California Law Will Obligate VC Firms to Report Portfolio Company Diversity Metrics

California Governor Gavin Newsom recently signed Senate Bill 54, which aims to increase diversity among founders that are backed by venture capital (VC) companies. If implemented in its current version, SB 54 will likely apply to many VC companies well beyond California so long as they have at least one investment or investor in the state. The law may also apply to VC companies that merely solicit investors in California.

The bill’s sponsors highlighted the concerns about the lack of diversity in VC funding and hoped that the information that is collected and published pursuant to SB 54 will ensure both greater transparency about the companies that VCs are backing and more diverse representation among their founders.

However, the industry’s chief advocate, the National Venture Capital Association, expressed significant concerns that gathering, compiling, and reporting the data required by SB 54 would present a significant administrative burden—particularly for smaller and younger VC companies—and impose an additional expense in the form of administrative filing fees and a penalty for noncompliance. 

We anticipate modifications to SB 54’s requirements to be announced in early 2024, as explained below, and will provide a further update at that time.

WHO MUST REPORT AND WHAT MUST BE REPORTED

As currently drafted, SB 54 applies to any VC company[1] that

• primarily engages in the business of investing in or providing financing to startup, early-stage, or emerging growth companies or manages assets on behalf of third-party investors; AND
• is headquartered in California, has a significant presence or operational office in California, makes “venture capital investments”[2] in businesses that are located in or have significant operations in California, or solicits or receives investments from a person who is a resident of California.

Under SB 54’s existing text, beginning on March 1, 2025, and annually thereafter, the VC companies described above will be required to gather and report to the California Civil Rights Department (CRD), on an aggregated basis, certain specific demographic information about the founding teams of the portfolio companies in which they made a VC investment during such year, including gender identity, race, ethnicity, disability status, LGBTQ+ status, and veteran status.

VC companies will also be required to report whether any member of the founding team of a portfolio company declined to provide any such diversity information to the VC company. The information will be gathered using a survey form provided by the CRD.

In addition to the diversity metrics, each VC company will be required to include the following information for each calendar year:

• The number of VC investments to businesses primarily founded by diverse founding teams, as a percentage of the total number of VC investments made by such VC company during such year, in the aggregate and broken down into the diversity categories set forth above;[3]
• The total amount of VC investments to businesses primarily founded by diverse founding teams, as a percentage of the total amount of VC investments made by such VC company during such year;
• The total amount of money invested in VC investments by the VC company during such year; and
• The principal place of business of each company in which a VC investment was made.

It is important to note that the information above that a VC company is required to disclose under SB 54 is not limited to the VC investments in California-based businesses.

The data gathered by the CRD will be published on its website. Failure to comply with these reporting requirements may result in a penalty that will be decided by a California court and will depend on the size of the VC company’s business and the nature of the failure.

NEXT STEPS

Governor Newsom, in a letter accompanying the signing of SB 54, highlighted that the new law contains “problematic provisions and unrealistic deadlines” and noted that administering it will be expensive. Therefore, he wrote, “cleanup language” will be proposed as part of the governor’s budget for 2024-25, which will be submitted to the California Legislature by January 10, 2024.

There are a number of ambiguities in the language of the new law and questions about its scope and applicability, and it remains to be seen whether the revisions will resolve these questions or whether we will see one or more lawsuits challenging its validity and/or enforceability.

Morgan Lewis will continue to monitor the implementation of SB 54 and will provide any updates if and when Governor Newsom makes any changes in January 2024.