Venture capital’s diversity problem isn’t just bad PR — it’s bad for business

Ellen Pao, Therese Lawless, Alan Exelrod

Legendary venture capital firm Kleiner, Perkins, Caufield & Byers was cleared of any wrongdoing in last week’s sensational trial alleging gender discrimination against Ellen Pao, a former member of the firm.

But there’s no question that the venture capital world suffers from a lack of diversity — a situation that persists even though researchers at the country’s top business schools have shown it’s bad for business, which should be the bottom line for any investor.

One study, from researchers at Harvard, Wharton, and MIT, found that prospective investors were more than twice as likely to back a male entrepreneur over a female one, even when they gave identical startup pitches.

Harvard Business School researchers have also found that when VCs partner with investors from another firm — a common practice in the biggest deals — they are more likely to choose a deal partner who comes from a similar background. But doing so actually hurt financial returns in the long run.

Another HBS study has also shown that women, who are in the minority among venture investors, tend to get less help from more senior mentors in the industry — and that affects their performance, pushing investment returns down across the board.

“You’d think they’d be incredibly smart, open-minded people,” said Paul Gompers, an HBS professor who has studied the dynamics of venture capital. “But their organizations certainly fall along a pattern that could be improved upon.”

One study that Gompers co-authored looked at the dealmaking and biographical details of about 3,500 VCs over nearly 30 years. It found that the more alike two VCs were, the worse they did on deals together: the likelihood of a successful investment dropped by 18 percent if the two VCs had previously worked at the same company. The probability of a good return dropped by 22 percent if the two investors went to the same college as undergraduates. If investors were from the same ethnic minority group, their financial performance sunk by 25 percent.

“People who have the same background generally view the world in similar ways, and you’re decision-making has correlated errors — you’re likely to make the same mistakes,” Gompers said. “Having diverse individuals around the table provides an opportunity to look at problems in different ways, and can lead to better decisions.”

In the study examining financial performance by women in VC, Gompers and his co-authors found that women in VC between 1975-2003 performed about 15 percent worse than their male counterparts, after controlling for other factors. The gap, they said, “is largely attributable to a lack of contribution to performance from a female venture capitalist’s male colleagues.”

“Performance in venture capital is more of a team sport. It’s not golf — it’s more like basketball,” he said. “Your performance certainly hinges on how good you are, but for most venture capitalists, how good your partners are certainly enhances your own performance.”

So if it’s clear that a lack of diversity hurts financial returns, why are venture firms still so male-dominated? There aren’t many clear-cut answers. But a large part of the problem is probably a matter of culture: venture capital has long been a relatively small, person-to-person “cottage industry” compared to other financial industry careers.

That means firms tend to be smaller in size, and since they operate largely as private partnerships between a relatively small number of business owners, there isn’t the kind of proactive human resources infrastructure that you might find in a more corporate job.

Gompers, in fact, was a paid expert witness for Kleiner Perkins in the Pao trial. His testimony illustrated the general lack of women in venture capital, but also was used to highlight Kleiner’s relatively good track record in having women as investors and heads of portfolio companies.

“I don’t think that these venture capital organizations where women haven’t done as well are bad people. It’s just that I think they need to rely more on formal structure,” Gompers said.

The situation also may improve with time and generational turnover, provided that women remain interested in making headway in a male-dominated profession, either as startup executives or the investors who back them.

Michelle Tandler, an HBS student who also works for VC firm Trinity Ventures, said the Kleiner/Pao trial led to plenty of questions from her friends. “I was getting asked all the time: are you nervous to get into venture?” she said.

But for Tandler, who grew up in San Francisco and saw some familiar faces in the Kleiner trial coverage, the daunting part of a career in venture capital has more to do with its intensely competitive nature and the low likelihood of finding success: “I feel that I would be extremely challenged in this industry, but not because I’m a woman — because it’s extremely challenging.”

In fact, Tandler said, she’s found that venture capital firms are very interested in finding women to add to their teams, but aren’t yet finding enough women to fill those jobs. “I actually think there’s a funnel problem, and there aren’t as many women trying to be VCs,” she said. “I’m still very optimistic, because I think the industry is recognizing this, and it just might take more effort to go find women.”

Jo Tango, a founder of Boston-based VC firm Kepha Partners, has bumped up against the lack of diversity his whole career. Tango said he was one of only two Asian-Americans in the VC sector around Boston when he started in the late 1990s.

Tango said he admired Pao for filing her lawsuit and taking it to trial, rather than accept any possible settlements. And it’s had an effect, he said, generating repeated conversations about gender and bias issues between Tango and his two partners, who also are men.

In the end, Tango said, busting through the diversity logjam in venture capital will likely rely on a heavy dose of the disruptive attitude that venture firms look for in portfolio companies that can upset the status quo in other industries.

“The irony of venture for a long time was we fund disruption, but we’ll never be disrupted, because it’s all about the top 10 brands,” Tango said. That has changed in recent years, however, with a rise in successful new large firms, such as Silicon Valley heavyweight Andreessen Horowitz, and ultra-competitive early stage accelerator programs, such as Y Combinator.

“The only thing you can really do to change things is get access to the seats of power and act accordingly,” Tango said. “Make visible the issues you want visible.”