funds are usually from pension funds, institutional endowments, foundations, finance companies, and high-net-worth individuals. These investors in venture funds are called limited partners (LPs). LPs aim to minimize risk and aim for a target financial return; since investing in VC funds is much riskier than investing in the S&P 500​2​, LPs have to strategically select which VC funds to invest in to outperform the stock market and produce good returns. Simply put, LPs invest their money in selected VC funds which in turn invest money, time, and guidance in selected portfolio companies/startups.

Problem: ​The VC industry, historically a boys’ club, suffers an underrepresentation of females on both sides of the table as investors and as company founders. According to All Raise, a nonprofit organization focused on diversity and inclusion efforts in the VC space, less than 10 percent of decision-makers at VC firms are women and 74 percent of U.S. VC firms have zero female investors. Of the $131 billion venture capital investment, only 2.2% of it went to female-founded startups and 15% of it went to mixed-gender founding teams. Despite being known to be one of the least diverse industries (with respect to gender and race), VC decides which companies and founders are given oxygen for their ideas. D​ o venture capitalists have a responsibility for driving greater diversity in the start-up ecosystem and within VC itself?

Even though there has been an increase in diversity-focused venture capital funds and funds that are run by diverse teams of general partners (GP)​3,​ their relative lack of track record, proprietary deal flow4​ ​, and experience working together make them unattractive to LPs who are focused on proven returns and wise investments. According to Catherine Ulrich, an Exeter alumnus and a venture partner at FirstMark Capital​5​, responsible LPs are supposed to make the best returns; in order to do that, they may not invest in diverse VC teams as current mainstream VC teams/funds, run mostly by white men, have more experience, better track record, better networks and are proven to work. S​ hould LPs then be forced to invest in venture funds run by diverse teams? Overall, w​ ho’s responsible for improving diversity in this space

1 https://www.statista.com/statistics/423054/venture-capital-investments-usa-by-industry/ ​

Game Setup: After 20 minutes into the class discussion, every pair of students should receive a list of VCs that I’ve compiled. These VCs, GPs, and statistics are based on 2014—2015 stats to showcase the lack of incentives when it came to investing in diverse VC funds/firms back then. The students will act as LPs and decide on which VC funds to invest in; this allows them to hopefully get an LP’s perspective on this issue. They should discuss their decisions and the reasoning behind it, then refer back to the questions/class discussion and see if their opinions/perspectives has changed.

Other Questions to Consider: Thinking about the video on Monica Dodi’s Women Venture Capital Fund, should VC be diversity-blind and invest simply through merits and performance or focus on driving greater diversity in the start-up and VC space? Simply put, is it fair to judge applicants on anything other than their merits?

Past evidence would say no to LPs being forced to invest in venture funds run by diverse teams because mainly male VC teams have shown proven returns. They have worked in the industry for years and have worked together becoming a strong team — so if an LP has a fiduciary responsibility to make wise investments with proven returns, then why should they be forced to invest behind diverse teams?

The early data about female founders show that they perform well and even better than the average male founder; however, are these findings due to a cherry-picking of only the best women founders by the VC industry?

Consider this issue similar to affirmative action (the practice or policy of favoring individuals belonging to groups known to have been discriminated against previously). Is it ethical to implement a policy similar to affirmative action in the VC space; would mismatch (which is the idea that minority students are harmed by policies that allow them to attend competitive colleges for which they lack adequate academic preparation) occur in this space as well since the selected VC funds would likely lack the experience and track record needed for survival and success?

Additionally, as it becomes more socially accepted, will more women start or co-found companies meaning that the data we see now (which shows that female founders outperform their male counterparts) will change? (This is a common trend for products in that the first set of highly motivated customers often perform better than what you see at scale).

Where’s the line between spurring diversity and maximizing returns?

Glossary:

1) Venture capital — a​ form of private equity that usually finances startups and small businesses that are believed to have exceptional growth potential.

2) S&P 500 — a​ stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States and is considered to be one of the best representations of the U.S. stock market

3) General partner —​ the venture capital partner of the management company. GPs raise and manage venture funds, set and make investment decisions, and help their portfolio companies exit, because they have a fiduciary responsibility to their Limited Partners.

4) Proprietary deal flow ​ — A proprietary deal lets a specific buyer have a first chance to purchase a company before the company is presented to other buyers by the owner or an investment banker. In the VC space, education, track record, experience, and networking are some of the largest sources of proprietary deals. For example, if Person A graduated from Harvard, they’ll have connections and look for people who went to that institution. In addition, VC teams with more experience and a proven track record would get better deals; usually, they’re teams of white men which make the overwhelming majority in the VC industry. So, a lot of these forms are institutions that have also been structurally privileged and not diverse.

5) FirstMark Capital — a​ prominent venture capital firm based in . FirstMark invests in early-stage technology companies, frequently as the first . Notable investments include , Pinterest, Shopify, DraftKings, Upwork, and InVisio