Closing the Gap: Addressing Gender Inequality in Venture Capital Financing
Gender inequality is a pervasive issue in venture capital financing, with studies consistently revealing the severe disadvantage female entrepreneurs face when raising private funds for their companies. Research shows that female founders receive only a fraction of the total venture capital dollars invested each year, despite launching companies that far outperform those founded by men. My paper attributes this imbalance to, among other things, gender bias among investors, a lack of diversity in decision-making teams, and governmental inaction. The solution: SEC mandatory reporting and disclosure requirements for venture capital firms.
The Negative Effects of Gender Inequality
American regulators have historically played a limited role in the venture capital ecosystem to avoid impeding innovation and economic growth. However, a lack of effective regulations can also limit growth and hinder the promotion of diversity, particularly the inclusion of women in the industry. Studies show that male founders raise almost 50x more capital than their female counterparts. This disparity can be attributed, in part, to subconscious biases utilized by venture capitalists during the pitch deck stage. If these biases are left unaddressed, they can promote toxic corporate practices such as ‘venture bearding,’ where women employ men as front persons. The homophilic nature of the industry presents a significant barrier to diversity, as investment decisions often prioritize minimizing risk by investing in familiar networks, which tend to be male-dominated. This is a paradoxical state of affairs given the fact that the industry is ostensibly dedicated to innovation and change. Without concerted efforts to address gender inequality, the venture capital industry risks maintaining its male dominance, potentially impeding broader economic progress.
A Possible Solution: Mandating the Joint Standards and Requiring Diversity Disclosures to Investors and the SEC
The Securities Act of 1933 and the Securities Exchange Act of 1934 grant the Securities & Exchange Commission (‘SEC’) comprehensive authority to regulate not only the offering and sale of securities, including those from private companies, but also to oversee and govern all aspects of the secondary market. This includes regulatory oversight over the major players in the industry, including securities exchanges, securities brokers and dealers, transfer agents, and private funds. Additionally, Section 342(b)(2)(C) of the Dodd-Frank Act requires the SEC to establish an Office of Minority and Women Inclusion (‘OMWI’) for the promotion of diversity in management, employment, and business activities. The OMWI Director is consequently tasked with developing standards for the evaluation of diversity policies and practices of SEC regulated entities. As a result, the Joint Standards for Assessing the Diversity Policies and Practices of Entities Regulated by the Agencies (‘Joint Standards’) were created. The Joint Standards prescribe voluntary self-assessments of the regulated entity’s diversity policies and practices through a Diversity Assessment Report form. However, venture capital firms are generally subject to limited compliance obligations and are afforded greater flexibility regarding communication, custody, and bookkeeping rules. In line with this practice, the SEC, in an explanatory statement, listed the entities subject to the Joint Standards, excluding venture capital firms, and thereby exempting them from the purview of these specific regulatory standards.
In light of these oversights, I propose that the SEC mandate the Joint Standards for all regulated entities including venture capital firms, and enforce two additional diversity reporting requirements.
The first reporting requirement is, quite ironically, inspired by Nasdaq. The SEC recently approved a rule proposed by Nasdaq, requiring Nasdaq-listed companies to disclose to their shareholders the diversity statistics of their board members, specifically their race, gender, and LGBTQ+ status. Should the company fail to have at least two diverse directors, then they must explain why that is to the shareholders. Similarly, venture capital firms should be mandated to disclose the self-identified gender of their associates and partners, in an anonymized form, to their investors. They should also require firms that do not have at least two female partners to explain why. As ESG standards put increasing pressure on institutions to promote diversity, investors could use this information to make investment decisions and capital allocations most in line with their preferences and business judgment. In fact, some firms have already started requiring such information through an ‘inclusion clause’ in their term sheets. However, partial and inconsistent implementation of such diversity measures often fails to produce meaningful progress towards equality in a growing industry. Federal regulatory action represents the main mechanism capable of compelling every entity to prioritize equality.
The second reporting measure would require firms to report the percentage of portfolio companies with a female CEO or at least one woman in the founding team to the agency. The SEC can leverage this data to create a publicly available generalized report to help benchmark the industry's progress in gender diversity over time without disclosing confidential information about any specific entity. This can also help identify areas where improvement is needed and track the effectiveness of diversity initiatives. When data is public, it can also create a competitive environment where venture capital firms strive to demonstrate their commitment to gender diversity. Firms may increase their efforts to finance more women-led businesses to enhance their reputation and market standing as female entrepreneurs, and founders may use this data to make informed decisions about which venture capital firms to approach for funding, favouring those with a better track record of supporting women-led companies.
The integration of such measures aligns with the SEC's broad authority to promulgate disclosure requirements necessary or appropriate for the protection of investors and the public in general. This is evident from the SEC’s recent proposal of a rule requiring registrants to disclose information related to climate-related risks that are reasonably likely to have material impacts on its business or consolidated financial statements, and greenhouse gas emissions metrics that could help investors assess those risks. By integrating gender diversity disclosures into its regulatory framework, the SEC would not only be reinforcing its commitment to investor protection and market fairness but would also be acknowledging the importance of social responsibility in the investment world.
Without mandatory reporting requirements, it is unlikely that regulated entities willingly disclose pertinent information regarding their diversity initiatives. The SEC possesses the requisite expertise and nuanced understanding needed to effectively implement equity strategies targeting the world of private investment. As a prominent regulatory body, the SEC often sets a benchmark for financial regulations and guidance worldwide, and this move could inspire similar measures in other countries, promoting a more consistent approach to gender equality in the industry. Such requirements could directly affect multinational venture capital firms, necessitating the alignment of their international operations with these new US standards and potentially influencing gender diversity practices in venture capital financing globally.
Janhvi Patel is a J.D. Candidate at William & Mary Law School.
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