AUTHENTIC INCLUSION

Foundational diversity strategies for private equity & venture capital

By Mercedes Chatfield-Taylor

Private equity has predominantly been a white, male-dominated industry since its inception — that much is undeniable. And although the subject of diversity is discussed more frequently in PE today, the progress at many firms has been insignificant, well-stated intentions notwithstanding. Consider that just 2.6% of active U.S. PE firms are led by women, according to Pitchbook data. Among venture firms, the nonprofit All Raise reports that 71% of venture capital firms have no female partners. Minority representation is even more scarce.

Still, the marketplace has a way of gaining the ear of private equity and their venture capital brethren. And, as has been the case with other industries, the marketplace has been increasingly vocal in advocating for diversity.

So far, venture capital’s limited partners, institutional and potential IPO investors have shown interest in promoting diversity, and some high-profile startup founders have even refused funding from non-diverse firms. Consumers, customers, employees, and potential executive hires are also increasingly advocating for improved diversity on the boards and leadership teams of venture and PE-backed companies.

Diversity is a growing imperative for every boardroom, and the calls for boards and leadership teams that reflect the diversity and broader economic realities of their customer base will only get louder from here. And, the reward for heeding these calls can be great. Repeated studies have shown that diverse leadership teams provide a business performance edge — call it a credit to diverse viewpoints leading to better decision-making.

At Artico, we understand that the time has come for diversity to be a foundational business strategy for PE and venture firms and their portfolio companies. But we also understand the complexities inherent in this mandate: Diversity must be pursued in a way that is as thoughtful and intentional as every other element of the business strategy.

Getting an Early Start

In order to understand the nature of the challenge facing VC and PE firms, it’s important to understand the diversity imperative within the larger context. Securing the highest-quality leadership talent has always been a non-negotiable for PE and venture firms. Meeting the time-sensitive business goals set for portfolio companies requires nothing less. But the tendency of PE and venture firms to return to a small population of tried-and-true portfolio company executives time and time again has effectively created a roadblock in terms of diversifying leadership teams.

New strategies for recruitment, retention, and leadership development are required to expand the strategic talent horizons for PE and venture firms. Diversity needs a robust pathway in, and talent management practices must address inclusion for retention beyond the mandate of hiring diversity.

Building a market-ready, diverse company should begin well before any intended liquidity event. It needs to be a foundational piece of the company’s business strategy and include hiring diverse talent at all levels within the company. Company leadership should map out plans to include diversity of expertise, age, ethnicity, race, religion, gender, and sexual orientation. Showing a diverse leadership face to the world early on — even when the portfolio company may have only a half dozen employees — is important to the company’s ability to hire diverse talent as it grows.

When working with clients, we strongly emphasize the value of building diversity early on. Busy founders often include diversity as a business goal — -but it resides way down the priority list. That is a mistake. Evidence suggests that homogenous organizations only become more homogenous as they scale up. Working with the same principle — amplified by intentional strategy — diverse organizations can more naturally continue to foster diversity as they grow.

At Artico, we also find it valuable to introduce high-potential talent to PE firms long before a specific role is on the horizon. This allows the firms and the talent to get to know one another, understand the rising leader’s capabilities and goals, and establish the leader as a ready candidate when the right position comes along. This can be a particularly effective way to introduce diverse talent into the pipeline.

Putting Strategies into Action

As in all executive search, the key to broadening the pool of highly qualified candidates is widening the aperture. Relying on personal networks and referrals can be toxic to diversity, as those networks usually deliver more of the same. Acknowledging the presence of unconscious bias and potentially using blind resumes takes a step in the right direction. And PE and venture partners who will be decision-makers in the hiring process should be counseled to work from objective standards when reviewing candidates, rather than citing cultural fit and other intangibles.

Constructing the list of candidate profile requirements more carefully also widens the aperture. Too often, executive search profiles unnecessarily narrow the candidate pool based on a proliferation of “must have” profile requirements. But is it imperative that the next CFO of a company in, say, the DevOps space has experience bringing a PE-backed DevOps company through a liquidity event? CFO experience in a company with a similar go-to-market motion in a high-volume, low-touch technology company might be equally relevant, while also broadening the candidate pool to include diversity.

If diversity is not already present in a portfolio company, a good opportunity to recalibrate the board and leadership team comes when the company transitions away from being a founder-led organization — often led by a collection of the founder’s personal contacts — and brings in a professional management team. This broad introduction of new leadership allows a rethinking of the best profiles for numerous roles for both the management team and board.

To be clear, all Artico slates present only the most qualified candidates for the role. That is our mission and our commitment to clients. And a slate is unlikely to include only diverse candidates. Yet, the repeated inclusion of diverse candidates in a series of slates tends to have its impact — and this is also an important commitment for us.

The Cost of Lacking Diversity

To build organizational support for this strategic shift to diversity, firms need only review the financial cost and opportunity loss that accompanies a lack of diversity.

When it comes to both deal generation and access to funds, this cost is getting clearer. A growing number of institutional investors — including giants BlackRock and State Street — have adopted social value guidelines that influence their investment decisions. The lack of a diverse leadership team or board might prove exclusionary. KKR’s George Roberts has stated that the firm plans to have at least two female directors on every KKR portfolio company board.

On the talent side, non-diverse companies can lose access to a significant population of leaders. When diverse candidates are approached to become the first-and-only diverse member of a fully developed leadership team, the usual response is “No thank you, I don’t want to be a token.” As ever, the most qualified leaders have many options, and they prefer to join a team that values their presence and input. This dynamic can have an ongoing impact, as that non-diverse company then finds itself denied access to future hiring of the best diverse talent.

The performance cost of homogeneity is well documented. Harvard Prof. Paul Gompers led a recent study of venture capital investing that found greater similarity among investment partners led to lower investment performance. Attending the same schools was shown to lower average performance by 11.5%. Shared ethnicity among investment partners reduced the comparative investment success rate by more than 25%.

Another recent study of PE and venture funds in the emerging markets area (representing $800 billion in assets) found that gender-balanced senior investment teams generated returns that were 10–20% higher than those with majority male or majority female leadership. The study was conducted by the International Finance Corp., a member of the World Bank Group, in conjunction with the alternative investment firm RockCreek and consultancy Oliver Wyman. The report defined gender-balanced leadership as including at least 30% of the team’s minority gender. The study also reviewed portfolio company performance, finding that companies with gender-diverse leadership teams outperformed the less diverse companies by 25%.

“Different ideas, attributes, skills, faces — companies need all of these to compete for talent, win customers and make great decisions,” said Hilary Gosher, managing director at Insight Venture Partners. “Diversity is about winning.”

Retaining a Diverse Team

The commitment to retain a diverse team must continue after the leaders are on board. Building a culture of inclusion, acknowledging and addressing unconscious bias, attending to employee personal development, and mapping out viable and attractive career paths are all part of retaining a top-performing diverse team. It’s no different than any other top-performing team — companies need to work to build them, and to maintain them.

Significantly, diversity will not look the same at every company, nor should it. Diversity relates to adding leaders who have different attributes than those already at the company. And the collection of attributes present among the leadership team should reflect the company’s customer base.

It is time for PE and venture firms to bring women, minorities, and other diverse individuals into their organizations. The alternative is to watch them establish their own firms — and become competitors. Some PE leaders tell us that other executive search firms say it is too difficult to develop a shortlist of high-potential diverse talent. You will never hear that from Artico. Our talent connections are robust.

At Artico, we are committed to always identifying the best candidate for the role. PE and venture firms are dedicated to returning shareholder value through their investments. Without any compromising of those goals, we can partner with PE and venture firms to thoughtfully employ practical and proven best practices to build appropriate leadership teams and boards for portfolio companies — recruiting talent that will serve them well now and into the future.

About the author

Mercedes Chatfield-Taylor; San Francisco

The go-to search partner for venture capital and growth equity firms and their portfolio companies, Mercedes co-founded Artico with Matt Comyns to lead the growth executive search team. Mercedes is passionate about diversity and inclusion across investor and operating roles. She has deep expertise across consumer, fintech, security, SaaS and other transformative technologies. Mercedes has completed over 75 CEO searches as well as partner, principal, and other CXO level assignments. She led the venture capital practice at firms including Caldwell Partners, Heidrick & Struggles, Highland Partners, and iCOM a boutique search firm she co-founded in 1999. A graduate of Boston University, Mercedes is based out of San Francisco, with offices in Austin and New York.

mchatfieldtaylor@articosearch.com