Smaller funds, those that have $50 million or less in assets under management, are helping to usher in a new wave of diversity within venture capital. And the reasons for this are simple.
The latest crop of investors stems from historically overlooked or marginalized communities that are setting up funds and then investing back in those funds. “Small funds operate with a sense of purpose, leveraging their limited resources to drive positive change and foster diversity in the entrepreneurial landscape,” B. Pagels-Minor, the founder of DVRGNT Ventures, told TechCrunch+.
Emerging managers often target early-stage companies with diversity in mind, which is important because many of these companies do not last long enough to make it to, say, a Series B. The dearth of later-stage Black companies is in part tied to a lack of early support at the pre-seed and seed-stage levels.
Though many small funds do not explicitly have a diversity mandate, a considerable number of these funds are led by those from underrepresented backgrounds; larger funds, on the other hand, are lacking talent from diverse communities. This in itself creates an opportunity for smaller fund managers to step in and back the founders being overlooked and ignored on a higher level.
Ramzi Rafih, the founder of the London-based No Label Ventures, has a fund that focuses on backing immigrant founders within Europe. He says that the community is still undervalued in the startup ecosystem compared to the U.S., where such immigrants account for more than 50% of all unicorns. “If we can focus on solving obstacles faced by immigrant founders and make them more visible to VCs, we think we can deliver outsized returns to our investors,” he told TechCrunch+. This means often being the first investor in a round and connecting a founder with other investors and corporate clients, as well as helping with visa issues.
No Label is trying to fill the gap left by some larger funds, which often don’t support diverse talent and instead leverage the network they’ve built over the years. Many larger funds also simply do not know how to diversify their network, or they don’t know or agree that investing with diversity in mind can create outsized returns.
“Being small allows us not to compete with VCs to win founders but play a very different game to them,” Rafih said. “It allows us to be very focused on our sourcing, and as a result, we find immigrant founders very early, usually before other VCs do. We are often among the first investors to back them. When we back them, we usually write checks big enough to help them get traction in their raise and small enough to leave space for a top VC to come in and lead the round.”
And because diversity within venture is still considered nascent to many limited partners, smaller funds raising less institutional capital gives them more leverage to take risks, which is what investing in diversity is seen as.
“At larger scales, such as funds exceeding $100 million, it becomes increasingly challenging to generate substantial returns for investors. This is particularly true for funds that primarily target later-stage investments, where the emphasis is solely on the potential for high returns,” Pagels-Minor said. “However, it is crucial to recognize that a wealth of data supports the notion that embracing diversity can de-risk investments and lead to better financial outcomes.”
Still, building a brand is important for creating awareness with limited resources, and the role of a smaller fund is often split evenly between raising awareness and cutting checks. “It comes down to the reach of our communities, the lived experiences we use as investors to judge founder-fit, and our ability to authentically lead as investors, fund managers, and diverse individuals ourselves,” said Madeline Darcy, managing partner at Kaya Ventures.
Though the increase in smaller funds is helping shepherd diversity within venture, there are still challenges that make such efforts strenuous. It can take a while to raise and thus deploy a fund when you are a diverse fund manager looking to back diversity, creating an extended timeline. And smaller funds are working with less money in which to operate, meaning less money on hiring, events and investing in programs, compared to larger funds.
The industry could also use more large players with at least $100 million AUM to sustain growth and stability within this newly nubbed niche market. This provides more opportunities to diverse fund managers and founders, as well as helps prove the viability of the market. Perhaps the biggest challenge is still that limited partners do not believe diversity leads to financial returns, backing the sector into a corner and billing it as niche based on their own limited understandings regarding the mass appeal and desire for more diversity.
Compounded with the lack of LP push is the lack of care from larger fund managers. It would be ideal for larger funds to take the lead in this conversation. The industry runs on the mantra of FOMO, and larger funds taking a serious stance and actually deploying capital to diverse founders would signal to others that there are opportunities in doing so.
This, paired with the work happening with smaller funds, could help create a pipeline where early-stage companies can filter through and receive opportunities for later-stage funding that can then help them grow. It could also create more prospects for emerging fund managers and reveal other creative ways to boost inclusion, like pouring more money into institutional endowments, such as the Historically Black Colleges and Universities, to establish a pipeline of talent into venture capital.
But this will take a committed effort over a long period of time and necessitates a change in the way power and resources are allocated. “Many still don’t see the case for making venture a more diverse ecosystem,” said Darcy, speaking of more traditional VCs. “Though we saw a lot of progress post-George Floyd, we are now seeing many of those efforts scale back, including LP commitments to diverse emerging managers, promotions, and hiring of more diverse investment teams, and more funding and support for diverse-led startups.”
The surge in smaller VC firms is fueled by necessity, but there is still an unsustainable amount of pressure on those at the bottom to maintain what is a structural issue at the top. The current gaps in the ecosystem right now only equate to an opportunity to foster change. The more, the better, until one grows into an oak.
This piece was updated to reflect B.’s last name.
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