Is Pattern Recognition Killing Innovation?

(Source: www.forbes.com)

Venture capital has been defining innovation for decades, from the early days of giants like Bill Draper and Donald Valentine (founder of Sequoia, who invested in Atari in 1975) VCs have helped support, fund and bring to market products and services that we still use every single day, and which have transformed our lives for the better. From ride sharing apps to social media, from business software to life-saving health solutions, we owe much of our modern life to the people who were the first to take a risk on a new and unrealized idea and made it available for us all.

Over the years, the homogenization of the investment sector has narrowed the field of innovations and created a bias towards solutions and ideas that appeal to a small cohort of people. This is due, in part, to pattern recognition processes, by which we interpret the world around us and which help us determine the difference between friend and foe, danger and safety. Yet these same essential patterns can be harmful to deal flow evaluation processes within the investment industry because they prevent people from recognizing successful ideas which are unfamiliar. Our analysis of social-economic and demographic shifts, and our experience working with women entrepreneurs, have proven that good ideas and promising founders are going unfunded. We’ve seen how a diverse management team not only sources a wider range of deals but also creates better decision-making process within the investment committee and is better able to recognize a potential success story.

Underrepresented founders face greater challenges in convincing a fairly homogeneous industry that issues they are solving are significant enough, that the services they provide are widely needed and that they are the ones to take this vision into a multibillion dollar company. Katrina Lake, founder of Stitch Fix, and Shan Lynn Ma, founder of Zola (both multibillion dollar companies) have spoken out about their struggle to raise funding and felt it was due to the lack of diversity in the VC industry. “You can’t blame the kind of individual for having that preference, but then you step back and realize 94% of venture investors are male and have similar preferences. And so, I think that it unquestionably made it harder,” says Lake.

In a sector that is driven by business ‘intuition’ and ‘gut feeling’ based on past patterns, female founders and other underrepresented founders, lose out. This is, to some extent, due to what experts call “homophily” in which similarity breeds connection, which means VCs prefer to hire, invest in, or co-invest with those that are similar to themselves.

If venture funds are to keep up with new opportunities and be able to recognize emerging financial success stories, there are actions that can be taken right now to change course. Here are 3 things VCs can do today to make their investment portfolio more innovative:

  1. Create a systematic competency matrix – When people think of business success they often have in mind a stereotypical ‘male CEO’ template. When they meet an entrepreneur who fails to exhibit traits like being aggressive and confident, they rule them out as not having ‘what it takes’. But Lake went to her company’s IPO at the NY Stock Exchange with her 14-month-old baby on her hip. CEO’s don’t fit a mold anymore and assessing success potential requires a broader definition of success. In practical terms, once a pitch meeting is systematized and identical, then it’s possible to weed out biases. We suggest drawing out the key competencies that you’re looking for in a founder and putting them into a matrix. This will help set a benchmark for all pitch meetings and ensure male, female and minority founders are all being assessed on the same objective criteria. Research from Harvard Business Reviewed showed that investors (including women) tended to ask men questions about the potential for gains at their startups, while they asked women about the potential for losses. This is one of the reasons attributed to the much smaller sums of money female founders are able to raise (just over $5 million for women and around $12 million for men in 2017). Awareness is the first step to change – a systematic approach at pitch meetings will prevent bias in questions to founders.
  2. Be mindful and proactive – a few months ago, while trying to enhance underrepresented founders’ access to VCs, we invited GPs to use our women entrepreneur’s Facebook community to announce an invitation to office hours reserved specifically for female entrepreneurs. Only female GPs accepted and agreed to hold special women-only office hours. This led to due diligence processes with some of these female entrepreneurs. A male GP responded that they had never offered special office hours for men so questioned the motivation behind offering them to women. While treating everyone the same seems like an egalitarian approach, it actually assumes a level playing field and ignores the specific challenges that women face. Female only office hours are a way of declaring an intention to proactively encourage female founders and acknowledge that a VC fund is willing to go the extra mile to do so. The most innovative solutions and new consumer and business products are already coming from the margins, from those who are following non-conventional entrepreneurship tracks, bringing new challenges and ideas to the table. To make sure VCs are tapping into these emerging success stories it’s important to be pro-active in seeking out and welcoming in diverse founders – through special office hours, a dedicated call for proposals or by initiating community-specific outreach.
  3. Model good behavior – Reese Witherspoon started her own production company because she felt there was audience out there for more diverse stories than those being produced. This is true for innovation as well. A diverse group of people could see the potential in, and fund, a much wider range of solutions that focus on under addressed communities and needs. It’s important to be mindful of who is sitting around the table on the investment committee. The bad rep the VC sector has acquired has not always been justified but it’s certainly keeping a lot of good ideas, strong entrepreneurs and talented potential partners away, costing untold billions in lost investment returns. Attracting diverse talent today and nurturing the next generation of diverse VC managers will ensure VC funds stay fit for purpose.

The venture world has been instrumental in creating new economic models that allow good ideas to be taken to scale, responding with agility and ingenuity to a vast array of human conditions across the globe. But what got us here, is not what’s going to get us there. It would be wise to ensure the current dynamic and diverse cohort of founders who are knocking on VC’s doors are met with a responsive investment approach and a diverse group of decision makers that can realize and fully leverage what they have to offer.

More Info: www.forbes.com

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