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A Hidden Market: Why Venture Capitalists Should Prioritize Diversity

drawing of two capitalist men holding hands

A recent report published by Morgan Stanley has revealed that there exists a trillion-dollar market inefficiency – and investors, entrepreneurs, and consumers are all losing. What’s the culprit? A lack of investment in companies founded and led by women and people of color.  

Surveying and interviewing over 100 venture capital investors, researchers found that although these decision makers understand that investing in women and ethnic minorities is likely to be lucrative, it is still not at the top of their agenda. More specifically, 83% of investors believe they can “maximize returns” in companies led by women and people of color, however three in five also admit that “prioritizing investments in women and multicultural entrepreneurs is not a firm-wide priority”.

So where does the problem lie? Carla Harris, Vice Chairman at Morgan Stanley, asserts in an interview with CNN that venture capitalist firms are being “held back by their historical behaviours”. Venture capital funders should conduct a Personal Capital review, double check their biases, and take action to integrate more inclusive policies for vetting and funding early stage entrepreneurs.

Investing in Diversity: A Huge Opportunity

Estimated to be nearly $4.4 trillion dollars, researchers at Morgan Stanley urge funders to think about why investing in diverse startups is not only good for their pockets, but also good for consumers.

Traditionally, startups have been led by predominantly white males who went to prestigious universities. While this has given birth to renowned tech leaders like Mark Zuckerberg, there is still potential in the market to address other consumer problems – problems only women, people of color, or ethnic minorities can solve.

According to Harris, they “represent new market opportunities as the demographic shift continues”, and due to their unique personal experiences, they have the insight and ability to serve the needs of these growing markets. However, investors are still hesitant to fund these individuals, despite recognizing these leaders could help them tap into new or underserved markets. 

The Barriers and Need for a Personal Capital Review

If funders recognize the value that diverse entrepreneurs bring to the table, why are they not investing in them? Harris believes it’s due to historical behaviours and inherent bias. For example, she mentions investors’ outdated sourcing and vetting methods which rely heavily on existing social and business networks. Unsurprisingly, women and people of colour can find it difficult to break into these networks; making it very difficult for them to develop the right relationships with decision makers over time. 

The Way Forward

Not all hope is lost; the sheer fact that funders recognize the value in investing in more women, people of colour, and ethnic minorities is the first step towards an honest Personal Capital review. However, the next step is to improve the processes and specific actions around the venture capital investing process. 

In the full report, Morgan Stanley suggests investment firms should increase transparency in the decision making process, set reasonable targets, and develop a more inclusive screening and vetting procedures. In reality, this could look like hosting more demo days and conferences targeted towards minority business leaders. Firms could also incorporate the use of more startup incubator programs, instead of relying so heavily on existing networks. To measure impact, Morgan Stanley also suggests tracking and monitoring diversity initiatives in order to make improvements to the process over time.

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