Closing the Racial Funding Gap: How VC Investors Are Missing Black Startups

In May 2020, when the George Floyd protests kicked off around the country, Emmanuel Yimfor's wife asked him what he was doing to contribute to the major cultural moment. Yimfor, an assistant professor in Columbia Business School's Finance Division, knew where he could have the most impact. “My competitive advantage is not standing there with a sign,” he says. As a specialist in entrepreneurial finance, he believed he could help shed light on racial income disparity. 

That conversation led to three years of research analyzing the persistent funding gap for Black founders in venture capital, a disparity that had generated considerable debate but had never been carefully researched. His most recent research, “Funding Black High-Growth Startups,” currently being peer reviewed, found that less than 3 percent of startup founders receiving VC funding are Black and Black-founded startups raise a fraction of the capital of their non-Black counterparts. But the research also suggests that by diversifying the partners on VC boards, that gap could be closed.

Overcoming Bad Data

Yimfor's first hurdle in this endeavor was finding a dataset. “The big challenge is, how exactly do you identify which startups have Black founders?” Yimfor says. The Consumer Financial Protection Bureau (CFPB) should have been a simple, central source of this information, but he uncovered a problem in its data collection methodology: Because not all companies self-report their demographics, CFPB uses last names and geography to triangulate a best guess about founders' race and ethnicity.

Yimfor, who is Black, used himself to illustrate the system's pitfalls. The US Census Bureau provides lists of all surnames that appear on the census more than 100 times. “My last name is unique — anyone with my last name is related to me — so I am not on the census roll of last names,” he says. “And I'm on the Upper West Side in New York, so in my neighborhood, there's a low likelihood that I'm Black. If you combine those two things, the algorithm is not going to predict that I'm Black.”

The method was implicitly biased and leaned on stereotypes that were less likely to include successful Black startup founders. The impact of this faulty dataset could be sweeping. “You will be excluding a whole segment of Black entrepreneurs by using a prediction algorithm,” he says. “And then you will bias the results.”

Instead, Yimfor and his team had to collect the data themselves. “It was a huge undertaking,” he says. They pulled nearly 150,000 photos from LinkedIn and Facebook. “It took a long time to pull together the database, but we ended up with about 92 percent of all of the founders in PitchBook.”

To sort them by race, they let AI do the first pass, sorting the images into folders — which was about 85 percent accurate. But then they combed through each image to confirm they were sorted correctly. That process was revealing on its own. “The errors were mostly with Black women,” he said. “If they straighten their hair or put on a lighter foundation, the AI is more likely to put them in the 'white' folder.”

Minding the Gap

In analyzing this new dataset, Yimfor and his team found that only 3.47 percent of the founders seeking funding from VC firms are Black, suggesting there are systemic barriers for Black founders to get these opportunities. But even among those that have made it into the VC pipeline, Black-founded startups raised only a third of the amount raised by non-Black startups.

The implications of that funding discrepancy are the subject of Yimfor's next step in his research. “One obvious implication is the wealth gap,” Yimfor says. “The average founder is going to make close to $50 million when the company sells from IPO or acquisition. What this means is there's a big racial wealth inequality gap driven by this access to high-growth entrepreneurship.” And once founders sell their company, they're more likely to sit on a VC board themselves, which can reinforce and perpetuate racial inequity: If fewer Black founders are able to fund and sell their startups, fewer Black investors then sit on VC boards and, therefore, fewer VC funds invest in new Black startups. 

But the effects of that gap can be even broader than they seem. Great, innovative ideas, he says, are randomly distributed throughout the population. But if Black entrepreneurs are generally not getting funded, more than 13 percent of those life-changing ideas aren't making it to the market. “There's this multiplier effect,” he says, “which would have a huge contribution not just to wealth inequality but to economic growth in general.”

Trickle-Down Capital

Yimfor's findings suggest, though, that there is an actionable solution to help close this gap. His team investigated investments made immediately after the George Floyd protests in 2020 — a moment that presented unique pressure to invest in Black founders — and assessed the decisions of Black and non-Black venture investors. The team's review suggests that if a Black person heads the investment team, the funding gap narrows by nearly 50 percentage points.

Having Black leaders at investment firms could, therefore, have a trickle-down effect. Recent research has demonstrated that diversity in the boardroom can impact a company's overall diversity. Yimfor found similar trends in VC: His team's research suggests that Black investors are more likely to identify successful Black founders than their non-Black counterparts. “We split Black and non-Black founders to look at what characteristics affect the likelihood that they get funding,” he says. Black investors are more likely to have overlapping networks and backgrounds, which can help contextualize a founder's potential for success. “Black partners are more able to fund Black entrepreneurs because they rely less on the traditional metrics of who is going to be successful in venture capital,” Yimfor says.

The results of Yimfor's work point to one answer: Get Black investors in the room. But there are a lot of ways to do that. One option, he says, is for white-run VC funds to collaborate with Black-owned funds, which are more likely to identify a great Black founder. “I have a list of all of the Black-owned VC funds on my website,” Yimfor says. “If you're looking at a founder, and his idea seems great, you can lean on some of these Black-owned funds that understand their characteristics a little better. They might be willing to make a deal with you.”

Watch CBS Professor Dan Wang discuss his latest research on the science of social networks and the role they play in relationships between VCs, entrepreneurs and startups: