Editor’s note: This post was republished with permission from the Ewing Marion Kauffman Foundation’s Growthology blog.
This guest post is the fifth in a series by Kauffman Foundation grantees and other partners sharing insights on entrepreneurship diversity and inclusion. These timely topics will be discussed at this year’s Mayors Conference on Entrepreneurship, Dec. 1-2, in St. Petersburg, Florida.
In 1928, Scottish biologist Sir Alexander Fleming was investigating the properties of the bacteria that create staph infections. Sir Alexander was a legendarily messy scientist, and one weekend, he left without thoroughly cleaning up all of his petri dishes. It was a musty, damp weekend, and in his lab, mildew began to creep into the dishes. When he returned, one of the dishes had a specific mold growing in it that had killed the bacteria. He had discovered penicillin—the most widely used drug in the world.
What I think about every time I hear that story: what happened if Sir Alexander had overlooked the dish? Similarly, what petri dish—or revolutionary advance—are we overlooking today?
In the United States, venture capital investors pump an astonishing $50 billion a year into startups. Yet nearly 80 percent of that funding goes to just three U.S. states. Less than 5 percent goes to women founders, and less than 1 percent goes to people of color. Why aren’t we investing more in entrepreneurs, regardless of who has an idea or where they’re from?
Shortcuts in the venture capital industry are preventing opportunity for entrepreneurs in most people, places, and industries. Venture capitalists are under extreme pressure to deliver profits to their investors. In order to capture this value quickly, venture capitalists often utilize what they call “pattern recognition” to invest in ventures that they recognize. That means decision-makers are investing in people who live near them and share similar experiences.
This has bad consequences for the economy. The Kauffman Foundation estimates that nearly all of the net new jobs are created by startups, and in America, more firms are dying than were started 30 years ago. It’s also not working for investors in venture capital: “pattern recognition” is not effective forecasting of which companies are likely to be successful. The Kauffman Foundation estimates that the vast majority of venture capital firms are not worth the fees investors pay them.
That’s the bad news. Now, the good news. We see tremendous opportunity in entrepreneurs across the country—who, when we develop better ways to invest, can deliver better results.
Take, for example, Emily Morris, an engineer from Georgia Tech in Atlanta. Her company, Emrgy, is essentially a floating pontoon that can be placed in any moving body of water and generate hydroelectric power. Despite a contract with the City of Atlanta, more traction than most energy companies and a major U.S. Department of Energy pilot, Emily struggled to raise funding. A major local angel group expressed interest and spent months alternating between asking for significant amounts of information and returning with radio silence. Emily felt that she had to show up and be a mix of confident, deferential and patient, even though the angel investors were not taking the time to get to know her business.
At our firm, Village Capital, we have thought critically over the past seven years about better ways to identify, support and invest in entrepreneurs. Instead of investment professionals making investment decisions, we enable peer entrepreneurs to select which entrepreneurs are most likely to make a successful investment.
A growing body of research in forecasting, led by Stanford professor Justin Berg and others, suggests that the most able evaluators of an idea’s ability to succeed are not professionals higher-up in the hierarchy, but other innovators in the same sector who are also creating their own ideas. (Based on this research, Cirque du Soleil now selects which acts will go on stage not by manager’s decision, but by peer evaluation.)
In 2015, Village Capital ran a national program in Albuquerque, in partnership with the Kauffman Foundation and the City of Albuquerque, where Emily and other top innovators in water came from across the country to learn from each other and experts as they built their business. We pre-committed $100,000 in investment capital to two entrepreneurs who were selected by their peers—and when the evaluations were in, Emily earned the investment in a landslide.
Beyond the perks of investment, Emily said that the peer review was much more collaborative and productive, and ultimately gave her a much fairer shot than the traditional venture capital/angel investor process. When pitching to venture capitalists, Emily felt pressure to promise the moon and hockey-stick growth. But with her peers, Emily felt that she could under-promise and over-deliver because they understood the same industry. She felt like, for once, she got a fairer shot.
Although Emily and her team was a shining star, we have found that her story is shared by other entrepreneurs who participate in the Village Capital peer-selection model. Entrepreneurs who are under-valued by the market tend to over-perform in peer selection. Moreover, using this model, Village Capital has made 90 percent of our investments in states other than Massachusetts, California and New York. We’re also proud that 40 percent of our investments have been in women, and 20 percent have been in people of color.
Investing in entrepreneurs overlooked by traditional venture capitalists doesn’t just feel good, it yields better results. In an Emory University study of our alumni base, female-run companies have out-performed male-led firms by at least 20 percent in revenue earned and full- and part-time jobs created, yet still attract only 80 percent as much equity funding as male-run companies. Yet we’ve found that when firms with women cofounders receive a first investment in their first two years of operation, controlling for other variables, their revenue growth exceeds men-run companies even more—30 percent—and the entire fundraising gap is closed.
Fleming famously told newspapers of the time: “One sometimes finds what one is not looking for. When I woke up just after dawn on September 28, 1928, I certainly didn’t plan to revolutionize all medicine by discovering the world’s first antibiotic, or bacteria killer. But I guess that was exactly what I did.”
At Village Capital, we see the more cities seek to expand the access to capital, talent and resources to founders who the market is under-valuing, the more potential they have to come up with redefining breakthroughs that revolutionize entrepreneurship. This, in turn, helps create the more prosperous and inclusive economy we are all striving toward.
Ross Baird developed the Village Capital concept in 2009 and, as CEO, has led the development of programs worldwide.