Venture Capital Firms Caught in the Middle of DEI Legal Fights

The tug-of-war over diversity, equity, and inclusion is increasing the threat of legal scrutiny for venture capital 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. But on the other side, investigation demands the Southern Poverty Law Center sent to state attorney generals in early August and an upcoming California diversity reporting law have signaled to VCs that a heavy tilt in funding toward White and male targets could prompt claims of discrimination in investment choices.

“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,” said Robin M. Bergen, an attorney with Cleary Gottlieb Steen & Hamilton LLP who advises venture capital and other investment firms.

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. Women-founded businesses accounted for 2.2% of funding for the year, 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.”

Proof of Bias

Lawsuits over disparities in funding tend to be hard to bring due largely to the difficulty that hypothetical plaintiffs would face in proving an investment firm’s decisions were motivated by bias, especially 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 said.

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 entrepreneurs they back.

“One purpose of this law was to help identify investigation targets” for state regulators, Bergen said.

The new California law—first passed in 2023 and amended this year (SB 164) to delay its initial reporting deadline to 2026—raises the possibility of giving plaintiffs and regulators the kind of evidence they need to bolster bias claims, whether via litigation or agency enforcement actions, Bergen said.

Investment firms with a venture capital focus will have to share with the state the race, gender, and other demographic information about the founders of their portfolio businesses, along with the percentage of funding that went to businesses primarily launched by diverse founders.

The state is required to make the reports “readily accessible, easily searchable, and easily downloadable.”

Civil rights groups, though reluctant to discuss specific litigation strategies going forward, said the wave of anti-DEI litigation over the past year heightens the need for fighting discrimination with any legal means available, including in the realm of venture capital funding.

“For decades our antidiscrimination laws have given us the tools to implement programs aimed at remedying that type of past and present ongoing discrimination, so long as those programs meet certain criteria,” said Amber M. Koonce, assistant counsel at the NAACP’s Legal Defense and Education Fund. “We are concerned that remedying that racial disparity in the market is being challenged.”

Venture Capital Letters

The SPLC urged the attorneys general of Florida, Georgia, and Louisiana in letters dated Aug. 5 to investigate investment firms in their states whose portfolios consist of predominantly White-founded businesses for potential discrimination against minorities. The SPLC said it targeted those Republican AGs because each has publicly supported the legal efforts challenging DEI and affirmative action programs.

Those AGs should “scrutinize the white favoritism policies of some companies as vigorously as they oppose the affirmative action policies for people of color,” said Scott McCoy, deputy legal director at the SPLC.

Having to publicly report the diversity metrics of their portfolios will put VC firms in an uneasy spotlight, even though many of them already are aware of and working to address the racial and gender disparities in startup funding, said Arman Pahlavan, an attorney with Perkins Coie LLP in Palo Alto, Calif., who advises investment firms.

Investors will face growing scrutiny of their decisions, both from the plaintiffs’ bar and from anti-DEI activist groups, he said, but they should be able to defend against bias claims if they aren’t advertising explicit racial or gender preferences. That’s partly because so many factors go into each investment decision, including the underlying technology or intellectual property driving a business and its existing customer relationships when it seeks funding, he said.

Minority business owners ran into the difficulty of proving racial motivation when suing the city of Greensboro, N.C., under Section 1981 of the 1866 Civil Rights Act, after it denied them a small business loan to develop a television sitcom. The US Court of Appeals for the Fourth Circuit ruled in the city’s favor in 2020, finding the plaintiffs’ evidence, such as a case study showing the city awarded relatively few contracts to minority-owned businesses, wasn’t enough to establish bias in the denial of their loan request.

The Florida and Georgia AG offices and the investment firms named in the SPLC’s letters didn’t respond to requests for comment. The Louisiana AG’s office declined to comment.

Racial Preferences Challenged

Business funding efforts that directly target capital to women and entrepreneurs of color have faced a steady stream of legal challenges over the past year, many of which use Section 1981. The 1866 law was originally enacted to bar racial discrimination in the enforcement of contracts against Black Americans, but has been recently leveraged by DEI opponents.

The Eleventh Circuit’s ruling to block Fearless Fund’s grant program because it excluded entrepreneurs who are not Black under Section 1981 could inspire more such challenges.

“Fearless Fund opens up grant-making foundations or entities who have explicit racial criteria for eligibility to suit,” making it “an extremely important case,” said William Jacobson, a professor at Cornell Law School who filed an amicus brief supporting the challengers in the appeal.

A federal district court in Texas reached the same conclusion in August about a similar program to provide grants to minority-owned businesses, run by the nonprofit Founders First Community Development Corp. Like Fearless Fund, that case was brought by the American Alliance for Equal Rights, led by Edward Blum, the same advocate who instigated the lawsuits against Harvard and the University of North Carolina that led to the Supreme Court’s affirmative action reversals.

A similar challenge against Progressive Preferred Insurance Co. failed on procedural grounds and is pending appeal at the Sixth Circuit. In that case—backed by former Trump advisor Stephen Miller’s America First Legal Foundation—a challenger claimed Progressive’s grant program to help Black-owned businesses buy commercial vehicles was discriminatory against business owners of other races. An Ohio federal district court ruled the plaintiff lacked legal standing to bring the claim.

“This is something the Supreme Court is likely to take up—and rule once and for all on Section 1981 as it would apply to the grant making process,” perhaps through a Fearless Fund appeal or some future case, Jacobson said.