From Crowdfunding to Shark Tank: persistent biases in fundraising

Many factors can influence the success of individuals in seeking and obtaining capital. These factors are not only dependent on the investment itself, but surprisingly they are also dependent on the personal characteristics of the parties involved, such as appearance or even the tone of voice.

According to Harvard University, men are 60% more likely to succeed in pitch competitions than women.

And, among men, good looks represent 24% of the probability of success. But what if investors could not see entrepreneurs, would the results be different? The researchers find that, even when investment opportunities are identical, 68% of investors prefer those presented by male voices.

More recently, researchers at the University of Miami, using data from the Shark Tank show, found evidence that there is homophily in venture capital markets. The concept refers to the human tendency to favor other people with characteristics which are similar to yours (for example, the same race or gender). This happens on both sides of the investment table; either on the investor side, when deciding who to invest in, or on the company’s, when deciding who to accept an investment offer from. For example, a match is more likely to occur when both the investor and the entrepreneur are women or when both are white men.

In addition to affecting the likelihood of an investment offer occurring at all, homophily also affects the outcome of the negotiations after an offer is made. That is, the valuation (sales price a company) and consequently, affecting the amount of money offered. It would be reasonable to expect that the valuation, whether requested by the entrepreneur or offered by the investor, would be more correlated with the characteristics of the company and the opportunity, and less with the entrepreneur's demographics. However, the evidence shows that younger entrepreneurs, women and blacks underestimate their own valuations, and inconsistently with their sales and profit margins. But even worse is that, for black entrepreneurs in particular, in addition to receiving lower investment offers, also receive a lower valuation from investors in their negotiations. In other words, they face systematic discrimination in how their businesses are evaluated by investors.

Another study, by researcher Lauren Rhue, analyzes more than 193,000 records from the entire list of projects on the crowd-funding platform Kickstarter to look for clues about racial disparities in fundraising.

The results show that black fund raisers are 82% less likely to succeed.

In addition to the success rate, race also influences the total number of sponsors. The author adopts a methodological strategy that considers only identical projects in their observable characteristics, thus eliminating any doubts about differences in the quality of the projects presented.

Although crowdfunding platforms exist to "democratize" financing; However, as they become more visual and provide more context about the opportunities, entrepreneurs encounter similar discrimination in the online and offline worlds.

Aware that the demographics of entrepreneurs have implications for fundraising, the Prosper.com platform omits certain identifiable characteristics such as gender and race, so that potential sponsors are forced to judge only on the basis of the value of the project. However, according to the study by Northeastern University professors, Peter Younkin and Venkat Kuppuswamy, it is important that black entrepreneurs be aware that there is also a consumer bias. According to them,

consumers can hide their implicit racial bias about the capabilities of blacks, disguising unfair price offers for products as uncertainty surrounding the “suitability” of the entrepreneur and the product.

One might wonder if the current machine learning (ML) algorithms might be able to eliminate human behavioral biases when performing credit assessments by application, for example. However, due to the lack of financial history to calculate appropriate interest rates, the new digital platforms have resorted to analyzing the customer's personal relationships network. The new algorithms, therefore, reproduce the same human biases and subtly introduce a new type of discrimination; the one that uses the "social score" to deny loans to individuals who might even be creditworthy, but who have no creditworthy connections. To solve this problem, algorithmic bias mitigation strategies will have to be designed.

There is overwhelming evidence that my gender and race are obstacles between the investment and me. Existing biases not only affect the entrepreneur but produce imperfect decisions with sub-optimal results in investment markets. As markets and the profile of investee companies change, resisting change means that investment portfolios will perform progressively worse. 

You may have heard about diversity certifications, anti-racism training, and ESG policies. All of this is good and applicable, but they underestimate the pending challenge of changing the investment sector. The actors of the investment industry in this country must stop deluding themselves that their own attitudes would in no way change the situation of exclusion that affects more than half of the Brazilian population. 

The truth is that the capital market reflects exactly the Brazil that we are, in all its desire and fear of change. And, therefore, to challenge the capital industry is to challenge the Brazilian elite that does not become moved by the exclusion of others. 

Although there is no single answer to the exclusion that is sown in the fabric of our society, what is certain is that a new paradigm is necessary. One where the distance between the two sides of the investment table is not affected by one’s appearance, but the content of their character and the possibilities of wealth and impact creation of their ideas.