After years of strong growth, the economic cycle is clearly turning. Inflation is hitting the U.S., interest rates are set to rise, and companies across all sectors are bracing for disruption.
For diverse founder-led businesses, such signals provide ample cause for concern. They’ve had a promising and productive few years (elevated in priority given the public commitment of support as a result of Black Lives Matter and George Floyd Awakening), but a sluggish economy is likely to bring back the norms of previous downturns. It’s during these slowdowns that investors and philanthropists begin to deprioritize underserved communities and businesses, believing that “impact” is more appropriate during boom times.
That mentality misses the point. Diverse founder-led businesses must be seen as a crucial part of the economic picture. Without them, the U.S. stands at a disadvantage as it attempts to maximize growth in a challenging environment with one hand effectively tied behind its back.
Investors should bet on these business owners to succeed and help elevate the communities in which they work, live, and lead. A shift in approach to financing capacity growth is a good start, and it’s already in progress with initiatives like:
- alternative selection processes that identify businesses well positioned to address gaps created by systemic social economic justice issues;
- less reliance on requirements for high personal finance scores and asset accumulation, which naturally penalize those with fewer economic resources;
- alternative underwriting that provides flexibility around issues related to historical performance, debt service coverage and loan amounts as a percentage of revenue;
- funding models that allow for fluctuations in revenue growth given the stage and life cycle of the company and provide for supplemental, favorably priced capital based upon performance;
- supplemental solutions that provide underserved companies with support beyond capital, such as access to expertise, resources, recognition and partners.
Revenue Based Financing (RBF) is one example of a “win-win” alternative. Founders First Capital Management relies on this financing model, which serves as a blend between bank debt and venture capital, RBF is a non-dilutive type of capital through which investors lend money to companies in return for a percentage of revenues until the initial loan amount and repayment cap have been paid off. Payments go up and down based on how much revenue the company brings in.
With this model, founders retain equity and investors can count on a reliable return – exactly the type of stability that both parties seek during volatile economic times.
The results are encouraging and show potential for long term momentum. Those in the Founders First program who take an RBF investment see revenues increase 92% on average. Overall in 2021, these founders saw a 65% increase in revenues, 417 jobs created – including 52% premium wage jobs – and 56% of companies added new revenue streams.
Losing out on economic impact
The U.S. works against itself in all economic environments when it dismisses an entire segment of the working population. Under-represented business founders face manufactured challenges that make it difficult to expand beyond the startup stage, provide meaningful employment within their communities, and generate true wealth that contributes to GDP growth, tax revenue, investments, and more.
The result is a significant gap. “This disparity is also a lost opportunity for the US economy as a whole,” noted McKinsey in its 2020 report, Building supportive ecosystems for Black-owned U.S. businesses. “If existing Black-owned businesses reached the same average revenue as their white-owned industry counterparts (excluding publicly held companies), the result would be an additional $200 billion in recurring direct revenues, which could equal about $190 billion in additional GDP.”
Expand the pool beyond Black-owned business to include minority women, and the contrast is just as stark: 4 million new jobs and $981 billion in revenue would be added to the U.S. economy if the average revenue of minority women-owned firms matched that of white women-owned businesses, according to the 2019 State of Women Report.
The impact on specific communities is even more acute, as the lack of funding and revenue generation creates a vicious cycle of lower-income opportunities. The Brooking Institute found that when investments in entrepreneurial ventures don’t make it to diverse founders, it translates into fewer opportunities for those around them.
“Business dynamism patterns in minority communities reveal a concerning tradeoff,” wrote the Institute in Economic dynamism thrives in America’s minority communities. “Old, less productive employment is replaced with low-paying jobs that are not necessarily more productive or technology-enabled.”
The sticking points are clear. Diverse founders face the traditional challenges of launching a business – daunting in themselves – but also must manage through an additional layer of societal and financial roadblocks. The three main hurdles are:
- Limited, customer-based or transactional revenue that is negatively impacted when the economy slows down.
- Lack of reserve capital to overcome revenue shortfalls during economic downturns.
- Lack of access to resources and partner connections to help them adapt their business models in a changing economic environment.
These economic barriers take a toll in the form of lower levels of capital that can be deployed to safeguard the business. “Start-up capital is associated with better business performance,” wrote McKinsey, “but Black entrepreneurs have less of it. Black entrepreneurs start their businesses with about $35,000 of capital, white entrepreneurs $107,000.”
Women, BIPOC, veteran, and LGBTQ founders all have similar funding issues that prevent them from gaining momentum. They need enough working capital to get their operations into a flow, support experimentation with different models, and create new revenue streams that diversify the business and spread risk during a downturn.
Creating long-term economic value
Impact investors have been attracted to this challenge in recent years, driven in part by the pandemic’s ravaging effect on diverse communities. That sentiment is dangerously temporary, though: diverse founders need support that is inspired not by a timely issue, but by favorable economics. Put simply, when everyone stands to benefit financially, solutions tend to rise to the fore.
There are turbulent times ahead. We know that diverse founders will be exposed to greater risk than other business owners. With the right tools and funding mechanisms, however, investors can change the paradigm. The first step is empowering these founders without sacrificing their ability to create wealth or the investors’ ability to benefit from reliable returns.
Kim Folsom is Founder, Chairperson and CEO of Founders First Capital Partners.