The tug-of-war over diversity, equity, and inclusion (DEI) is increasing the threat of legal scrutiny for venture capital (VC) firms, whether they proactively back more diverse business founders or maintain a status quo that tends to funnel most capital to White male entrepreneurs.
Investment firms face growing and competing pressures around diversity, much like law firms, corporations, and universities making promotion, hiring, and admissions decisions. A 2023 US Supreme Court decision striking down affirmative action in higher education quickly spawned litigation challenges to DEI programs across sectors.
For VCs and other business funding programs, the pressures are amplified by a June federal appeals court ruling blocking Fearless Fund’s grant contest for Black women entrepreneurs. Conversely, the California diversity reporting law signals to VCs that a heavy tilt in funding toward White and male targets could prompt claims of discrimination in investment choices.
Robin M. Bergen, an attorney with Cleary Gottlieb Steen & Hamilton LLP who advises venture capital and other investment firms, remarked, “It’s a challenge. My clients are worried about backlash, whether reputationally, public criticism, or lawsuit or investigations. You can imagine it now coming from either direction.”
The lack of diversity in recipients of VC funding is widely acknowledged by investors, some of whom have begun to take action in recent years. Less than 0.5% of all VC funding awarded in 2023 went to Black founders, according to Crunchbase data, while women-founded businesses accounted for 2.2% of funding, according to Pitchbook.
“The venture capital industry should better reflect the diversity of our nation,” said Bobby Franklin, president and CEO of the National Venture Capital Association, in an emailed statement. “This is crucial for both the long-term prosperity of the VC industry and the creation of opportunities for all American entrepreneurs.”
However, lawsuits over funding disparities are challenging to bring due largely to the difficulty in proving an investment firm’s decisions were motivated by bias, specifically in the absence of specific criteria that limit funding to groups by race or gender.
“If facially the criteria is open to all, it’s difficult to win that challenge,” Bergen noted.
The California diversity reporting law, which will require annual reports starting in March 2026 to cover the prior year’s investment decisions, could raise the risk of bias claims and state enforcement actions by forcing investment firms to publicly disclose the demographics of the entrepreneurs they back.
“One purpose of this law was to help identify investigation targets” for state regulators, Bergen said.
The Southern Poverty Law Center (SPLC) is pushing for scrutiny from Republican Attorney Generals in states like Florida, Georgia, and Louisiana, urging them to investigate investment firms with predominantly White-founded businesses for potential discrimination against minorities.
Having to publicly report diversity metrics will put VC firms in an uneasy spotlight, even though many already are aware of and working to address the disparities, noted Arman Pahlavan, an attorney with Perkins Coie LLP. Investors will face scrutiny from both the plaintiffs’ bar and anti-DEI activist groups but should be able to defend against bias claims if they aren’t advertising explicit racial or gender preferences.
The Eleventh Circuit’s ruling to block Fearless Fund’s grant program because it excluded non-Black entrepreneurs under Section 1981 could inspire more challenges. A similar case involving a program by Founders First Community Development Corp was blocked, and challenges against Progressive Preferred Insurance Co. are also pending.
This polarization in venture capital funding is likely to continue generating legal scrutiny as firms navigate the fine balance between promoting diversity and avoiding claims of bias.