How to Start Funding More Than White Men
When it comes to news articles on tech and startups, the majority of headlines and conversations focus on funding announcements, valuations, and IPOs. And yet, only a small fraction of startups actually raise venture capital. Coupled with the appalling funding disparities for women and people of color – who already face historical and systemic inequalities – lack of access to capital further marginalizes the under-represented founders innovation, creation and creation of wealth.
As such, we shouldn’t ask ourselves whether people are missing out on opportunities because of their identity; this is obvious. The best question is how many and what is the magnitude of the opportunities they are missing?
Here is what we know:
Through Grid 110, Los Angeles-based startup and small business accelerator that I co-founded in 2015, I’ve worked with over 300 entrepreneurs, the majority of whom are women and people of color. They create businesses ranging from side activities to profitable and bootstrap businesses to high growth companies. I have seen firsthand that VC is absolutely not a one-size-fits-all model.
VC is often equated with jet fuel for high growth companies, but most companies cannot support this kind of acceleration. In fact, it will probably be more harmful to them than helpful. After all, you wouldn’t fill a Volvo’s gas tank with kerosene.
At Grid110, my team and I work first to understand the type of business that an entrepreneur is building and then educate them on the funding avenues that make the most sense to them. Unfortunately, there are few viable financing instruments for entrepreneurs in the early stages of starting a business. This is an opportunity to create innovative financing models that occupy the space between traditional bank loans and VC. Yet the tech industry continues to rely primarily on a single model to advance innovation. This narrow focus results in a bottleneck that disproportionately affects those who are already under-represented in the tech economy.
There is a huge white space opportunity to fund the 99.95% of companies deemed unsuitable (or perhaps overlooked) for venture capital. Firms run by under-represented founders, able to do more with less, harness their resources and fill gaps in economic opportunity, are particularly good places for this type of investment.
Where are we going to start? With the sponsors (LPs). Institutional LPs (things like pension funds, endowments, foundations, and corporations) invest in venture capital funds and primarily focus on generating returns on their investments. So why don’t they prioritize investing in diverse teams that consistently outperform their all-white male counterparts? And what needs to change to see more innovation in the venture capital ecosystem?
Adjust funding models to close the gap
The first step in fixing things is for investors to diversify the founders they choose to fund. It is simply a smart business. Women and founding teams of various ethnicities are outperforming their all-white male peers, but they are still the least likely to raise funds. According to a recent industry report by All Raise and Pitchbook, female CEOs have left companies faster than their male counterparts in nine of the past ten years.
If a fund is focused on returns, why the stark contrast in funding? Studies published by Capital of the first round, McKinsey and Kauffman Fellows support the claim that investing in diverse founders yields better economic returns. So from an economic standpoint, anyone looking to invest in a business would do well to choose one with a diverse founding team.
This disparity also raises the question of why investors are not more interested in financing these companies. To truly effect large-scale change, we need to diversify donors. Investment decision makers are 72% white menSo it’s no surprise that the majority of startups that receive funding are run by equally white males. Current funders tend to invest in their similar networks and pedigrees, leading to a vicious cycle in the investment space.
On the other hand, various funders will fund various founders. Organizations like BLCK VC, HBCUvc, VC Include and Increase everything are working to change demographics and diversify career paths in venture capital at different levels. How can we support the expansion and growth of these and other similar organizations to create more non-traditional pathways to VC knowing that this will be the best way to impact the industry as a whole? ?
LPs should prioritize this type of diversification over their current funds and continue to seek support for various emerging fund managers who will change the landscape for the better.
Develop new models
You might conclude that venture capital is not for 99% of companies. It is best suited for a specific type of business that has the ability to accelerate growth in a very short period of time resulting in an exit (either through IPO or acquisition) in order to provide a return on investment to the fund. Finding these companies is essentially the job of a venture capitalist: they want to invest their LP money in places that will result in disproportionate returns.
But most businesses are not designed to support this kind of growth on time. And even worse, most companies backed by venture capital won’t even reach the inordinate yields expected of them, and 75% will fail absolutely. For an industry that invests billions of dollars annually with these results, the fact that there has been so little exploration of alternative models in this space is truly surprising. We need to revolutionize outdated models and structures to keep up with emerging opportunities in the market.
Some people in the VC world have made efforts to establish alternative models of capital. Examples include revenue-based funding (Lighter Capital), rewards-based crowdfunding (Kickstarter, Indiegogo), or equity-based crowdfunding (Republic, WeFunder, Start Engine). But some of them did not live up to LP’s expectations.
For example, after investing in companies for six years as part of what started as an experimental fundraising strategy, IndieVC recently announced he would no longer invest in companies through his innovative financing model. Indie preferred real companies focused on sustainable growth and profitability. Although his portfolio has shown comparable returns to more traditional investments, he has faced increasing difficulties in getting LPs to engage in this model. Nonetheless, IndieVC and its GP Bryce Roberts have proven to be a trailblazer in this area, sparking the conversation and paving the way for alternative funding models like Earnest Capital, Chisos Capital and Collab Capital.
There seems to be a shared feeling that the industry cannot change unless institutional LPs actively change it. If LPs believe both diversity matters and returns benefit, then more of them should mandate it from their funds or invest in funds intentionally focused on diversifying the industry through economic inclusion like Backstage capital, Harlem Capital, BBG Ventures, MaC Venture Capital and Slauson & Co. Here are a few examples of what is possible, but there should be more. This kind of focus on diversity should be the norm.
After all, the Golden Rule says those with the gold make the rules. LPs can be the main drivers of change, but they seem to change your own habits. But maybe there’s another way to look at it: instead of changing what LPs believe, how do you change who LPs are?
In just a few short years, equity crowdfunding platforms have shown that ordinary people want to become retail investors. In 2016, the SEC made changes that allowed unaccredited investors to invest money in companies through platforms such as Republic and WeFunder.
The most recent bundle of changes increased the limits on the amount businesses could raise through these types of campaigns. Backstage Capital raised $ 5 million (the new limit) in just seven days to support the operational leg of their fund. So what should happen for the SEC to allow retail investors to invest in real funds through these same platforms?
Paige Finn Doherty wrote a brilliant piece called “the Essential guide to unionsWhich describes how anyone (even an unaccredited investor) can organize a special purpose vehicle or syndicate for other investors (eg Angels, VCs or even traditional LPs) to invest directly in a ephemeral fund for a company. Similar to participatory equity investing, this path is another way of democratizing access to capital for founders that also creates new opportunities for funders. Rather than having to raise a traditional venture capital fund, an organizer can mobilize support for one-off investments in companies using a platform like Assure, which handles all of the back-fund administration. end. The good news is that in this model, the organizer does not need to be accredited themselves or have the necessary background to raise a traditional fundraiser.
A better landscape starts here
Venture capital is largely focused on growth at all costs, but it continues to shy away from growth opportunities for itself. The industry has largely avoided innovation in its own niche by neglecting new funding models that could benefit both companies already in the market and those trying to enter. Changing this structure will allow for greater diversity in the economy as a whole and prepare VC firms to capitalize on a changing market.
While we have a long way to go to change the equity in the funding gap, there are emerging and innovative opportunities (if they can be scaled up) that could bring significant changes to the industry. We need more education, accountability and amplification / attention to voices on the ground that are closest to the current issue.