In June, California approved amendments to its October 2023 law, Fair Investment Practices by Venture Capital Companies (California VC Diversity Law). The California VC Diversity Law requires covered venture capital investment vehicles to report aggregated demographic information about the founding members of their portfolio companies.
Covered Entities
The California VC Diversity Law applies to “venture capital companies” that meet the following two requirements. First, the venture capital company must primarily engage in the business of investing in startup, early-stage, or emerging growth companies. Notably, the meaning of “primarily engage” or the precise definitions of startup, early-stage, and emerging growth companies are not provided in the statute. Second, the venture capital company must fall within the statute’s jurisdictional reach by meeting at least one of the following criteria:
(1) being headquartered in California;
(2) having a significant presence or operational office in California;
(3) making “venture capital investments” in businesses located in, or with significant operations in, California; or
(4) soliciting or receiving investments from California residents.
Based on the breadth of the fourth jurisdictional prong, the statute appears applicable to any fund engaging with California residents for fundraising purposes – even if no California resident invests in the fund.
A “venture capital company” under the California VC Diversity Law is an entity that – at least once during the annual period following its initial capitalization and at least once in each year thereafter – holds at least 50% of its assets in “venture capital investments.” “Venture capital companies” also include entities classified as “venture capital funds” under the Investment Advisers Act or “venture capital operating companies” under ERISA. A “venture capital investment” is an acquisition of securities in an operating company that provides the acquiring entity’s advisor or affiliates with certain broadly defined rights to participate in the management of the company. Importantly, the definition of a “venture capital company” captures the entity that makes the venture capital investment (that is, the individual fund, rather than the investment manager). Accordingly, sponsors should assess which of their funds are subject to the statute and complete the required reporting for each covered fund.
Requirements
By March 1, 2026, an entity subject to the California VC Diversity Law must submit its name and certain contact information to the California Department of Financial Protection and Innovation (the “DFPI”). Then, commencing on April 1, 2026, and annually each April 1 thereafter, such entity must submit the following information to the DFPI:
- On an aggregated basis, information concerning the gender identity, race, ethnicity, disability status, LGBTQ+ status, veteran or disabled veteran status, and California residency status of each “founding team member” of a business in which it made a venture capital investment in the prior year. The statute defines “founding team member” as either (1) a chief executive officer or president of a business or (2) a person who owned initial shares in a business, contributed to the concept of the business (or contributed research, development, or related work for the business) before initial shares were issued, and who was not a passive investor in the business. The covered entity must also indicate whether any founding team members declined to provide the requested demographic information.
- On an aggregated basis subdivided according to the demographic categories identified above, the number and amount of venture capital investments made in businesses primarily founded by “diverse founding team members,” listed as a percentage of the total number or amount (as applicable) of venture capital investments. The statute classifies a business as being “primarily founded by diverse founding team members” if more than half of its founding team members responded to the covered entity’s demographic survey and at least half of such respondents self-identified as a woman, nonbinary, Black, African American, Hispanic, Latino-Latina, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, disabled, veteran or disabled veteran, lesbian, gay, bisexual, transgender, or queer.
- The total amount of money the covered entity invested in venture capital investments in the prior calendar year.
- The principal place of business of each company in which the covered entity made a venture capital investment in the prior calendar year.
The information described above must be collected through a survey delivered to each founding team member of a business in which the covered entity holds a venture capital investment (on a standardized form to be provided by the DFPI). Respondents will be permitted to decline to provide any demographic information requested in the survey, and the survey must be accompanied by a statement from the covered entity indicating that (1) a founding team member’s disclosure of the requested information is voluntary, (2) no adverse action will be taken if a founding team member chooses not to respond, and (3) the aggregate data collected through the survey will be reported to the DFPI. Covered entities are required to anonymize (to the extent possible) all demographic information collected from founding team members and reported to the DFPI.
The California VC Diversity Law provides that the aggregate results of reporting will be published in an easily accessible, searchable, and downloadable format on the DFPI’s website. A covered entity must retain all records produced in connection with its reporting obligations under the statute for at least five years following the delivery of the associated report.
Enforcement
If a covered entity fails to file a report required by the California VC Diversity Law by April 1 of a given year, the DFPI will notify the entity of its noncompliance and grant 60 days to cure the violation without penalty. If a covered entity does not submit the required report within such 60-day cure period, the DFPI may assess fines against the entity (in addition to other permitted enforcement remedies, such as issuing an order to desist and refrain from the violation or requiring the entity to reimburse reasonable costs incurred by the DFPI in responding to and investigating the violation). The DFPI is generally permitted to assess fines of up to $5,000 per day for each day the violation remains uncured, though it may impose higher fines for reckless or knowing violations (in amounts the DFPI deems sufficient to deter the violation). The DFPI is required to consider mitigating factors in assessing penalties and must assess fines that are appropriate to the violation, the entity’s history of previous violations, and its financial standing, financial resources, and assets under management.
Considerations for Sponsors
Though the reporting requirements under the California VC Diversity Law do not come into effect until 2026, there are several steps a sponsor can take to prepare for the statute’s roll-out.
- Identify which of the sponsor’s investment vehicles currently qualify as “venture capital companies” (or are likely to qualify as such in the future) subject to the statute’s reporting requirements.
- Evaluate whether it is feasible (or desirable) to exclude California residents from fundraising activities for venture capital companies controlled by the sponsor (to avoid triggering the statute’s jurisdictional scope).
- Ensure that the sponsor has up-to-date information regarding the identities of the founding team members of its early-stage and startup portfolio companies.
- Monitor the DFPI website for relevant resources or guidance for complying with the statute’s obligations (such as standardized demographic survey or reporting templates).
