Excerpted From: Jennifer S. Fan, Startup Biases, 56 U.C. Davis Law Review 1423 (April 23, 1012) (446 Footnotes) (Full Document)


JenniferSFanGuilty. That was the verdict for Elizabeth Holmes in four of the eleven charges of fraud. Even before her conviction, Holmes' actions had severe repercussions for other women in startups. Many women noted that on top of already having to prove they belonged in the “male-dominated field of startups,” they now also faced the “additional hurdle of fighting assumptions that they were like Ms. Holmes ....” Moreover, they noted that their male counterparts did not share this additional hurdle. One journalist stated the following in her coverage of Holmes: “What I found most compelling was hearing from female founders, especially in life sciences and health care. Many of them told me that the downfall of Elizabeth Holmes is still impacting them.” As an example, some women founders in health technology startups report being compared to her in an unfavorable fashion. Holmes' trial “raise[d] issues of deception, gender, transparency, out-of-control hype and the sartorial influence of the Apple co-founder Steve Jobs ....” The Holmes case is just one example of how biases proliferate in the startup world. Venture capital (“VC”) is famously known for funding some of the most transformational startups (and now public company behemoths) of our time, such as Apple, Amazon, Facebook, Google, and Netflix. But for every great startup that is funded, there are many more that are not. For entrepreneurs who are women or racial and ethnic minorities, gender and racial bias play a significant role in why this is the case. One CEO observed, “‘[a]lthough VCs would have founders believe that their decision is built on complete rationality, the reality is that many VCs still have personal bias and are influenced by their peers.”’ This presents a problem because in order to continue to innovate at the highest levels, founders need to be drawn from every part of our society, not only a select part.

Gender and racial bias in startups have received significant scholarly attention in the business scholarship context. However, in the legal academy, studies on such biases primarily focus on the public company, and more specifically, its board. Public companies report their diversity numbers, but not in the numbers one would expect. As an example, among the Fortune 500 companies, 256 of them published racial and ethnic data in 2020, but only twenty-two companies provided a breakdown of the percentage of minorities in their companies. For these companies, legal solutions have come in the form of state legislatures mandating the representation of women and racial and ethnic minorities on public company boards. The Nasdaq Stock Market also proposed new listing rules to promote board diversity using a “comply-or-disclose” framework which requires annual disclosure about voluntary self-identified gender and racial characteristics and LGBTQ+ status of board members; it was approved by a divided Securities and Exchange Commission (the “SEC”) in August 2021.

The problem of gender and racial bias in venture-backed startups, however, cannot be solved in a similar fashion. Private ordering--“the development of firm-specific governance terms” much of how startups operate; it has shortcomings when using a diversity, equity, and inclusion (“DEI”) lens. Unless founders or investors prioritize diversifying startups and get to the root of the problem-- “disparity of opportunity” ordering is ill equipped to address gender and racial bias.

This Article fills a gap in the current scholarship on gender and race in corporations by looking at the issue from a private company perspective. Specifically, it provides an original descriptive account of the startup ecosystem and how it remains homogeneous. Put simply, the absence of rules and regulations perpetuates this lack of diversity which then has a detrimental effect on how much startups can innovate. This Article describes how companies are funded and shows how founders and investors dictate who is on the board and whether DEI initiatives are prioritized. In particular, it illustrates that startups need both legal and non-legal tools to address gender and racial biases and explains why the private ordering on which VC has historically relied upon is inadequate unless the entire ecosystem, from founders to investors to advisors (such as their legal counsel) to limited partners, chooses to diversify.

By doing so, the Article makes three primary contributions. First, it provides an original descriptive account of startup biases and shows how a set of processes and practices emerged in VC financings that continue to impact who gets funded, what terms are negotiated, and who is on the board. Legal academics have primarily studied corporate governance and DEI issues in the public company context. Private companies, in contrast, have received much less attention. They operate under a vastly different set of rules--one might say a lack of them--and less information is available to conduct analyses. This Article provides examples that illustrate how bias permeates the startup landscape, which influences who gets to fund startups, who makes investment decisions, and who obtains funding; the confluence of all these factors also ultimately determines whether DEI initiatives are prioritized or discussed at all. As an example, historically, limited partners originated from the ranks of a select few schools, foundations, pension funds, and wealthy investors. It is only when instances of social reckoning occur, such as the #MeToo Movement and Black Lives Matter, that changes start to happen.

Second, current corporate governance mechanisms do not work well in the DEI context. In fact, negative consequences have emerged from the absence of any directives on DEI issues. Since startups are not subject to the robust regulations of the securities law regime that public companies are, DEI matters are an afterthought; the focus is on ensuring the startup's survival and next big financing. This Article argues that the founder-centric approach to corporate governance in startups means that the diversification of the startup ecosystem largely depends on founders and, to a lesser extent, investors. This Article identifies a number of suboptimal implications for corporate law and governance as a result of this approach from a DEI perspective.

Third, a holistic account of startup biases illustrates how corporate governance in startups is not a neutral set of processes. Instead, how and when corporate governance is implemented largely depends on a few key players. This is not to suggest that when corporate governance measures are implemented, they are done incorrectly, but with respect to DEI issues, they fall woefully short. This has resulted in a patchwork of DEI initiatives that is not built into the infrastructure of startups. The data predicts that this patchwork method will continue and have negative consequences as startups grow, as was the case with Uber and WeWork. A fundamental shift in how DEI issues are approached is necessary for any meaningful advancement to occur regarding the diversification of who gets funding, who sits on the board, and who gets to participate in VC financings. Absent the will of the founders and investors of startups to change the current system, the numbers of women and racial and ethnic minorities who receive funding will continue to remain low, with incremental change or change driven by social forces being the norm.

This Article proceeds as follows. Part I provides a brief historical timeline of how the world of VC and VC-backed startups evolved, with relatively few women and racial minorities playing any significant role. Part II delves into current day startup biases, showcasing how persistent and deep-rooted these biases are. In particular, it illustrates how women and racial minorities remain largely absent from the startup ecosystem due to systemic bias. Part III examines how the problems of gender and racial bias have been addressed in the public company context and explains why similar legal mechanisms would likely not work for startups because of how they operate, receive financing, and the culture in which they do business. This Part will show that in the founder-friendly era of startups, much depended on the proclivities of the founder and whether DEI was a priority for him/her/them. More specifically, it will discuss the role of private ordering in diversity initiatives and predicts that a patchwork approach to DEI will continue to be the norm unless there is some fundamental change. Part IV offers legal and non-legal options to create a path forward for combatting gender and racial bias in startups, such as legal reforms applicable to unicorns and investors of a certain size, the diversification of investors and limited partners, the use of contractual mechanisms, and the examination of current hiring practices.

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Although gender and racial and ethnic bias on boards and their companies have been an unfortunate fixture in the world of startups, scant attention has been paid to it in the private company context. Instead, the focus has been on imposing rules and regulations in public companies to address the issue. It is time to look at other avenues to tackle startup biases since relying on private ordering has not worked. Regulators should explore whether certain laws to advance diversity which only apply to public companies, can be applied to unicorns and certain VC firms. Even if these efforts fall short, it begins a conversation on how to remedy the pervasive startup biases.

Venture capitalists operate in a world of pattern recognition and what some scholars have dubbed homophily. This homophily has meant that many women and racial and ethnic minorities who are startup founders have either not been funded or grossly underfunded, despite the enumerated benefits of diversity in terms of returns and other metrics. Also, with eye-popping returns from their investments in various startups, many venture capitalists are reluctant to change how they identify new ventures for funding because the current system has made them extremely rich. The absence of any meaningful change with respect to diversity in the startup ecosystem shows the shortcomings of private ordering. Although private ordering is viewed as a way to ensure flexibility and customization with respect to corporate governance, it is not a beneficial way to advance diversity. Over seven decades have passed since VC investing started, yet little progress has been made in diversifying the VC ecosystem. As this Article has illustrated, startup biases are built into the VC ecosystem.

To tackle startup biases, the problem needs to be approached from a multipronged perspective that encompasses both legal and non-legal tools. It also needs to target not only the issue of board diversity, but diversity in management, investors, workforce, and limited partners which invest in VC firms. Unless a holistic approach is undertaken to address startup biases, progress will be incremental at best, and the biases that plague startups will continue to exist.

Jennifer S. Fan. D. Wayne and Anne Gittinger Professor of Law and Associate Dean for Research and Faculty Development, University of Washington School of Law.