As Silicon Valley Bank’s customers panicked about their money stuck at the lender last week, some deep-pocketed nonprofits, including major foundations, privately floated an unorthodox idea: Giving cash infusions to startups in exchange for their agreement to certain diversity and ESG (environmental, social, and governance) principles, people familiar with the matter said.
The government’s move on Sunday to protect all uninsured deposits made those funds unnecessary. But the proposal reflects the growing, opportunistic demands of venture capital investors, like university endowments and nonprofits, which have been sending questionnaires to VCs they back about diversity numbers, greenhouse gas emissions, and other governance issues.
The collapse of SVB, which shook the tech industry, has given more leverage to those investors that have showered the industry with easy capital for more than a decade.
The diversity and environmental data requests from pension funds and other institutional investors also often cover a venture capital firm’s portfolio of startups, according to half a dozen industry insiders. They have ramped up in recent months, as economic headwinds for the venture capital industry have given more power to its investors to make demands.
The questionnaires often come in response to a fundraising round by a venture capital firm. They are often detailed, like how many people in the company suffer from chronic illnesses or how many identify as transgender.
Some VC firms described the requests as onerous, partly because it’s understood that once they start tracking this data, they’ll have to continue doing so and those numbers, especially on diversity, will be expected to improve.
Venture capital returns have been sky high for an unprecedented 15 years, in part because low interest rates made other investments such as bonds less attractive to investors. The top firms had long lines of pension funds, endowments and others clamoring to get in on new funds, and VC partners would often not entertain demands or even listen to advice from their investors, according to people familiar with the interactions.
Alison Nankivell, a senior vice president at BDC Capital, a Canadian venture fund and an investor in other VCs, said the pressure around diversity and climate change started with shareholders pressuring companies on those fronts and has been filtering down to venture firms over the past year.
“That conversation, which had been brokered over the past 12 to 18 months, has just grown that much more pronounced because of the current climate where there is a greater willingness on the part of [venture capital firms] to understand what they need to do to secure a long-term commitment,” she said.
Nankivell and others say they view improving diversity and climate change disclosures as “risk management,” which will ultimately increase the market value of companies that build those muscles early, and venture capital firms have the ability to influence that decision making at young companies.
“Anecdotally, we are hearing of more LPs asking their GPs to record this type of data,” said Beezer Clarkson, who leads venture fund investments for Sapphire Partners. “Diverse teams drive strong results, and it’s important to invest in and amplify diverse voices throughout the entire venture ecosystem,” she said.
The battles over cultural issues that have become central to American politics are increasingly spilling into finance, as top Republican figures including Florida governor Ron DeSantis denounce “woke capital.” DeSantis last year described ESG as “ideological corporate power,” and in the immediate wake of the SVB collapse, he was widely mocked for suggesting that the bank’s woes came from an excessive focus on diversity, equity, and inclusion programs.
I’m told the foundations thought better of those initial opportunistic musings in the midst of the SVB crisis, but they illustrate how aggressive their efforts are going to become in the long term.
In some sense, this is just finance, where each shift in the economic winds is an opportunity to advance one’s interests. We reported on this over the weekend, as hedge funds swooped in like vultures to offer 60 cents on the dollar for Silicon Valley Bank deposits.
Nobody I spoke with used the term “woke,” partly because the term has been turned into an insult by conservatives. And for those who adhere to the ESG philosophy, it has become the conventional wisdom on how to run a company well.
That is maddening for conservatives, who seem to think just the opposite — that ESG goals actually hurt companies. While there is almost no data to support that notion, and quite a bit that says the opposite, data is irrelevant in culture wars.
The short term crisis has now passed. Long term, the power balance will continue to shift away from venture firms and to their investors. Just over the past year, according to people familiar with the matter, several top VC firms received diversity requests from unapologetic investors when they were almost unheard of in the past.
They will continue to make demands, including the “G” in ESG — governance. Most VC firms will have to jump through hoops now to win over investors, who are going to keep a more watchful eye on the fundamentals of the startups funded by the VCs. They’re beginning to request that venture capitalists sit on fewer company boards so they can put more focus on oversight.
Room for Disagreement
A Harvard Business Review article in March found that funds focusing on ESG investing performed worse than their counterparts.
What’s even more problematic, the article says companies that publicly state they have ESG goals actually had worse records on labor and the environment.
One conclusion: Some companies use ESG as a cover for bad business practices. The author suggests companies should pay attention to ESG as part of best business practices, but not necessarily establish public goals on that front.
The View From Silicon Valley's trenches
Despite these requests for data, the overall picture of diversity in the tech industry in the wake of the financial downturn is discouraging. There’s a sense that the layoffs will disproportionately affect people of color and pullbacks in capital will hurt a crop of young, diverse venture capitalists who have only just begun to gain footing in the industry.
The View From Europe
The European Union’s Corporate Sustainability Reporting Directive already requires investors to track ESG numbers and the mandate extends to many U.S. venture capital firms that take money from European investors.
“I’ve had conversations with VCs who say I’m not even talking to European LPs at the moment because that would implicate me in these reporting requirements,” said Johannes Lenhard, a University of Cambridge researcher and co-director of VentureESG, a nonprofit that works with venture firms and their investors.
Now, the question is whether U.S.-based investors in venture firms will tighten the screws. “The asset owners, they have a little bit more power. Now the question is still, are they going to be brave enough to use it in the U.S.?”
- Investors in VCs like to grumble, but usually not publicly. The Information reported in November that Andreessen Horowitz’s backers were unhappy with the firm’s choices to invest in Elon Musk’s Twitter takeover, Adam Neumann’s new company, and Andy Rubin’s internet-of-things startup. The article was a sign that these investors were feeling emboldened.
- The California Public Employees’ Retirement System, or CalPERS, is reportedly considering offering direct lines of credit to startups, in order to fill the void left by the SVB collapse. Why is that significant? CalPERS was a pioneer in ESG investing and if it takes on a bigger role in the Silicon Valley ecosystem (it’s already a massive investor in venture funds), it will no doubt leave an ESG footprint.