In this edition of Author Talks, McKinsey Global Publishing’s Alexandra Mondalek chats with tech venture capitalists Freada Kapor Klein and Mitchell Kapor about their new book, Closing the Equity Gap: Creating Wealth and Fostering Justice in Startup Investing (HarperCollins Publishers, March 2023). Cofounders of Kapor Capital, Kapor Partners, and SMASH Academy, the authors discuss their gap-closing impact investments and share how their equity-focused approach creates opportunity and generates wealth in vulnerable communities. An edited version of the conversation follows.
Why did you write this book?
Freada Kapor Klein: Mitch and I decided to write this book because we launched a bold experiment in 2011: we set out to see if one could earn respectable financial returns from a portfolio that was 100 percent gap closing. By that, we meant investing in tech start-ups, where the core business closes gaps of access or opportunity or outcome for low-income communities and/or communities of color.
Close to a decade into that investment thesis, we were achieving top-quartile financial returns. So, we decided to write the book to share our experiences: where we made wrong turns but also, overall, what was successful about our investment thesis, what our portfolio looks like, and to share stories of our founders.
What surprised you in the writing process?
Mitchell Kapor: There really were surprises along the way. One of the things we learned early is that entrepreneurs, in pitching their business plans to investors, generally were hiding something. That is because anytime, in preparing to pitch, they would mention diversity or impact, they would get coaching: “You have to take that out.” Not from us, obviously. “You know, that will completely tank any ability you have to raise money.”
So when we planted our flag and said, “Actually, we want to hear from teams that are diverse and have impact and gap closing in their mission,” we were surprised by just how many such founders there were. And that they were really waiting for someone to come along who was an investor who would work with them and be aligned in their values. The latent demand for what we’re doing was very, very surprising, in a positive way.
Freada Kapor Klein: One of the really interesting things that happened along the way is that in the summer of 2015, [managing partner] Brian Dixon and I were running a focus group of our founders because we were getting ready to hire our first portfolio services director. We wanted to know from our founders, “What are the skills that this person should bring to the job? What help do you need? What kinds of ‘platform services’ would you like available? How can we support you in building and running your companies?”
The number-one issue they had was in hiring technical talent across the board. It didn’t matter what sector their company was; it didn’t matter what stage. That was the number-one request across the board. What they said was, “We can’t compete with Google or Facebook” at the time. “We can’t compete on compensation with those companies. But we know that if we had some way of identifying that we have Kapor Capital funding, and we believe in certain values, we know that we could attract great engineers who care about values alignment more than they care about top compensation. They want to be paid fairly, but where they work and the products they’re building matter more to them.”
They asked us, “Can’t you come up with the equivalent of a ‘Good Housekeeping Seal of Approval’?” And our founders’ commitment was born. We put it in place in January 2016: that’s a whopping seven years ago! We were the first venture capital firm that said, “We will not write you a check unless you commit to building a diverse team and an inclusive culture.”
And it wasn’t a performative, check-the-box action; it wasn’t a “gotcha game”; it was, “Let’s help you.” So we designed a series of workshops—that I copresented with our first portfolio services director—to help people think about what business they’re in, what’s the profile of their customers, and are they hiring team members that look like their customers? While you might call this some kind of diversity pledge, it’s actually a good, smart business pledge to have your team reflect the demographics of your customers.
Tell us about the pushback against impact investing.
Freada Kapor Klein: It isn’t clear what impact really means; it isn’t clear what ESG criteria are. I think that lack of rigor has given the “anti” argument more force. We’ve been critical all along of standard ESG criteria. Mitch often says, “If you have enough recycling bins, you can get to be certified as a B corp.” And that’s not what we’re aiming for. In fact, we encourage our founders to become public-benefit corporations so that in their charter, they have a duty not just for financial returns but for some other kind of impact returns as well. And they need to document those.
To the degree that ESG criteria can have some rigor and result in superior financial returns, then, as Al Gore and David Blood, the cofounders of Generation Investment Management, wrote in a recent Wall Street Journal editorial, “Then it’s merely echoing good fiduciary responsibility.” I think we forget ESG is a tool; it’s a measurement tool. It’s nothing more and nothing less. And if it needs to be refined, let’s refine it.
What advice would you give to young venture capitalists about today’s market?
Mitchell Kapor: The first thing I would say is that the market is not a monolith, and what’s going on in later-stage private companies and in very early-stage seed and pre-seed companies are two different things. Of the pre-seed and seed markets, what I would say is: first, valuations have just gotten much more realistic, but the volume has not gone down all that much. There are still entrepreneurs with great and innovative ideas, and there are still funds that are very actively investing.
What’s interesting are all the kinds of investing that aren’t in the mainstream. Let me give an example. One piece of good news is that while there is still a very long way to go, there is increasing diversity in the ranks of investing partners. Both White and Asian women at big firms, on the one hand, and a significant number of Black-led seed-stage firms. That’s really important, because it matters who’s around the table making these decisions. What I see as a trend in the VC market is a willingness to rethink assumptions about who gets a seat at the table and how.
After George Floyd was murdered, our partner, Brian Dixon, wrote a blog post addressing the concern and interest that VCs had: “Oh, we don’t have any Black founders. We need to write some checks right away. What do we do?” Almost as if we need to tell them, “Oh, go look in aisle 12." No.
But what Brian said was, “This starts with who’s on your investment team. And why don’t you do something simple, which is when you have an open partner role, post it openly?” Believe it or not, that had never been done. It was inspiring when he said that. A couple of major firms acknowledged, in print, that it caused them to rethink, both first-round capital and initialized, to do something they’d never done, which was to post a position so that anybody could apply.
And, of course, they got a much wider range of applicants. They saw people outside their networks whom they never would have seen before. And, first round, in fact, hired their first Black partner as a result and credited Brian in print, in Forbes magazine.
Explain the ‘Silicon Valley Meritocracy Myth.’
Freada Kapor Klein: For many decades. Silicon Valley firms, especially top-tier VC firms, have believed that they have the secret to hiring the best and brightest talent for their own investment teams and that they have the ability to pick the best and brightest entrepreneurs.
What they haven’t done is hold up a mirror and look at the ways in which they are merely reflecting their own biases, what Mitch called, more than a decade ago, a “Mirrortocracy.” They are self-serving myths that say, “If we hire at these schools—only the top talent from these schools—then that’s a screen for the best and the brightest,” without digging to another layer and looking at all of the biases that result in somebody getting into one of those schools. For a long time, Silicon Valley venture capital firms have confused pedigree and privilege with merit. So you need a new yardstick.
For a long time, Silicon Valley venture capital firms have confused pedigree and privilege with merit. So you need a new yardstick.
And what we learned early on is that, if you measure distance traveled—whether this is for people on your investment team or for the entrepreneurs who are pitching you or if you’re an LP [limited partner] in funds, the fund managers—it works in all of these settings. It works to understand the circumstances in which one began life, and where they got to on their own steam. What are their character traits? What barriers did they overcome? That tells you a lot more about who they are going to be in a downturn than where they got a degree.
What are some essential takeaways from your book?
Mitchell Kapor: I would expand a little further on this notion of gap closing, because it is quite central to our entire investment discipline. We, of course, want to know. We see it in entrepreneurs, other investors: Could this get to be a large market? Can they achieve a dominant position and keep it? How strong is the team?
But we also ask a different set of questions: If this thing works, who’s going to be better off in the world? And who is going to be worse off? Will it increase the gap between the top and the bottom, or bring people together? Will it have a disproportionate benefit—a disadvantage on the other hand—for people at the bottom of the ladder?
That’s how we get at the relationship of the core business model to its social impact: Is it gap closing? We’ve woven that in from the first minute we have contact with an entrepreneur through the entire process of sourcing deals, of decision making, and of supporting those companies.
And it leads to a portfolio that looks very different from a conventional portfolio. It’s different not in financial performance, although top quartile is top quartile, but in that these are all companies fundamentally committed to making a positive difference in the world in measurable kinds of ways. Not “happy talk,” not “ancillary.” And you can build a VC firm out of that. Wow.
Is there anything else you want to mention?
Mitchell Kapor: What have we really learned over the decade of doing this? We started out with a hypothesis that this kind of gap-closing impact investing could work. We now have a dozen years’ worth of data saying that it actually does work and produces top-quartile results. But the larger point is that it’s a demonstration that the conventional wisdom is often not right.
There is still a deeply embedded view in Wall Street and in the financial community that if you do anything for impact or anything for diversity, it’s concessionary. It is going to reduce returns. If you look carefully at what we’ve done, at the stories of our founders, and at the results we’ve produced, you see that just does not stand up to logic and reason.
There is still a deeply embedded view in Wall Street and in the financial community that if you do anything for impact or anything for diversity, it’s concessionary. It is going to reduce returns. . . . That just does not stand up to logic and reason.
So what we’re hoping is that people who come in—not agreeing with us, who really believe, oh, this is concessionary nonsense—will take a look at the actual data and the facts, and they may rethink it. That would be a great outcome.
Watch the full interview
