This column was published in What Investment magazine in September 2020.
By Matthew Cushen
Imagine having a meeting with an investment manager. They run you through their investment thesis, their portfolio and the help they give to the businesses they invest in. You are liking what you hear. Everyone stands up to leave, and the investment manager politely opens the door for you to pass through. Then you glance back to find they have left a trail of cash behind them. You’d likely think that negligent, possibly arrogant and certainly wasteful.
But that is what most investment managers are habitually doing. Leaving cash on the table. Our industry’s woeful record of bias and exclusion directly impacts investment returns.
An investment manager’s record of inclusion and of funding diversity is not just about whether they are doing the right thing for our society. That’s important and we may well find that society becomes more demanding that capital is deployed more inclusively. But it is fundamentally a measure of the manager’s ability to overcome their inherent conscious and sub-conscious biases and therefore their ability to access and appreciate the highest potential deals.
For early stage seed investing, the only investment area I can speak for, only 9% of equity funds are directed to businesses with a female founder and only 1% goes to all female founded businesses. London gobbles up 73% of funding, leaving just 27% for the rest of the country. (All sourced from The Deal, Beauhurst, February 2020). We cannot even find any decent benchmarks for ethnicity.
Do we really believe that women, as 50% of the population somehow only have 9% of valuable propositions? Or that regions outside of London are so less capable of surfacing fast growth businesses? Or a BAME founder has less of the tenacity & resilience that are pre-requisites for a being a successful entrepreneur?
Most investment managers I speak to are pleasant people and conscientious in their investing activities. Few are likely to deliberately go out of their way to harm the community around them or to damage their potential returns. But unfortunately, very few are even understanding their own performance for how they are directing their funding. They are either unconsciously incompetent or recognise the issue and avoid casting light on it.
Having been angel investors for over ten years, my mate Paul and I set up a small venture capital business five years ago and we have a fund through which other investors can follow us whilst benefiting from all the tax advantages of Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS).
We are two white, middle class, greying, blokes living in/around London. Much like most of the investment profession. But we believe ‘genius is evenly distributed, opportunity is not’ (quote often attributed to Mitch Kapor who created Lotus 1-2-3). So we deliberately designed our investment approach to reduce the influence of our innate bias.
The unhelpful bias is in our sub-conscious, so we’ll never know conclusively we remove it. However, we can look for clues in some data. Our Start-Up Series Fund, over the last 18 months, directed 12% of funds to businesses a fully female founding team and 38% to business with at least one female founder. 19% of funds to businesses with a non-white founder and 81% of funds into businesses outside of London.
To stress, this is not the result of any positive discrimination. These numbers stem from baking five ingredients into our approach to attracting and distilling deal flow.
The Start-Up Series competition: most investors do relatively little to proactively attract deal flow – it is usually the case that those that need capital have the job of seeking out and approaching those with capital. Warm introductions are 13 times more likely to reach investment committee and be funded than cold submissions (source: UK VC & Female Founders report, British Business Bank, Diversity VC & BVCA, February 2019). Inadvertently perpetuating funding of people from similar backgrounds to many investors – white, middle class, middle aged & London based. We have a unique source of deal flow, the Start-Up Series competition. It is super easy to enter (then very hard to win), it removes barriers and is promoted nationwide.
Transparency: our competition usually runs each month, and the distillation process for the six weeks following. The six-stage process is clear and transparent to the entrepreneurs and the criteria used is published as part of the feedback given to those that are unsuccessful. Then we are creating more visibility of our data. It’s harder to be biased if others have the information to hold you to account.
Ditching the pitch: we don’t ask anyone to ‘pitch’ at any point in our competition. Too much emphasis in early stage investing is put on the ability to pitch an idea, where confidence and bravado (often the privilege of those who have been fortunate to go to the better schools) can disproportionately outweigh insight, analysis and thoughtfulness. We still value the ability to succinctly put across a market insight and idea (the first part of our competition only asks for a 2-page summary or a 2-minute video), but this doesn’t have to be face to face where personality can overcome commercial nous.
Market insight: our investment criteria place a heavy emphasis on the attractiveness of the market and the strength of the market need. We value market insight very strongly – if you have inspirational & differentiated insight there is more chance you will have created a differentiated proposition. Location, ethnicity and gender are likely to have a role to play in the strength of empathy with real consumers and the ability to see problems that need solving or opportunities to be exploited. Often people based in London can have an abnormal view on real life for the families or high streets across the UK. Ethnic populations and behaviours make up huge and fast-growing markets. There is some science that shows women are generally more empathetic to the world around them and therefore create stronger insight.
Business model: when we look at the economics of how a business grows, there is some attraction in being based outside of London and the South East. The market for talent is less competitive and better value and property costs are cheaper.
We have further to go. On the data, we track entries to our competition for gender and region but do not yet track for ethnicity. We are going to start to do so when our competition re-launches following a corona-break in September. We are getting more granular with the data through all stages of our investment process. Then the big question we ponder is why 40% going to female founders is not 50%? And we haven’t even started to understand the dynamics of our investor base and what we could do to make that more inclusive.
So, for investors and their advisors, what’s the take-out here? We all have biases, mostly sub-conscious. When talking to investment managers question them on how much cash they are leaving on the table. How are their biases being actively eliminated? Is there commercial and investment logic in the spread of resulting portfolio of investments? What are their stats on diversity? Whilst no investor should positively discriminate, an unbiased process for deal flow, distillation and criteria should end up with a portfolio which mirrors the entrepreneurial talent in the country, rather than mirroring the look and location of the investment professionals making the decisions.