Making diversity in venture-capital funding a priority

SB 54 — a bill signed into law by California Governor Gavin Newsom in October 2023 — makes the state a pioneer in requiring venture-capital firms to report on the diversity of the founding members of businesses they invest in.

Legal mandates tend to push businesses toward transparency, and SB 54 is set to encourage precisely that. The bill compels VC firms to create internal systems for tracking diversity metrics, a practice many firms might not have embraced voluntarily.

While 74% of VC firms have established organizational diversity, equity, and inclusion targets, and 68% have portfolio DEI targets, there’s still a notable diversity gap. McKinsey found that just 1% of VC funding goes to Black founders, 1.5% to Latino founders, 1.9% to women founders, and only 0.1% to teams founded by Black or Latina women.

As an ardent supporter of inclusivity within the industry, I believe SB 54 isn’t just a legal mandate but has the potential to be a catalyst for change, unlocking unprecedented funding opportunities in venture capital for women-led and other underrepresented founder startups.

A precedent that could spread

California often sets industry standards across various verticals and SB 54 will likely have a ripple effect beyond the state. With its progressive policies, New York could follow suit. There’s also the possibility of a progressive federal administration leading to nationwide changes. The impact of SB 54, even on firms outside California, showcases the state’s influence and the potential for a nationwide shift toward greater transparency.

As for the results of SB 54, immediate changes might not be evident now. However, the law could gradually alter the venture capital diversity landscape. Some firms may initially drag their heels, but as the law’s March 1, 2025, implementation deadline approaches, I anticipate a surge in compliance measures, transforming funding opportunities and venture capital for underrepresented founder startups.

As for the practicalities of the bill, integration of diversity reporting into existing processes is key. This might be a smoother transition for larger firms with established diversity reporting structures.

However, some smaller firms are exempt from certain kinds of federal reporting if they have less than a certain threshold of assets under management. So, for those firms, this may be something new, requiring a bigger muscle movement to achieve this level of reporting.

Beneath the surface, a deep interrogation of internal processes is critical for business leaders. Firms will achieve success by closely examining their internal processes and identifying areas for improvement.

This isn’t merely about setting venture-capital diversity goals. It’s about understanding the biases within the selection processes for portfolio companies. Uncovering and rectifying these biases is critical to venture capital diversity success in response to SB 54.

The profitability paradox

Ironically, the venture-capital industry could naturally boost profits by embracing diversity. Venture-capital demographic statistics support this claim, indicating that diverse teams consistently outperform their monolithic counterparts, offering better returns.

For example, firms with ethnically and culturally diverse teams are 36% more likely to outperform companies with less diverse teams in profitability. They also tend to have 2.5 times higher cash flow per employee, as well as 19% higher innovation revenues and 9% higher EBIT margins.

As we navigate this transformative era marked by SB 54, my hope is that venture-capital firms don’t just see this as a need for compliance but rather as an opportunity for profound change. Beyond the legal mandate, proactive measures and a critical examination of internal processes will pave the way for a more inclusive and profitable venture-capital landscape.

SB 54 might have originated in California, but its echoes will undoubtedly reverberate across state lines, shaping a more equitable and diverse future in venture capital.