In 1971, Yale psychologist, Irving James, founded the now well-known term, "groupthink." Thought of as a parallel to George Orwell's "doublethink" term from his dystopian novel, "1984," groupthink is defined as the tendency of people to conform to the same thoughts when in a group. This restricts the ability to think critically, use logic and reasoning, and avoid bias.
Since the term's coining over 50 years ago, many studies have displayed the dangers of groupthink. In fact, groupthink is largely believed to be partially responsible for some of the country’s most famous disasters, such as the Challenger space shuttle explosion.
While the movement has existed for some time, diversity, equity, and inclusion (DEI) has never been more important. Let's dive into the current state of diversity in private equity, why diversity is important in business and firms alike, as well as the specific benefits of diversity investing.
Humans crave comfort and familiarity. Newness can feel scary, albeit slightly exciting. But the goal of business is to grow. And as firms know, once you've saturated a market, there's no more growth to be had. Unless you diversify — or expand into a new market, add new products or services, or disrupt the status quo.
Portfolio diversification is not a new concept. But the connection between the benefits of a differentiated portfolio and the benefits of diversity within firms is still taking root. According to research done by the Harvard Business School, the industry has remained a predominately white, male one. After compiling data on every venture capital organization and investor since 1990, they found that only 8% of investors are women, with non-white ethnicities even less represented. Just 2% of VC investors are Hispanic, and under 1% are Black.
Diversity — both in your portfolio companies’ and your firm’s workforce — is key to growth. By having people of different backgrounds and experiences, with varying ethnicities, religions, and proclivities, you open your firm up to new opportunities.
Investing in diversity enables your firm and portfolio companies to create unique industry advantages. Embracing varying viewpoints, opinions, and experiences enables dealmakers to diverge off the beaten path and discover growth strategies and investment opportunities that the competition doesn't even know exist. Let’s dive into the benefits of diversity investing in more detail:
Innovation is all about coming up with new ideas and ways to solve a problem. But when all the voices in the room say the same thing and groupthink takes over, creativity can't happen.
In fact, a study by the Boston Consulting Group found that companies with a more diverse management team have 19% higher innovation revenue. Meaning, the more diverse a team is, the more money they make from newer products and services. According to the study, nearly half the revenue of those companies came from products and services launched within the past three years.
Developing and harnessing new technologies like AI is now a critical part of doing business. Embracing diversity — and the increased innovation that comes with it — empowers your firm and portfolio companies to grow at a faster and steeper trajectory than previously possible.
In the 1500s, the Catholic church created the "Devil's advocate" position specifically to facilitate counter-arguments during the canonization of Saints. They knew that only when you've exhausted all the options and understood the situation from all sides can you be sure you've made the right decision.
Just as the most valuable lessons are learned from failing, diversity fosters friction — which is a good thing. Having real discussions with people of different backgrounds and with different opinions means you have to collaborate to make a decision. The value of conflicting opinions and varied ways of thinking is yet another reason why diversity is important in business and firms alike.
The private equity industry is notoriously competitive. Firms want the best of the best, and diversity ensures that happens. Not only does a wider candidate pool increase the likelihood of finding the perfect new analyst or executive, but diversity is also increasingly important to younger generations.
A Glassdoor study found that 76% of both job seekers and employees mark diversity as an important factor when considering a company or job offer. 1 in 3 wouldn't even apply to a job where there is a lack of diversity. By 2025, 75% of the workforce will be millennials, and DEI will be a mandate more than a suggestion.
From exit success rates to higher returns on investments, multiple studies have shown that diversity impacts and improves investments' financial performance.
According to research by Harvard Business Review, shared histories, such as educational backgrounds, reduced the success rates of acquisitions and IPOs by 11.5% on average, compared to those investments with LPs and GPs from different schools. Shared ethnicity had an even stronger correlation and reduced success rates by 26.4% to 32.2%.
The effect of diversity also extends to the founding teams. Kaufman Fellows found that exit multiples on IPOs and acquisitions were 30% higher on companies with diverse founding teams. While white founding teams earned an average 2.5x median realized multiple, diverse founding teams had a 3.26x realized multiple.
McKinsey & Company also found that higher overall business revenue correlates positively with increased diversity. More diverse companies — both from an ethnicity and gender perspective — were more likely to have financial performance above the national industry median.
For your firm and portfolio companies to continue to succeed and grow, you must invest in diversity. The cost of not embracing diversity investing is high, but the benefits you stand to gain from improving your DEI endeavors are even higher.
While transitioning your team to be more diverse isn't an endeavor you can complete overnight, you can adopt other methods of reducing discrimination and bias in your firm. Investing in a DEI program can improve your firm's transparency, raise awareness, and show your commitment to DEI to both potential employees as well as existing ones.
In addition to a DEI program, becoming a firm that uses data-driven decision making can help to reduce bias. Not only can the practice improve your deal sourcing practices, but it can also help you decide on the best course of action using objective data. Check out this post for the basics of data-driven decision making in private equity, as well as a framework for how to implement it at your firm.