Equity, Inclusion And the Evolution Of Venture Finance
Is the global private capital landscape ready to finally begin shifting from its historical pale and male dominance?
Commitments to gender and racial representation in financial markets have been escalating over the past several years, from Goldman Sachs to the International Finance Corporation. And it's no wonder, research from McKinsey & Co. has indicated that companies in the top quartiles for ethnic diversity are 35 per cent more likely to generate higher than average profits. Similarly, companies with the highest gender and ethnic diversity in management had innovation revenue that was on average 19 per cent higher than counterparts with below-average diversity in leadership. Meanwhile, Fortune 100 companies with the highest women’s representation in leadership generated 53 per cent higher returns on equity.
In line with this shift in the global financial landscape, gender lens investing has leapt from funds managing $2.2 billion in 2018, to 138 funds managing nearly $5 billion by 2020. More recently, in the aftermath of the George Floyd lynching and a global Black Lives Matter uprising, many funds have likewise pledged to begin backing greater shares of Black founders and Black and minority ethnic GP's. In fact, racial justice index funds and ETFs are gaining increased momentum and investor attention.
Nonetheless, shifting to a more gender and racially inclusive investment ecosystem may mean shifting the modus operandi, especially when it comes to funding underrepresented entrepreneurs.
Gender-inclusive Financing: Paving New Pathways for Women
Data from various accelerators and government research suggest that women-led ventures in emerging markets get stuck at earlier stages than their male counterparts. This is in spite of regions such as sub-Saharan Africa recording more women than men starting up businesses. This discrepancy stems from various factors. For example, the gender pay gap limits women’s availability to bootstrap for as long and as far. Women are also shouldering an average of three times greater childcare and household labor burdens, which further diminishes availability of time and capital for their businesses. In a post-COVID world, this is exacerbated by the fact that women are facing greater income losses due to factors that include women’s sector representation in the hardest-hit sectors, as well as workplace unconscious bias. And when women go on to accelerators and incubators, they reap far lesser gains in investment that would propel them beyond seed and early-stage. Initial IFC and Village Capital research shows male-led companies raise nearly three times more equity than female-led companies graduating from such programmes.
Initial research is showing that while women-led companies are less likely to raise capital, they perform better and deliver more than male-led counterparts when they do receive it.
A Multi-faceted Market: Adapting to Serve More Diverse Entrepreneurs
As each investor’s strategy will be heavily influenced by key factors, including but not limited to sector, stage, market, and LP requirements, there is no one-size-fits-all tactic that can be applied across the board to make all fund managers and their portfolios gender-equitable and racially-representative. However, there are few core action areas.
Build Teams That Reflect the Market
One piece of the puzzle requiring attention is the lack of diversity in investors and investment committees where the majority of venture capitalists are male and white. In a world where 75 per cent of white Americans admit to having no social relationships with Black Americans, there are obvious pipeline limitations for the majority of venture capitalists seeking more diverse entrepreneurs. Perhaps the most important long-term step to building a demographically representative portfolio is building a more diverse team and a gender and racially representative investment committee.
Leverage Partnerships That Can Bring Diversity and Insight
Another more immediate strategy is to leverage partnerships that build pipelines and can also provide market, cultural and/or consumer insight. For some VC firms this may simply mean partnering with local fund managers in emerging markets to better identify and evaluate opportunities that can unlock high returns. This is what US-based VC fund Enygma Ventures did through partnering with Africa Trust Group to drive investment in women-led businesses in Southern Africa. Such partnerships are particularly valuable with cross-border and cross-cultural investment into diverse founders, as local partners tend to be better able to spot and understand the non-obvious opportunities available within certain contexts and to surmount typical language and cultural barriers.
Adapt Products and Operations to Respond to More Inclusive Markets
There is an approximated $3+ trillion global funding gap for businesses that don’t meet venture capital requirements nor have enough assets to meet collateral requirements of traditional lending. For some companies this may simply mean short-term debt. This is particularly interesting in light of the unique obligations of women entrepreneurs. For example, in some emerging markets, women are less eager to take equity investment, because of the social expectations regarding their role in the family and household. Equity investments require entrepreneurs to forfeit more control over their business’ strategy and operations to their investors - the consequences of potential loss of control and ensuring compliance with equity investors is likely even more intimidating to the women entrepreneurs already struggling with balancing venture growth and family /household obligations.
In attempting to create a more equitable ecosystem, there's an opportunity for investors to adapt and/or innovate financial products to better serve entrepreneurs, particularly women entrepreneurs. In order to better serve women-led companies, Africa Trust Group is exploring drawdown accounts, which still give investors visibility yet are completely fit-for-purpose. At the same time, revenue sharing, non-dilutive revenue-based financing and quasi-equity models can be an attractive option for early-stage B2B companies. More than serve as benchmarks, these examples serve as beacons calling attention to the large gaps in early stage capital ecosystems.
All of the action areas mentioned must be driven, informed by data and analysis, and as such, will be iterated over time. Acknowledging gender and racial inequities in private capital markets has been an overdue awakening, as there’s such significant evidence of the handsome upsides to creating a more representative financial system. More responsive and diversified private capital markets will end up being more profitable and sustainable for investors and more impactful in generating inclusive growth.