Earlier this month, the California State Budget released for approval by the state legislature included an updated version of Senate Bill 54 (the “VC Diversity Law”). The latest version contains several updates to the VC Diversity Law, including revisions to the definition of “covered entity;” that said, as we discuss below, it is not clear that the scope of coverage will meaningfully differ. The updates also delay the initial reporting date to March 1, 2026 (from the original date of March 1, 2025), and reflect a change to the California governmental division responsible for enforcing the law.
Background
California Governor Gavin Newsom initially signed the VC Diversity Law on October 8, 2023. It required “venture capital companies” with business ties to California to file annual reports detailing (1) specified demographic data for the founding teams of all portfolio companies invested in during the prior year and (2) the aggregate amounts of investments made by the venture capital company during the prior year and investments in specified categories of portfolio companies. As we discussed in our Cleary Enforcement Watch post, the VC Diversity Law requires covered venture capital companies to obtain demographic data through voluntary surveys sent to each founding team member of a portfolio company that receives funding from the venture capital company. The data, in anonymized form, will be publicly available – and searchable and downloadable – on the California Department of Financial Protection and Innovation website.
Covered Entities
The VC Diversity Law’s reporting requirements apply to venture capital companies as opposed to advisers. As a result, the law will apply to entities that are not necessarily subject to state law reporting, such as SEC‑registered advisers and exempt reporting advisers under the Venture Capital Fund Adviser Exemption (Rule 203(l)-1) and Private Fund Adviser Exemption (Rule 203(m)-1) of the Investment Advisers Act of 1940 (the “Advisers Act”), as well as entities that are not subject to the most or all provisions of the Advisers Act, such as offshore advisers and excluded advisers such as family offices and banks.
The latest updates to the VC Diversity Law change the definition of “covered entity” so that it no longer captures venture capital companies that manage third-party assets but do not “primarily engage in the business of investing in or financing startup, early-stage, or emerging growth companies.” That said, it is not clear that this change will make much practical difference—there may be very few venture capital companies that would have been considered “covered entities” under the previous definition only because of their management of third-party assets. The revised definition still contains a broad set of criteria that, if any are met, will subject the company to the reporting requirements. These criteria were not changed in the updated version of the VC Diversity Law, and will continue to capture venture capital companies with no California nexus other than accepting or even soliciting investments from California residents, so long as the companies meet the “primarily engages in the business” test of the definition.
Because one of the criteria is marketing directed to a single California investor (either an entity or a natural person), in practice the presence test will likely only spare private funds that have specifically excluded all California residents from fundraising activities. California residents may of course be located in other jurisdictions at the time marketing is undertaken, so screening for such investors is likely to carry a significant compliance burden. In addition, “significant” is not defined regarding either presence or operations, and as such, will require advisers to make difficult and subjective judgements that are likely to be scrutinized by the California Department of Financial Protection and Innovation ( the “DFPI”)—the department that, under the updated VC Diversity Law, will be in charge of receiving the reports and enforcing the VC Diversity Law instead of California’s Civil Rights Department. A “venture capital company” is defined by reference to the California exemptions from state investment adviser registration, and has not been changed. It includes any entity that meets any of the following requirements:
- 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, valued at cost, are “venture capital investments” (generally securities conveying management rights in operating companies);
- is a “venture capital fund” as defined in Rule 203(1)-1 under the Advisers Act, which, among other requirements, is a private fund that (a) represents to investors and potential investors that it pursues a venture capital strategy and (b) holds at least 80% of its aggregate capital contributions and uncalled committed capital, valued at cost or fair value, in equity securities of qualifying portfolio companies (generally non-public companies), tested after the acquisition of each non-qualifying investment; or
- is a “venture capital operating company” as defined in U.S. Department of Labor rule 2510.3-101(d) (which has generally the same meaning as (1) above).
On its face, this definition is both broad and ambiguous. For example, “venture capital strategy” for purposes of prong (2) is not defined in the Advisers Act, and prongs (1) and (3) have no requirement that an entity invest in “venture capital” investments at all (merely operating companies that grant management rights), meaning ordinary private equity funds could be captured depending on their portfolios. Prongs (1) and (3) are not limited to private fund vehicles (i.e., vehicles that rely on the 3(c)(1) or 3(c)(7) exemptions from registration under the Investment Company Act of 1940) and there is no requirement that the applicable venture capital company be an advisory client of an adviser. Single investor co-invest vehicles and AIVs are therefore in scope, as are vehicles such as business development companies and trusts that do not qualify as “private funds.” When applying the venture capital company designation, advisers will likely need to be consistent with the classification they have given an investment vehicle for purposes of reporting on Form ADV and, if applicable, Form PF.
Required Information
The updated version of the VC Diversity Law does not change the reporting requirements for venture capital companies. They must report several different types of data with respect to both their portfolio companies and their investment holdings writ large.
At the portfolio company level, a venture capital company must report, at an aggregate level, for each member of the “founding team” of a portfolio company that received an investment in the prior year: (1) gender identity (including nonbinary and gender-fluid identities), (2) race, (3) ethnicity, (4) disability status, (5) whether such member identifies as LGBTQ+, (6) whether such member is a veteran or a disabled veteran, and (7) whether such member is a resident of California. The venture capital company must also report (on an anonymized basis) if any member of the founding team declined to provide any of this information. The updated VC Diversity Law still does not specify whether team members must affirmatively decline, or whether a failure to respond by a specified deadline is sufficient.
“Founding team member” is defined as either (a) a person who has been designated as the chief executive officer, president, chief financial officer, or manager of a business, or who has been designated with a role of similar authority, or (b) a person who (i) owned initial shares or similar ownership of the business, (ii) contributed to the concept of, research for, development of, or work performed by the business before initial shares were issued, and (iii) was not a passive investor in the business. Whether an individual is a founding team member will be a facts and circumstances determination, and in many cases advisers may face challenges in both identifying all relevant founding team members and successfully soliciting survey responses.
At the aggregate portfolio level, a venture capital company must also report, for the prior calendar year:
- on an anonymized basis, the number of venture capital investments to businesses “primarily founded by diverse founding team members”, as a percentage of the total number of venture capital investments the venture capital company made, both in the aggregate and broken down into the diversity categories described above,
- the total dollar amount of venture capital investments to businesses primarily founded by diverse founding team members in the past year, on the same bases as category (1),
- the total dollar amount invested in each company that is a venture capital investment during the prior calendar year, and
- the principal place of business of each company in which the venture capital company made a venture capital investment during the prior calendar year.
Venture capital companies are required to obtain this information in a standardized voluntary survey provided to each founding team member of a business that has received money from the venture capital company. A business “primarily founded by diverse founding team members” means a founding team for which more than half of the founding team members responded to the 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.” This proscribed calculation means if founders don’t respond, a venture capital company’s reporting burden will be significantly reduced, and, conversely, an adviser will not be able to report successful diversity conscious investments if founding team members do not submit survey responses.
The updated VC Diversity Law still does not define the “principal place of business” of a business, or provide for this information to be anonymized.
If a covered venture capital company fails to submit a report to the DFPI by April 1 of a given year (a shift from the original bill’s annual deadline of March 1), beginning in 2026, the department will notify the entity that they must submit the report within 60 days. If the company fails to submit the report within 60 days, the DFPI is entitled to enforce the law by filing in court to both compel the respondent to comply with the law and submit the report, and to pay a penalty sufficient to deter the company from failing to comply.
The updated VC Diversity Law removes the power of the department to subpoena witnesses or compel their attendance, which was included in the original version. However, the DFPI will retain many of the other enforcement powers from the original version, including the ability to inspect books and records, to require the production of books, papers, correspondence, and memoranda, and to take possession of the books, records, and accounts of a covered entity.
Covered entities will also need to submit to the DFPI by March 1, 2026 an initial report with information regarding entity name, individual point of contact, and contact information including address and website. Each covered entity will be required to keep the filed information up-to-date and submit any changes when filing its annual report. The first substantive report will be due by April 1, 2026.
Finally, the updated VC Diversity Law makes a change regarding anonymization of the information submitted to the DFPI. Under the original version, information provided pursuant to the law’s reporting requirements “shall be anonymized to the extent necessary to protect business confidential information,” whereas the new version provides that such information “shall be anonymized to the extent possible.” Absent any further explanation or guidance, it is difficult to know what position the DFPI may take in the future in assessing whether firms’ approach to anonymization of information was appropriate.
Takeaways
The VC Diversity Law is intended to increase transparency into the allocation of venture capital funding, and in doing so increase diversity in recipients. Proponents noted that funding to startups led by women, Black, or Latinx founders has never risen more than 5% in any given year. The law is also intended to increase awareness of existing funding discrepancies and highlight venture capital companies that are supporting diverse founders, allowing investors to make informed decisions about which venture capital companies, and which advisers, to support.
In practice, however, the VC Diversity Law may be unwieldly and burdensome for advisers (and not only venture capital advisers) to implement, and is being adopted at a time when private fund advisers are (and will continue to be) grappling with expanded reporting and other requirements under the amended Form PF and other expected rules. Our previous article discusses some of the key compliance issues for covered entities, including the VC Diversity Law’s broad scope of application—in some cases, to advisers and entities that may not have the compliance infrastructure in place to implement the far reaching data collection and reporting requirements of the VC Diversity Law – and may not even realize it captures them.
In addition, the law provides for no grandfathering, so advisers may face a considerable compliance challenge to gather necessary reporting data for legacy funds by the expected effective date. The postponement of the initial reporting deadline from March 1, 2025 to April 1, 2026 will likely be a welcome change for many and offer a more achievable timeline, but the challenges discussed above will largely remain.