Venture Capital’s Next Act

Diversity & impact as drivers of financial return

Among the recent history of big buzz words in the VC world, you’ll hear about on-demand services, bots, social apps, and other technologies aimed at streamlining our everyday lives. While these are developments that have generated a large amount of interest, there are larger themes playing out that will profoundly change the venture world. Startups led by diverse and mission-driven management teams are about to take the main stage, and you won’t want to miss their opening act.

Diversify Your Assets
If portfolio and asset-level diversification are widely accepted best-practices in the investment world, why wouldn’t this apply to the most valuable type of asset: Human Capital?

The degree to which the VC ecosystem is lacking in diversity is shocking. According to CB Insights, Black and Latino founders represent less than 1% of VC-backed startups each, yet they collectively comprise approximately 30% of the US population. Women only represented 8% of founders. On the investor side, Latinos (1%), Blacks (2%), and women (11%) are again significantly underrepresented.

This needs to change and will change. I’ve had the pleasure to speak with investors leading the charge on this front, including Arlan Hamilton (Backstage Capital), William Crowder (Comcast Ventures), and Monique Woodard (500 Startups) and am confident that diversity will continue to increase. Kapor Capital has also been on the forefront of promoting diversity and announced in January that it will start requiring new portfolio companies to invest in diversity. Additionally, Steve Case’s Rise of the Rest initiative promotes entrepreneurship in emerging startup ecosystems that have traditionally been overlooked by VCs. These are all encouraging developments, but much work still needs to be done.

Raised by a Bolivian single mother in a highly immigrant-dense DC suburb, I have seen too many smart and talented friends and classmates not reach their potential due to the various barriers associated with coming from low-income minority families in the US. I firmly believe talent is equally distributed globally, and it is certainly a fact that opportunity is not. I was fortunate enough to attend UVA and later on receive my MBA from Wharton, which has given me great access to strong networks and career opportunities. The statistics regarding diversity remind me how lucky I am to have made it this far.

Show Me the Mission
We saw the ugly side of capitalism during the Great Recession but now we are beginning to see its beauty. Gone are the days where financial return and positive impact are generated exclusively. In fact, in many cases the positive impact generated by a company reinforces its financial success.

The number of for-profit entities incorporating social and/or environmental elements into the core of their business increases every year. For example, startups are using the one-for-one model (Warby Parker, CommonBond), certifying as a B Corp (Back to the Roots, Change.org) and actively engaging their stakeholders by disclosing sustainability/impact metrics (Oliberté, Patagonia).

Later stage companies have also been very active on this end. Rally Software, a software development firm, and Etsy, a P2P e-commerce firm focused on handmade and vintage items, became the first certified B Corporations to IPO in 2013 and 2015, respectively. Laureate Education, a global network of campus-based and online universities, stands to become the first Public Benefit Corporation to IPO.

The impact investing movement, which focuses on companies that seek to provide a financial return alongside a significant social and/or environmental impact, currently represents $77 billion in assets under management and is projected to grow to between $400 billion and $1 trillion by 2020. Within the impact investing spectrum, those seeking to maximize financial returns believe that the financial success of their portfolio companies will be reinforced by the inherent impact their business model has on society. Great examples of funds embracing this approach are Collaborative Fund and Core Innovation Capital. As the number of funds investing with an impact lens continues to grow and longer track records are developed, impact assessments will become a normal part of the due diligence process alongside traditional financial analysis.

“Companies whose financial success inherently pushes the world forward will produce the greatest return on investment over the next decade and beyond”
— Craig Shapiro, Collaborative Fund

Mo Impact, Mo Money
You may have gotten this far and thought “well this is an interesting impact story, but I’m trying to deliver superior returns for my LPs.” To this I say: these two themes represent the biggest financial opportunities of our lifetimes.

Various studies have been done indicating that diverse teams perform better. Diversity in every sense (gender, race, sexual orientation, city, etc.) needs to be emphasized. Founders and investors who don’t fit the typical Silicon Valley white male mold have incredibly valuable perspectives into market opportunities that are largely overlooked. For example, Mayvenn is disrupting the $9 billion African American hair products market and are backed by notable investors such as 500 Startups, a16z, and Core Innovation Capital. The Latino market is also significant and relatively untapped. According to a study by Stanford GSB, Latino-owned businesses could generate an additional $1.4 trillion in economic output if they have adequate access to capital. As the US becomes increasingly diverse, these “not-so-mainstream” ventures will only become more lucrative. For VCs, it will take diversity of thought to develop the insights necessary to identify deals where others are not looking. These opportunities are out there and entrepreneurs are going after them. They just need more help to scale their pursuits.

Milton Friedman famously posited that a company’s sole mission is to maximize profit. Increasingly, research indicates that this view is incomplete — in order to maximize profit, companies need to be proactive on environmental, social, and governance issues. On the public equity side, Harvard Business School recently published a report concluding that companies who score best on ESG metrics tend to outperform. On the private market side, Wharton recently published a study showing that impact investing funds can deliver competitive financial returns compared to traditional strategies. This has serious implications in the venture world. Shifts in attitudes toward businesses’ role in society will help mission-driven companies that emphasize social and/or environmental issues to outperform.

Millennials, who stand to inherit $30 trillion dollars from Baby Boomers in the largest wealth transfer in US history, overwhelmingly believe that business success should be measured by more than just financial metrics. Younger generations are increasingly preferring to work for companies where they find more purpose, eat and live healthier, and purchase goods that are ethically sourced. This means that there will be a massive talent drain from companies that are not mission-driven and that companies who are embracing impact will have a recruiting edge for top talent, which will translate into greater financial performance. Entrepreneurs who are looking to solve critical issues and are not just opportunistically looking to cash in on the latest market trends are typically more passionate about their company and better-equipped to persevere through the ups and downs of startup life. Over the long-term, the companies that generate strong financial returns will do so because of their focus on critical issues facing our society.

A New Normal

As previously mentioned, there are already investors focusing on one or both of these themes, however they represent only a handful compared to the entire VC landscape. Investing with a diversity/impact lens will eventually become the new normal in venture investing — it is just a matter of time.