Over three and a half years since the death of George Floyd spurred some members of the venture capital community to enact promises to increase their investments in diverse entrepreneurs, California has enacted legislation in an attempt to track that performance. On October 8, 2023, California Governor Gavin Newsom signed into law Senate Bill 54 — “Fair Investment Practices by Investment Advisers.”[1] Commencing on March 1, 2025, covered venture capital firms will be required to annually report to the California Civil Rights Department (CRD) on the diversity of the founding members of their portfolio investments from the prior year and the extent of their investments in startups led by diverse founding members.[2]
What Will Be Reported?
The law requires covered venture capital firms to report to the CRD specific information about the funding determinations, including at an aggregate level, demographic information about the founding teams of all of the companies in which they have invested in the prior calendar year. The law seeks to determine the extent to which venture capital firms are investing in founding teams who are diverse by requesting information regarding the gender identity, race, ethnicity, disability status, LGBTQ+ status, and veteran or disabled veteran status of founding teams. While the law requires that venture capital firms request demographic information, founders are not required to provide it and may respond by stating that they decline to provide such information.
Specifically, the law seeks reporting on the number of investments made by a covered venture capital firm to startups founded by diverse founders in the prior calendar year as a percentage of the total investments made by the covered venture capital fund. Further, the law seeks reporting on the total amount of invested capital in startups founded by diverse founders in the prior calendar year as a percentage of the total amount of invested capital made by the covered venture firm. The CRD will make the reports available and searchable on its website, and the CRD may publish the aggregate information on its website.
VCs Outside of California Are Not Safe
Non-California based venture capital firms will need to monitor the further development and implementation of the law as its reach extends well beyond the California state line. The new law covers any venture capital firm that (i) is headquartered in California; (ii) has a significant presence or operational office in California; (iii) makes venture capital investments in businesses that are located, or have significant operations in, California; or (iv) solicits or receives investment capital from a California resident.[3] The scope of the law will end up capturing a substantial number of the country’s venture capital firms.
Enforcement and Implementation Concerns
The law as drafted provides the CRD with enforcement options should a covered venture capital firm fail to timely file its annual report. The enforcement tools available include bringing a civil action or levying a penalty on a delinquent covered venture capital firm.[4] Although he signed the bill into law, Governor Newsom raised his administration’s concerns about the ability of the CRD to successfully implement and enforce the law as written in his signing statement.[5] In particular, the Governor expressed concern about the overall cost of implementing the law, as well as the number and duration of the investigations the CRD would be required to undertake. As a result, his administration will propose cleanup language to ensure the successful implementation of the law in the 2024-25 budget.[6] While the budget was shared on Jan. 10, the cleanup language has still yet to be released.
In summary, venture capital firms who have any contact with California should stay tuned as a new reporting requirement is on its way in early 2025.
——————————————————————–
This DarrowEverett Insight should not be construed as legal advice or a legal opinion on any specific facts or circumstances. This Insight is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal question you may have. We are working diligently to remain well informed and up to date on information and advisements as they become available. As such, please reach out to us if you need help addressing any of the issues discussed in this Insight, or any other issues or concerns you may have relating to your business. We are ready to help guide you through these challenging times.
Unless expressly provided, this Insight does not constitute written tax advice as described in 31 C.F.R. §10, et seq. and is not intended or written by us to be used and/or relied on as written tax advice for any purpose including, without limitation, the marketing of any transaction addressed herein. Any U.S. federal tax advice rendered by DarrowEverett LLP shall be conspicuously labeled as such, shall include a discussion of all relevant facts and circumstances, as well as of any representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) upon which we rely, applicable to transactions discussed therein in compliance with 31 C.F.R. §10.37, shall relate the applicable law and authorities to the facts, and shall set forth any applicable limits on the use of such advice.
[1] https://www.gov.ca.gov/wp-content/uploads/2023/10/SB-54-SIGN-MSG.pdf
[2] https://legiscan.com/CA/text/SB54/id/2844706
[3] https://legiscan.com/CA/text/SB54/id/2844706
[4] https://legiscan.com/CA/text/SB54/id/2844706
[5] https://www.gov.ca.gov/wp-content/uploads/2023/10/SB-54-SIGN-MSG.pdf
[6] https://www.gov.ca.gov/wp-content/uploads/2023/10/SB-54-SIGN-MSG.pdf