*

Fearless Fund lawsuit could impact billions in

diversity-focused

investments.

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Black founders received less than 0.5% of US venture

capital

funding last year, according to Crunchbase data

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Fearless Fund has invested nearly $27 million into 40

startups

led by women of color

By Krystal Hu

July 2 (Reuters) - Just weeks after a U.S. appeals court

blocked a Black-owned venture capitalist from funding

women-of-color-led businesses, the ruling has had a chilling

effect across the small industry of diversity-focused venture

capital funds, according to founders, investors and lawyers who

spoke to Reuters.

The Atlanta-based 11th U.S. Circuit Court of Appeals in early

June found an anti-affirmative action group's lawsuit that

accused Fearless Fund of discrimination would likely succeed,

reversing a judge's decision to allow the firm to continue

making grants while the case proceeded.

The Fearless Fund, established in 2019 to bridge the gap in

venture capital funding for women of color, is facing a lawsuit

by the American Alliance for Equal Rights, run by conservative

activist Edward Blum, who led the successful U.S. Supreme Court

challenge to the consideration of race as a factor in college

admissions.

While the 11th Circuit ruling against the fund affects only

Georgia, Alabama and Florida, investors and corporations running

diversity investment programs elsewhere in the country are

paying close attention to how this could expose them to similar

lawsuits.

"We are already seeing the interim effect, where people say,

'We are either going to restructure the descriptions or

documents we use, or we're not going to say things out loud but

will engage in the same practices,'" said Ed Zimmerman, a lawyer

at Lowenstein Sandler who advises venture capital clients.

The backlash against diversity, equity and inclusion (DEI)

initiatives has expanded from Wall Street to Silicon Valley in

the past year after the Supreme Court's decision in Students for

Fair Admissions v. Harvard, which ended affirmative action in

college admissions. Companies that championed diversity

initiatives are now re-evaluating strategies to avoid legal

entanglements.

This shift in sentiment has led to increased scrutiny of

programs specifically designed to support underrepresented

groups, from hiring practices to funding initiatives. Major U.S.

companies, including JPMorgan Chase ( JPM ), have modified

policies meant to boost racial and ethnic representation after

conservative groups threatened to sue, a Reuters analysis

shows.

Diversity-focused funds were created to level the playing

field for communities who were historically excluded from

services, employment and funding opportunities before the Civil

Rights Act of 1964, which ended segregation. Corporations

stepped up their funding initiatives after widespread protests

over the death of a Black man, George Floyd, at the hands of

Minneapolis police in 2020.

The outcome of the Fearless Fund lawsuit could affect over

$200 billion committed in similar programs and roll back the

scant benefits these funds have so far given to Black founders,

who received less than 0.5% of the $140.4 billion of venture

capital funding of U.S. startups last year, according to data

firm Crunchbase. Venture financing of Black founders, which

surged in 2021 after corporations pledged more diversity

spending, has plunged since then, Crunchbase data shows.

"The ruling is a significant concern to us. It contradicts

civil rights law and ignores the reality for entrepreneurs of

colors," said Ying McGuire, CEO of the National Minority

Supplier Development Council, a nonprofit focusing on promoting

opportunities for minority businesses.

Some founders are already feeling the impact. Sheena Allen,

founder of digital bank startup Capway and a recipient of a

Fearless Fund investment, took down her company's website after

funding dried up this year. The current climate has made it

difficult for fintech startups to seek funding, especially for a

Black female founder, she said.

Fearless Fund, which has invested $26.5 million into 40

startups led by women of color, said some of its committed

limited partners have pulled out, citing the litigation. One of

its cofounders, Ayana Parsons, stepped down as general partner

and chief operating officer last week.

"People have the right to fund marginalized communities if

and when racial disparities exist, and that is something needs

to be protected," Arian Simone, CEO of Fearless Fund, told

Reuters. "People who are serious about this work will find

creative ways to do it regardless, but they shouldn't have to

find a creative way to do it."

Other venture capital funds are exploring ways to mitigate

the risks of running diversity-focused programs, investors say.

After consulting her lawyer and limited partners, Shila

Nieves Burney, a general partner at Zane Venture Fund, another

Atlanta-based venture capital fund, decided to hold her ground

and leave intact her fund's website description of supporting

diverse and inclusive founders.

Burney, an outspoken voice in the community of Black female

investors, organized a petition to start a campaign to rally

support for the Fearless Fund last year.

She and co-organizers gathered dozens of VC investors, most

of them Black women, to strategize on how to help fight back on

the legal challenge by conservative activist Blum.

But the efforts stalled last year due to a lack of funding,

she said. While her own fund continues to back diverse teams,

Burney fears there will be fewer capital available for Black

founders and that corporate backers will shy away due to

reputational risks.

"If Fearless Fund is not able to raise their next fund, that

creates a huge gap in the ecosystem. When there's an attack on

Black VCs, who's going to fill that gap?" said Burney.

That is the question that now confronts Allen of Capway.

Allen, who has been an entrepreneur since college, was able

to self-fund and grow build her previous company. However, a

fintech startup like Capway required significant funding to

scale. She is contemplating either pivoting the company's

direction or shutting down and starting a new venture.

"I know it's hard for everybody, but as Black women, we've

already had it a million times harder anyway," she said.