The Reconstruction | October 27, 2021

Patient capital for established BIPOC businesses to close racial wealth gaps

George Ashton
Guest Author

George Ashton

Yes, startups led by Black, Indigenous and people of color-owned need growth capital. But meeting the growth and operating capital needs of established BIPOC businesses is also key to closing the racial wealth gap.

For years, overwhelming evidence has pointed to community-based businesses as one of the most effective tools to close the racial wealth gap. The economic activity generated by entrepreneurship, including increased community access to jobs and opportunity, has the potential to enact self-sustaining and intergenerational change in communities.

The good news is that the number of minority-owned small and medium-sized businesses increased by 79 percent from 2007 to 2017, and they accounted for more than 50 percent of new business ventures over the last decade.

And yet, the wealth gap continued to widen. The gap between Black and White families, for instance, grew from a median of about $100,000 in 1992 to $154,000 in 2016. Latin families have also seen persistent gaps, holding just 21 cents for every dollar of White wealth in 2019.

So, why is there no correlation between an increase in the number of minority-owned businesses and a decrease in the racial wealth gap?

The answer can be found in the details of the data. The average annual revenue for Black-owned businesses is $1 million, in comparison to $6.4 million for White-owned businesses, according to a 2017 Small Business Labs report. Even more eye opening is this: less than 5 percent of Black-owned small businesses have a cash buffer greater than two weeks (compared to 35.9 percent of White-owned small businesses), meaning 95 percent of Black-owned businesses are living “paycheck to paycheck.”

This makes Black-owned businesses more vulnerable to economic shocks, less able to expand during times of opportunity, and less likely to receive traditional financing. They can’t build the kind of financial strength and sustained growth needed to help shrink the racial wealth gap.

Growth capital

Rather than focusing only on support for Black, Indigenous and people of color-owned startups, we also need to determine what established BIPOC businesses need to grow their operations and become more resilient.

Minority-owned businesses that have survived for years with very little access to capital tend to be led by battle-tested owners who, with the right kind of financing and support, could deepen their customer bases, expand their geographic presence, enter higher margin business models, diversify business lines, and, most importantly, hire more employees. In short, with the right capital these businesses would grow to offer (1) significant wealth creation opportunities for the entrepreneur as well as (2) substantial job creation that would create family financial stability and lead to next-generation success. Both are strong movements toward shrinking the racial wealth gap.

To achieve that kind of self-sustaining resilience, BIPOC entrepreneurs need access not just to grants and loans but also to growth capital. Grants, though vital in crisis situations like the pandemic, are often too small to support business expansion. Low-cost debt can be helpful for building operations, but its repayment structures and default provisions often discourage entrepreneurs from taking on necessary risk for growth. 

Patient, equity-like investments, on the other hand, allow owners to take on the risks of expanding their businesses, while also positioning them to weather economic storms. By expanding access to growth capital, we can make our small business ecosystem more diverse and robust, matching appropriate financing to the needs of community-based businesses.  

Changing the racial wealth outlook

For many start-ups, the typical approach to capital is to tap “friends and family” as the first investor group. But BIPOC communities lack access to network wealth as a result of historical discrimination in lending and housing policies and, in turn, lack the equity available to capitalize home-grown businesses. 

McKinsey estimates that 15 percent of White Americans hold some business equity, while only 5 percent of Black Americans do. And of those Black Americans that have equity, it is worth about 33 percent of the average for White Americans. Essentially, a Black-led business would need three times more assets to look just as appealing as a White-led business to a bank.

To fill this gap, investors and funders should step up to provide growth capital. Based on the experience of my organization, LISC Strategic Investments, we estimate that small businesses need, on average, $50,000 to $250,000 of capital to fund growth that will significantly change their trajectory and, consequently, that of their owners, employees and communities. 

What should this capital look like? It could come in the form of either convertible debt or equity-like products that provide flexibility to investees. It should give entrepreneurs the space and confidence to try new growth endeavors during times of opportunity, endure economic shocks, and meet business milestones.

Some community development financial institutions (CDFIs) and small business lenders are already testing these kinds of highly tailored products, as well as the investment funds that might be built around them. For mid-scale businesses there are a number of entities offering revenue based non-recourse notes that only require payback as a percentage of the businesses’ revenue and don’t push the entrepreneur into default for bad performance. For smaller community based businesses, a recoverable grant structure offers similar flexibility, with the entrepreneur only paying back the grant if the business plan succeeds. 

As we do, it is imperative that we respond to the needs of minority-owned businesses and the communities they serve.

At this point, we are all well informed of the historical decisions that have entrenched the racial wealth gap. The only question now is whether or not we are willing to right the path. We believe offering patient, flexible growth capital to promising BIPOC businesses is a critical step in doing so. 

George Ashton is managing director of LISC Strategic Investments, which structures and manages impact investment funds for the Local Initiatives Support Corporation (LISC) that are designed to close racial and socio-economic gaps.