Outside the Box: Silicon Valley and venture capitalists are blowing this huge opportunity
Silicon Valley built its prowess asking the question, “What great company has not been created?” They then build it and do it again — and again.
The question suspiciously absent today in Silicon Valley is, “What great entrepreneur has not been funded?” Recent controversy over Uber’s corporate culture and, earlier, Ellen Pao’s unsuccessful discrimination lawsuit against powerful venture capital firm Kleiner Perkins Caufield & Byers, her former employer, are among the events spotlighting the problem of monoculture and homogeneity in the venture community.
A problem can also be an opportunity — a potential arbitrage opportunity in this case. Arbitrage, the practice of taking advantage of a price difference between two or more markets, is born of a mismatch in information. One side in any transaction has a more accurate picture of an asset’s true value — this party is able to realize an outsized profit by purchasing an asset at a below-market valuation.
Psychologists term a difference in interpretation as having “cognitive bias.” In cases where there is a high degree of homogeneity around a particular factor, such as ethnicity or gender, the potential for cognitive bias escalates.
Arbitrage in such circumstances can occur even though both the buyer and the seller have the same information. In this case, the arbitrage can occur not because of a difference in the data, but rather the interpretation of the data.
Two incongruent data points illustrate how cognitive bias has created arbitrage in the venture capital industry:
1: Of the $ 60 billion that venture capitalists invested in 2016, $ 1.5 billion went to women-run companies, or just over 2%.
2: Studies show that female CEOs in the Fortune 1000 produce three times the returns of S&P 500 SPX, +0.82% enterprises run predominantly by men.
1: Of the thousands of venture deals done between 2012 and 2014, so few black female founders raised money that, statistically speaking, they registered as zero. (The exact number is 24 out of 10,238, or just 0.2%.) The few who have raised money averaged $ 36,000 in funding. In contrast, the typical startup, usually founded by a white male, raised an average of $ 1.3 million in venture funding — even though most of them fail.
2: Black women constitute the fastest-growing group of entrepreneurs in the country today. They have over 1.5 million businesses — a 322% increase since 1997. These businesses generate more than $ 44 billion a year in revenue.
The venture capital industry is a monoculture of gender and ethnicity — 89% men, 76% white men — while just 7% are women, 1% identify as African-American, and less than 1% identify as Latino.
An arbitrage play for those who identify talent that the venture-capital community has discounted and overlooked.
Homogeneity within venture capital creates a cognitive-bias arbitrage opportunity. Ability and intelligence cut across race, sex, and gender orientation, but opportunity, as well as access to capital, does not. This represents an arbitrage play for those who identify talent that the venture-capital community has discounted and overlooked.
The venture-capital community needs to recognize that any system with 90% homogeneity is vulnerable. Diversity builds resilience into a system, and resilient organizations and investments outlast and outperform peers.
Bias among venture capitalists keeps a large segment of our economy on the sidelines. Nonwhite, nonmale entrepreneurs have little access to the fuel needed to bring about meaningful innovation. Because of this, what great entrepreneur has not been funded, what loss to society are we suffering by accepting this deficiency, and who will take advantage of the arbitrage?
Shawn Lesser and Michael Whelchel are co-founders of Big Path Capital, an investment bank and placement agent that focuses on impact investing.