Overview
On October 8, 2023, California Governor Gavin Newsom signed Senate Bill 54 (“SB 54”) into law, which attempts to increase diversity, equity, and inclusion amongst venture capital (“VC”) investments. The law is the first transparency measure of its kind in the United States and will have a wide reaching impact on VC companies nationwide. Thus, it is important to know which VC companies it affects and what the bill’s future holds.

SB 54 aims to increase diversity in the recipients of venture capital money by increasing transparency into the diversity of founding teams in the VC industry. SB 54 will require venture capital companies, including VC funds (as defined under the Investment Advisors Act of 1940), with any “nexus” to California to report demographic data on the founding members of companies in which the fund invests.

Under the bill, a “covered entity” is any VC company that meets two requirements: (i)  the VC company must either primarily engage in the business of investing in or providing financing to startup, early-stage, or emerging growth companies, or it must manage assets on behalf of third party investors, including investments made on behalf of a state or local retirement or pension system; and (ii) the VC company must have some nexus with California. Whether a VC company has a “nexus” with California depends on whether the VC company: (a) is headquartered in California; (b) has a significant presence in California; (c) makes VC investments in businesses located in or having significant operations in California; or (d) solicits or retrieves investments from a person who is a resident of California. If a VC company is engaging in any one of these activities, it has a “nexus” in California and is considered a covered entity.

Requirements
If considered a covered entity, the VC company must comply with the SB 54 reporting requirements. The bill requires covered entities to report the demographic information it collects for the founding teams of all portfolio companies in which it invested in the prior calendar year. The demographic information that covered entities must collect includes:

1. Gender identity, including non-binary and gender fluid identities;
2. Race;
3. Ethnicity;
4. Disability status;
5. Identification as LGBTQ+;
6. Veteran status; and
7. California residency.

Covered entities are also required to report data on the total number and amount of investments made in the prior calendar year in portfolio companies primarily founded by diverse teams. The bill defines a “diverse founding team member” as being an individual who “self-identifies as a woman, non-binary, Black, African American, Hispanic, Latino-Latina, Asian, Pacific Islander, Native American, Native Hawaiian, Alaskan Native, disabled, veteran or disabled veteran, lesbian, gay, bisexual, transgender, or queer.” The covered entity must present this disclosure as a percentage of VC investments it made that year and broken down by the demographic categories listed above. Covered entities must also report the total amount of money in VC investments it invested in each portfolio company during the prior calendar year and where each portfolio company has its principal place of business.

Potential Challenges
VC companies should expect delays in the implementation of SB 54 and additional clarification or guidance in the coming months regarding implementation of SB 54. When signing the bill into law, Governor Newsom stated that the bill “contains problematic provisions and unrealistic timelines that could present barriers to [its] successful implementation and enforcement.” He additionally stated that his office will propose “cleanup language” in an effort to ensure that this improvement to diversity in VC investments can properly be implemented.

Additionally, recent litigation in California suggests that SB 54 could face a variety of legal challenges. Other similar legislation in California includes Assembly Bill 979, a bill intended to increase diversity on corporate boards of directors by presenting a requirement for publicly traded companies based in California to have a certain number of board members from traditionally underrepresented communities. Assembly Bill 979 was met with challenges based on the “mandated quota” requirements and the trial courts issued a permanent injunction barring the state from enforcing the legislation. However, SB 54 differs from this legislation in that it does not require VC investments to be made in diverse businesses. It instead aims to increase transparency and shed light on funding discrepancies so that there may be greater accountability among VC companies.

With the potentially vast impact, challenges, and delays, it is important that VC companies pay attention to this evolving landscape and ensure they are in compliance with all reporting requirements.