An overlooked aspect of systemic racism is how it hampers the ability of the Black entrepreneur to obtain funding to support their business dreams.
Every entrepreneur needs supportive conditions to flourish. One of the pillars of the proverbial American Dream is the opportunity to leverage the entrepreneurial spirit, energy, and infrastructural support uniquely provided by the United States to make a better life for oneself.
Unfortunately, the cancer of racial bias and its attendant manifestations entrenched through the alarming levels of income inequality and racial disparity of shared prosperity has metastasized into investment and funding ecosystems.
"Credit disparities are where past injustices lead to present disparities," says Mehrsa Baradaran, a law professor at the University of California, Irvine.
However, despite institutional shackles to business growth, minority owners do more than enough to pull their weight.
The Center for Global Policy Solutions, a think tank, and advocacy group report that in the throes of the Great Recession and its aftermath (between 2007 and 2012), minority-owned small businesses added 1.3 million jobs to the U.S. economy.
Forbes reports that almost within this same period and beyond (2007 and 2017), minority-owned small businesses experienced growth at a rate 10 times faster (79%) than the general growth rate for U.S. small businesses, reaching 11.1 million.
Yet, Black entrepreneurs seem to constantly have their back against the wall. In Silicon Valley and beyond, they receive less than 1% of venture capital, according to estimates from Harvard Business Review.
But it isn’t only Black entrepreneurs that suffer. These discriminatory financial practices are costing the US economy as much as 9 million in missing jobs and $300 billion in lost national income.
Racial bias in both lending and equity is the most overriding factor responsible for Black entrepreneurs' struggles to obtain business funding.
According to Forbes, structural racism and power imbalance is fuelling discriminatory financial practices and crippling the growth efforts, especially during early-stage financing. Venture capital (VC) financing startup ecosystems are heavily biased toward startups operated by white males.
Part of the problem is a glaring lack of representation: an anemic less than 1% of US venture capital-backed firms are Black, and their proportion in decision-making roles within Venture Capital companies is equally appalling. Until recently, data from credible digital surveys haven’t included the race of the respondents, making it tough to get a clear picture of interracial skills gaps in different industries.
Despite how dismal the current situation might appear, there should probably be a special section dedicated to gender bias against African American women because they bear the worst brunt of lending discrimination.
According to digitalundivided’s Project Diane, an organization that provides insights into the state of Black women founders, an infinitesimal .0006% of VC funding went to black women-led startups between 2009 and 2017.
There is nothing to suggest this has improved; in all likelihood, it has probably grown worse.
This negative bias is illogical, especially toward Black women, who are among the best-educated and most entrepreneurial groups in America, according to the U.S. Census data.
Lower net worth
The cycle of wealth disparity perpetuates itself through the funding — or lack thereof — of Black founders by banks and other institutional investors because they lack assets that can be used as collateral.
Therefore, banks’ traditional bias against applicants with meager collateral and little cash to spare coincides with the condition Black owners often find themselves. The Pew Research Center reports that the median white household enjoys a wealth gap that is 20 times more than the median Black household. Meanwhile, white household assets are 18 times more than their Hispanic counterparts.
Because of this predicament, minority owners are thus less likely to own expensive assets or homes that banks normally favor as collateral. Consequently, non-minority business founders start at a distinct advantage, with 16% more capital than their minority counterparts.
A good or perfect credit score is often a proxy or strong requirement for business loans. Good credit history is usually correlated with wealth, and the average minority owner’s credit score is usually 707, which is about 15 points lower than the average comparable small business owner.
The fear of being declined maintains this gap as 19% of minority businesses fail to apply for small business loans since it seems like a far-fetched, impossible task to accomplish.
Opportunity blindspots due to lack of diversity
Investors often don’t understand the investment focus of Black entrepreneurs, nor do they appreciate the opportunity for returns on the investment their business deals represent. The different perspective of the minority entrepreneur is based on the fact that they encounter different problems within their community, and consequently, see different solutions.
Because the VC decision-maker that the Black founder is pitching to haven’t had similar life-experiences, the tendency for them is to “evaluate a company and gain a frame of reference through all the other deals they’ve already seen,” says James Norman in the Harvard Business Review.
This pattern matching — which is employed by VCs to mitigate risk — even works against seasoned investors like Monique Woodward who has been a venture partner at name-brand companies such as 500 Startups. “Even after seeing the data, many LPs (limited partners) don’t understand this investment focus or see the opportunity for returns,” she declares.
To correct for bias in pattern recognition, some VCs and accelerators such as Village Capital are implementing a Peer Selection process grounded in the belief that like-minded entrepreneurs would be more adept at recognizing good opportunities than traditional investors.
Heightened risk-aversion to minority businesses
Institutional lenders tend to see Black businesses as more risky investments than their counterparts. This risk-averse behavior is rooted in the fact that the structural representation of these investors doesn’t reflect the race, ethnic, or gender diversity of the overall society.
The good news, however, is that over the past few years, online brokers have gone through a reboot, and now most of them have stock trading apps that cater to young, tech-savvy investors. In other words, as more people get into investing online, it’s clear that racial profiling won’t matter as much. For the time being though, research from the Small Business Administration shows that the location of a business, more so than the ethnicity of the owner, still plays a stronger role in the approval or denial of a business loan.
There can be no real equality without a level-playing field for economic opportunity. When Black entrepreneurs and people of color are denied adequate capital, their business cannot reach its full potential.
The growing income inequality is caused and exacerbated by racial bias that pervades the loan lending and investment funding system.
To prevent Black entrepreneurs from being hampered due to funds, part of the remedy requires policymakers to consider social and economic inequities when formulating policies to ensure greater access to capital is made available to minority-owned firms.
Copyright © 2023 SCORE Association, SCORE.org
Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.