Race in Private Equity and America’s C-Suite Diversity Problem

August 04, 2020

America’s moment of reckoning around systemic racism is seeping into the corporate setting.

Many high-profile CEOs have issued statements in support of racial equality and social justice, but they do so primarily as White individuals with predominately White teams. A McKinsey & Company analysis of 279 North America-focused companies found 87% of their C-suite executives were White. Meanwhile, just 3% were Black.

The lack of racial diversity pervades many of America’s more highly-compensated jobs. White Americans make up 68% of the U.S. population yet represent over 90% of non-clerical and non-laborer workers within financial firms. This underrepresentation seems to be especially prevalent inside private equity.

While anecdotal evidence regarding the lack of Black PE professionals abounds, there is a lack of comprehensive research on the subject. However, the data that does exist along with the traditional PE pipeline and the inherent culture of private equity allow us to make educated assumptions.

A 2019 analysis from the Knight Foundation found just 3.8% of all U.S. private equity firms had minority ownership (ownership defined as holding at least 50% of the firm’s equity). While far from an impressive number, the underrepresentation of Black PE professionals becomes further apparent when you consider that the author’s definition of “minority” included Hispanic, Black, Asian and Native American. This illustrates a recurring theme in data on Black PE professionals. While there exist numerous reports on “gender” or “gender and ethnic diversity” in private equity, very few address ethnic diversity alone, and those that do tend to portray “minorities” or “people of color” as one group.

Achieving gender parity is a pertinent issue but it cannot be used as a blanket solution for diversity in general. Gender diversity and racial diversity are not the same thing and conflating the two can hide the lack of progress in one area behind the achievements of the other. Also, the struggles of these two minority groups are not the same. Being a White woman comes with a very different set of discriminatory obstacles than being a Black man or even a Black woman.

Research has found “one size fits all” diversity initiatives tend to benefit only a subset of individuals. Therefore, using the exact same set of initiatives to help these divergent groups makes little sense.

Though private equity firms largely operate outside the public eye, their racial diversity has an outsized impact on America’s management class at large.

The U.S. now has roughly half the number of public companies it did in 1997. Meanwhile, the number of PE-backed companies has exploded during the same time period. A report from the American Investment Council and Ernst & Young found the U.S. private equity sector directly employed 8.8 million workers in 2018. Record volumes of dry powder all but guarantee the ratio of American workers employed by private equity-backed companies will increase over the next ten years.

PE firms are largely responsible for the hiring of executive-level roles in their portfolio companies. If the PE pipeline has not retained Black talent, there can be no high-ranking Black individuals participating in these hiring decisions. Humans tend to connect with those who look like them and if PE management is predominantly White, hiring tendencies will likely tip towards maintaining the status quo. A Falcon analysis of C-suite roles at a random sampling of 50 PE-backed companies further strengthened this assumption.

Hiring discrimination against Black males, intentional or not, has remained largely unchanged in the past thirty years. White men are still about 36% more likely to get a positive response to a job application. And once hired, Black professionals face an environment where they are often the lone – or one of few – Black people in the company. In private equity hiring, adherence to a strict career trajectory and favoring elite backgrounds exacerbate the obstacles Black Americans face.

While a number of Black Americans have surmounted these obstacles and achieved success in PE, this does not equate to far-reaching progress in racial diversity. Black Americans who reach the executive class often do so not in the absence of racial injustice, but rather in spite of it. One such executive is Vista Equity Partners founder Robert Smith.

This past June, Smith sent an open letter to his firm featuring a personal anecdote on how racialized violence has impacted his life. Smith described the recent murders of young Black men as a reminder of the “many times I have been judged not by my character, but by the color of my skin.” Smith’s letter is a stark reminder that even those Black professionals who achieve success and prestige are not immune to discrimination and racial trauma.

We do know racial diversity has not been a priority for most PE firms in the past. The Ernst & Young 2020 Global Private Equity Report found that 74% of PE firms under $2.5b did not have set targets for ethnic diversity and had no plans to set any.

While this attitude may shift as a result of recent protests across the country as well as the responding heightened public and corporate awareness of systemic racism, it should not take such extreme circumstances for racial diversity to become a priority.

The privately-held nature of PE may contribute to a slower or less significant response compared to publicly-traded companies where shareholder scrutiny can send share prices tumbling as a result of public missteps or lack of action around social issues.

Yet private equity has financial incentive to embrace more diverse leadership.

A 2019 McKinsey report found companies in the top-quartile for ethnic diversity out-performed those in the bottom-quartile by an average of 36%. While the report found a direct correlation between increased gender diversity and higher profitability, it noted that, “the likelihood of outperformance continues to be higher for diversity in ethnicity than for gender.”

This again highlights the risk companies take when their data or initiatives conflate gender and racial diversity as one in the same. There are tangible steps PE firms and their portfolio companies can take to increase racial diversity and retention of diverse talent.

1. Prioritize More Focused Data Collection

More detailed data collection on racial diversity must become a priority for firms and their portfolio companies. As outlined in this article from the Harvard Business Review, pooling “women” and/or “people of color” into broad categories obscures visibility and hinders an enterprise’s efforts to become truly diverse. For example, a company may have high turnover for Black women yet average turnover for women in general. Superficial diversity data could conceal this truth and cause it to go unaddressed.

A clear understanding of the challenge empowers smarter solutions, and enhanced data collection will be vital in measuring the true impact of any chosen initiative. PE firms are often lauded for their analytical, metrics-driven approach to creating value. Those same strategies cannot go by the wayside when addressing racial diversity. As funds explore ways to increase their awareness of diversity and inclusivity, it is important to notice who is, and is not, in the room.

2. Broaden Your Outreach

The use of traditional networks to hire new talent can perpetuate a lack of diversity. Partnering with organizations such as the SEO Career Network or ramping up recruiting efforts at Historically Black Colleges will help broaden the talent pool.  University affinity groups are excellent resources, as are university-sponsored recruitment programs that specifically target racial minorities and women. Such groups can be found through each university’s career services program.

3. Support Employee Resource Groups

Employee Resource Groups (ERGs) are voluntary, employee-led groups that foster a diverse, inclusive workplace aligned with organizational mission, values, goals, business practices and objectives with the benefit of developing future leaders, increased employee engagement, and expanded marketplace reach.

These groups have been shown to lead to higher retention rates in those companies that support them. ERGs have existed for decades, but often lack financial and organizational support. Management teams that embrace ERGs and commit dedicated budgetary resources to support their endeavors create positive experiences for various affinity groups and can have a positive impact on the bottom line.

4. Engage Diversity and Inclusivity Professionals and Start a Dialogue

Cultural change begins with open and honest conversations. While this in part means creating a space for Black employees to voice their concerns, it also means having open dialogue between White employees. These conversations are best facilitated by trained Diversity and Inclusivity professionals. It is not the responsibility of Black employees at the firm to teach their colleagues about race and if a Black employee expresses interest in doing so, they should be empowered and compensated for these efforts.

Private equity professionals are world-class problem solvers. Considering the fiduciary responsibilities of private equity firms and the proven impact of ethnically diverse leadership on profitability, the need for change is undeniable. By placing an emphasis on racial diversity not only within the firm but also at the portco level, private equity has an opportunity to make a difference in achieving diverse representation in thousands of executive teams and beyond.

Falcon provides C-suite talent solutions for middle-market private equity firms across North America. Follow us on LinkedIn.