Why do so many venture capitalists ignore the single best predictor of the future: demographics?
Paul Graham, cofounder of Y Combinator, observes, “Many suspect that venture capital firms are biased against female founders. This would be easy to detect: among their portfolio companies, do startups with female founders outperform those without? A couple months ago, one VC firm (almost certainly unintentionally) published a study showing bias of this type. First Round Capital found that among its portfolio companies, startups with female founders outperformed those without by 63%.”
One of my particular interests is looking for women & minority entrepreneurs in which to invest. It’s not because of personal ties; I’m yet another white male in the overwhelmingly white male VC industry. According to the National Venture Capital Association/Dow Jones VentureSource, the VC industry is dominated by men (89% of VC Partners), specifically white men (76% of the total). Of all VC Partners studied, just 10% identified as Asian, 1% as African-American, and less than 1% as Latino.
I’m looking for non-traditional entrepreneurs because I’m a fiduciary. My job is to look for new opportunities and new markets.
The gender and racial makeup of venture-backed companies is wildly inconsistent with the demographics of the country as a whole, in particular U.S. consumers. The U.S. population is 37%-minority today according to the Census Bureau, with the fastest-growing groups being multiracial Americans, followed by Asians and Hispanics. Furthermore, minorities are projected to become a majority of the U.S. population by 2043, and this demographic shift is mirrored by the rise in purchasing power of these minority groups. According to the Selig Center for Economic Growth, Hispanic-Americans comprised $1.2 trillion of U.S. purchasing power in 2013, with African-Americans comprising $1 trillion and Asian-Americans comprising $700 billion. These figures are only projected to increase.
Even more striking, however, is the growing purchasing power of women in the U.S. Women have pulled ahead of men in terms of percentage of college graduates, and they now hold around 50% of the non-farm jobs, according to Time Magazine. More importantly, they disproportionately hold the purse strings, making or influencing the majority of household purchasing decisions, including 80% of healthcare purchasing decisions and 58% of online retail buying decisions. (I only have daughters; in my household, women make 100% of the decisions.)
For example, consider PureWow, a general lifestyle content site focused on women over 30. Somewhat to their surprise, the tech section is one of the highly-trafficked and well-read topics. “PureWow offers content on categories like recipes, books, home decor, and gardening, but tech remains one of the strongest. This is huge for PureWow because, unsurprisingly, it’s women that often make gadget purchasing decisions, too,” wrote Erin Griffith.
Despite all this, the companies receiving venture capital are coming from a long-ago decade. CB Insights found that companies headed by male executives received 98% of all venture investments, totaling nearly $1.88 billion. In addition, 83% of companies had a racial composition that was entirely Caucasian, while only 12% of founders were Asian and less than 1% of founders were African-American.
VCs have to be pattern-matchers by virtue of the deluge of incoming companies they need to process. For example, ff Venture Capital looks at roughly 3,000 companies a year and invests in only 10-20 new ones (between 0.5 and 1%). Unfortunately, many VCs use demographics as a quick and easy filter. They often tend to stay in the same pool they’ve always looked at and can easily match. They’re not necessarily inherently biased; they just don’t bother to look.
These trends create an attractive opportunity to invest in companies that are targeting the emerging domestic economy and/or whose founders represent the growing minority and female business leader populations in the U.S. And it seems obvious that more venture investors should also be pursuing this market opportunity.
I published in 2010 a research study on best practices in how private equity and VC funds source investments. One of our conclusions was that VCs get better returns when they invest outside of the traditional geographic hotspots of New York, Boston, and the San Francisco Bay Area. ffVC has seen this first-hand, with some of the firm’s best investments being located outside of the tech hub geographies, e.g., Cornerstone On Demand in Los Angeles. ffVC has 3 investments in Israel; 2 in Canada; and 1 each in the UK and Holland.
It seems obvious that investors should pursue uncrowded markets, but common sense is not always common. We think the same logic applies to being receptive to companies that target women and minority market segments, and/or are led by folks from underrepresented backgrounds. These companies are likely to create a new set of patterns that are different than the ones that venture capitalists have seen in the past. In the words of Wayne Gretzky, investors should be skating to where the puck is going to be, not where it’s been.
I break down the opportunity set this way:
|Mass Market||Emerging Markets|
|Conventional Founder Background||Quadrant I: Most VC-backed companies, e.g., Mark Zuckerberg, Founder/CEO, Facebook||Quadrant II: Paul Gollash, Founder/ CEO, Voxy*|
|Under- represented Founder Background||Quadrant III: Joe Fernandez, Founder/ CEO, Klout* (sold to Lithium);
Adeyemi Ajao, Co-Founder/ Co-CEO, Identified*; (sold to Workday); Don Charlton, Founder/CEO, Jazz HR*
|Quadrant IV: Karen Bantuveris, Founder/CEO, Signup.com*;
Tristan Walker, CEO, Walker and Co
(* = ff Venture Capital company)
Almost all VCs are happy to fund Quadrants I. Quadrant II and III are a little harder for many VCs to invest in, and Quadrant IV companies can have problems even getting in the door, let alone bringing in dollars.
ff Venture Capital does not market ourselves as focused on women & minority entrepreneurs. We invest based on the merit, qualifications and the size of opportunities presented, without regard to race, religion, national origin, age, sex, marital status, sexual orientation or any other basis. We market ourselves as having open doors, and not pre-emptively rejecting entrepreneurs based on their personal characteristics. The results: ffVC today has 9 companies with women co-founders and/or CEOs, and many (some listed above) with entrepreneurs from underrepresented backgrounds. For context, we currently have 48 active portfolio companies, so we have very disproportionate representation of non-traditional teams.
A few additional venture funds and angel groups have also begun targeting the emerging domestic economy. These groups include Astia Angels, a global network of angel investors focusing on women-led ventures, and the Comcast Ventures Catalyst Fund, which focuses on minority entrepreneurs. I am also happy to say that there have also been an increasing number of venture funds started by women, including Cowboy Ventures, Forerunner Ventures, and Aspect Ventures. Organizations such as CODE2040 are also playing a role in increasing minority representation in the technology industry.
Another example is 645 Ventures, a new venture fund founded by Nnamdi Okike. 645 Ventures is a seed and early-stage venture fund that focuses on Internet and software companies. One of the aims of the fund is to focus on non-conventional entrepreneurs and provide them with the capital, resources and mentorship needed to build their companies. Nnamdi is also seeking to build an investment team that mirrors the diversity of his target entrepreneurs, with the belief a diverse team will be better able to identify promising entrepreneurs who don’t fit the mold.
Nnamdi observed that the lack of venture-backed women and minority entrepreneurs is often influenced by the lack of women and minorities in senior roles at VC funds. VCs often invest in entrepreneurs within their personal networks, and women and minority entrepreneurs are less likely to inhabit those same personal networks. Therefore, these entrepreneurs have a lower likelihood of connecting with the right VC to invest in their businesses, not necessarily due to VC bias but instead due to lack of access.
While 645 Ventures will invest in entrepreneurs from all backgrounds, the fund has been developing a sourcing strategy targeting companies in quadrants III and IV. As examples, Nnamdi cites his fund’s investments in Mindblown Labs, an ed-tech company providing highly engaging, experiential learning tools to teach young adults personal finance, and AbbeyPost, an e-commerce provider of custom apparel targeting the plus-size market.
In Mindblown Labs, Nnamdi sees a company that can lead the way in enabling young adults to make smarter financial decisions. Headquartered in Oakland, CA, Mindblown was founded by Jason Young and Tracy Moore, both African-American Harvard graduates. The founders are passionate about educating the next generation of high school and college students to be smarter about their finances, a change that is sorely needed given ballooning student debt and the challenges that today’s college graduates have in finding jobs.
AbbeyPost is targeting the plus-size market, sized at $16 billion according to Forbes. With the average American woman wearing a size 14, AbbeyPost’s CEO Cynthia Schames decided to create a business that capitalized on a major market inefficiency: the inability of plus-size women to find attractive, well-made apparel that fits. When Nnamdi first met AbbeyPost’s CEO Cynthia Schames over lunch, she rattled off enough statistics on the plus-size market to make his head spin, and his fund invested in AbbeyPost shortly thereafter.
The Harvard Business School Alumni Angels of Greater New York (HBSAANY) launched two years ago the Venture Capital Access Program (VCAP), focused specifically on helping women & minority entrepreneurs raise capital from our network. This is a partnership between HBSAANY and the National Association of Investment Companies (NAIC), the trade association for investment managers focused on the “emerging domestic market” (i.e., the America that is not just white men.). VCAP will relaunch late summer 2014 via NAIC’s non-profit entity The Marathon Foundation (TMF), but will extend beyond New York. Over the next year, VCAP Fellows will be named in Chicago, Miami, Los Angeles, and Washington, DC, leveraging an ecosystem of entrepreneurs that will aim to increase access to capital, coaches, mentors, and deal opportunities. Applications to become a VCAP Fellow will be available May 2014 by visiting marathonfdn.org.
Additionally, HBS Alumni Angels is also now organizing its first pitch night jointly with the Harvard Business School African-American Alumni Association, on May 5 in Manhattan. The event will showcase high-potential companies founded by African-American entrepreneurs (regardless of school affiliation). To apply, just register on the site. My co-chair for the May 5 African-American-focused pitch night is Nnamdi Okike.
The VC industry has a proven tendency towards groupthink, which is ironic given that we’re supposed to be investing in people pursuing orthogonal strategies. We think that investors who acknowledge reality and adapt to a changing market are likely to have better returns than those who think the future will look just like the past.