On October 8, 2023, California Governor Gavin Newsom signed into law Senate Bill 54 (“SB 54”), which will apply to a majority of U.S. venture capital investment firms, even if they are not based in California. SB 54 aims to tackle the ongoing issue of underrepresentation of certain ethnicities, races, genders and disability statuses in the venture capital industry by requiring the collection of diversity data with respect to portfolio company founding teams (including in respect of portfolio companies not based in California). The first report applies to investments made from and after January 1, 2024, and is due on March 1, 2025. Senator Nancy Skinner, who sponsored the bill, stated that the bill is “designed to help more women- and minority-owned startups access vital VC funding” as the “first transparency measure in the nation.”1
Who Needs to Comply
The law requires a “covered entity” that meets “specified criteria” to report to the California Civil Rights Department (“CRD”) certain information regarding its funding determinations. In order to qualify as a “covered entity”, an entity must be a “venture capital company” (as defined below) and satisfy both of the following criteria:
- It 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, including, but not limited to, a state or local retirement or pension system;
- It must satisfy at least one of the following criteria: (i) it is headquartered in California; (ii) it has a significant presence or an operational office in California; (iii) it makes venture capital investments2 in businesses that are located in, or have significant operations in, California; or (iv) it solicits or receives investments from a person who is a resident of California.
A “venture capital company” is defined as a firm that satisfies at least one of the following conditions:
- 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 certain short-term investments), valued at cost, are “venture capital investments” (i.e., securities in an operating company in respect of which the venture fund or an affiliate has or obtains certain rights to substantially participate in, to substantially influence the conduct of, or to provide (or to offer to provide) significant guidance and counsel concerning, the management, operations or business objectives of the operating company);
- It is a “venture capital fund” under the Investment Advisers Act of 1940; or
- It is a “venture capital operating company” under the Employment Retirement Income Security Act of 1974 (ERISA).
We note that reporting is required even by firms that do not have a physical office or personnel in California, and that the broad definition of “venture capital company” could require compliance from certain private equity firms, accelerators, or other investor groups not commonly considered to be venture capital firms.
What Information is Required
Starting on January 1, 2024, each covered entity is required to send a standardized, CRD-drafted survey to each portfolio company in which the covered entity makes an investment (but only after the covered entity has executed an investment agreement with the portfolio company and has made the first transfer of funds). The survey will request demographic information in respect of the gender identity, race and ethnic identity, disability and veteran status, sexual orientation and California residency status of the portfolio company's founding team members.3 The covered entity will then collect and report the responses it receives from the survey to the CRD, on an aggregated and anonymous basis.
Founding team members are not required to disclose any demographic information to covered entities. In fact, covered entities are required to notify founding team members that their participation is voluntary, that no adverse action will be taken against them if they choose not to participate, and that aggregated data for each demographic category will be reported to the CRD.
Although the founding team members’ responses are voluntary, each covered entity is required to issue an annual report to the CRD, with the first such report due on March 1, 2025. In addition to the demographic information collected in connection with the survey process, each covered entity will also be required to report the following information with respect to the investments it made during the prior calendar year: (i) the number and total amount of investments it made in businesses in which a majority of the founding team members belong to one of the identified under-represented groups (in each case, as a percentage of the aggregate venture capital investments made by the covered entity during such year); (ii) the total amount it invested in all venture capital investments during such year; and (iii) the principal place of business of each portfolio company in which it invested during such year. The reports will be publicly available via the CRD website.
SB 54 grants enforcement authority to the CRD, including the power to seek a court order compelling compliance and to impose monetary penalties sufficient to deter future non-compliance.
Governor Newsom’s signing statement acknowledged “problematic provisions and unrealistic timelines that could present barriers to successful implementation and enforcement.” It also noted that the bill’s language would be “cleaned up” in legislation prior to the first reporting deadline of March 1, 2025.4
If previous efforts by California to increase diversity in the corporate setting are any indication, this new law is likely to be subject to legal challenges. California sought to increase diversity on corporate boards of directors by enacting AB 826 and AB 979, each of which would have required publicly traded companies based in California to have board members from traditionally underrepresented communities. Conservative advocacy groups filed lawsuits challenging the constitutionality of both laws. The basis of their arguments were that the laws “mandated quotas” by requiring certain minority board members. Trial courts agreed with the challengers and issued permanent injunctions barring the State of California from enforcing the board diversity mandates. The California Secretary of State is currently appealing the trial courts' decisions. On the other hand, SB 54 differs from these board diversity mandates in that does not require that venture capital investments be made in businesses with diverse founding teams. Rather, its stated goal is to increase awareness and transparency of the funding discrepancies so there is greater accountability in the VC space.
SB 54 also faces other potential challenges. A number of VC industry groups, including the National Venture Capital Association, have already opposed SB 54, claiming it would result in "misleading and counterproductive data that would hurt the cause of diversity, equity, and inclusion efforts while creating unnecessary costs and risk for California venture capitalists."5 TechNet has also voiced concern that VC firms may face potential liabilities caused by the release of sensitive individual information to the CRD.6
Although additional guidance and clarification from the CRD and Governor Newsom's office is expected, and there is some uncertainty about if and when the law will ultimately be implemented, U.S. venture firms should begin preparing to comply with SB 54.
 Sen. Nancy Skinner, Gov. Newsom Signs Sen. Skinner’s Bill to Boost Investment in Women – And Minority – Owned Startups, Oct. 9, 2023 available at: Gov. Newsom Signs Sen. Skinner’s Bill to Boost Investment in Women- and Minority-Owned Startups | Senator Nancy Skinner (ca.gov).
 Venture capital investments are limited to the acquisition of securities along with some management rights such as a board seat. Cal. Code Reg. § 2260.204.9(a)(5).
 Founding team member is defined as (a) those who contributed to the development of the business before initial shares were issued and owned initial shares of the business; or (b) the CEO, President, CFO, or other role with a similar level of authority.
 Gavin Newsom, Letter from the Office of the Governor, Oct. 8, 2023 available at: SFresno_Biz23100820370 (ca.gov).
 Elizabeth Edwards, Nothing to Hide: California’s New VC Diversity Reporting Law, Forbes, Oct. 10, 2023 available at: Nothing To Hide: California's New VC Diversity Reporting Law (forbes.com).
 Dominic- Madori Davis, California passes law mandating VC firms to release investments’ diversity information, Tech Crunch, Oct. 9, 2023 available at: California passes law mandating VC firms to release investments’ diversity information | TechCrunch.