When even due diligence can be biased

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The venture capital industry’s corrosive gender bias, on full display in the past few months, has already cost one of its most valuable new companies billions of dollars; brought about the dissolution of one partnership; and forced the resignation of one of its most public spokesmen.

It’s also been on display at our own TechCrunch Disrupt New York conference (more on that later).

These recent events are the latest in a string of high profile conflicts between venture capital’s idealized version of itself as a meritocratic haven for free-thinkers of all stripes, and the more unfortunate reality of a business beset by the same problems of systemic privilege as any other that involves massive monied interests and a highly selective group of (mostly) hyper-educated, white, male elites as its gatekeepers.

Indeed, venture capital’s problems with women (and with people of color, and with sexual orientation) extend far beyond the obviously terrible behavior exposed in the excellent reporting done by The New York Times (which would have been impossible without the brave entrepreneurs who came forward to speak on the record about the sexual misconduct they had to confront).

It extends beyond Susan Fowler’s exposure of sexual harassment at Uber and the company’s unwillingness to address the issue.

Sexual abuse, harassment and misconduct are the most egregious and violently awful signs of a pervasive problem that the industry is in the midst of struggling to address. But that struggle plays out in a number of ways. Even in the conversations that investors and entrepreneurs have during the startup founders’ sales pitch for investment.

That’s why the study published earlier this week in the Harvard Business Review is so important. In it, the authors examined the ways that investors pose different questions to the men and women they’re vetting for potential investment dollars… and the ways that those questions and their responses impact financing.

The study’s authors found that investors tended to ask men questions about the potential for gains and women about the potential for losses. Both men and women expressed the bias against women founders.

According to the psychological theory of regulatory focus, investors adopted what’s called a promotion orientation when quizzing male entrepreneurs, which means they focused on hopes, achievements, advancement, and ideals. Conversely, when questioning female entrepreneurs they embraced a prevention orientation, which is concerned with safety, responsibility, security, and vigilance. We found that 67% of the questions posed to male entrepreneurs were promotion-oriented, while 66% of those posed to female entrepreneurs were prevention-oriented.

Importantly, this matters for funding companies. Every prevention question posed to an entrepreneur meant $3.8 million less in funding for their companies FOR EACH QUESTION. According to the study, entrepreneurs who fielded mostly prevention questions raised $2.3 million in aggregate funds for their startups through 2017. That’s seven times less than the $16.8 million raised by entrepreneurs who were asked promotion questions.

Controlling for factors that may influence funding outcomes — like measures of startups’ capital needs, quality, and age, as well as entrepreneurs’ past experience — we discovered that the prevalence of prevention questions completely explained the relationship between entrepreneur gender and startup funding.

The problem in investment isn’t just the overt physical and psychological abuse, but covert biases that block women’s ability to succeed from the start.

The research that formed the core of the study consisted of the authors observing initial due diligence between 140 investors (40 percent of whom were women) and 189 entrepreneurs at TechCrunch Disrupt New York.

The data from Disrupt came from the startup battlefield competition and was representative of judges and investors that were plucked from the arena — so representative of the industry, but not culled from the questions the entrepreneurs were asked by judges from the Disrupt stage.

The authors then tracked funding rounds for startups that launched at Disrupt. The companies, according to the study’s authors, were comparable in terms of quality and capital requirements.

Still, male-led startups raised five times more funding than companies led by women.

The study and its findings go a long way to explain the enormous gender gap in venture capital funding in the U.S.

Women startup founders raise roughly 2% of all venture funding, even though they own 38% of the businesses in the country, the study’s authors write.

That gap has only increased even as more women become venture investors.

What’s worse is that all of this flies in the face of any number of studies indicating that diverse companies, boards, and investment partnerships produce better results.

As Karin Klein, a founding partner at Bloomberg Beta, wrote in a Medium post from last year:

Study after study shows this also makes business sense: we have ample evidence that inclusive teams make for superior performance. Of the over 20,000 venture backed companies from 1997 to 2011 that Dow Jones analyzed, successful startups had double the median proportion of female executives as the unsuccessful ones.

As startups continue transform our society, it’s important to take into consideration the potential gender inclusion can have on innovation. This holds true for other diversity as well.**** Having a narrow selection committee could mean missing out.

We’re simply asking that we VCs begin to collect the data and that LPs ask us for it — a sort of transparency pledge. Women contribute to 25 percent of the GDP growth. Women are starting more companies. Women outperform men in both brokerage performance as well as hedge fund performance. Why not see how this plays out in venture capital? With so many new funds being formed, the opportunity for LPs to change the game is now.

Klein’s call for more, better data, is a good start. Data can shed a light on how to address some of the industry’s more egregious problems of financing.

Equally as important, investors and the limited partners that finance their funds should be aware of the ways in which they interact with the founders and even the would-be venture capitalists that are seeking their money.

It’s the small, unconscious biases like those that effect funding and fundraising that play as much of a role in perpetuating problems in the industry as the headline-grabbing reports.

The blatant misconduct and misogyny is (sadly) somewhat easier to identify and address, getting at the roots of bias will take a more sustained and systemic interrogation of everyone’s behavior.

When even due diligence can be biased, you know you have a huge, and complex problem on your hands.