The State of California just passed a bill that mandates the public disclosure of diversity metrics for venture capital investments. It will go into effect on March 1, 2025.

Now Tracey Warren, CEO of F5 Collective, wants to bring the law to Australia. F5 runs a $5M micro-VC fund that represents about 0.00025% of the global $2 trillion in venture funds under management, has made just seven investments, and is yet to prove it can generate returns. The law, as in California, would require that VCs disclose the sexual orientation and gender of their portfolio company founders.

Here's why I think such bills are a well-meaning but fundamentally bad idea.

Fiduciary Obligations

As a VC firm, your primary responsibility is to generate returns for your investors, private individuals who've entrusted you with their hard-earned cash. Mandating diversity metrics can interfere with that sacred fiduciary duty and deliver sub-optimal returns based on playing politics instead of finding the best founders to invest in, regardless what they identify as. If VC firms are going to aim to meet investment quotas, then they need to clearly articulate this in their fund IMs and when pitching to would-be LPs, and definitely not change course half way through a fund investment period.

Supply and Demand

There's a reason why less than 10% of sole female founder startups get funded—it's almost an accurate reflection of percentage of startups founded by solo women. If we want more females funded, we need to get more women starting companies, not arbitrarily funding a greater percentage of them relative to men.

Merit

Startups should be funded based on merit and their potential to turn a profit and generate outsized returns, not the gender or the sexual orientation of their founders. True equality means judging on the content of one's character - no the colour of their skin, gender, or who they choose to get romantically involved with.

VC Power Laws

Venture capital is an unforgiving space. The top 20 firms in the U.S. capture 95% of returns. Many firms struggle to beat the S&P500's modest returns. You're picking needles from a haystack. Adding diversity quotas to the mix and making the pool disproportionately smaller makes it an order of magnitude harder to pick winners.

Unseen Diversity

Mandating gender and sexual orientation disclosure says nothing about other factors—socioeconomic background, political beliefs, ethnicity, migrant status, and so on.

And on bringing Gavin Newsom's law to Australia, one can't help but consider the following.

California as a Role Model, Really?

Let's face it, California's not exactly a shining beacon of common sense right now. The state reached record move-out numbers of net 400,000+ residents in 2022 for a reason. Under Gavin Newsom, it has endured some of the most draconian and socialist policies that have turned once thriving urban centers into tent cities for the homeless, rife with crime and drugs. The success that California, and in particular Silicon Valley, has had over the past few decades is obviously not a reflection of Newsom's four years in office.

Lost in Translation

Importing laws from one region to another doesn't necessarily translate well. The dynamics, challenges, and cultural contexts can be starkly different.

Not Forcing, Just Naming an Shaming

Ms Warren suggests that this proposal won't force VCs to invest in diverse founders, just to disclose who they invest in. This is a con of sorts. Disclosing is the first step to being named-and-shamed, as numerous tech conference organizers have learned the hard way for not having 50/50 gender splits on panels (despite there being seven-times less female founders than male founders). 

Final Thoughts

This proposal might be well-intentioned but is sadly misguided, short-sighted and is unlikely to drive positive outcomes.

VCs should back promising startups, no matter who's at the helm - white, black, brown, Asian, Hispanic, male, female, non-binary, gay, straight, and so on.

If they're high-potential founders working on high-potential solutions, then capital should flow to them.

And if we want more minority founders to get funded, then we need to ask why they are under-represented in the startup ecosystem writ large, which of those reasons we can and should do something about, and what we do about it.