California Governor Gavin Newsom (D) has signed a bill that mandates venture capitalists to report the diversity of the founding members of businesses they invest in, making the first state to require venture capital firms to disclose the race and gender of the founders of the companies they fund. The bill, known as SB 54, is a measure to promote transparency and accessibility to venture capital funding for women and minority-owned startups.

This bill would require venture capital firms to disclose the demographic data of the founders they fund to the California Civil Rights Department for the first time. It would apply to venture capital firms that are located in, or have significant operations in California, as well as those investing in California companies and soliciting investments from state residents.

If companies refuse to disclose this demographic information, the bill empowers the state to take them to court and penalize them for their non-compliance. It also states that the Civil Rights Department could use the data provided to bring further civil action against venture capitalists. It has sparked controversy and criticism from various quarters as some feel it could potentially hinder the venture capital ecosystem in the state. Venture firms would have until March 1, 2025 to provide demographic data to the California Civil Rights Department.

Sen. Nancy Skinner recently told TechCrunch that venture capitalists might not be aware of their statistics, so disclosure and transparency will hopefully nudge them to do better.

While the venture capital industry has been much maligned for a historical lack of diversity, recent National Venture Capital Association data published earlier in 2023 from 315 venture capital (VC) firms representing more than 5,700 U.S.-based, full-time employees and $594.5 billion in assets under management shows some improvements:

• Nearly one-half of VC firms surveyed are incorporating diversity, equity, and inclusion (DEI) strategies (up from 15% in 2016), with 60% of firms saying they have a staff person or a team responsible for DEI (up from 16% in 2016).
• More VC firms are seeing DEI interest from limited partners and focusing on DEI at portfolio companies, with 47% of firms reporting that LPs requested their DEI details.
• Women are far from parity although representation is trending upward, with female employees representing 26% of investment professionals (up from 15% in 2016).
• Racially and ethnically diverse people are still seeing slim gains (whether women, black or Hispanic), fueling the demand for more to be done to address the perceived inequity.

Furthermore, there are concerns about the constitutionality of SB 54. Critics argue that delving into the gender, racial, ethnic, and sexual preference status of investment company founders constitutes an unwarranted invasion of privacy and a violation of the First Amendment.

The National Venture Capital Association has opposed SB 54, asserting that the diversity data collected may be misleading and counterproductive. One noteworthy point of contention is the support for SB 54 from the F5 Collective, a fund exclusively investing in female founders.

More to come. Make sure to watch this space.