There's a huge investment opportunity in front of you. Don't let your brain make you miss out.
It’s 2023. We all know the abysmal statistics around diversity and venture capital. Right?
ICYMI: Approximately 97 percent of venture capital dollars are managed by white male fund managers. And approximately 97 percent of venture dollars go to startups led by white men.
These numbers have barely changed from year to year, even though countless articles have been written on these ridiculous and seemingly immovable statistics. More come out every day.
What’s only slightly less well known is this: Research study after research study (by the big dogs, too – BCG, McKinsey, and more) find that companies led by gender and ethnically diverse teams do better financially. Meaning if investors were actually investing based on what could provide the best financial returns, they would invest in diverse founders and fund managers.
So, everybody seems to know only a trickle of capital is controlled by or going to women and people of color. Businesses run by women and people of color do better financially. Countless financial institutions say they want to do better on diversity. Furthermore, investors have access to common sense and generally understand investing only in a tiny pool of homogenous humans and ignoring top performing talent who don’t come in a white, male body isn’t actually rational economic behavior.
But very little has changed.
Why the heck not? Why, when Morgan Stanley is telling anyone who will listen that they are leaving “a trillion-dollar opportunity” on the table by investing in the same old, same old, has the needle barely moved?
Yes, of course institutional racism and misogyny are a big factor, and few other areas of the economy have such extremely pronounced gender and racial imbalances. So why is venture capital and investing so out of balance?
It’s Your Brain, Stupid
One potential answer lies in the way our brains handle uncertainty. Investing in startups is a classic example of decision-making fraught with uncertainty. As Nobel Prize-winning economist Daniel Kahneman explains in his book, “Thinking Fast and Slow,” human brains are not set up to handle uncertainty and complexity. Instead, our brains generate “heuristics” which help our brains make hard decisions using intuitive shortcuts.
As Kahneman writes, judgment heuristics, “are quite useful for our human brains, but sometimes lead to severe and systematic errors” (emphasis added). The irrational statistics on diversity in venture capital can only be described as a severe and systematic error.
Here are some of the heuristics that lead our brains to make bad decisions under uncertainty:
- Availability Heuristic: Making decisions based on the ease with which instances or occurrences can be recalled. It’s easy to bring an image of a successful white male founder to mind but much harder to name a unicorn company created by a woman CEO.
- Affect Heuristic: Decisions are directly guided by feelings of liking and disliking with little deliberation or reasoning. People are much more likely to be friends with and be comfortable with people who are like them. For example, many white male investors don’t have Black founders in their networks and therefore may feel less comfortable investing in Black founders.
- Representativeness Heuristic: Also referred to as pattern-matching, this is when we make our decision by assessing how similar it is to an existing mental prototype. This is the fallacy famously identified by Michael Lewis in “Moneyball.” Professional baseball scouts used to (poorly) forecast potential player success by their “build and look.” The same goes in investing.
It’s easy to see how these heuristics could be influencing complex, uncertain decisions about who should control investment assets and which companies to bet on.
Still, we can overcome our built-in thought errors with awareness and knowledge. If you are on to your brain, you can do better both as an investor and as a human.
Don’t Let Your Brain Get in the Way of an Historical Opportunity
At this moment, we have available investment capital and newly available, top-tier startup talent. But there’s a mismatch happening—the capital isn’t flowing to the best talent.
In economist speak, this represents a market dislocation. In investor speak, this represents an unusual and enormous opportunity to make money.
As Marcia Page’s MPowered Capital put it in a recent report on capturing the untapped investment opportunity in underrepresented fund manager talent, “A dislocation on this scale doesn’t come around often, and when it does it represents a rare opportunity to produce superior risk-adjusted returns for those who recognize it and have the skills, knowledge and capabilities to seize it.”
If you have read this far and are someone with the financial capability to invest, here’s the great news—you now have the skill, knowledge, and capability to seize this rare investment opportunity.
How to Seize the Money
Write a check to companies with talented, driven founding CEOs who identify as women, Black, Indigenous, People of Color, LGBTQ+, and non-binary. Don’t know any of these CEOs or not sure how to pick? Then invest in venture funds led by diverse fund managers who have made it their job to invest in a portfolio of companies led by diverse CEOs. A new wave of venture funds like these have been emerging and are hungry for investor dollars, representing an exceptional chance for a newer and more diverse pool of investors to access venture capital returns.
But stay sharp. Don’t get tricked by diversity-washing. Don’t invest in startups or funds that pretend to invest in diverse talent when they’re really investing in white male CEOs and “teams” of women or people of color who don’t get to make decisions. This isn’t where the true opportunity lies. Ask about CEO demographics. Ask about the cap table and find out who holds the power within the company.
This moment in time won’t last. Investing in diverse founders and fund managers is eventually going to become mainstream. And just like any other resource, there’s only so much top-tier, diverse fund manager or CEO talent to go around.
Don’t be late to the party.
