Herds of Unicorns: Why VCs Need To De-Risk Racial Cognitive Bias
When Dr. Chris Brooks and I co-founded Brown Venture Group (BVG), people thought we were a combination of crazy and naïve. After all “who starts a venture firm focused exclusively on Black, Latino, and Indigenous technology founders when everyone in Venture Capital knows how hard it is to find investable BIPOC companies?” Moreover, who starts a venture Capital firm in Minneapolis of all places? Although BVG was a contrarian idea to many within the traditional gated community of Venture Capital, our why was based on empirical research, and quite frankly, just made great business sense. How so you ask? Let’s first start by answering the question “Why Minnesota.”
If you have never been here, you may get the impression that winter lasts for 12 months of the year, and everyone talks like Frances McDormand’s character “Marge Gunderson” from the 1996 movie “Fargo”. Although Minnesotan is an active dialect spoken today in many parts of Minnesota, what is less known about our State is the robust startup ecosystem that we have. In fact, we have one of the highest per capita clusters of Fortune 500 companies in America, have one of the world’s largest medical device clusters, and a university that is ranked 38th according to the recent Top 100 Global Universities report. This combined with the fact that historically, Minnesota has boasted some of our nation's highest business survivability rates, we naturally came to the conclusion, “Why not Minnesota.”
With regards to our focus on BOPIC Technologist. Our research was informed by objective data and our thinking was governed by racial economics, that is, the intersection of behavioral science and racial diversity. From this vantage point, we observed a disconnect between the amount of VC investments in communities of Color, roughly 3% of total investment, this has resulted in a $13 Trillion lost business opportunity which communities of Color have represented over the past 20 years. Assuming for a moment, as traditional economic theory teaches us, that we are all rational economic players, seeking the greatest return of our scarce resources, this rather large disconnect did not appear to make economic sense. Take Black women for example. For years Black women have been well documented as one of the most educated entrepreneurial groups in America, yet despite this established fact, VC investments in Black women between 2009-2017 were statistically insignificant at 0006%. Put differently, from a racial economic perspective, racial and gender biases have led many VCs to miss out on potential Unicorns (a privately held startup company with a value of over $1 billion) due to the fact they have been kept outside of the traditional White male gated community that is venture capital.
Before you miss interpret our conclusion, I think that it is important to disentangle any perceived notion that we are implying that all white male venture capitalists are racist, rather what we are saying that all humankind are biasist and are prone to cognitive easing, which as a result has led venture capitalist to miss out on opportunities in plain sight. So, like any rational investor, we came to the conclusion that investing in undervalued BIPOC contributors, with enormous upside potential, just made business sense.
In this article, we will unpack 3 causal factors which have historically kept communities of Color out of the gated community of venture capital. We will explore The Redline Effect and why mapping your social network could reveal why you are having a hard time sourcing BIPOC deal flow or hiring top BIPOC talent. We will also unpack why framing Disparities as Opportunities may help VCs discover new VC investment models. Finally, we discuss the powerful implications of shifting organizational focus from doing things "For" communities of Color to doing things "With" communities of Color. Let us first begin with The Redline Effect.
The Redline Effect: Mapping Out Your Social Network
When framing the ongoing barriers to economic contribution within communities of Color in the United States, it is quite easy to understand the adverse effects historical governmental and social policies such as The Black Codes and Jim Crow laws have had on contributors of Color. In fact, many of the disparities that continue to produce headlines today can be traced back to the artificially created poverty that these policies created as it pertains to communities of Color. These barriers to contribution have elicited feelings of survivor guilt by many White contributors, and it seems like the only remedy to this guilt, is to help "at-risk youth". What is less understood, however, is the adverse effect that these policies have on White contributors. I can't tell you how many times that I have heard, "Dr. Campbell, I can't find diverse deal flow or qualified Black talent to hire". This is often followed with "I feel bad, but I have a fiduciary responsibility" or " I have to hire the most qualified talent" as an explanation as to why investors and hiring managers continue to produce poor diversity and inclusion (D&I) results. Both of these challenges, however, can be traced back to the historical implications of redlining. This government-backed practice widely used in post-World War II America during the 1940s and 1950s, necessarily created interracial relationship gaps due to the proximity of Black and White contributors. Therefore, the natural result of this racial separation combined with the higher cost of capital artificially placed on contributors of Color, meant that the probability for serendipitous and organic relationships between White and Black contributors was substantially lowered. This Redline Effect did not occur as a result of the invisible hand of the market, rather by the visible hand of governmental and societal intervention. Put differently, before you, a White contributor, and me, a Black contributor, were ever a twinkle in our mother's eye, somebody made a decision for us as to how easy it was for us to form an authentic and meaningful relationship with each other.
What does this have to do with venture capital and D&I? The Redline Effect has created barriers to hiring top diverse talent as well as identifying investable startups founded by communities of Color. This is due to the homogenous communities that redlining artificially created. Meaning, that despite the sophisticated platforms we use to source deals and hire talent, much of the deal flow and recruiting still comes from informal and organic relationships. What this means, if your VC firms and Organizations are predominantly White, you are limited to at best the third-tier networks of your existing talent within your organization, which often means that your D&I initiatives may be doom to fail before you ever get a chance to execute them. Skeptical of this network effect? Try mapping out your and your leadership team's 1st, 2nd, and 3rd tier professional and social networks. How many People of Color are there in the network? What do you know about them both personally and professionally? How many of them were provided sponsorship opportunities or pathways to senior-level positions within your organization? The same is true when it comes to identifying potential portfolio companies outside your firm. In a recent article in the Harvard Business Review titled "How Venture Capitalists Make Decisions", the authors documented that 30% of deals come from colleagues or work acquaintances (i.e. first-tier relationships), 20% of deals come from referrals by other investors (i.e. second-tier relationships), 8% of deals come from existing portfolio companies (i.e. second-tier relationships) and 30% of deals are generated by VC initiated contact, which historically has been from homogeneous communities with access to friends and family rounds of investment (i.e. third-tier relationships). What this means is that roughly 88% of all deals come from White homogeneous closed networks. The implications of this are that VCs are missing out on trillions of dollars in potential deal flow, and organizations on top talent, as a result of the lack of relationships with communities of Color.
So how can leaders fix this problem? There are no doubt systemic issues that will need to be addressed in the years ahead. I, however, have found that some of the lowest hanging fruit in which leaders can put their efforts towards, is closing the relationship gap. Much like the old sage investment advice, that is, the best time to start investing was 10 years ago, the second-best time is today. The second best time to start forming authentic interracial and diverse relationships is now. We may have missed things 10 years ago but we now have an opportunity to close these relationship gaps today through cultural residency. That is, intentionally spending time building relationships in cultural contexts outside of our own, which increases the probability of forming authentic relationships. To be clear, this process may be uncomfortable at first. However, the mutually enriching experience will produce greater insights than if you only hired a consultant for unconscious bias training. Moreover, cultural residency will also increase the probability of getting exposure to top diverse talent as well as realizing greater returns from diverse deal flow. As you will see through this process, opportunity is an event, what one can do with that event is their capacity. If you increase the events for communities of Color, you will find that there is no lack of capacity.
Turning Mountains Into Mole Hills: How To Break Down Disparities Into Fixable Problems
Science shows us how water takes the path of least resistance. Oftentimes this cognitively holds true when it comes to decision making or problem-solving. In fact, many of us are unaware that our fight or flight functions are subconsciously engaged with simple tasks like walking through the cereal aisle at Target. While searching through what seems like endless brand options, our minds become cognitively strained by choice overload. This of course is happening all while competing thoughts such as trying to make a mental note that we still needed to pick up milk, leads to decision fatigue, and a possible repeat visit to the store because you forgot something. As a result of this cognitive strain, our brains have adapted to provide the quickest path to a satisfactory outcome or a decision given the overabundance of data and the time frame in which to compute the information. These cognitive rules of thumb, known as heuristics, help to simplify decision-making in order to prevent the brain from shutting down due to cognitive information overload. These mental shortcuts, however, often result in a good enough decision as opposed to the most optimal one. Put simply, people may love options but they hate making choices. So it comes as no surprise that when faced with a mountain of a problem like racial economic disparities, that our minds tend to seek good enough decisions like working with "at-risk" youth, or worst yet, stop trying to solve the problem as a means of subconscious cognitive self-preservation.
Why is this important to know? It is somewhat counterintuitive to think that bringing awareness to disparities could actually lead to further disengagement with regards to developing optimal solutions to address their underlying cause. To be 100% clear, I am not saying that disparities should not be quantified, rather, that they should be accompanied by a set of recommendations that keep contributors cognitively engaged long enough to effectively solve the problem. For example, when climbing a seemly insurmountable mountain, if you focus only on how big the mountain is, you may miss the fact that the mountain can indeed be climbed, all be it one foot at a time. Likewise, as leaders have focused on economic disparities within communities of Color, many leaders have prematurely discounted their ability to contribute to the solution. In other words, the problem isn't how big the disparities are, it is understanding what you can individually do to solve it. No, I am not asking you to solve racism all on your own. What I am saying, like in the case of climbing a mountain, the best approach is to simply take the step that is in front of you. What does this mean? If you are in sales, provide opportunities (or events) for young contributors of Color to learn sales from you. If you are a rising star in your organization, reach back to lift up a promising contributor of Color as you climb the corporate ladder. Again, it is not an issue of capacity, rather, it is the frequency of opportunities that a driven contributor is been provided that ultimately determines their success.
The reason this cognitive strain is important in venture capital is that oftentimes general partners rely on pattern recognition, which may be referred to as a "gut feeling". This "gut feeling", however, is prone to cognitive easing, and often takes the path of least resistance. The result of which leads VCs to play it safe by limiting where they pick winners from to their own homogenous networks. Additionally, as a result of the disparities highlighted in the media, the relationship gap described above, and the historical barriers to economic contribution within communities of Color, VCs have been led to falsely believe that what they are seeing before them is insurmountable mountains. They, therefore, are prone to overweigh investment risks based on Color rather than capability and have been blinded to the disproportionate investable upside of BIPOC startups that are in plain sight. So what can Venture Capitalist do about this? Like many verticals in the finance industry, private equity is based heavily on relationships and trust. The simple and clear step in front of VCs today is to work on expanding representation within their firms. The relational networks that diverse fund managers bring will naturally increase VCs probability of capturing a piece of the multiple Trillion-dollar upside potential in which communities of Color represent. The opportunity before VCs is to reimagined their theory of business or investment thesis and to get outside their gated communities. By doing so, they will increase the probability of greater returns. One of the ways of achieving this is for VCs and organizational leaders to shift their thinking and efforts from doing things “For” communities of Color to doing things “With” communities of Color.
“For” vs. “With”: Shifting from Project Management to Partnership Developers
In the 1960s Harvard psychologist Robert Rosenthal and Lenore Jacobson, an elementary school principal in the South San Francisco Unified School District, conducted a study on student outcomes that became known as the Pygmalion Study. In this groundbreaking research, Rosenthal and Jacobson predicted that a teacher's subconscious expectation of a student would have a correlation to a teacher's behavior in ways that would have implications regarding the likelihood of a student's success or failure. Turns out they were right. In this study, students were given a disguised IQ test at the beginning of the year. Instead of providing the teachers with the results of the IQ test, they were given a list of students (about 20% of the learners chosen at random) that they could expect to be cognitive and intellectual late bloomers. At the end of the year when the test was given again to the students, the "intellectual late bloomers" experimental group showed statistically significant gains compared to the gains made by their none experimental group peers. Essentially Rosenthal and Jacobson were able to substantiate the hypothesis known as the observer-expectancy effect. That is, that reality can be positively or negatively influenced by the expectations or biases of others. The implications of these findings have a significant correlation to VCs and Organizational behaviors. Compounded by the Redline Effect, this observer-expectancy led many VCs to miss out on potential Unicorn investments. How so? Consider if you will the linguistics used regarding communities of Color and our culture. Our youth are described as "at-risk", our young men as thugs. Black culture is often viewed as "Ghetto", which is ironic when considering the American Ghetto was a result of artificially created poverty outside of Black Culture. Well-educated and assertive Black women often are seen as threatening "Angry Black Women" as opposed to high potential candidates. In other words, when combined with the lack of meaningful proximity to communities of Color, this language reinforces a subconscious bias that Black and Brown startups and founders are inherently riskier than that of our White counterparts. This observer-expectancy effect as it pertains to VCs and Organizations leads to the self-fulfilling prophecy that leaders can't find investable BIPOC led startups or BIPOC talent for roles within their organizations. The result of which creates a lack of a diverse deal flow and racial diversity in the C-suite.
If this problem has been known since the 60s, why is it that we still find ourselves dealing with it today? I am convinced that a paradigm shift from doing things "For" communities of Color to doing things "With" communities of Color is needed. When organizations have historically done things "For" communities of Color it has been seen as a project to be managed or an optional cost center to be cut when profits are down. Like in the Pygmalion Study, doing things "For" contributors of Color has led to a self-fulfilling prophecy of a lack of diverse deal flow and talent pipeline. As mentioned above. The perception created by the language used to describe communities of Color combined with the lack of cultural familiarity has led General Partners and Hiring Managers to play it safe passing over unknown high potential diverse contributors for known slightly above average talent within their own homogenous communities. That being said, leaders who are able to make the shift today to doing things "With" contributors of Color, can benefit from the economic and social gains that come from this paradigm shift. I don't think I need to provide an exhaustive list of the economic benefit of Diversity and Inclusion as Mckinsey&Company have already done a great job at that. What I am advocating is that by organizations shifting their thinking to doing things "With", contributors of Color, they will increase their likelihood of realizing the gains that diversity and inclusion have been objectively quantified to bring. The bottom line is this, the greatest de-risking need in Venture Capital and Business today is not the color of my skin, rather it is the unconscious bias that prevents VCs and Organizations from achieving better bottom-line results.
We unpacked a lot in this short article. The underlying theme here is that there is no lack of capability within communities of Color, just a lack of events or opportunities. In order for VCs and business leaders to capture the tremendous upside potential which communities of Color represent, they are going to need to form meaningful and authentic relationships that are based on collaboration, not paternalistic projects. Furthermore, leaders will need to consider how their own thinking may have been influenced and limited by the homogenous communities they have grown up around. Or how relational proximity to Black and Brown contributors may prevent obstacles to D&I initiatives. What is clear to me now and hopefully you too, by co-creating a more economically inclusive ecosystem, will not only increase economic and human flourishing for contributors of Color but all contributors in America. A rising tide raises all ships.
