Investors who back VC funds are worried about Valley culture

Limited partners in venture capital funds are having conversations about how to prevent themselves from investing in the next Binary Capital, the Silicon Valley firm that has collapsed over allegations that one of its co-founders sexually harassed female entrepreneurs. This includes the largest LP trade group – the Institutional Limited Partners Association – which tells Axios that it is planning to address these issues this summer, as part of the development of its new ILPA Principles 3.0 document.

Why it matters: Silicon Valley, and venture capital in particular, has swept sexual harassment under the rug for decades. Binary Capital, coming on top of the situation at Uber, has grabbed that rug and begun to shake it vigorously.

Who are limited partners in VC funds? Usually institutional investors, like college endowments, pension funds and charitable foundations. Also a lot of funds-of-funds that invest money on behalf of those aforementioned groups.

A big problem: Investing in a VC fund is really investing in people, even more than investing in a startup. But LPs rarely spend more than a few hours face-to-face with prospective managers, and often live outside the startup hotbeds where it's easier to hear market rumor. Instead, they often rely on past investment performance (which wouldn't reflect something like harassment) and references (both "on list" and "off list," if they're doing proper due diligence). The reality, however, is that few in the venture ecosystem are willing to be honest with LPs are the personal failings of a peer, particularly if it's a former colleague launching a new firm. Even if that colleague is only "former" because they've been told to find a new place of employment.

Need proof? When's the last time you heard of a VC being fired from his or her firm, outside of some extraordinary situations that involved outside legal action (e.g., Michael Goguen with Sequoia, Ifty Ahmed with Oak). Instead, firms ask troublesome partners to leave, and then play along with cover stories like the ex-partner leaving "to pursue a different investment strategy." Binary is an obvious example of this happening, but it's hardly unique.

What can LPs do? For starters, many LPs need to improve their due diligence. "Check the returns and check the box" no longer cuts it and, if an LP walks into the next Binary that way, they deserve what comes from their superiors. There has been some talk of inserting morals clauses into LP agreements, and that could be helpful if well written. A better option, however, could be to require that any allegations of sexual harassment, discrimination (sexual or racial), violence or other misdeeds by a member of the VC firm be confidentially reported to the firm's limited partner advisory committees (LPACs). Even if no action is taken, the largest fund investors would be aware, and it would better inform future commitment decisions.

What VCs can do: Stop covering up for bad behavior. Perhaps you are legally prohibited from telling an LP why a former partner has gone solo, but that doesn't mean you need to give a reference. An un-returned phone call can speak volumes without counting as defamation. If you believe your partner harassed women but you still tell LPs that they should support his new fund, then you're Silicon Valley's version of Catholic Church officials who moved around pedophile priests.

What's promising: I never before recall hearing LPs discuss these issues. Change is coming.