Startup Biases

Startup Biases is a project that grew out of a prior paper, The Landscape of Startup Corporate Governance in the Founder-Friendly Era, which employed survey and interview methods to understand the current state of startup corporate governance from the perspective of experienced lawyers in venture capital financings. One area of the paper that needed further study was the topic of diversity, equity, and inclusion (‘DEI’) in venture capital-backed startups. DEI issues are generally not prioritized in corporate governance among private companies; instead, the focus is on growing as quickly as possible. I shared some of my initial thoughts on why DEI was important to address in the startup context in an op-ed piece for TechCrunch which eventually culminated in Startup Biases.

Women and racial and ethnic minorities remain woefully underrepresented in startups; private ordering has not done much to change this reality. Unlike public companies, which must abide by a robust set of rules and regulations, startups are governed by private ordering which essentially means that the development of corporate governance terms depends on whether or not founders or investors prioritize such development. Although numerous studies have concluded that diverse teams lead to better outcomes in startups, little progress has been made. In fact, venture-backed startups are notorious for their glaring lack of diverse founders, management, boards, and investors. Much of the scholarship has focused on how to diversify the boards of public companies, but a more holistic perspective that looks at the entire innovation ecosystem is needed in order to gain any traction on DEI issues.

In this paper, I fill a gap in the current scholarship on gender and race in corporations by addressing the lack of diversity from a private company perspective. It offers an original descriptive account of DEI issues in the startup context and shows how a set of processes and practices emerged in venture capital financings that continue to impact every aspect of the venture capital ecosystem from who gets funded to what terms are negotiated to who sits on the board. Using a three-pronged approach, this research documents the persistence of startup biases, shows how public versus private companies address bias, and considers both legal and non-legal solutions to combat bias.

I begin by tracing the history of venture capital, which continues to be dominated by white males to this day. Next, I illustrate that in attempting to replicate startup successes those who fund startups rely on the homophily principle (similar to birds of a feather flock together) which means that startup biases stubbornly persist and are embedded in the fabric of the startup ecosystem. Less diversity in the startup ecosystem comes at a cost—there are fewer innovations. I then examine steps taken in the public company context at both the federal and state levels to determine if similar tactics can be employed in the startup context, but ultimately conclude that it would be difficult to implement them in the private company context. Private companies do not have the same type of levers as public companies, and much of their inner workings are opaque. Corporate governance mechanisms are implemented as startups see fit, and the founders drive the process of when they are implemented. Sometimes outside forces, such as social movements, can move the needle, but generally the focus is on how to grow the company quickly; DEI issues are rarely prioritized. While private ordering gives private companies maximum flexibility in terms of corporate governance, it also gives them the ability to ignore DEI issues. In addressing the issue of startup biases then, the work cannot be limited to the board level, but must include the entire startup ecosystem: founders, investors, limited partners, employees, board and executive composition, and startup culture.

Litigation is generally not used as a lever to effect change in startups due to the reputational risks and costs. However, there are other alternatives that could help to diversify the venture capital ecosystem. During the founder-friendly era of the past decade, DEI initiatives have been neglected in favor of a focus on startup growth. This has resulted in a patchwork of DEI initiatives that will likely continue unless diversity is purposefully incorporated into startups. A holistic approach is required to tackle startup biases and generate meaningful and diverse change in the startup ecosystem. Otherwise, we may lose out on innovation. I propose both legal and non-legal solutions to combat startup biases ranging from undertaking legal reforms that are applicable to unicorns and investors of a certain size; diversifying investors and limited partners through diversity riders and limited partnership agreements; recruiting more diverse limited partners (eg, HBCUs); changing the management fee and carry structure; capitalizing on the momentum from social movements such as Black Lives Matter by creating more funds focused on historically underrepresented groups in startups; mandating greater transparency on diversity metrics; and rethinking hiring practices and mentorship structures. Without a holistic approach to diversify the startup ecosystem, startup biases will continue to impact our innovation ecosystem in detrimental ways.

Jennifer S Fan is the D Wayne and Anne Gittinger Professor of Law and Associate Dean for Research and Faculty Development at the University of Washington School of Law.