Unlocking a $4.4 Trillion Opportunity

As a general partner of a startup academy focused on underrepresented tech founders,  I have often been asked how much of our returns we expect to sacrifice by investing in overlooked founders such as women and people of color. This question implies that tech companies led by diverse founders are certain to provide inferior returns when, in fact, investing in diversity is one of the biggest economic opportunities of our time. According to Morgan Stanley, overlooked founders could represent a $4.4 trillion opportunity each year in the U.S. alone, not to mention the social benefit that comes with wealth creation among more varied groups and the variety of innovations they will create. So what is next, and how can investors help ensure that the founders that they back will succeed?

Kapor Capital, a leading venture capital firm focusing on investing in diverse founders, recently released a report on the returns of their portfolio. The numbers are jaw-dropping. To date, Kapor Capital has achieved an internal rate of return (IRR) of 29.09% which is substantially above PitchBook’s 75th quartile (25.96% IRR) for other venture capital funds. Additionally, a recent spate of blockbuster successes such as Canva, Rent the Runway, StitchFix and Away have demonstrated more anecdotally that diverse founders are perfectly capable of building global, multi-billion dollar companies. 

Despite a steady chorus of success stories such as those mentioned above, investors have been slow to deploy capital toward high-growth enterprises led by women and founders from diverse backgrounds and geographies. This inertia stems from investors mitigating risk by pattern-matching against past investment success. Unfortunately, with the imbalance of access to capital, historical investment data has created a self-fulfilling cycle around an archetype that is a white, male founder who attended an elite university, studied engineering or business administration and is based in a mature tech hub such as Silicon Valley. 

In 2018, only 12 percent of venture capital went to startups with at least one female founder, one percent went to those led by black founders and one percent went to Latinx founders. This lack of diversity in allocation is dwarfed only by the lack of diversity in the allocators with 40 percent of partners in VC firms coming from just two universities (Harvard and Stanford) and women accounting for only eight percent of investment partners at the top 100 venture firms in 2018.

It’s not just anecdotal stories that point toward the potential of investing in a greater variety of founders and startups. Research has suggested that investing in groups that do not fit the classic Silicon Valley pattern results in superior economic outcomes. A study by Boston Consulting Group and MassChallenge showed that for every dollar invested in female-run companies, $0.78 were returned versus just $0.30 otherwise. Another study by McKinsey, found that companies with diverse leadership are 35 percent more likely to outperform those without such diversity. This is likely because a great majority of founders innovate for what and who they know. As such, overlooked founders are often uncovering markets that have been neglected by others. 

Investing in a greater diversity of founders and startups also includes breaking geographic bounds. According to a Pitchbook/NVCA report, 79 percent of venture capital is allocated to just three states in the U.S. in 2018: California, New York and Massachusetts, with the first of these accounting for over 48 percent. At the same time, Jason Rowley from Crunchbase reported that investments in startups based in regions such as the Midwest and South outperform those based on the coasts, where traditional tech hubs are located. For example, the median multiple on investment for Midwest-based startups is 5.17x compared to the Northeast where the median is only 3.89x.

The movement to deploy capital to a greater variety of innovators might be still inchoate, but the tide is likely to change rapidly as venture capital and private equity investors realize the economic potential that is knocking on their doors. While opportunity abounds, unlocking the economic opportunities from a group of founders that have been underserved is not without unique challenges, which we must recognize to deploy capital and human resources efficiently. Here’s how: 

First, if we invest in tech entrepreneurs that do not fit the old Silicon Valley pattern, we might need to complement these founders’ unique experience and skills with a different set of knowledge and resources. At Beta Boom, we provide our startups with product and marketing coaches that work alongside them daily to improve their product and grow their customer base. We know that product design, marketing and growth hacking skill sets can be developed over time, but grit and outstanding domain expertise—the two qualities we prize in our founders—are irreplaceable.

Second, a startup has a long journey before it provides a return for the founders, employees and investors through an acquisition or initial public offering. It’s very likely that everywhere along the journey underrepresented founders will face biases, including from later-stage investors and strategic partners and acquirers. Investors cannot rest on their laurels and instead, need to work hard to make connections for and champion their portfolio companies. 

Third, beyond implicit (or explicit) biases, there are networking hurdles that underrepresented founders often face. The next generation of superstar tech founders might no run in the same social and professional circles as many investors and are thus less likely to find their way to the investors’ doorstep through warm introductions. Likewise, if we seek to broaden our geographic focus beyond traditional tech hubs such as Silicon Valley, New York and Boston, investors can’t require startup founders to fly for in-person meetings at the drop of a hat or move their entire team.

Venture capital firms such as Village Capital and Indie.VC are trying different investment and operational models to better unlock the opportunity that diverse founders present, and they are not alone. The number of firms, family offices and angel networks innovating and focusing on startups led by diverse founders is growing rapidly. The question is increasingly not whether diverse founders will produce market-rate returns but rather who will catalyze and capitalize on this growing movement and who will be late to the game.