Study: Racism hinders minority VC and private equity fundraising

Black and Hispanic-owned venture capital and private equity firms have a particularly onerous time raising follow-on funds, according to new research from Harvard, Vanderbilt and the University of Michigan.

Why it matters: This trend exacerbates existing wealth disparities between racial groups.

• Not only in terms of fees earned by fund managers, but also because Black and Hispanic-owned funds are more likely to invest in Black and Hispanic-owned businesses.

Findings: It's no secret that Black and Hispanic-0wned firms are a distinct minority in the VC/PE universe. In fact, it's something that some of the researchers had previously quantified via work backed by The Knight Foundation.

• What's new is the discovery that sensitivity to past performance is stronger for such firms than for others, especially for underperforming funds.
• Or, put another way, track records of Black and Hispanic-owned firms get less benefit of the doubt from limited partners, particularly on valuations of non-exited portfolio companies.
• It's worth noting that the researchers found no evidence that Black and Hispanic-owned firms overstate carrying values more than do other firms. In fact: "The performance of investments by exited transactions by [Black and Hispanic-owned] firms is not distinguishable from that of other groups, while the reported valuations of unexited deals (where valuation manipulation would occur) are actually lower."
• Black and Hispanic-owned firms also are less likely to raise the amount they're seeking for first-time funds, instead missing targets by between 19% and 25% more than the broader first-time fundraising market.

• The only exception is during what the researchers call "periods of high racial awareness," like after the murder of George Floyd.

A big takeaway is implicit racial bias on the part of limited partners. It's not something the researchers are comfortable saying definitively, as it's more a qualitative than quantitative judgment, but Harvard's Josh Lerner does say that the data suggests "evidence of statistical discrimination."

• Lerner adds that he and his colleagues utilized industry databases and SEC filings to determine ownership, typically using a 50% cutoff for firm founders and/or senior partners.

The bottom line: Pattern recognition is perverted when found in mirrors, rather than in portfolios.