The overall growth in the UK venture capital market has been a positive development but overall, it has been skewed toward groups with common characteristics.
Venture Capital plays an important role in starting and scaling innovative companies. The UK has the largest venture capital market in Europe, larger than France and Germany combined1 .
The ratio of venture investment to GDP in the UK has almost quadrupled from 0.27% in 2015-17 to 0.97% in 2020-2022)2 . This investment is mainly in software, fintech, R&D intensive and deep tech sectors.
There have been nascent steps towards greater diversity in the investment pipeline: founding teams that raised equity for the first time have become slightly more diverse in terms of their gender and ethnic composition in the past decade. For example, the proportion of all male founding teams involved in first-time deals declined from 2013 to 2022 by around 10 percentage points from 81% to 72%. The same was true for the share of all-White founding teams which declined from 84% to 74%. The proportion of all Ethnic Minority founding teams rose by five percentage points3 . (Figure 1-1 and Figure 1-2).
However, female founders’ share of the market for first time deals, in terms of investment value, has remained relatively static at around 6% in 2022, while the value of deals to mixed gender teams declined to 10% in 2022, from 17% in 2013 (Figure 1-3).
In contrast, teams with at least one Ethnic Minority founder made up 42% of investment value of first-time deals in 2022, with all-Ethnic Minority teams accounting for 19% (Figure 1-4).
- 1
Small Business Equity Tracker 2023, British Business Bank (2023).
- 2
Small Business Equity Tracker (2022) and Small Business Equity Tracker (2023). British Business Bank, based on PitchBook data.
- 3
This covers first-time deals only, announced and unannounced deals, companies in all stage of evolution and all investor types. Beauhurst used Onomap (https://onomap.org/) to categorise ethnicity based on names. Onomap classifies first names and surnames into 185 distinct ethnic, cultural, and linguistic groups, used to assign ethnicity. The ethnicity classification for a random sample of 1,000 entrepreneurs was verified using a machine learning algorithm developed by Extend Ventures, to minimise errors in identification of people from ethnic backgrounds. The Beauhurst data was also cross-checked against gender and ethnicity reported by research participants during our interviews with VC firms.
Figure 1-1
Share of first time deals by gender of founding team, 2013-2022
Source: SQW analysis of Beauhurst data
Figure 1-2
Share of first-time deals by ethnicity of founding team, 2013-2022
Source: SQW analysis of Beauhurst data
Figure 1-3
Share of first-time investment value by gender of founding team, 2013-2022
Source: SQW analysis of Beauhurst data
Figure 1-4
Share of first-time investment value by ethnicity of founding team, 2013-2022
Source: SQW analysis of Beauhurst data
First-time deals indicate the strength of the pipeline. Focusing on first-time deals provides an indication of diversity at the start of the investment funnel, where barriers to entry can be highest, including access to networks, lack of track record and information asymmetries between founders and investors.
Research by Extend Ventures (2020)4 paints a sobering picture of the lack of diversity in UK venture capital investment:
- Only 0.24% of venture capital funding between 2009 and 2019 went to Black founders;
- Only 10 Black female entrepreneurs received venture capital investment (0.02% of the total amount invested) over 10 years from 2009 to 2019;
- Over 40% of the total venture capital invested at seed stage between 2009 and 2019 went to founding teams with an elite education5 .
Diversity is also limited within venture capital firms. Research from BVCA and Level 20 (2023) shows the proportion of women in senior investment roles remains low (14%), while only 10% of senior investment professionals are from an Ethnic Minority group. Just 3% of those in senior roles (investment and non-investment) are women from an Ethnic Minority background, with no senior Black women identified in the UK survey6 .
The lack of diversity in venture capital is symptomatic of several systemic, underlying market problems. These problems are specific or more acute for underserved founders compared to the average, and include:
Information is gold but networks provide security.
There is information asymmetry between entrepreneurs and potential venture capital investors, particularly for early-stage investments, reflecting the relatively fixed cost of due diligence and a lack of objective and measurable information to assess track record and founders’ prospects for success. This means investors rely heavily on signals of entrepreneurial quality. In place of objective information, investment decisions are partly based on trust and connections between parties. As a result, investments tend to occur within a (closed) network7 comprising of entrepreneurs and investors with similar characteristics such as gender, ethnicity, and education.
- This preference for individuals to gravitate towards others with shared characteristics (known as homophily) leads to a cycle of investment in the same communities.
- The narrow networks of venture capitalists and the tendency to invest through ‘warm’ introductions8 has implications for identifying and investing in diverse prospects.
- The connections and networks (formal and informal) help to source deals, syndicate, and make quality investment decisions9 and are important for individuals to enter, and progress in, the venture capital industry, which has been historically male dominated and White-dominated.
Diversity starts with the firm.
The limited diversity among venture capital investors means that the investment community is not representative of the breadth of businesses seeking funding. This results in social distance between underserved groups and the investor population and can impact on which businesses get funded10 . Furthermore, most venture capital firms are small, which can make it more difficult for them to become diverse (Harvard Kennedy School, 2019)11 . This is partly due to some small venture capital firms having less structured processes, for example, in relation to HR and Diversity, Equity and Inclusion data collection.
Discouraged but not defeated.
Many entrepreneurs from underserved communities experience ‘discouraged demand’. This refers to entrepreneurs that want or need venture capital investment, but are discouraged from applying due to a perceived likelihood of rejection. This can arise from stereotypes around successful entrepreneurs or, in some cases, having experienced being turned down for finance. In view of the above issues, the structure and practice of the venture capital industry has resulted in a bias for the ‘status quo’ (Harvard Kennedy School, 2019)12 . The nature and scale of the problem means that venture capital firms need effective solutions available to them, if they are to help improve the investment environment for founders from underserved communities.
- 4
Diversity Beyond Gender – The State of the Nation for Diverse Entrepreneurs, Extend Ventures (2020).
- 5
At least one team member went to Oxford, Cambridge, Harvard or Stanford Universities.
- 6
BVCA and Level 20 (2023) Diversity & Inclusion Survey 2023. Assets under management (AUM) of £100m used as a proxy for VC firms.
- 7
Founders from underserved communities may not have access to the same mainstream investor and business networks (formal and informal) as the majority of the business population.
- 8
Founders introduced through a pre-existing relationship with the fund manager or investor.
- 9
C Brush, A Ali, D Kelley, P Greene (2017)The influence of human capital factors and context on women's entrepreneurship: Which matters more?; Journal of Business Venturing Insights; and M Ewens, R Nanda, M RhodesKropf (2018) Cost of experimentation and the evolution of venture capital; Journal of Financial Economics.
- 10
J Lerner, R Nanda (2020), Venture capital's role in financing innovation: What we know and how much we still need to learn; Journal of Economic Perspectives.
- 11
Chilazi., S. (2019) Advancing Gender Equality in Venture Capital. What the evidence says about the current state of the industry and how to promote more gender diversity, equality, and inclusion. Women and Public Policy Program, Harvard Kennedy School.
- 12
Chilazi., S. (2019) Advancing Gender Equality in Venture Capital. What the evidence says about the current state of the industry and how to promote more gender diversity, equality, and inclusion. Women and Public Policy Program, Harvard Kennedy School.