The numbers tell the story. US venture capital firms have $444 billion under management, including $121 billion in “dry powder” waiting in reserve—all in pursuit of the next “unicorn” startup that will grow to be worth billions. But about three-quarters of the industry’s cash goes to support software innovation—a habit that’s looking particularly short-sighted at a time when the nation is facing its worst public health crisis in a century. 

On top of that, most of the people who allot venture cash are white men, and they mostly fund startups led by white men. Fully 65% of venture capital firms have no female partners, and 81% have no Black investors. Only 2% of the cash distributed by venture firms in 2017-18 went to women-led startups, and over the period from 2013 to 2017, only 1% of venture money percent went to Black entrepreneurs.

For the July issue of MIT Technology Review, financial journalist Elizabeth MacBride took a hard-hitting look at the venture industry and its successes, failures, and blind spots. This week on Deep Tech she talks about why the mystique of the VC cowboy with a nose for huge profits is mostly a fabrication, and why it’s hard to disentangle the industry’s bias toward funding white, male, Ivy League-educated entrepreneurs from its bias toward the software industry, where it’s easiest to obtain outsized returns.

Links and Show Notes

Why venture capital doesn’t build the things we really need, June 17, 2020

The Code: Silicon Valley and the Remaking of America, by Margaret O’Mara

The narrowing ambitions of venture capital, September 6, 2012

What’s wrong with venture capital?, February 23, 2010

Full Episode Transcript

Elizabeth MacBride: What you can pin on the venture industry is this untruth, this kind of embrace of a false narrative that Silicon Valley was not built on the government.

Wade Roush: Elizabeth MacBride writes about the world of business, finance, and technology, where she says venture capitalists have long tried to promote an image of themselves as risk-hungry mavericks who build whole industries from nothing. She says the reality is that the venture business got its start in the 1960s by investing in computing and other areas that the federal government had been bankrolling ever since Sputnik.

Elizabeth MacBride: So that they’ve put this kind of mistaken idea into our national narrative that we don’t need the government, we don’t need collective action, that they’re the cowboys, they’re the only people that can do innovation.

Wade Roush: For the July issue of Technology Review, MacBride took a hard look at the way venture capital works, and doesn’t work, to fund innovation in America today. We’ll talk with her about how the industry got its start, why it funnels so much of its money to white male software developers, and what it could be doing to fund broader kinds of businesses. I’m Wade Roush, and this is Deep Tech.

[Deep Tech theme]

Wade Roush: There’s no doubt that venture capital is one of the key engines bringing new conveniences to consumers in the US and around the world. All those TV shows and movies you can watch on Netflix? You can thank venture capitalists for those. The fact that taking an Uber is usually cheaper than taking a taxi? Again, venture.

I’m someone who’s been covering technology startups for 20 years, and the creativity and energy of the entrepreneurs I’ve met along the way has been nothing short of astonishing. But the statistics show that only a tiny fraction of the startups backed by venture capital are led by women or people of color. They also show that venture firms put three-quarters their cash into software companies. Of course, those two facts are interrelated, since most software companies are headed by white men.

So far 2020 has been defined by the coronavirus pandemic and the uprisings over police killings of Black Americans. So it’s a natural time to ask whether the venture industry is giving us the kinds of innovation we really need, like technologies to measure and protect public health. And it’s also time to ask why venture has failed to support innovation by women, people of color, and people from low-income backgrounds. That’s what Elizabeth MacBride does in the current issue of Technology Review. And in my conversation with Elizabeth I thought we should start with the basics.

Wade Roush: I think the venture capital business is fairly mysterious and opaque to most people. And so I wanted to start by asking you to help explain what the venture capital industry does. Like, who works inside it? What kinds of companies does it fund? And why do most startup entrepreneurs with technology ideas almost always end up feeling like they have to play the VC game to get their companies off the ground?

Elizabeth MacBride: Yeah, I think that’s a really good question, because I think there are a couple of levels of misunderstanding about what venture capital is. So to start with, I’d say that most entrepreneurs don’t realize a very basic fact, which is that in venture capital the fund managers are not really in charge. They’re fund managers. They get money from limited partners, who are often like hedge funds or big institutional investors, like pension funds, wealthy families. They take all that money and then they turn around, invest it in startups, and hope to produce returns on at least one of the startups so that they can then return money back to their investors at a pretty high rate of return. You know, they’re aiming for rates of return of like 20% a year after their fees, which is hard. So it’s a really, really difficult business. And the people who are really in charge in that model, of course, are the investors, the limited partners who are saying “We want our returns. We want our money back.”

Elizabeth MacBride: The other sort of misunderstanding about venture capital ... So in my article, my first call as I was reporting was to my friend Charlie Ellis, who is just a great and longtime advocate for small investors. Charlie is a former board member of Vanguard, which is the world’s largest mutual fund company. And Charlie was also on the board of the Yale endowment, which is a hugely successful institutional investor. So he would know about the venture capital business from the perspective of somebody who has been one of those LPs who’s invested in a venture capital firm. And he’s also just a straight shooter, so I often call him at the start of a complicated story and I say, hey, Charlie, tell me what’s really going on. And what he said to me is that venture capital is really less finance and more human resources. So the model of a successful venture capitalist is to find an entrepreneur that they believe has promise and a promising idea. Then they’ll surround that entrepreneur with resources, money, connections to talent, marketing, like all kinds of resources that help that entrepreneur grow.

Wade Roush: So he thinks of it as an edge. I mean, in my mind, when I read that line in your piece, I was thinking, “Hey, wow, Charlie’s really helping us to de-romanticize this industry.” If it’s just HR, that doesn’t sound like a lot of value-add, but maybe it is.

Elizabeth MacBride: It is de-romanticizing it, but it’s still an edge. It’s funny, right, that so much of the world is built around people. And finance has long since been taken over by algorithms. What’s really romantic here is this illusion we have that there is some magical way to make money. There’s not. There’s no magical way to make money. The only magic is in working with other people to create value.

Wade Roush: If you had to imagine or paint a picture for us of the average venture capital firm, where would it be located? Who would be working there in their office? What would be the spectrum of kinds of faces you would see inside that office?

Elizabeth MacBride: So, much of the venture capital business is located in San Francisco, in Palo Alto, in San Jose, in that area. It’s gradually been globalizing so that you will find pretty substantial venture capital firms in big global cities as well. I’ve noted a bunch. In Dubai and London, Singapore, places like that, there are venture capitalists as well. Globally, what you find is that people who are among the elite of any given country are the people who are in the venture capital industry. And in the United States, which is still the leader in venture capital worldwide, the elite are white men, mostly, who went to Ivy League schools. To some extent there’s been some diversification. So you’ll often see people of Indian descent or Asian descent in the firms, but it’s very much dominated by men and mostly white men.

Wade Roush: You and I talked a little bit on email before the interview about how it’s probably too easy to think of VCs as either heroes or villains. There’s a more complex history here. The industry is part of a larger system. It’s a symptom of the era when it was born, which is sort of the ’60s, ’70s, and ’80s. Seems like there’s a higher than average or higher than expected number of folks who lean toward the libertarian end of the political spectrum in this business. What’s going on here?

Elizabeth MacBride: Yeah. So this was a fascinating discovery for me in reporting the piece. So I read The Code, which is Margaret O’Mara’s history of Silicon Valley. And what I discovered and had never known—except maybe glancingly, like I’d been told tiny bits and pieces over the years of covering Silicon Valley—but what she really lays out is the story of how the federal government played a huge role in the founding of Silicon Valley. And that it was the great innovation, the silicon chip, where Silicon Valley gets its name, was born out of this post-World War II era where the federal government was saying, hey, we have really got to get an edge on Russia.

Elizabeth MacBride: So that idea that the federal government had such a huge role in Silicon Valley, I think, has been lost to history to some extent for two reasons. One, I think that the people who initially were working on Silicon Valley, in Silicon Valley in the kind of ’60s and ’70s, they were like flower children. Right? They had this very idealistic view of the world. This idea that technology could really save things. And part of that was an anti-establishment bent. So they didn’t really want to acknowledge the government had a role in what they were doing.  And then as Silicon Valley kind of grew into a real center of corporate America in the 1980s and 1990s, it happened at the same time that libertarianism was growing up in America. And I think, you know, Ronald Reagan, like the great communicator, kind of put these two threads together.

Ronald Reagan [tape of March 1985 remarks to the American Business Conference]: Today’s economy is being powered by a high-tech explosion whose effects are only beginning to be felt ... When tax rates were cut, the dollars committed to venture capital exploded, from only $39 million in 1977 to over $4 billion last year. 

Elizabeth MacBride: Part of what was so appealing, I think, to Ronald Reagan was that he could create a narrative that said these were sort of the cowboys of the American business world. They didn’t need the government. So, it very conveniently ignored the fact that, yes, they did need the government. They were still taking a lot of government contracts and they, in fact, had built this whole place on government funding.

Wade Roush: Yeah, and that’s not even to mention another huge kind of government subsidy that the venture industry gets, in the form of the fact that carried interest, the income that VCs get on their investments, is not taxable in the same way that capital gains are, right?

Elizabeth MacBride: Yeah, I think it got to be a very convenient narrative. The idea that you could outsource innovation to the private sector and therefore they deserved to be paid very well and taxed very lightly. So that was, that’s like a convenient narrative for the Republicans, especially the libertarian wing of the Republican Party. But it's also a convenient narrative for Democrats, who then can reserve government funding for social programs. If you don't want to have to invest in innovation, it’s very handy to say, okay, we’ve got this great world, it’s all private sector out in Silicon Valley that’s just doing it.

Wade Roush: You quoted John Doerr, who’s a famous partner at a famous firm, Kleiner Perkins, who wrote that the best founders, quote, all seem to be white male nerds who’ve dropped out of Harvard or Stanford and have absolutely no social life, unquote. It's funny, I mean, if all that VCs really cared about was talent, then why is it that they wind up with this bias toward funding white male entrepreneurs?

Elizabeth MacBride: Yeah, it’s a big question, right? But it's also a complicated question. So I do think, and I try very hard to understand venture capital as part of our system of innovation. Because I don’t think it’s fair or right to say that venture capitalists are outright racist or biased. I don’t think they’re sort of evil people. I think some of some of them are difficult to deal with. Venture capital really loves to fund and in fact, finds only those returns it needs in software companies. For a long time, there has been a very specific kind of entrepreneur—white men, for whatever reason, were building those software companies. So it’s a more complicated question than to say that what they’re really looking for are white men, when part of what they’re looking for are software companies. Does that make sense?

Wade Roush: Oh, yeah. I mean, this is a very complex web of interlocking structural deficits in our society, in our economy, right? Obviously, if you’re Black or if you’ve had fewer opportunities throughout your entire life for wealth-building or if you haven’t gotten into an elite institution like Stanford or Harvard, you’re starting way behind. And you can’t necessarily pin that on venture capital partners in Menlo Park, California, right? It’s a systemic problem. That doesn't release any of us from responsibility.

Elizabeth MacBride: Yeah. That’s what I fundamentally believe. It is a shared responsibility. To those to whom much is given, much is asked. You could definitely say to those very wealthy, very successful venture capitalists, “Maybe you should be doing more to work on kind of righting these systemic problems in the United States.” And I believe that. I think most people probably believe that. So that was also part of my story, I think, this growing realization, as I reported it and we were kind of watching, like, all the scales were falling away from our eyes about what the United States really had become. As we were seeing the way we were responding well or not responding well to the pandemic, I was starting to think more seriously about what everyone’s responsibility was. And part of it is being very truthful about the privileges that you’ve been given, then being truthful as an industry, I think, in Silicon Valley about how much you owe to the government and to the nation for building up this great source of wealth.

Wade Roush: So how do we get out of this situation? So obviously we could try and fix income and wealth inequality. That would be the big thing to do. Do you think there are things the venture business could be doing on its own to give a say to a broader cross-section of people?

Elizabeth MacBride: Yeah, well, there are lots of efforts underway to come up with early stage investing of innovation that will work better. Or that at least will work in a way that delivers success more broadly. There is a non-profit venture firm called VentureWell, which raises money, I think, from foundations, and that sort of replicates what a venture capital firm would do, but goes for lower returns. So they’re not trying to hit that 20%. So maybe they can take a longer time to nurture a really huge innovation that doesn't have that software component, but is maybe an innovation in the physical world, like a better hypodermic needle or a better way to disinfect protective gear. These are obvious things that occurred to me as I was writing,  that we could have used the power and scale of the venture industry applied to this world of public health. And that’s not happened. But there are people who are working on it like  VentureWell. There’s also a whole world of impact investing. Right? Again, these are people who say “I’m okay with a 10% annual return as long as I know that what I’m doing actually helps as a benefit for society.”

Wade Roush: Elizabeth says you have to take all of those ideas with a dose of realism.

Elizabeth MacBride: People who keep you on the straight and narrow—intellectually honest—will remind you, money really flows where the returns are highest. So as long as there are high returns in software, that is where most of the early-stage investing dollars will go.

Wade Roush: All right. We’ve mentioned several times that there is this seemingly natural fit between software and venture capital. You ask in the piece why VCs didn’t do more to help us create a public health infrastructure where, for example, we might have been able to detect lurking viral outbreaks sooner or build an infrastructure that could develop vaccines faster or supply us with protective equipment or ventilators. Who knows? So to play devil’s advocate, a venture capitalist might say that’s an unfair criticism, because first off, we didn’t even know that those things would be specific needs until the covid-19 pandemic struck. But more fundamentally, it just feels like those are the kinds of innovations that have never led to outsize financial returns, like the ones VCs have to return to their LPs, as we’ve said. Now, you could call that a giant market failure. But is it fair to pin that market failure on the venture industry? And what responsibility do you think they should bear for helping to fix that kind of market failure?

Elizabeth MacBride: So I do not think it’s fair to pin that market failure on the venture industry. People are people, and they go for the highest returns, right? That’s just fundamentally true. But what you can pin on the venture industry is this untruth, this kind of embrace of a false narrative that Silicon Valley was not built on the government. So they’ve put this kind of mistaken idea into our national narrative that we don’t need the government, we don't need collective action. It’s not their job to fund a public health system. It’s probably America’s job, right? It’s our job, and they are part of that “our,” to fund a working public health system that is for everybody. But you can absolutely pin on them this kind of marketing idea that they embrace that they’re the cowboys. They’re the only people that can do innovation. Their innovations are the world-changing innovations. Some of that kind of ego-driven narrative, I think, has been really damaging to our sense that we need to act together.

Wade Roush: Okay, Elizabeth, thank you so much. I really enjoyed this conversation and it’s been a little bit tough, but I think this is a conversation we need to have. So thank you.

Elizabeth MacBride: All right. Well, thank you for having me on.

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Wade Roush: That’s it for this edition of Deep Tech. This is a podcast we’re making exclusively for subscribers of MIT Technology Review, to help bring alive the ideas our journalists are thinking and writing about.

You can find Elizabeth MacBride’s article “Losing the Winner’s Game” in the July issue of Technology Review. And you can find her new online publication The Times of Entrepreneurship at timesofe.com.

Also in the July issue, you’ll find the TR35. It’s our annual list of 35 innovators under the age of 35 who are working to advance fields like 3D printing, water desalination, and natural language processing. For more than 20 years readers have been looking to our list to find out who’s up- and-coming in science, engineering, and entrepreneurship, and whose inventions are going to change the world. Check out the whole list at technologyreview.com.

Deep Tech is written and produced by me and edited by Jennifer Strong and Michael Reilly. Our theme is by Titlecard Music and Sound in Boston. I’m Wade Roush. Thanks for listening, and we hope to see you back here in two weeks for our next episode.