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Venture capital’s quest for diversity and equity remains a work in progress

April 23, 2021, 11:00 AM UTC

Nearly a year ago, as the nation reckoned with the horrifying video of George Floyd’s murder in Minneapolis, Alejandro Guerrero, a general partner at early-stage venture capital firm Act One Ventures, sat alone at his home in Los Angeles, coming to terms with what he had just seen and bracing for the fallout.

“All the signs were that L.A. would go up in flames,” Guerrero recalls of a city already on edge from the stress of the coronavirus pandemic, pushed further to the brink amid racial tensions. “I was at home, in the dark in my living room, watching the footage and just crying and processing.”

A first generation Mexican American, Guerrero is the child of immigrants who had dropped out of school as adolescents to earn a living, in the hope of one day creating a better life for their own family. Guerrero had his own challenges growing up in Southern California, but he worked hard to ensure their sacrifice wasn’t in vain. He earned a degree at UCLA and founded his own tech startup, Uniq Apps, before eventually pivoting into the highly competitive, white-dominated realm of venture capital funding.

As he sat transfixed before his TV, Guerrero found himself reflecting on the inequities he had witnessed and experienced as a person of color in his chosen field and pondering how he could make a difference. It’s well documented that startup founders of color are at an inherent disadvantage when it comes to raising the capital they need to grow their companies; Black and Latino founders accounted for less than 4% of all venture capital deals and only 2.3% of all venture dollars raised in the U.S in 2019, according to Crunchbase data provided to Fortune.

“I know the brutality of trying to raise capital when someone looks like you,” Guerrero says of raising money as a founder of color. He had witnessed the other side of the equation as a venture capital investor, where he quickly came to terms with the unwritten rules of “access and privilege” that govern the checks that get written, and the funds—and, in turn, the portfolio companies—that they go to. “Just by riding shotgun into a world unbeknownst to people like myself, you start to see how it works.”

Spurred by his experiences, as well as the collective reckoning with the systemic injustices that had led to Floyd’s death, Guerrero was determined to do his part and try to change the way the VC industry operates. In August, Act One unveiled its Diversity Term Sheet Rider for Representation at the Cap Table, a “call to action” for VC firms to include underrepresented groups—including Black, Latino, women, and LGTBQ+ parties—as coinvestors on their deals. 

“What we need to do is provide a level of access and opportunity for people of diversity to get on cap tables,” Guerrero says of the thinking behind the rider. By ensuring that access, minority investors are able to “build the track records that are going to appease LPs [limited partners]”—the capital-rich, often institutional investors that back VC funds—while also gaining networking opportunities within the usually exclusive world of VC dealmaking. “It’s all about attribution and getting into the right deals and unlocking these networks,” he adds.

VC Diversity Equity-Alejandro Guerrero- Act One Ventures
Alejandro Guerrero, general partner at venture capital firm Act One Ventures.
Courtesy of Act One Ventures

Less than a year on, more than 45 venture capital firms have committed to deploying the diversity rider across all of their deals, according to Guerrero, including the likes of Greycroft, First Round Capital, Maveron, and Fifth Wall. Additionally, the rider’s goals have also gained traction among startup founders desiring a more diverse cap table for their companies. Payments startup Finix, led by Mexican American founder Richie Serna, deployed a similar framework in allocating 10% of its recent $30 million funding round to investors from underrepresented backgrounds.

Greycroft founding partner Dana Settle told Fortune that the Act One rider has helped her firm break out of a VC industry mindset that prioritizes “working with people you know” in order to more quickly find coinvestors to syndicate deals—a mentality that “perpetuates the problem of having a very insular network.”

“We would do deals, and as you were signing the term sheet and thinking of [coinvestors] to bring in, you’d look to your [existing] networks immediately,” Settle says. By forcing VCs to “get out of [their] comfort zone,” the rider has introduced Greycroft to a diverse array of coinvestors who “often have networks that are different than ours,” including diverse new founders and companies. What’s more, she says, prospective portfolio companies are “thrilled” to learn of Greycroft’s commitment to diversity, as it often mirrors their own values and organizational goals.

But while it’s proven a success story to date, Act One’s diversity rider is just one mechanism seeking to implement change across a sprawling venture capital sector that poured more than $150 billion into startups in the U.S. last year. And though the VC space has made progress, observers note that much work is needed if the industry is to break out of the white- and male-dominated paradigm that continues to dominate deal flow.

‘A drop in the bucket’

Like much of the business world, myriad venture capital firms were moved in the wake of Floyd’s killing last year to condemn systemic racism and take measures aiming to address racial and social inequities. Major players like Andreesen Horowitz launched funds seeking to invest in minority founders, while others joined initiatives designed to promote diversity and inclusion.

A Morgan Stanley survey of venture capitalists last year showed a shift in attitudes across the sector; 61% of VCs said the Black Lives Matter movement had affected their investment strategy, while 68% said they were more likely to invest in “multicultural-founded companies.” 

As far as dollars and deals were concerned, 2020 also saw an increase in U.S. venture capital funding to Black and Latino founders, who raised $3.7 billion last year—a $500 million jump from 2019, though still less than 2.4% of total U.S. venture dollars raised, according to Crunchbase data. So far, that momentum has carried into 2021, which has seen around $2 billion raised by Black and Latino founders through the first three months of this year—though still less than 2.7% of total U.S. venture funding.

That funding has been buoyed by the success of minority-led venture capital firms like Harlem Capital and MaC Venture Capital, both of which closed funds last month of $134 million and $103 million, respectively. “You didn’t see this kind of [fundraising] velocity last year or the year before,” Harlem Capital managing partner Henri Pierre-Jacques tells Fortune. “From a fund manager perspective, it has definitely accelerated massively.”

VC Diversity Equity-Harlem Capital
The leadership team at Harlem Capital, a diversity-focused venture capital firm that primarily invests in minority- and women-led startups.
Philip Vukelich—Courtesy of Harlem Capital

Not only is Harlem Capital led by a diverse team, but it’s also diversity-focused; 61% of portfolio companies in the VC’s initial $40 million fund are Black- or Latino-led, while 43% are led exclusively by women. Pierre-Jacques says the firm often looks to back founders “who maybe would have gotten [the funding needed], but it would have been a lot harder” without Harlem Capital’s backing.

“A lot of deals, we lead before anybody else says yes,” he notes. On some occasions, the firm finds itself backing a minority-led startup that Pierre-Jacques says doesn’t get the benefit of the doubt that one led by a white male founder would. On others, when the company in question isn’t up to par, Harlem Capital will make sure to provide feedback on how it can improve. “We know that other funds aren’t giving them that advice,” he says.

But while Black-led funds have found more success as of late, Pierre-Jacques points to a notable gender equity gap within that trend: “The other side is that all of these funds are [led by] Black men.” He cites venture investor Kesha Cash’s Impact America Fund, which recently closed a $55 million fund, as having the kind of success that’s all too rare. “Black men are raising large funds, but there’s certainly a gap for Black women.”

In 2020, the gender equity gap within the venture capital sector showed signs of worsening. The amount of venture funding secured by female-led firms fell sharply last year, according to Crunchbase data. In the U.S., startups led exclusively by women raised $3.3 billion in 2020, down from $4.2 billion in 2019.

For context, Robinhood’s recent $3.4 billion funding round was “more than all of the funding that went to women-led startups in 2020,” notes Yasmin Cruz Ferrine, general partner at VC fund Visible Hands, which is launching a fellowship program promoting underrepresented founders. “Fundraising during COVID is not an easy task, but we cannot allow that to be a shortcut as to why these trends are worsening and not getting better.”

Guerrero says he believes the pandemic has exacerbated challenges facing both women and minorities in the VC realm by allowing many investors to “lean back on their old networks” when it comes to the deals they back and who they back them with. He adds that while investment in diverse funds and founders has trended upward in recent years, it still represents too limited a share of an ever-growing VC industry.

“These big funds have launched even bigger funds,” he notes. “There is momentum—but remember, it’s a drop in the bucket of the overall assets managed by white men.”

No looking back

One group of stakeholders that may not be as eager to disrupt the status quo are the LPs backing venture funds. According to Morgan Stanley’s venture capital survey, VCs firms noted little in the form of heightened pressure from LPs; only 59% said they believe that “investing in diverse entrepreneurs is a priority to their LPs,” up slightly from 55% in the previous year.

“As long as LPs have a risk management perspective of investing in a different type of investor, it’s going to be hard to change the paradigm,” according to Cruz Ferrine. 

Greycroft’s Settle says she believes LPs are “certainly paying more attention” to the issue of diversity when it comes to how they’re allocating their capital. But as far as putting their money to work, she adds that she is “hearing about this more than I see it in practice.”

“I have yet to see really big pools of capital moving into this area, and I think it’s really important for that to happen,” she says. “But I do think large pools of capital are looking at diversity as an imperative. It’s the next major step that needs to happen.”

It may very well be a matter of time, as the matter of diversity, equity, and representation in venture capital—as in much of the broader business world—shows little sign of losing its significance as a hot-button issue.

“This conversation isn’t going to dissipate into the wind anymore,” Guerrero says. “I feel like in past times, it was ‘Thoughts and prayers—who cares, let’s move on.’ No longer.” George Floyd’s death was “such a profound moment of pause for all of us,” he adds. “We’re not looking backward.”