The Valuable Role of Diversity in Venture, Part 1

Sep 27


Nicole Davis

Creating diverse and inclusive workplaces has social and cultural value, but it also carries a very real business case for optimized performance. Aumni, a leading investment analytics platform for the private capital markets, and Bolster, an on-demand executive marketplace, recently hosted a webinar to explore the value of diversity in a business setting, particularly focusing on diversity within a company’s board of directors. Beyond the founding team and investors, the board can have a direct impact on an organization's inclusion efforts. If diversifying a company’s board drives results and performance, should companies be striving for greater diversity earlier in the company lifespan?  Let’s start with a look at what the data indicates. 

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Board diversity: what the data tells us

According to Bolster, more than half of boards are all one gender and 87% are either fully homogeneous or have just one person representing another gender. Some experts refer to singular representation as a tokenizing effect, which does not fully solve for diversity and inclusion goals. 

Independent directors, investor directors, and managing directors are the three primary board types, and, of those, independent director seats are far more likely to be represented and filled by women. However, only one in three private company boards today have independent directors. Furthermore, independent directors tend to be involved at a series C stage and later; meanwhile, 60% of the boards without racial or ethnic diversity actually occur at the stage series A or earlier, creating a gap for companies at those stages.  Bringing on an independent director early in a company’s evolution can catalyze board diversification. Also notable is that nearly two-thirds of CEOs are open to bringing on first-time directors to the board -- a promising sign. 

Aumni’s data indicates that female board representation increases in the later stages of a company’s growth. This data point aligns with stage-specific external pressures from investment banks and state mandates, which increase as companies are approaching a public position or IPO.  Furthermore, female board members hold a higher percentage of advanced degrees and attended Ivy League schools more often than their male counterparts. 

Data analyzed by Aumni also indicated that founding teams that include at least one woman are earning higher valuations at later stages. It is worth noting that the companies compared in the dataset raised the same amount of venture financing, excusing dilution as the explanation for this trend. 

Matt Glotzbach, CEO at Quizlet, agrees that a commitment to diversity in business settings yields different thoughts and opinions:

As we brought on independent directors, we found ourselves having deeper, richer, and more sophisticated conversations. This is partially due to diversity and the backgrounds and experiences we have added. Board meetings became much more energized with a more holistic perspective and vision of where we were headed.

VCs are driving board composition, particularly at earlier stages of a firm

Institutional LPs, endowments, foundations, and VCs care about diversity culturally and from a society perspective, especially universities and groups that are fundamentally focused on diversity in their charters. High-performing funds may have historically been able to table diversity for future discussions. However, it will become increasingly difficult to maintain performance if they are not actively addressing diversity initiatives and affording themselves the subsequent lift. If a fund’s performance starts to suffer by comparison to more diverse funds and they haven’t been actively addressing the need for diversity, the LP community is likely to notice.  

One of our experts on this topic, Sharmila Kassam, Executive Director of the AIF Global Institute, is a former deputy CIO of a large institutional investor. She has observed that chief investment officers are fielding many questions about their organization's diversity, particularly in their hiring process. She says: 

While diversity isn't a reason to substitute performance, there are strong managers with diverse backgrounds out there. A CIO will have to answer the question: ‘Why did you go with this manager when you could have tried to find another manager that was embracing the diversity and inclusion argument?’ There will be more pressure at the higher aggregate level of those organizations.

Taking action: 3 ways to improve diversity and independence 

As a trusted set of advisors, the board has a responsibility to do what is best for the company, and surrounding the founding team with a variety of expert sources fueled by different perspectives and experiences can positively impact company performance. The difficulty from an operator’s perspective is that while the makeup of a board is important, there is an apparent lack of urgency early on. Investors can educate founders on the importance of board diversity, including the addition of independent directors, helping them understand and prioritize the opportunity board independence and diversity represents.

Management teams may not have to search too hard for opportunities to add independent members. According to Bolster, approximately 60% of boards today have more than one management director on the board. While it might initially feel like a loss of control, swapping one of those managing director seats for an independent board member could improve board health. Founders can benefit from better advice and a more inclusive conversation at the board level, which in turn helps cultivate stronger leadership and direction for the company. 

Secondly, early-stage investors can play a meaningful role in providing independence guidelines to founders. For example, investors can recommend that the firm creates independent board seats in the first 90 days. Taking this step can have a tremendous impact over time.

While some companies might be tempted to seek out diverse founders and board members to simply “check a box,” especially when only one seat is opened for diversity's sake (i.e., tokenizing), this approach limits progress. Instead, companies should consider bringing on independent directors who will offer different perspectives that help strengthen the company’s position. Including numerous voices and perspectives -- aiming at a minimum for two to three individuals with different experiences throughout their lives, especially experiences that are often absent in boardrooms -- can be an effective way of inviting input that improves the company’s performance. 

Lastly, it is important to remind founders that a board member is not a permanent fixture, despite the perception that board seats are long-term positions. What a company needs today isn't going to be what it needs tomorrow. Setting the expectation that board membership is an evolution, one where the company is bringing in resources and advisors as they need them, lowers the stakes and makes the process more fluid.

A best practice is to consider board service as a two to three-year commitment. Board members that are well suited to Seed and Series A growth can be replaced by directors that are more valuable to the growth stage or can prepare a company to go public.  Board composition may follow the trajectory of a company’s size or team member base, according to Quizlett’s CEO Matt Glotzbach. The needs of a company with ten employees are different than that of a company that has grown to 50 employees with departments and leaders, then changes further when the company grows to 150 people, and so on. Glotzbach expands on this idea:

What you need when you're just starting out, as you turn your idea into a first version of a product and look for product-market fit, is very different than once you have product-market fit and you're looking for scale and the transition to revenue. Your needs change yet again when you're looking to ramp up, scale, and are perhaps going global or working through complex partnerships. The critical part is setting an expectation upfront with the board member or advisor, the executive team, and the rest of the employee base that they shouldn't see the transition of a board member as a negative step. It is a positive step associated with growth.

As we continue to analyze data and explore the many reasons why our analysis consistently indicates that diversity plays a valuable role in the business setting, we notice a growing conviction regarding the efficacy of inclusion. Hunter Walk, Partner at Homebrew VC, has a powerful analogy:

Diversity is not icing on the cake. It's an ingredient in the cake. Firms have to think about diversity early on, from the founder and team composition to the advisor and board composition, and also the cap table. We're seeing more and more individuals hold aside portions of their early rounds to make sure that their cap tables represent the type of diversity that they think can aid their company as well.

In the next post, we will explore several ways companies and VCs alike can fuel their search for diverse talent and promote diversity. To learn more and access the on-demand webinar, please click here.