On October 8, 2023, California Governor Gavin Newsom signed Senate Bill 54 (SB 54), Fair Investment Practices by Investment Advisers, which requires venture capital firms to collect and report data on the demographic composition of the founding teams of the companies in which they invest.  Governor Newsom stated that the intention of this law is to “advance equity and provide for greater economic empowerment of historically underrepresented communities.”

Part of a broader trend to promote transparency and diversity in venture capital investments, SB 54 is the first known law specifically requiring venture capital firms to collect and report founder demographic data of their investments to a governmental agency. SB 54 raises many questions and poses far-reaching legal implications for covered investment firms.

Which Investment Firms Are Covered?

As a threshold matter, SB 54 applies only to a “Venture Capital Company,” defined as a firm that satisfies one or more of the following conditions: (i) on at least one occasion during the annual period commencing with the date of its initial capitalization, and on at least one occasion during each annual period thereafter, at least 50% of its assets (other than short-term investments pending long-term commitment or distribution to investors), valued at cost, are venture capital investments; (ii) the firm is a “venture capital firm” under the Investment Advisers Act of 1940; or (iii) the entity is a “venture capital operating company” as defined by the Employment Retirement Income Security Act of 1974.

Venture Capital Companies are subject to SB 54’s reporting requirements if they also meet the following criteria. First, they must either (i) primarily engage in the business of investing in, or providing financing to, startup, early-stage, or emerging growth companies or (ii) manage assets on behalf of third-party investors. Second, one of the following must apply: they are (i) headquartered in California; (ii) have a significant presence or operational office in California; (iii) make venture capital investments in businesses that are located in, or have significant operations in California; or (iv) solicit or receive investments from a person who is a resident of California.¹

Notably, SB 54 broadly defines Venture Capital Companies such that companies aside from venture capital may be implicated, such as private equity firms, accelerators, or investor groups. To date, there is no clarification explicitly limiting the breadth of coverage.

What Information Must Be Reported Under SB 54?

SB 54 requires covered Venture Capital Companies to report to the California Civil Rights Department (CRD) the following information about their funding determinations in the prior calendar year:

• Demographic Information. At the aggregate level, the following information about the “founding team” of companies in which investments were made: gender identity (including nonbinary and gender-fluid identities), race, ethnicity, disability status, sexual orientation, veteran status, California residency status, and whether any member of the founding team declined to provide information.

• Number of Investments. The total number of investments in businesses primarily founded by diverse founding team members.²  

• Amount of Investments. Data concerning investments in businesses primarily founded by diverse founding team members. This must include the total amount invested in each business broken down as a percentage of total investments made in the aggregate and within the demographic categories listed above.

• Principal Place: The principal place of each company in which an investment was made.

How Must Demographic Information Be Obtained from Portfolio Companies?

Covered Venture Capital Companies must provide founding team members with a standardized survey form created by CRD to collect the required demographic information.³ However, whether to respond to the survey is voluntary and Venture Capital Companies cannot take adverse actions against founding team members who decline to participate. Anonymized survey data will be reported to the CRD which, in turn, will make this information publicly accessible on its website.

Reporting Deadlines and Enforcement

Covered Venture Capital Companies must report the required data to the CRD by March 1, 2025, and annually thereafter. As such, Covered Venture Capital Companies must attempt to collect the required information with respect to in-scope companies in which they make investments beginning on January 1, 2024.⁴ A 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. Failure to file a required report following the expiration of this 60-day period may result in an enforcement action by the CRD. SB 54 expressly permits 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.

Governor Newsom submitted a letter to the Members of the California Senate acknowledging the problematic and challenging provisions in SB 54 surrounding the reporting deadlines and enforcement. Governor Newsom said SB 54 contains “unrealistic timelines that could present barriers to successful implementation and enforcement.” In addition, Governor Newsom recognized that SB 54 requires substantial resources from CRD just to determine whether any given entity meets the criteria of SB 54, and that the CRD is not currently situated to perform this kind of work.  Governor Newsom also suggested that administering the law could create significant financial pressures on the state. As a result, Governor Newsom said he will propose clean-up language as part of the 2024-2025 Governor Budget to address these items.

Broader IE&D Efforts

Venture capital and other investment firms have been squarely at the center of efforts to promote and prioritize inclusion, equity, and diversity (IE&D) in the workplace. Many firms view identification of and investments in diverse founders as a core tenet of their organizations. SB 54 appears intended to build on that trend by making each Covered Venture Capital Company’s reports publicly accessible. Companies with problematic IE&D data may be subject to public criticism and pressure to augment their efforts to invest in diverse founders. Non-covered, non-California venture capital firms may feel pressure to follow suit and publicly disclose the demographic composition of their investments’ founders.

On the other hand, there has been a growing scrutiny by some of whether IE&D efforts in this space themselves constitute unlawful discriminatory practices, particularly on the heels of the U.S. Supreme Court’s recent opinion banning the use of race-conscious admissions policies in higher education. There may be legal challenges to the constitutionality of SB 54, especially in light of an April 2022 ruling that California Assembly Bill 574, which required California-based, publicly held corporations to include at least one director from an underrepresented community, was unconstitutional. There the court cautioned against quotas and specific number requirements. In contrast, while SB 54 defines a diverse founding team as one where “more than half” of founding team members meets criteria for diversity, it does not mandate specific quotas, nor does it direct that Covered Venture Capital Companies take mandatory business action to achieve specific quotas. For these reasons, SB 54 might be more likely to survive constitutional challenges, as have IE&D in the workplace laws in New York,⁵ Illinois,⁶ and Maryland.⁷

Last, there are privacy risks associated with SB 54. Although the law requires the data to be anonymized, the procedures mandate collection and retention of founders’ sensitive information. As a result, the California Privacy Rights Act (CPRA), which places restrictions on the use of "sensitive" personal information, including race and ethnicity data of identifiable individuals, could be implicated. Businesses must disclose how they collect and use such data and, in some cases, obtain consent before doing so. SB 54 allows voluntary disclosure of race and ethnicity data, with a requirement to make this clear in notices.

Key Takeaways

• Establishment of Reporting Requirements: Covered entities are required to annually report various demographic information about the founding teams of businesses they invested in during the previous year. This includes gender identity, race, ethnicity, disability status, sexual orientation, veteran status, and California residency. This information must be collected by a standardized survey provided to founding team members of the businesses covered entities have funded. Participation in the survey is voluntary, and the information collected is anonymized.

• Enforcement and Penalties: Failure to comply with the reporting requirements can lead to penalties imposed by the CRD, including fines and court orders compelling compliance. Moneys collected through these penalties will be deposited into the Civil Rights Enforcement and Litigation Fund, which is used to support the CRD’s enforcement activities.

• Companies around the world will continue to implement IE&D initiatives and legislatures will continue their efforts to regulate this space and promote equality. As a result, it is paramount that companies find a way to balance their IE&D initiatives with the legal landscape to effectively and legally accomplish their objectives.