Project W - The Funding Gap: How Tomorrow's Success Will Displace the Bias of Today

In August, we got the jaw-dropping news that Andreessen Horowitz invested $350 million in Adam Neumann's latest venture despite his previous multi-billion-dollar debacle. But only a few months before, we got some equally jaw-dropping news that seems to have gone unnoticed. In May 2022, a research paper published in the Journal of Organization Science concluded that female founders who receive early funding from female rather than male VCs are two times less likely to raise additional funding.

When you put these two pieces of breaking news side by side, it strains credulity. Really?

Investors are willing to throw down hundreds of millions of dollars to invest in a new venture founded by a man with a checkered track record, to say the least. Yet investors are unwilling to invest in female founders whose early backers are female fund managers.

While the results of this research are disturbing, it is way too early to throw in the towel. There are a number of reasons to believe that the conclusions drawn from this research do not foretell the future.

But, first, the research.

What the Research Reveals

The research conducted by Kaisa Snellman and Isabelle Solal builds on previous research relating to the consequences of homophily -- the tendency of individuals to seek out and bond with others like them. This line of research focused on gender homophily and found that when women – across disciplines but especially in male-dominated industries -- receive support from other women, observers tend to implicitly discount their competence and conclude that their success was motivated by considerations other than merit. The same assumptions, however, are not made when a man is supported by another man.

When Snellman and Solal tested this thesis in an entrepreneurship environment, they found that female founders who received funding from female rather than male venture capital partners were two times less likely to raise additional financing going forward. Based on this research, a female founder who raises her seed round primarily from female fund managers will have a more difficult time raising a Series A round.

This is bias at its most pernicious. It appears that later stage investors assume female founders can't build successful, scalable, and competitive companies and that they assume female fund managers don't make disciplined investment decisions based on facts and rigorous diligence.

Despite what the research suggests, the past need not define the future.

Here's why.

It's Early Days for Women in Venture

In the 40-year plus venture capital industry, women – founders and fund managers – are relatively recent entrants. There is a dearth of statistics from the first two decades of this asset class, and researchers did not start digging into gender data until the 2000s. What data there is indicates that the presence of women in the field in the 2000s was scarce. Even the research conducted by Snellman and Solal is based on a relatively small dataset: 290 companies out of a total of 2,136. And those 290 companies received their first round of funding between January 2010 and April 2018.

A lot has happened since April 2018. The annual review published by Female Founders Fund, which launched in 2014 as one of the first funds founded by women to invest in women, notes the year-over-year growth in Series A funding for female-founded companies. In the U.S., 279 female-founded startups raised Series A rounds in 2021 compared to just 115 in 2020, and the size of those rounds increased considerably.

If 2021 is a harbinger of the future, then there is cause for some optimism. While bias unquestionably still exists – only 2.0% of venture capital went to female-founded companies in 2021 – more of that capital was invested in Series A and later rounds. That funding – Series A and later – is the capital that is so critical for the growth and ultimate success of a company.

The Data Indicates That Women Outperform Their Male Peers

Even though the data set is still relatively small, the information we do have indicates that female founders and female fund managers outperform their male peers. Female-founded startups generate more in cumulative revenue than their male peers. And female-founded companies are quicker to exit and do so at higher valuations than all U.S. companies.

While there is a paucity of published performance data with respect to female-founded venture funds, women asset managers have been found to deliver superior returns across all other asset classes -- large cap equity funds, hedge funds, and private equity funds. Additionally, the more general findings regarding the impact of diversity on performance suggests that we can expect that data collected on founder and funder performance in the coming years will reveal continued delivery of superior outcomes. If that's the case, even the most biased investor won't be able to ignore the facts or pass up the opportunity to realize exceptional returns.

Female Fund Managers Are on Track to Raise Successive and Bigger Funds

According to Women in VC's seminal report, from 2015 to 2020 the number of women-led funds has nearly quadrupled, and that trend appears to be accelerating. However, 43% of those female funders are first-time fund managers. First-time fund managers typically raise smaller funds and, as a result, have less capital to deploy. That results in making smaller investments in companies in order to build a diversified portfolio. With less capital to deploy, those managers may also have difficulty obtaining allocations in a Series A round or leading a Series A financing.

Although many female fund managers invest at the seed or pre-seed stage, this is changing. More female fund managers are successfully raising a second or third fund with more capital to put to work. That enables these managers to hold back capital to invest in follow-on rounds. Others are following the lead of WomensVC Fund, the first venture fund in the U.S. to focus on Series A stage companies with gender diverse founding teams.

Deborah Jackson, founder and CEO of Plum Alley, invests in Series A rounds of companies with gender diverse founding teams. Deborah's experience is consistent with Snellman's and Solal's findings – female founders have the best chance of raising their next round if they have traditional male-founded venture funds on their cap table. Plum Alley now invests alongside those incumbents, but it took some time to get a seat at the table. In one case, Deborah had to "audition" with a fund leading a Series A round in order to get an allocation. However, that's changing. Core to Plum Alley's strategy is developing relationships with and supporting female founders early in their journey. Those founders go to bat for Plum Alley when raising their Series A rounds and, in some cases, even increase their rounds so Plum Alley can participate. Although Plum Alley doesn't lead Series A rounds now, someday they will. And, according to Deborah, when they do "they will bring in the men." That way, they access more money and achieve their ultimate goal – writing significant checks to fuel the growth of female-founded companies.

So, what is the effect of more female fund managers investing at the Series A stage? Female VCs are three times more likely than their male counterparts to invest in companies with a female CEO. With more female fund managers deploying more capital at the Series A or later stage, there is ample evidence to suggest that more capital will be invested in Series A or later rounds in female-founded companies, even if male-led venture funds continue to pass on these investment opportunities.

The Trend Line is Good but Not Growing Fast Enough

While there is reason to be optimistic that Snellman's and Solal's research is not predictive of the future, we can't just stand by and wait for better results. Here's what we can do:

• Invest financial, human, and social capital in female founders so they achieve successful exits in the next five to eight years. Money matters but so do resources and connections. Through our own Women Entrepreneurs Boot Camp we connect high potential female founders with experts, investors, and resources to help them get ready to raise Series A rounds.
• Become an LP in a female-led fund. Even if you can't write a big check, there are funds – like Portfolia – with lower minimum requirements to invest as an LP. Or look into becoming a member in investing platforms like Plum Alley, which enable investors to be part of a syndicate that invests in Series A rounds in female-founded companies. The more capital invested in female-led funds or investment vehicles, the more capital invested in female-founders.
• If you run a strategic fund that invests in underrepresented founders, consider investing in female fund managers. Investing in female fund managers is one of the most effective means to address the massive inequality in funding founders. Investing in female fund managers drives downstream deployment of capital to female founders.

At Project W we are motivated by a future where venture capital investors – women and men – will write seven or eight figure checks to invest in a generation of game-changing female-founded companies. But that future can't come soon enough. We need to make it happen.

If you'd like to learn more about Project W and join us in our work, please contact Lynn Loacker at lynnloacker@dwt.com or Emily Baum at emilybaum@dwt.com