Despite increases, diversity still comes up short in U.S. venture capital
Business leaders and organizations in the United States have lauded the impact of racial, ethnic, and gender diversity on companies’ bottom lines. From the acknowledgement by Forbes that a diverse workforce is more capable of forging innovative products, services, and business practices to research affirming the benefits of executive-level diversity for market growth, welcoming ethnic minorities and women couldn’t be more crucial at a time when more than 50 percent of Americans are projected to belong to a population of color by 2044. Yet despite the importance of diversity in business success, the weight of the evidence has had a negligible impact on a sector that funds new companies: venture capital.
In Diversity in Innovation, Harvard Business School professor Paul A. Gompers and Harvard economics doctorate student Sophie Q. Wang chronicle labor-participation trends among women and ethnic minorities in venture capital firms and as entrepreneurs of venture-financed startups. Using data compiled from VentureSource on 42,502 entrepreneurs and 11,555 venture capitalists between 1990 and 2016, the two researchers were able to determine changes in the entry of women and ethnic minorities into entrepreneurship and employment at venture capital firms over this period.
They find that between 1990 and 2016, women comprised less than 10 percent of the entrepreneurial and venture capital labor force, Hispanics around 2 percent, and African Americans consistently less than 1 percent. In contrast, Asians—in their paper comprising East Asian and Indian populations—experienced higher rates of entry into venture capital firms and entrepreneurship than other ethnic minorities, reaching 18 percent and 15 percent, respectively.
Remarkably, over this same period, 45 percent of the general workforce were women, yet the entry rate for women entrepreneurs held at around 7 percent in the 1990s and early 2000s, rising steadily but only to 11 percent since then. More astonishing is the low growth rate of women venture capitalists, which went from about 6 percent in the early 1990s to 9 percent in the late 1990s, and remained constant since. Among ethnic minorities, Hispanics experienced the fastest overall increase into the labor force, going from 9 percent in 1990 to about 16 percent between 2010 and 2015—though it’s worth noting that they accounted for 1 percent of both entrepreneurs and venture capitalists in 1990 before accounting for 5 percent of new entrepreneurs and 3.2 percent of new venture capitalists from 2010 to 2015, despite rapid labor participation increases.
Furthermore, despite the slow increase from 4 percent to 5 percent among labor-market entrants during this same period, Asians grew from 10 percent and 5 percent of all venture capitalists and entrepreneurs, respectively to 18 percent and 15 percent today. Patterns for African Americans have been similar to those experienced by women—their labor-market entry rate went from roughly 11 percent in 1990 to 12 percent between 2010 and 2015, overshadowing the fact that they accounted for 0.83 percent and 0.67 percent of all new entrepreneurs and venture capitalists, respectively.
Arguably the most interesting takeaway from the study is that in spite of their demonstrated lack of entry into the innovation sector, many women and ethnic minorities have received an education earning them entry into the field. For example, the share of bachelor’s degrees earned by African Americans doubled from 1990 to 2015, while black representation in venture capital remained small (0.67 percent) during the same period. This is despite entry gains in other financial industries such as investment banking, where African Americans represent 6.9 percent of investment bankers.
While growth in educational attainment among women and ethnic minorities has contributed to a slight uptick in venture capital’s diversity, it has done little to integrate the overall industry and the firms it subsidizes in a more equitable manner. Gompers and Wang’s data show that trends in venture capital entry remain consistent with overarching indications that hiring and awareness of job opportunities flow best between similarly situated people. It suggests that venture capitalists tend to hire people who look and think like them, thereby bolstering structural barriers to access to opportunities.
There is no detailed research on the consequences of the lack of diversity for venture capital investment returns, but financial returns among firms that lack diversity are not so much at risk of decline as they are at risk for stagnation, as detailed in a recent report by McKinsey & Company. According to Vivian Hunt, Dennis Layton, and Sara Prince at the global consultancy, companies in the bottom quartile for gender, racial, and ethnic diversity are less likely to achieve financial returns that are above average. Conversely, companies in the top quartile for racial and ethnic diversity are 35 percent more likely to accrue financial returns exceeding national industry averages, with those in the top quartile for gender diversity being 15 percent more likely to experience those same effects on returns.
These findings suggest that racial and ethnic diversity has a greater effect on returns than gender diversity, and that innovation cannot be achieved without acknowledging the needs of a demographically changing market. To ensure economic growth in a country projected to be majority minority by 2044, it is imperative that policymakers not only ensure equal access to education but also equitable access for qualified workers by confronting structural barriers to hiring and promotion. This task equally falls in the purview of for-profit businesses, which are major drivers of our overall economy. Only then can equitable growth be shared among all Americans, and new venture findings and new company formation tap into broader economic opportunities.