Is PE and VC fundraising landscape tilted against minority-owned managers?

Black and Latino-owned funds under more pressure from past performance, suggests research

Is PE and VC fundraising landscape tilted against minority-owned managers?

Black and Latino-owned private capital funds are affected by prior performance criteria more than white-owned funds when fundraising.

That’s according to a study titled "Racial Diversity in Private Capital Fundraising," which also found that minority-owned venture capital and private equity buyout funds are more likely to be judged harshly for past performance when soliciting investments for a second fund, reported Institutional Investor.

The research was conducted by Johan Cassel, an assistant professor of finance at Vanderbilt University; Josh Lerner, a professor at Harvard Business School; and Emmanuel Yimfor, an assistant professor of finance at the University of Michigan.

This trend reflects broader investor prejudices against minority-owned funds, including limited diversity in the asset management sector. Even though minorities made up 40% of the population in 2016, only around 1.4% of the assets under management in the U.S. were managed by companies owned by minorities in 2021, according to one of Lerner's earlier publications.

Read more: Canadian private-capital industry lagging in diversity

The asset management business is notorious for its homogeneity, but the causes of this lack of diversity are less well understood. Cassel, Lener, and Yimfor focus on venture capital, buyout, and growth investment businesses in their report as they consider potential causes.

The paper also mentions prior studies that revealed investors like to support entrepreneurs they share common characteristics with. Because of this, minorities may encounter considerable challenges while beginning a business, a crucial means of generating wealth.

Based on the data they used in their analysis the analysis, the researchers made three preliminary conclusions. First, they discovered that minority-owned funds in the U.S. are three to four times more likely to support minority entrepreneurs than majority-owned funds.

Second, the amount of capital raised by U.S. funds owned by Black and Latino investors is "modest."

Third, the authors discovered that getting money for a first round of funding is frequently more challenging for minorities.

The authors' examination of Form D filings revealed that white-owned funds are more likely than Black- and Hispanic-owned funds to reach the fundraising goals for their first funds.

Read more: What are private investors thinking about?

Turning to the potential causes of these inequalities based on the economics of discrimination, the authors proposed two hypothetical explanations.

“If there were many more minority-owned groups with low expected returns, even after controlling for observable characteristics, we would also observe that the success rate in first-time fundraising is lower for minority-owned groups,” Cassel, Lener, and Yimfor wrote. “Alternatively, the differences may be driven by preferences on the part of the limited partners (taste-based discrimination).”  

According to the paper, Black- and Hispanic-owned funds exhibited three times higher performance sensitivity. While all funds that showed high performance when raising funds for a second fund were more likely to be successful in that second raise, the authors noted a “striking” disparity with minority-owned funds being more impacted by past performance than white-owned ones – particularly on the downside – when it comes to fundraising for a second fund.

“[W]hen they are performing well, then minority funds are as likely as non-minority funds to raise funds, but if the performance deteriorates, investors are much less forgiving,” Cassel told Institutional Investor.