Gender Bias in Venture Capital

Diversity is key to providing outsized returns to investors.

Photo by rawpixel on Unsplash

If you’re familiar with the world of venture capital you won’t be surprised to hear that gender bias is a huge issue. You might have heard that that female founders deliver 2x the return to investors than their male peers. Given this commonly cited stat it might surprise you that female owned startups only received 2% of the venture capital invested last year. Given these facts it should be NO surprise that venture firms are aggressively targeting female owned startups for investment. As a result over the past decade female owned startups have been twice as likely to receive venture capital than male owned startups. Sadly, despite this advantage, gender focused investing hasn’t provided investors a positive return on their investments.

Twenty-four months ago we began working with several funds on a project to back-test a theory regarding pro-rata rights in anticipation of creating a fund of funds. I won’t go into the details of the research project, but I can tell you that much of our effort went into understanding which deals each fund did NOT end up funding. Along the way we uncovered a number of intriguing data points. First and foremost it became apparent that female owned startups were FAR more likely to raise capital than male owned startups — more than twice as likely. Clearly venture investors took note of the claim that female owned startups provided “2x the return” compared to startups founded by men. The problem is that very few female owned startups, as a percentage, actually approached these firms for investment. Of those female owned startups that pitched at least one venture firm in our sample, their male or mixed gender peers pitched three times as many firms as the female owned startups did. To put this in context, when I was raising venture capital for my first startup I met with almost 100 firms over the course of six months before I secured funding.

More interesting is that the statistic that everyone is using — i.e. that women owned startups provide twice the return as male owned startups — is demonstratabley false. Returns in the venture asset class are produced by just a few huge hits (think Uber, Twitter, and Facebook) and there has never been a female owned tech startup that has provided a home run level return. The study that is cited from BCG and MassChallenge actually claims that,

“Yet businesses founded by women ultimately deliver higher revenue — more than twice as much per dollar invested — than those founded by men, making women-owned companies better investments for financial backers.”

The study does NOT suggest that returns to investors are 2X — simply that the revenue generated by female owned startups are 2X of their male counterparts. From a venture investor’s perspective revenue is not necessarily a good thing — especially when it is gained at the cost of rapid growth. Of course venture investors (unlike other investors) have very specific goals based on the way fund economics work. They’re rarely interested in “good” businesses they’re looking for hockey stick growth at any cost. They’ll often sacrifice a “good” business by forcing them to take HUGE risks that 9 times out of 10 will mean the company fails despite the fact that if they didn’t take the risk they could have been a “good” business.

Despite this reality, today there is a strong bias in favor of funding female owned startups as a form of affirmative action and as a result female owned startups are twice as likely to get funded than their male or mixed gender peers. I regularly read articles and posts from those who are attempting to encourage more women to start companies and seek funding. Personally I am in favor of entrepreneurship and encourage anyone who is interested to give it a try, but I’m very much against creating litmus tests for funding that relate to a founder’s gender, creed, or race. My strong feeling is that startups are best when they are diverse. I personally wouldn’t fund or run a startup that didn’t include both women and men.

At the end of the day, women owned startups represent 0% of venture returns which shouldn’t be a surprise because women owned startups only receive 2% of venture funding. I don’t think all male startup teams are a good idea nor do I think all female startup teams are a good idea either. Businesses work best when men and women work together as a team — focusing on trying to find more “all women” startup teams will simply create all new problems for venture investors.

Where this is going…

My son is active on the national high school debate circuit and there is a huge focus on gender and race. Debaters are allowed to indicate their preference for a judge based on a 1–100 scale; however, there is concern that this “pref system” allows debaters to discriminate against black and/or non-cis male judges. As a result tournaments, with the best of intentions, have adopted sophisticated systems for “boosting” opportunities for black and non-cis male judges. For example, here is how Wake Forest University categorizes judges:

  • Category One: black, non-cis male
  • Category Two: non-black, non-cis male
  • Category Three: black cis male
  • Category Four: non-black cis male

The tournament director determines the sample mean for each diverse category and then if the sample mean for one of the categories is higher (i.e. worse) than the population mean, they will “boost” the judges to be equal to that difference in means. Here is the calculation:

(Aff Pref + Neg Pref)*PrefWeight+ Abs(AffPref — NegPref)*MutualWeight — JdgPref*JdgWeight

These systems create the risk that “bad” judges are “boosted” simply because of their membership in an under represented category. Even worse, students like my son who participate in these debates are being taught that a person’s gender or racial identity matters more than their ideas. The judge pref system was designed to allow debaters to privately rank judges based on their skill — now judges that are ranked lower than other judges are given a “boost” if they are black or non-cis male resulting in weaker judges judging more debates.