In a landmark move yesterday on October 9, 2023, California took a significant step towards promoting diversity in the venture capital world, becoming the first state to pass legislation on diversity in venture capital, specifically, requiring the vast majority of VCs to report on the demographics of the founders in whom they invest.
This development comes in the wake of the Supreme Court’s June 2023 decision to strike down Affirmative Action programs in college admissions, raising concerns about equal opportunities for underrepresented groups. With the VC industry under the spotlight for its lack of diversity, this new law is a critical move toward addressing the issue and fostering a more equitable startup ecosystem.
Given the current state of Congress and the Supreme Court, it’s great to see a State, particularly the State of California, which accounts for nearly 50% of the world’s venture capital today, take action. Even better: this law will affect even VC firms outside of California, extending to firms that either invest in California companies or raise money from California investors.
Back in February 2021, I wrote an article here in Forbes called “Check Your Stats: Diversity in Venture Capital is Worse Than You Think.” The article dissected a 2019 report by the James L. Knight Foundation, that showed that just 1% of the $70 trillion wealth management industry is controlled by women or minority fund managers.
Given that 70% of the population is either female or minority – and only 30% is white and male – a 99% allocation seemed a bit unbalanced.
The call to action in that article was simple:
“Congress should take action. Main Street investors should not be investing into blind pools that are invested 99% in white-male-owned funds… funds…should be required to disclose the ownership of firms in which they invest by race and gender.
If women, for example, knew their wealth manager was investing 100% of their capital with white men, they’d probably pick different wealth managers.”
That was then. How naïve of me to think that Congress would take action on anything – they can’t even elect a Speaker.
But then the incredible happened: a group of legislators in California introduced a Bill in December of 2021 – Bill 54 – and last night, Governor Newsom signed it into law.
By passing Senate Bill 54, California is bringing prejudice and discrimination out of the shadows and into the light.
California Governor Gavin Newsom signed the bill, which was introduced by Senator Nancy Skinner and co-authored by Senators Toni Atkins, Angelique Ashby, Steven Bradford, Maria Elena Durazo, Monique Limón, Dave Min, and Aisha Wahab and Assembly Members Isaac Bryan, Cottie Petrie-Norris, and Buffy Wicks.
The “Incredible Eleven” Co-Authors of Senate Bill 54
Co-Authors of California Senate Bill 54
H Venture Partners and California Legislative Photos
Of note, the Senate Bill 54 co-authors are all female or minority Senators and Assembly Members.
Why the New Law Matters
“Sunshine sometimes works to change behavior,” says California Senator Nancy Skinner, the bill’s lead sponsor. “I’m chair of the Women’s Caucus, and have heard from lots of women founders about how they don’t even believe they can get a meeting at a VC fund, let alone an investment. There’s so much economic and innovation opportunity being lost.”
What Senator Skinner was hearing from constituents is, in fact, a statistical fact.
Historically, female and minority founders have faced significant barriers when seeking investment. Data shows that a disproportionately small percentage of venture capital dollars goes to female and minority fund managers – and therefore female and minority founders, despite their outperformance.
Here’s what the numbers look like for 2022:
Figure 1
% of VC Dollars Invested vs % of US Population
H Venture Partners
Understanding the New Law
The new law is a response to the glaring disparities in venture capital investments. The legislation mandates VC firms to release data on the diversity of the founders they support. This includes information on the race, gender, and other demographic factors of the entrepreneurs and startups receiving funding. This law goes into effect March 1, 2025.
It applies to the vast majority of U.S. venture firms, including those not headquartered in California. That’s because covered firms include those whose portfolio companies are based in, or have significant operations in the state, plus firms that solicit or receive fund commitments from California residents.
The bill also requires firms to collect and release their diversity data to the public. That’s right! No more hiding behind carefully staged photos with a black guy in glasses and a female intern in a firm-sponsored Patagonia vest! No more getting off the hook with DEI pledges!
Firms will be required to annually survey their founders, who can opt-out, on their gender identity, race, ethnicity, disability status, and veteran status. This information will be submitted to the California Civil Rights Department, which then will publish it in a searchable online database. Firms that do not submit survey data could be fined. The law also relies on the Civil Rights Enforcement and Litigation Fund, so there are teeth to this law: if Fund managers don’t comply, they could face serious fines and litigation – which funds the continuing enforcement of the law.
The bill doesn’t include mandates or quotas around diversity — that would probably be deemed illegal by this Supreme Court – instead, the writers opted for a naming and shaming approach, a favorite of global human rights activists like Amal Clooney.
Shockingly, the National Venture Capital Association (NVCA), an industry lobbying group funded by VCs, came out against Bill 54, because “misleading and counterproductive data that would hurt the cause of diversity, equity, and inclusion efforts while creating unnecessary costs and risk for California venture capitalists.”
Ridiculous, but not unbelievable. Of course the lobbying group for a historically non-diverse industry would come out against the idea of accounting for its diversity.
While California is the first to legislate, this type of reporting is alive and well in the State of Illinois, spearheaded by Chicago Teachers Pension Fund, the Illinois Municipal Retirement Fund, and a plethora of Chicago and Illinois pension funds. Funds receiving capital from these institutional investors have been reporting their diversity stats for years, so it can be done – and pretty easily. It’s a simple Excel spreadsheet to upload once a year, which takes a grand total of 1-2 hours to complete. As someone who has reported diversity stats to my Illinois LPs for some time now, I can attest that counter to the NVCA’s claim, this bill will not “create unnecessary costs and risk for California venture capitalists.” I don’t think any VC can credibly claim that a demographic accounting of its portfolio is “too hard and costs too much” while subsequently raising a Deep Tech/Ai/Biotech/Health Care/Machine Learning/Tech fund. This is addition, people. Use some of that brilliant tech you’ve been creating.
The Supreme Court’s Decision on Affirmative Action
To appreciate the significance of this California Senate Bill 54, we must also consider the Supreme Court’s decision on affirmative action in college admissions. While the two issues may appear unrelated at first glance, they share a common thread: the pursuit of equal opportunities and fair treatment for individuals from underrepresented backgrounds.
Even more importantly: our universities are our VC talent pipeline.
In a stunning reversal on June 29, 2023, the Supreme Court effectively ended the use of affirmative action in college admissions. By a vote of 6-3, the justices ruled that the admissions programs used by the University of North Carolina and Harvard College violate the Constitution’s equal protection clause, which bars racial discrimination by government entities.
First, I was shocked to hear that Harvard is a government entity.
Writing for the majority, Chief Justice John Roberts stated that college admissions programs can consider race merely to allow an applicant to explain how their race influenced their character in a way that would have a concrete effect on the university.
Jeez. What a college essay prompt, JR.
But a student “must be treated based on his or her experiences as an individual — not on the basis of race,” Roberts wrote. The majority effectively, overruled its 2003 decision in Grutter v. Bollinger, in which the court upheld the University of Michigan Law School’s consideration of race “as one factor among many, in an effort to assemble a student body that is diverse in ways broader than race.” Jumping onto this crazy train were Justices Clarence Thomas, Samuel Alito, Neil Gorsuch, Brett Kavanaugh, and Amy Coney Barrett.
Justice Sonia Sotomayor, an alum of Princeton and Yale Law, dissented, and was joined by Justices Elena Kagan and Ketanji Brown Jackson. Sotomayor noted that the majority ruling would “cement a superficial rule of colorblindness as a constitutional principle in an endemically segregated society.”
Jackson wrote a dissenting opinion in the North Carolina case, joined by Sotomayor and Kagan. She noted that American society “has never been colorblind.”
“Given the lengthy history of state-sponsored race-based preferences in America,” Jackson wrote, “to say that anyone is now victimized if a college considered whether that legacy of discrimination has unequally advantaged its applicants fails to acknowledge the well-documented ‘intergenerational transmission of inequality’ that still plagues our citizenry.”
This quote from Jackson reminded me of a conversation I had with a male colleague after my February 2021 VC Diversity Stats article was published. He asked, “So, what, you’re against all white guys now?” to which I replied, “Not at all, however, I wasn’t aware that you needed an extra leg up.”
In 2003, I was finishing my undergraduate education at the University of Michigan and would frequently see President Lee Bollinger, our university president, who was named in the 2003 Affirmative Action Supreme Court case. Lee was an engaging and positive person. He invited me to several of his Fireside Chats with small groups of students. He wanted to know our thoughts on how to make the university better and more innovative. He seemed like a force for good.
After the Supreme Court’s decision to reverse affirmative action was handed down, Bollinger is quoted as saying, “Society’s got this complicated history – great and tragic – and that comes up in course after course after course in life.”
“You cannot assume that the world will get better and better. It requires constant effort to make the case.”
The University of Michigan has seen its Black student population drop by nearly half since Michigan voters outlawed affirmative action in 2006.
California Senate Bill 54 vs. Affirmative Action
It’s important to note that California’s Senate Bill 54 is merely reporting what has been already selected for investment. Affirmative Action is involved in actually selecting the student population – who gets to go to a college and who doesn’t.
California’s Senate Bill 54 requires nothing more than an accounting of what’s been done – and empowers people to make their own decisions. Maybe you want to invest in a Vice fund that only invests in gambling, nicotine, weapons, and pornography. That’s your choice! Maybe you want to invest in a firm that has historically exclusively invested in white male founders. Go for it! At least you’ll have the information you need to make an informed decision.
California’s new law is a step in the right direction for several reasons:
- Transparency and Accountability: Requiring VC firms to report diversity data promotes transparency and accountability within the industry. It forces firms to confront the disparities in their investments and encourages them to take steps to address these issues.
- Incentivizing Change: By making diversity metrics public, this law incentivizes VC firms to actively seek out and support underrepresented founders. The fear of public scrutiny can be a powerful motivator for change.
- Economic Benefits: Diverse startups bring fresh perspectives and innovative solutions to the market. Supporting a wider range of entrepreneurs can lead to more robust economic growth and job creation, benefiting the entire economy.
- Social Equity: This law aligns with broader societal goals of promoting diversity and reducing inequalities. It sends a message that California is committed to fostering an inclusive startup ecosystem where opportunities are accessible to all.
California’s new law requiring VC firms to annually report the diversity of founders they support is a significant step towards addressing the lack of diversity in venture capital. In a post-affirmative action landscape, it is crucial that other sectors take proactive measures to promote inclusivity and equity. By shedding light on the current disparities and holding VC firms accountable, this law has the potential to reshape the future of entrepreneurship in the US, creating a more diverse and vibrant startup ecosystem for all.
Sources for Figure 1:
1 According to Pitchbook as of December 19, 2022, https://pitchbook.com/news/articles/2022-female-founders-year-in-review#:~:text=Companies%20with%20at%20least%20one,deals%2C%20according%20to%20PitchBook%20data
2 According to Pitchbook as of December 19, 2022https://pitchbook.com/news/articles/2022-female-founders-year-in-review#:~:text=Companies%20with%20at%20least%20one,deals%2C%20according%20to%20PitchBook%20data
3 According to TechCrunch as of October 28, 2022https://techcrunch.com/2022/10/28/latinx-founders-see-vc-funding-drop-as-investors-retreat-from-underrepresented-cohorts/?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAALsXSDzdP7nTZbAdegQGIc_75A8YOWd18pY2xke7u8pxshwPMIgEOvGNkP5yaYZO15aVcUACDXybvUwf_DVFpCM0l7nFx2Ea4T3JHrUiZ3yqOLZww6ZDelfgIYVqDd_KzNkCmSW-xgJ8618T_mzlCGjadrfUHLSM8TbDfPjd0p1I
4 According to TechCrunch as of October 21, 2022https://techcrunch.com/2022/10/21/black-startup-founders-raised-just-187-million-in-the-third-quarter/
5 https://www.newprivatemarkets.com/lgbtq-founders-are-routinely-overlooked-and-undervalued-by-venture-capital/#:~:text=LGBTQ%2B%20founders%20have%20raised%20less,to%202021%20data%20by%20Gallup
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