Social Impact Entrepreneurship Finance & Accounting Jul 20, 2020
Black-Owned Businesses Often Struggle to Access Capital. Here’s How Financial Institutions Can Change That.
Banks and investors need to redefine creditworthiness, diversify their boards, and think more about social returns.
The COVID-19 pandemic, despite being called an invisible enemy, has revealed a number of visible structural inequalities plaguing the United States: from which workers are considered “essential” to which neighborhoods are most susceptible to the virus’s spread to which families have reliable internet. The killings of Breonna Taylor, George Floyd, and others at the hands of police—and the widespread protests of systemic racism that have followed—have only highlighted these inequalities further.
So what role does the financial industry play in exacerbating inequalities? And how can banks and investors ensure that Black and other minority-owned businesses have access to capital?
This is the time to reckon with these questions, says William Towns, an adjunct lecturer of social impact at Kellogg and managing director of a private equity fund at 4 S Bay Partners, LLC that targets minority operating businesses within opportunity zones in the Chicago region.
“What we are witnessing in the broad protests across our country is a whole new generation of people whose eyes have been opened wider to the inequities within our economic system and the awareness of the role businesses will have to play in order to help ensure that their impact is equitable across different communities and people,” he says. “We’re at a point now where a return to ‘normal’ would be a complete failure of our country’s full potential.”
Towns offered three ways the financial industry can support diversity and equity moving forward.
Banks Need to Revisit How They Measure Creditworthiness
One of the biggest barriers to Black and minority entrepreneurship stems from long-held beliefs by banks and other financial institutions that these entrepreneurs are higher-risk candidates for mortgages and other loans.
Take, for example, JPMorgan Chase, whose leadership has been outspoken in the need to support entrepreneurs of color, even releasing photos of CEO Jamie Dimon kneeling in front of a bank vault with other team members in a gesture of solidarity with Black Americans. But some aspects of the bank’s lending behavior tell a different story.
“JPMorgan is the largest bank in the United States, and they do more loans in one Northside Chicago neighborhood—Lincoln Park—than they do combined in all of the predominately African-American neighborhoods in the city,” Towns says. “So there are segments of their business that still aren’t living up to the standards they have publicly stated need to happen.”
A better approach, he says, would be to do away with credit scores and available credit limits as primary factors for determining loan eligibility. Instead, banks should focus on applicants’ credit and payment history.
“We need to get people on these boards who either look like the individuals from these businesses or come from these communities.”
— William Towns
“It’s a simple change to say, ‘Have they ever missed a payment? No? Then why are we penalizing them for using a larger portion of their credit limit?’” Towns says. “We now know through research and data that it’s not a good indicator of who’s a good person to lend to, and it has no impact on their ability to be a good borrower.”
Another issue is that banks know that many of these small business loans are just that—small. These smaller loans take the same amount of work as larger, often more profitable loans to businesses that have plans to scale quickly. It’s these larger loans that allow banks more opportunities to provide additional services, including credit cards and wealth management.
“There are plenty of small companies with a couple of locations and a customer base that are not looking to scale but to stabilize,” Towns says. “These businesses sustain the owners, their employees, and their families for a comfortable life. But they need access to capital.”
Boards of Directors Need to Step Up
Towns also suggests that, for Black- or other minority-owned companies to get funding from private equity firms, venture capital funds, angel investors, and banks, the boards of directors of those funders need to reflect the communities they purport to serve.
“We need to get people on these boards who either look like the individuals from these businesses or come from these communities,” Town says. “If that is not the case, they need to be at least understanding and appreciative of the unique situations, circumstances, and opportunities these entrepreneurs present.”
Instituting that kind of change requires that boards not only interview diverse candidates but also support their candidacy. Well-paying, highly coveted board seats tend to be filled through a network of referrals—networks that frequently leave out women and minorities. This leads to women and minorities, regardless of their expertise, often being left out of the opportunity to strategically enhance the business.
“All too often, even when women and minorities are up for positions, people make statements that disregard them before they are ever spoken to and others don’t speak up,” says Towns.
Changing this starts at the individual level, Towns says, with board members from underrepresented groups and their allies speaking up for those candidates, as well as calling out bad behavior by their fellow board members. It is not just the job of the minority board member to speak up on these issues, Towns says, but of the board itself.
Towns knows from personal experience how difficult speaking up can be. While serving on boards in the housing, healthcare, banking, and education sectors, he has had found himself listening as fellow board members disparaged candidates they perceived as different or not a good “fit.” In those instances, Towns has not always felt empowered enough to speak up.
“We have all been in situations where we have seen things happen or heard something said, when we should have stepped up, myself included,” he adds. “We have to look at ourselves first and what we can do as individual before we begin to talk about what we can do collectively.”
Impact Investing Needs a Boost
Impact investing also offers promise as a way to give a diverse set of entrepreneurs the funding and mentoring they need to thrive. But among entrepreneurs of color, it is highly underutilized.
“How much is going to entrepreneurs of color from an impact-investing standpoint? It’s relatively small,” Towns says.
One reason for this is structural: impact investors are often board members and finance executives who have retired or left the same institutions whose policies created the structural inequities we see today. In their efforts to be more equitable in their encore endeavors, they apply the same investing principles that perpetuate the inequities they are trying to combat.
“They see impact investing as an opportunity to give back, but they carry a lot of the same underlying training with them as they get into the social-impact space,” Town says.
Another issue is that the rate of return for investors is relatively modest compared to other forms of investing—inherently limiting how much capital can be raised.
For example, investors in Benefit Chicago, a $100 million place-based impact fund Towns previously led, understand that their investments enable the businesses supported by the fund to grow and develop. Their return calculation includes a 1.5 to 3 percent financial return in addition to the social return of job creation and business expansion in communities that have been overlooked. Yet this rate of return does not compare favorably to that of, say, Tesla, which has more than a 500 percent return over the last year.
The key, according to Towns, is to realize that a balanced investment portfolio should contain some mix of both types of investments.
Again, perceived risk plays a factor in the lack of investment. Many entrepreneurs of color don’t have a track record of running successful businesses because of the lack of access to capital. But the same could be said for WeWork cofounders Adam Neumann, Rebekah Neumann, and Miguel Mckelvey, who were able to raise hundreds of millions of dollars based almost entirely on a concept.
“We just don’t see that kind of commitment and risk-taking to support a lot of our founders of color and women,” Towns says. “We need to recognize that this is the case.”
Towns has personally seen how a deep commitment to Black entrepreneurs and other entrepreneurs of color can pay off—for their businesses and their communities. These include investments in companies like Sweet Beginnings, which now sells its honey-based skin-care products in retail stores like Whole Foods and Mariano’s, and developer DL3 Realty, which built a 48,000-square-foot Jewel-Osco supermarket in the Woodlawn community on Chicago’s South Side, the first full-service grocery store in the community in more than 40 years.
“You get a sense of not only getting profit return, but a sense of feeling like you’re really contributing towards helping make cities better.” Towns says. “Chicago is a world-class city, but in order to remain one, all of its neighborhoods must be world-class.”
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