Better diversity in venture capital investing might mean putting it in the contract

This week, a group of venture capital firms announced that they’re planning to make diversity a core part of their deals with startup founders.

The 10 firms committed to including new standard language in the contracts, called term sheets, they make with startup founders. It’s a diversity rider that says that the company and lead investor will make every attempt to include a member of an underrepresented group as a co-investor.

It’s not binding, but the idea is that it’ll create opportunity for underrepresented investors to participate in deals and attract founders who prioritize a commitment to equity.

The initiative was started by Alejandro Guerrero, a principal with the Los Angeles-based firm Act One Ventures. The following is an edited transcript of our conversation.

Alejandro Guerrero: I wanted funds to feel this is important, and everybody out here is talking about it, and all the founders are trying to see more, [so] that if we’re the ones signing up for it, we’re actually going to be the ones that have the competitive advantage. Because founders are looking to work with individuals that are trying to do more. [The rider] doesn’t have the teeth to say it is enforceable. But that wasn’t the point. Right? The point here is that all of us know what this is about. All of us are making a commitment. It’s going to take some effort, it’s going to take a bit of work, particularly if you didn’t have that diverse network of potential co-investors to bring in. But now it’s a reason to do that. It’s a reason to go out and build more networks, meet individuals that you can invite in, that you’ll get to know more. And then hopefully, when you build that trust, you’ll start seeing incredible new deal flow.

Molly Wood: I wonder, why wouldn’t a firm want to have a diversity rider like this?

Guerrero: I can’t speak to why they wouldn’t want to do it. Every fund is different — the way that they’re structured, their makeup, their cash, their [limited partners]. I don’t know. I can only talk about why I wanted to do it, why it matters to me.

Wood: What will success look like?

“Diversity is forever”

Guerrero: I’m hopeful that within a few years that we see this in the majority of venture funds. And hopefully founders will take it to fund and say, “Would you embed this in my term sheet?”

Wood: Best case, could you see a scenario where, as this conversation becomes more prevalent, the push from founders and the competition could also incentivize firms to bring on more underrepresented partners?

Guerrero: Exactly. That’s where I hope this is all going to go. No matter what we do, it’s not enough. Hire more people, write more checks, do the rider, create office hour program, cohorts, all of it. It’s not enough. The gap is so wide.

Diversity is forever. And if we start thinking about it in that regard, then it will become part of our normal behavior when we’re out building networks, when we’re out looking for companies, when we’re out doing deals, how we start structure them, how we advise our founders to think about building their executive ranks, their boards, all of it. [That] will give [way] to a more equitable and just world, and that’s the world that I want to live in. I’m an optimist, and I’m hopeful that that’s the world we’re going to see ourselves in, in the coming years here.

Related Links: More insight from Molly Wood

There are some notable absences from the diversity rider program: big Silicon Valley names like Sequoia, Andreessen Horowitz and Kleiner Perkins. We asked all three if they had plans to include this totally nonbinding language in their term sheets, with the goal of starting a conversation about diversity at all stages of the investing lifecycle.

Andreessen Horowitz pointed us to its Cultural Leadership Fund, an $18 million fund made up of 100% Black limited partners, whose primary investor is also Black. One of its goals is to “enable more young African Americans to enter the technology industry.” 

I should note that the limited partners who’ve put money into the Cultural Leadership Fund are pretty much all celebrities, corporate executives and some athletes. So not the scrappy, would-be investors who Guerrero said he’s hoping will get a foot in the door with something like the diversity rider.

A TP Insights piece from last month notes that the Cultural Leadership Fund has invested in 65 companies. And of those, just three have at least one Black founder and 11 have at least one female founder. Just saying: Maybe more conversations wouldn’t hurt.

Kleiner and Sequoia didn’t immediately respond to a request for comment.  

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TikTok CEO Kevin Mayer, who had just taken over a few months ago, saw that pale horse coming and promptly quit. He announced the move Thursday.

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