Willfully Passing on Trillion-Dollar Potential

If you observed somebody acknowledging but ignoring a clear opportunity to boost their financial returns, you’d probably want to shake them and say something like, “Hey, what’re you doing? You understand you’re walking away from a lot of money here?”

Well, that’s exactly what one of the world’s leading financial service firms, Morgan Stanley, did to the entire venture capital industry near the end of last year. The company published a report that showed VC firms acknowledge the potential for great returns among business led by women and multicultural entrepreneurs but they’re not investing in them. Essentially, the organization shouted, “Hey, you’re walking away from a trillion-dollar opportunity here.”

Surprising Stats

Morgan Stanley conducted a survey of about 200 organizations including venture capital firms based in the U.S. and diverse entrepreneurs that successfully raised venture capital. Findings were published in a report titled “Beyond the VC Funding Gap” and reflected a bitter truth. A majority of VC firms agree there is money to be made by investing in companies led by women and multicultural entrepreneurs (WMBEs), but they’re not making any kind of major efforts to target them.

“83% of VCs believe they can intentionally invest in companies led by WMBEs and maximize returns, yet only two-in-five say that doing so is a firmwide priority,” the report’s authors said. “The VC industry is not taking steps known to increase either their exposure to diverse entrepreneurs or the likelihood that they will invest in more women and multicultural founders.”

Several other surprising findings were contained in the report:

Not the right fit? – Authors said that “VCs have a reputation for investing in new, emerging and unfamiliar markets, better known as “expansion risk.” However, when they encounter diverse entrepreneurs, VCs are rigid in applying their definitions of fit and are unlikely to look at businesses led by women and multicultural entrepreneurs as opportunities to take calculated expansion risks, compared to other new investment areas.”

• The top type of risk VCs are likely to take to maximize returns are calculated expansion risks, and on average, 20% of the companies in their portfolios represent an expansion or divergence from their typical investments; and
• 88% of VCs view the lived experiences of underrepresented entrepreneurs as a competitive advantage in identifying problems to be solved and markets to be addressed.
• Yet, “not the right fit for me” and “market-related issues” are among the top reasons cited by women and multicultural founders for VCs not investing in their companies.

VC firms aren’t very diverse themselves, and that holds them back. – “The lack of diversity among VC firms contributes to the funding gap,” authors said.

• Among VCs who have hired more diverse fund managers, LPs, partners, or board members, 71% report it as a “very effective” way to increase the diversity of companies and founders they invest in; and
• Nearly two-thirds of multicultural founders reported that they have had more success with diverse VC firms.
• Yet, only 11% of entrepreneurs say that they have interacted with VC firms that are diverse in terms of both gender and race.

A Trillion Ignored

A trillion-dollar lost opportunity might sound fictitious, but it’s supported by findings from a previous Morgan Stanley report from 2018 titled “The Growing Market Investors are Missing.” That report contained a breakdown of how researchers arrived at their conclusion.

“To help put the cost of unequal access to capital into context, consider a scenario where revenues for WMBEs are proportional to their representation in the U.S. labor force. Using data from the U.S. Census Bureau’s 2012 Survey of Business Owners and the U.S. Department of Labor’s Bureau of Labor Statistics, we know revenues for women and minority businesses were $2.4 trillion,” researchers wrote.

“Had the number of women and minority-owned businesses and portion of revenues matched their percentage in the labor force − 56% − then 2012 gross receipts would have increased to $6.8 trillion, suggesting a missed opportunity of up to $4.4 trillion.”

This Can Be Turned Around

Researchers pointed out that VC firms can reverse this trend by taking just a few rather straightforward actions when it comes to investing in WMBEs.

“Our research indicates that with a few subtle shifts in their approach, VCs can better position themselves to take advantage of these entrepreneurs and generate superior returns,” said Carla Harris, Morgan Stanley Vice Chairman, Global Wealth Management and Multicultural Client Strategy Group Head.

Specific strategies amounted to three key points:

1. Redefine “Fit” – Adjust the definition of “expansion risk” to include WMBEs.
2. Increase Diversity – More women and more multicultural professionals in your venture capital firm increases investments in diverse companies and also decreases your overall risk.
3. Make the First Move – Develop a publicize a comprehensive strategy to increase diverse entrepreneurs in your portfolio.

More Diverse = More Profit for Everyone

Hopefully, report’s message resonated with its target audience, because there’s every reason to increase WMBE investment. Not only will it bring great returns for investors, but it’ll increase access to capital among historically disenfranchised business demographics and thereby increase growth potential. Essentially, diversity is profitable for both sides of the table and it’s well agreed upon. So now it’s time for VC firms to start taking a serious look at their approach to WMBEs.