Five years ago, in the aftermath of the George Floyd murder, Black-founded startups had "a moment" when venture capitalists (VCs) were eager to invest. In the two years after Floyd's death, the share of VC dollars that went to Black businesses jumped by 43%.
Unfortunately for those fledgling companies, and the ones that have followed, that interest and those dollars were short-lived, according to new Cornell research.
"The main increase in funding was among those investors who, before May 25, 2020, had never invested in a single Black entrepreneur. That's where you see the big change," said Matt Marx, the Bruce F. Failing, Sr. Chair in Entrepreneurship and professor of management and organizations in the Charles H. Dyson School of Applied Economics and Management, in the Cornell SC Johnson College of Business.
"It's not so much that the investors who had Black entrepreneurs in their portfolios doubled down," Marx said. "It's more so that those who had basically nothing to say before were suddenly on the scene."
"The rise and fall of VCs' interest in Black startups represented tokenism designed to burnish the VCs' reputations," said Qian Wang, M.S. '21, a doctoral candidate in management and organizations, and co-author of "Minimum Viable Signal: Venture Funding, Social Movements, and Race," which published Aug. 19 in Management Science (MS).
Marx is also an author of "Funding Black High-Growth Startups," forthcoming in the Journal of Finance (JF). In that study, the researchers found that Black-owned startups raised only about a third as much funding in the first five years after starting their firms as startups without any Black founders, even when comparing similar startups in the same industry, year and state.
Emmanuel Yimfor, assistant professor of finance at Columbia Business School, is a co-author on both papers. Lisa D. Cook, professor of economics at Michigan State University and member of the Board of Governors of the Federal Reserve, is a co-author of the JF paper.
For both studies, Marx and his team analyzed data from PitchBook, a repository for information on public and private capital markets, including venture capital, private equity and mergers-and-acquisitions transactions. The team used machine-learning algorithms to classify photos, combined with manual review, to classify the race of 150,000 founders and 30,000 investors from 2000-23 for the two papers.
One challenge, said Marx, was that with a few exceptions, it's difficult to ascertain race solely from a person's name. So the tedious work of reviewing founders' LinkedIn and other profiles was necessary.
In entrepreneurship, a "minimum viable product" is a company's first foray into the market with an item that has just enough features to be useful to consumers, and not so much investment that, should the product fail, the principals aren't out a ton of money.
Marx, formerly an engineer and entrepreneur whose research focuses on reducing barriers to the commercialization of science and technology, borrowed that phrase to characterize the fleeting interest in funding Black startups.
"The title of our paper is just a play on words, and a bit cynical," he said, "because 'minimum viable signal' is saying you're doing the least you can to make people think that you're serious."
The other key finding was that the most VCs who started investing in Black entrepreneurs after May 2020 were unlikely to invest in more than one Black business, and were less likely to engage more actively in the company - i.e., taking a seat on the startup's board of directors, not uncommon among VCs.
In the JF paper, Marx and his team refer to "screening discrimination" - the idea that an employer or VC will make decisions based on perceived group differences, even if those differences don't reflect abilities. It is through this lens that Marx found that Black startups founded by Black VCs tend to do better than those backed by non-Black VCs.
"When you have in-group applicants and evaluators, they have more information about each other, and they're going to be able to make better evaluations, even when they're not trying to be biased," he said.
Another key finding: The gap in funding between Black and non-Black startups is much smaller when looking at businesses spawned through accelerators, such as Techstars and Y Combinator (the latter co-founded by Paul Graham '86). In venture capital, it's not always what you know -sometimes, it's who you know.
"It's not that Black entrepreneurs are overrepresented at the accelerators," he said. "But by comparison to venture capital, the gap is way lower, and I attribute that in part to the fact that you can apply; you don't have to know somebody. By contrast, many VCs say that 'you need to figure out how to get a meeting with me.' But if you're not in the club, that's hard to pull off."
Marx wants to make clear, however, that he doesn't see VCs as racist.
"We looked for evidence of what economists call 'taste-based discrimination' - another way of saying racism," he said. "Because if you thought that venture capitalists didn't want to invest in Black founders, you'd think that when they do, it must be an exceptionally strong startup, and so the IPO rate for Black-owned startups that do get funded by non-Black VCs would be higher.
"But we found the opposite: Black startups outperform when they are backed by Black VCs," he said. "Again, that points to overlap in networks and shared understanding of markets that Black entrepreneurs are uniquely qualified to exploit."
