In first-of-its-kind legislation, under SB 54, California will require venture capital companies to collect and report diversity data from portfolio company founders as soon as March 1, 2025. The new Fair Investment Practices by Investment Advisers law intends to increase transparency regarding the diversity of founding teams receiving venture funds from covered entities in California.
Venture capital companies are covered by the new requirements if they:
- Primarily engage in the business of investing in, or providing financing to, startup, early-stage, or emerging growth companies, or manage assets on behalf of third-party investors, including, but not limited to, investments made on behalf of a state or local retirement or pension system.
- Have a nexus to California, by:
- Being headquartered in California
- Having a significant presence or operational office in California
- Making venture capital investments in businesses that are located in, or have significant operations in, California
- Soliciting or receiving investments from a person who is a resident of California
Key reporting requirements
Starting March 1, 2025, and annually thereafter, covered entities must report specified information about the founding teams of all businesses in which the covered entity made a VC investment in the prior calendar year and certain other investment information to the California Civil Rights Department. (CRD is the government agency that collects pay and demographic data from private employers of 100 or more employees in California.)
- Founder Demographic Data
Covered entities must report, at an aggregated level, for each member of the founding team (to the extent information was provided, as disclosing information by founding team members is voluntary and they will not be penalized for declining to answer), such person’s gender identity, race, ethnicity, disability status, sexual orientation, veteran status, and whether such person has California residency. Data must be provided to CRD on an aggregated level and anonymized basis.
- Investment in Diverse Funding Teams Data
Covered entities must also report the total number and dollar amount (each, as a percentage of total VC investments made) of VC investments to businesses primarily founded by diverse founding team members, aggregated and broken down by each of the above categories.
“Primarily founded by diverse founding team members” means more than half of the founding team members responded to the annual survey, and at least half of the founding team members self-identify as a woman, nonbinary, Black, African American, Hispanic, Latino-Latina, Asian, Pacific Islander, Native American, Native Hawaiian, Alaskan Native, disabled, veteran or disabled veteran, lesbian, gay, bisexual, transgender, or queer.
Further, covered entities must disclose the total amount of money in VC investments the covered entity invested in each business during the prior calendar year and the principal place of business of each company in which the covered entity made a VC investment during the prior calendar year.
Information on racial or ethnic origin and sexual orientation are categories of “sensitive personal information” that receive additional protections under the CCPA. Businesses are allowed under the CCPA to use sensitive personal information as necessary to comply with applicable law (such as this one). And VC companies remain free to use sensitive personal information without inferring characteristics, which should cover most legitimate use cases to satisfy the reporting requirement. VC companies that do infer characteristics based on racial or ethnic origin or sexual orientation information of a California resident would have to carefully analyze restrictions, compliance requirements, and risks under existing civil rights and anti-discrimination laws.
Failing to report
Failure to timely file a report will prompt the CRD to notify the covered entity that it must submit a report within 60 days of the notification. Further failure may result in an enforcement action by the CRD.
The legislation empowers the CRD to seek court orders to compel compliance, impose penalties to deter future non-compliance, recover its attorney’s fees, and grant other relief as deemed appropriate.
SB 54 was adopted in the context of increased scrutiny of ID&E efforts.
Earlier this year, the US Supreme Court banned the use of race-conscious admission policies in higher education (see our prior article here), and last year, a California court found that a prior bill, AB 979, requiring publicly held corporations with a principal executive office in California to include at least one director from an underrepresented community (including individuals who self-identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identify as gay, lesbian, bisexual, or transgender) was unconstitutional (see our prior article here).
On October 18, 2023, the Court of Appeals for the Fifth Circuit decided against plaintiffs who challenged a Nasdaq stock market rule that requires listed companies to disclose board diversity data, Alliance for Fair Board Recruitment et al. v. SEC, case number 21-60626. Plaintiffs asserted that the Nasdaq rule would cause unconstitutional discrimination, but the court ruled that the SEC only accepted and did not propose the rule and that Nasdaq is a private entity not subject to constitutional scrutiny.
SB 54 may become subject to similar legal challenges that may delay implementation. However, the VC companies should assess their internal capabilities to prepare for collecting the required information for investments made during calendar year 2024 in order to comply with the reporting obligations and meet the expected March 1, 2025 reporting deadline.