This year marks the 30th Anniversary of the historic billion-dollar leveraged buyout of Beatrice Foods, put together by African-American business pioneer Reginald Lewis. As recently profiled in the PBS Documentary “Reginald Lewis and the Making of a Billion Dollar Empire,” Lewis was a business icon who paved the way for minority investors to ascend to the highest levels of finance. Thirty years later, his landmark acquisition of Beatrice and the example it set still resonates.
If Reginald Lewis were a young man investing today, he wouldn’t be doing leveraged buyouts in traditional, bricks and mortar industries. He would be investing in the technology industry. Why? Because, according to his daughter Christina Lewis, that is where the opportunity and action is.
The technology industry has become a catalyst for tremendous wealth creation in the United States. Productivity in digital industries grew at a rate of almost four times the rate of productivity in physical industries over the past fifteen years. At the end of 2017, the top five most valuable companies in the world were technology companies. Three of the five wealthiest people in the world are technology entrepreneurs.
The venture capital industry is the engine that drives the technology industry. The early risk capital that fuels startup innovation helped businesses such as Google, Facebook, Netflix, and Tesla get off the ground. And although only a small percentage of businesses in the U.S. receive venture capital, they comprise a disproportionate share of the economic wealth created through entrepreneurship. Of the companies that went public since 1979, VC-backed companies comprised 43 percent of all companies, 57 percent of market cap, 38 percent of all employees, and 82 percent of R&D.
The challenge for minorities is that they have not participated in the venture capital industry at large firms in a meaningful way. According to a study by the National Venture Capital Association and Deloitte, blacks and Hispanic/Latino groups comprise only 3 percent and 4 percent of the venture workforce, respectively. Of senior positions at VC firms, blacks comprise only 2 percent of positions.
However, an encouraging trend is that minorities are now increasingly starting their own venture firms. According to institutional investor Fairview Capital, in 2017 there were 114 women and minority-owned private equity firms raising capital, of which 54 percent of firms were pursuing venture capital investments. Almost half of these managers were pursuing funds of less than $150 million.
The challenge for minority managers is that although their performance often outpaces that of non-diverse venture firms, their ability to raise capital often lags far behind. A 2017 National Association of Investment Companies study indicated that diverse private equity funds outperformed the median Cambridge Associates’ U.S. benchmark 63 percent of the time on an IRR (internal rate of return) and MOIC (multiple on invested capital) basis, and over longer time horizons consistently performed both median and upper quartile funds in the Cambridge indices. Nevertheless, capital allocated to diverse managers remained low or non-existent for many institutional LPs (limited partners) studied, and generally less than 10 percent of an institutional investor’s total assets.
Nowhere is this inefficiency more evident than for early-stage minority venture capital managers. Early-stage venture firms invest at the riskiest stage of a startup’s development, where the probability of failure is high, but also where the potential for significant equity value appreciation is greatest. Data indicates that although perceived risk is high, smaller venture firms often outperform larger funds.
Furthermore, the last decade has witnessed a rise of high-performing micro-VC firms which have provided the seed capital to unicorns such as Uber, Airbnb, Twitter, Stitch Fix. These firms include names such as Floodgate, First Round Capital, Felicis, Baseline, and IA Ventures. Many of these firms started relatively small, generally with funds that were smaller than $20 million.
An opportunity exists for institutional LPs to seed the next wave of diverse early-stage venture capital managers. These new firms include 645 Ventures, Cross Culture Ventures, Connectivity Ventures, and Precursor Ventures. These firms are targeting exceptional fund performance, leveraging differentiated investing strategies and access to the best entrepreneurial founders. They aim to capitalize on the evolution of the venture capital business, and seek to build the leading venture firms of the future. They also seek to follow in the footsteps of exceptional later-stage investment firms run by diverse managers, in particular that of Vista Equity Partners, one of the highest-performing buyout firms.
In order for institutional LPs to seize this opportunity, they may be forced to make exceptions to their traditional rules, and invest in funds of $50 million and below. But just as LPs in the seed funds such as First Round Capital and Baseline have been richly rewarded as those firms grew and prospered, institutional LPs who take risk on early-stage minority managers may be richly rewarded as well.
As we celebrate the 30th anniversary of Reginald Lewis’s billion-dollar buyout of Beatrice Foods, we also look to the future. The next wave of great minority financiers may indeed come from the venture capital industry, and the potential for wealth creation is significant. Investors should not miss out on the opportunity to invest in this new era of wealth creation.
