How To Make Real Systems Change: A Case Study

A psychological phenomenon known as primacy bias causes us to fixate on the symptoms of a problem rather than the root cause. For those of us in the business of driving change - which, in today's tumultuous environment, should be all of us - the critical success factor is understanding and addressing the underlying causes of problems, rather than just fixing the symptoms. For example, you can take a pill to lower your cholesterol, but a more sustainable solution is to examine our diet and exercise habits to fix the problem at a systemic level.

The lack of diversity among the entrepreneurs who receive investment funding is a big problem that's rightly getting a lot of attention these days. By not funding entrepreneurs who are representative of the population, we miss out on valuable solutions to problems that affect the population as well as important economic growth. To the tune of $300 Billion in lost income and 9 million jobs not created, according to the Center for Global Policy Solutions. And so funds have been popping up in recent months with a focus on investing in underrepresented entrepreneurs - generally including female, black, and Latinx founders. This is important progress - and a smart investment thesis for investors. Diversifying the people making investment decisions recognizes our human instinct to support people who look like us.

But there's not enough discussion about changing the system that has resulted in this sub-optimal allocation of capital, beyond the important and more immediate step of changing the actors in the system.  Last week, I had the chance to facilitate such a discussion at the Social Innovation Summit, "Diversity the Money to Diversify the Founders," with investors representing a wide array of investment approaches, including commercial and charitable: GV, NPX Advisors, Omidyar Network, and Just Business. (While we failed to represent the racial diversity we tried for among speakers, four of the five of us are female, our ages span more than two decades, and our professional backgrounds include not-for-profit, public sector, corporate, and small privately held for-profit organizations.)

Nell Derick Debevoise

Our conversation at SIS.

The position of the panel was that to really move the needle on who's getting funded, we need to diversify the investment structures in which capital is allocated. The venture capital model is based on the hypothesis that the majority of its investments will fail, requiring a small number of its portfolio companies - one or two of every 10 - to create all of the return for the fund and its investors with a huge exit.  This model only works for businesses positioned for fast growth and dominance in huge markets.

First of all, we debunked the notion that VC as an asset class creates returns of 20-30%, which are achieved only by an elite few funds, while the average VC fund returns 3-12%, depending on the time horizon. The second important point is that there are plenty of worthwhile, and profitable, ventures that may take longer than 7 years to mature (eg IBM, Corning Glass, Steals.com), not have a logical exit strategy (eg SAS, Stella & Dot), or address a niche market that may not obviously merit a billion-dollar valuation (eg Ties.com, Blackbaud).

The calls to increase the number of female, black and Latinx investors are valid and should be heeded. But there's a larger conversation to be had about how we're allocating investment money. Venture capital funds invested $71.9 billion in 2017 to companies solving problems felt by the people investing that money, in other words, Ivy League-educated straight white men living in the metro SF, NY, and Boston areas. Only 15% of venture-backed businesses address our collective existential challenges, like food, health, financial services.

Our panel's experience investing in mission-driven businesses with a wide range of investment products, including grants, concessionary loans, equity-like debt, and patient equity, demonstrated the diverse founder portfolios that are created when you change the investment terms. (Not that women- and minority-owned businesses can't make for popular and well-performing VC funds, as Rethink VC and Backstage Capital have shown.) Indeed, research shows that women-owned startups generate more revenue and better returns for investors. Specifically, women-owned and -led businesses return 78 cents for every dollar invested, as opposed to 31 cents for companies started and led by men.

Amy Klement pointed out that the tensions created by the diversity of stakeholders involved in Omidyar Network's investments lead to improved performance by their portfolio companies. This observed effect of diverse perspectives on company performance is well-supported by research. Women and minority entrepreneurs are more likely to solve problems that matter to large portions of society, giving them large and growing markets to serve as well as the sense of purpose that has been shown to enhance likelihood of survival. Indeed, inadequate markets and lack of motivation are cited as the top causes for startup failure. In our majority-minority nation, where women control 70-80% of purchasing decisions, it's a no-brainer that founders of color and female founders will build the products and brands that win.

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https://www.forbes.com/sites/nelldebevoise/2018/06/19/how-to-make-real-systems-change-a-case-study/