The Real Deal

Why Smart Investors and Founders Use the “Inclusion Premium”

By November 24, 2019 No Comments

If you’ve ever thought about spending your money with one brand instead of another because one of them had a better reputation, you’ve got impact investing in your DNA.  I care passionately that my “imprint” on this world is a positive one, from my lifestyle (mostly vegan), to my conversation style (direct), to my car (electric), and to my work (venture capitalist).  The area I’m most passionate about is making sure investments I make have every opportunity to optimize ROI. One tool I use to do that is by using the Inclusion Premium.

The inclusion premium is what happens when you manage the risks of group-think proactively instead of reactively.

Everyone has experienced an episode of group-think. Maybe it’s a board you’re on, a sports team, a charitable organization, or a company you know well—but group-think is when everyone is so sure they’re right they do not seek to entertain contrary opinions. You know how that tends to work out . . . it’s fine as long as the world remains status quo, but in times of change, stress, pressure or dynamism, everyone thinking exactly the same way leaves the group less prepared to adapt.

Groups with different perspectives have inherently contrary opinions. They have to work through disagreements to wind up at a consensus. This tough, uncomfortable process contributes to dramatically better financial outcomes according to lots of research–and perhaps even your own personal experience.

Here is some of the financial research on using the inclusion premium to manage downside risk and optimize upside potential:

  • “Racially and ethnically diverse startups outperform industry norms by 35%. “(McKinsey, Why Diversity Matters)
  • “In testing the performance of 2,360 public companies globally over the last 6 years, companies with one or more women on the board have delivered higher average returns on equity, lower gearing, better average growth and higher price/book value multiples.”  (Credit Suisse, Gender Impact)
  • “Among top-quartile investment managers, there’s actually an overrepresentation of diverse managers, with 39% of diverse managers falling in the top quartile of performance, vs. 25% for non-diverse managers. And so it’s particularly interesting to note that you actually have a better chance of outperforming the benchmark by investing with diverse managers.” (Cambridge Associates’ Jasmine Richards writing for SuperReturn 2019, “Expansive viewpoints for better results: why you should consider diversity when choosing managers”)
  • “Along all dimensions measured, the more similar the investment partners, the lower their investments’ performance. For example, the success rate of acquisitions and IPOs was 11.5% lower, on average, for investments by partners with shared school backgrounds than for those by partners from different schools. The effect of shared ethnicity was even stronger, reducing an investment’s comparative success rate by 26.4% to 32.2%.” (Harvard Business Review, 2018, The Other Diversity Dividend)
  • “This research utilized the Morningstar database to gather information on 5,000 US mutual funds to compare net alpha and value added between male funds and female funds. The present research found that female managers have statistically significantly higher net alpha and higher value added, compared to male managers, likely indicating that females are not allocated enough capital but have higher skill, as they are able to extract high value added even without proper capital allocation.” (Natalie Borowski, Ph.D., “The Impact of Mutual Fund Manager Gender on Investor Capital Allocations”)

Research like this makes the reality of an “inclusion premium” for investors clear.

At Valor, we’re actively using inclusion premium analysis as an additional layer of investment risk management and returns optimization.

Here are three ways we do it:

  • Sourcing Inclusion: We use industry benchmarks to make sure our funds source investments from across the full spectrum of founders seeking venture capital today. The end result is that Valor’s portfolio is led by 60% under-represented founders–a striking departure from the United States aggregate venture capital environment where less than 5% of venture capital is invested in under-represented founders. One of the ways we succeed at creating such clear alpha is through the nonprofit Foundation we started, Startup Runway. It is the largest pitch event for under-represented founders in the country. It has sourced many of our most interesting and innovative investment opportunities precisely because it sources from a group (startups led by women and people of color) that is historically under-invested in. See it for yourself—join us at the next Startup Runway Showcase.
  • Recruiting Inclusion: When Valor makes an investment, the journey is just beginning. That team we invested in will be scaling quickly, and as they do that, we want them to be able to “see around corners.” That means making sure the next hires  are exceptionally skilled and have exceptional perceptions and understandings that accent the core team’s DNA. We know more perspectives earlier in a company’s journey create an inclusive culture that is more effective in terms of financial performance and more attractive to acquirers.
  • Governing Inclusion: I was recently speaking with a successful Atlanta software company founder who walked away from a $100 million valuation and large investment at the 11th hour. He shared that when the final board composition was revealed, it “looked like a picture I didn’t want to be a part of”—all one race, all one gender. Smart founders—and investors—know that the board composition also has to also be informed by multiple perspectives, which is why when Valor takes a board seat, we pay attention to talents, skills, chemistry, and inclusion.

Inclusion is one of the risks controllable by investors.

Inclusion is also one of the few risks that, if well managed, has a strong positive outcome for the investment. If topics like these get you going, and you want to join forces with us on the journey of inclusive innovation, please check out one of Valor’s upcoming events.

###This article was first published as a guest blog at  The Georgia Social Impact Collaborative (GSIC), a division of the Atlanta Community Foundation which provides resources to connect, educate and inspire stakeholders for the purpose of accelerating the development of Georgia’s impact investing ecosystem.