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Executive Summary - Disparities in Capital Access between Minority and Non-Minority Businesses
This report was developed under a contract with the U.S. Department of Commerce’s Minority Business Development Agency, and contains information and analysis that was reviewed and edited by officials of the Minority Business Development Agency.
Capital access remains the most important factor limiting the establishment, expansion and growth of minority-owned businesses. Given this well established constraint, the current financial environment has placed a greater burden on minority entrepreneurs who are trying to keep their businesses thriving in today’s economy.
In this study, Dr. Robert W. Fairlie and Dr. Alicia Robb provide an in-depth review and analysis of the barriers to capital access experienced by minority entrepreneurs, and the consequences that limited financial sources are placing on expanding minority-owned firms.
Minority-owned businesses have been growing in number of firms, gross receipts, and paid employment, at a faster pace than non-minority firms. If it were not for the employment growth created by minority firms, American firms, excluding publicly-held firms, would have experienced a greater job loss between 1997 and 2002. While paid employment grew by 4 percent among minority-owned firms, it declined by 7 percent among non-minority firms during this period.
Minority-owned businesses continue to be the engine of employment in emerging and minority communities. Their business growth depends on a variety of capital, from seed funding to establish new firms, to working capital and business loans to expand their businesses, to private equity for acquiring and merging with other firms.
Without adequate capital minority-owned firms will fail to realize their full potential. In 2002 there were 4 million minority-owned firms, grossing $661 billion in receipts and employing 4.7 million workers. If minority-owned firms would have reached parity with the representation of minorities in the U.S. population, these firms would have employed over 16.1 million workers, grossed over $2.5 trillion in receipts, and numbered 6.5 million firms. Increasing the flow of capital for minority-owned businesses must be a national priority to re-energize the U.S. economy and increase competitiveness in the global marketplace.
David A. Hinson National Director Minority Business Development Agency
Minority business enterprises (MBEs) make a substantial contribution to the U.S. economy, generating $661 billion in total gross receipts in 2002. Minority-owned firms also employed 4.7 million people with an annual payroll totaling $115 billion. The growth rates in the total number of firms, employment and gross receipts of minority-owned businesses far outpaced non-minority-owned businesses between 1997 and 2002. Had minority-owned businesses reached economic parity, the U.S. economy would have recorded higher levels of key economic activity estimated at $2.5 trillion in gross receipts and 16.1 million employees. As defined by the Minority Business Development Agency, economic parity is achieved when the level of business activity of a business group is proportional to that group’s representation in the U.S. adult population.1
Minority-owned firms are an engine of employment, with young firms creating jobs at similar rates as young non-minority firms. Greater capital access for minority-owned firms is essential to sustain their growth, reduce national unemployment levels, and in particular the high rate of unemployment in minority communities.
At the very time that broad economic productivity is critical to strengthening the economic foundation of the nation, the growth potential of minority-owned businesses is being severely hampered. Across the nation minority-owned businesses face the obstacles of access to capital, access to markets and access to social networks, all of which are essential for any business to increase in size and scale.
A review of national and regional studies over several decades indicates that limited financial, human, and social capital as well as racial discrimination are primarily responsible for the disparities in minority business performance. Inadequate access to financial capital continues to be a particularly important constraint limiting the growth of minority-owned businesses. The latest nationally representative data on the financing of minority firms indicates large disparities in access to financial capital. Minority-owned businesses are found to pay higher interest rates on loans. They are also more likely to be denied credit, and are less likely to apply for loans because they fear their applications will be denied. Further, minority-owned firms are found to have less than half the average amount of recent equity investments and loans than non-minority firms even among firms with $500,000 or more in annual gross receipts, and also invest substantially less capital at startup and in the first few years of existence than non-minority firms.
The current economic crisis is posing severe challenges for minority businesses to meet their potential of creating 16.1 million jobs and generating $2.5 trillion in annual gross receipts. Existing obstacles to greater minority business success challenge the realization of the American Dream of ownership and wealth creation. Unless immediate action is taken, minority communities will continue to lag behind their non-minority counterparts undermining the ability of the nation to quickly regain its economic footing.
1U.S. Department of Commerce, Minority Business Development Agency, The State of Minority Business Enterprises, An Overview of the 2002 Survey of Business Owners, Number of Firms, Gross Receipts, and Paid Employees (2006).
Young Minority-Owned Firms Create Jobs at Similar Rates as Young Non-Minority Firms - Young minority firms created jobs at similar rates as young non-minority firms over the first four years of operations. Between 2004 and 2007, young minority firms created 3.1 jobs while young non-minority firms created 2.4 jobs during the same period according to an analysis of the Kauffman Foundation Survey.
Minority Businesses Create Jobs with Good Pay - The average payroll per employee was not substantially higher among non-minority employer firms compared to that of minority-owned firms. In 2002, payroll per employee was $29,842 for non-minority employer firms compared to about $26,000 for minority-owned firms, according to data from the U.S. Census Bureau. Minority-owned firms are employing workers at similar wages as non-minority firms, and are the backbone of many minority communities across the nation.
2001 U.S. Recession Benefited from Minority Business Job Creation - Between 1997 and 2002, total employment declined by 7 percent among non-minority firms, however total employment increased among minority firms during the same period. Total employment grew by 11 percent among Hispanic owned firms, by 5 percent among African American owned firms, and by 2 percent among Asian firms. For all minority firms employment increased by 4 percent during the same period. If not for employment growth among minority-owned firms over this period the loss in total employment would have been even larger: an additional 160,000 jobs would have been lost.
Minority-Owned Firms Outpace Growth of Non-Minority Firms - Between 1997 and 2002, minority-owned firms far outpaced non-minority firms in terms of growth in number of businesses total gross receipts, number of employees, and total annual payroll. Minority firms grew in number of firms by 30 percent and in gross receipts by 12 percent, compared with an increase of 6 percent in number of firms and 4 percent in gross receipts for non-minority firms. Total employment grew by 4 percent and annual payroll by 21 percent for minority-owned firms compared to a decline of 7 percent in total employment and an increase in annual payroll of 8 percent for non-minority firms during the same period.
Minority-Owned Firms Lag Behind in Size Compared with Non-Minority Firms - Although minority-owned firms outpaced the growth of non-minority firms in several business measures, minority-owned firms are smaller on average than non-minority firms in size of gross receipts, employment, and payrolls. In 2002, average gross receipts of minority-owned firms were about $167,000 compared to $439,000 for non-minority firms. Average employment size of minority employer firms was 7.4 employees compared to 11.2 employees for non-minority employer firms in 2002. Average payroll of minority employer firms was about $200,000 compared to $333,000 for non-minority employer firms.
Capital Access Disparities
Minority-Owned Firms Are Less Likely To Receive Loans than Non-Minority Firms - Among firms with gross receipts under $500,000, 23 percent of non-minority firms received loans compared to 17 percent of minority firms. Among high sales firms (firms with annual gross receipts of $500,000 or more), 52 percent of non-minority firms received loans compared with 41 percent of minority firms according to 2003 data from the Survey of Small Business Finances.
Minority-Owned Firms Receive Lower Loan Amounts than Non-Minority Firms - The average loan amount for all high sales minority firms was $149,000. The non-minority average was more than twice this amount at $310,000. Conditioning on the percentage of firms receiving loans, the average loan received by high sales minority firms was $363,000 compared with $592,000 for non-minority firms.
Minority-Owned Firms Are More Likely To Be Denied Loans - Among firms with gross receipts under $500,000, loan denial rates for minority firms were about three times higher, at 42 percent, compared to those of non-minority-owned firms, 16 percent. For high sales firms, the rate of loan denial was almost twice as high for minority firms as for non-minority firms.
Minority-Owned Firms Are More Likely To Not Apply for Loans Due to Rejection Fears - Among firms with gross receipts under $500,000, 33 percent of minority firms did not apply for loans because of fear of rejection compared to 17 percent of non-minority firms. For high sales firms, 19 percent of minority firms did not apply for loans because of a fear of rejection compared to 12 percent of non-minority firms.
Minority-Owned Firms Pay Higher Interest Rates on Business Loans - For all firms, minority firms paid 7.8 percent on average for loans compared with 6.4 percent for non-minority firms. The difference was smaller, but still existed between minority and non-minority high sales firms.
Minority-Owned Firms Receive Smaller Equity Investments than Non-Minority Firms - The average amount of new equity investments was $3,379 for minority firms, which is 43 percent of the non-minority level. The average amount of new equity investments was $7,274 for minority firms with high sales, which was only 38 percent of the non-minority level according to 2003 data from the Survey of Small Business Finances.
Venture Capital Funds Focused on Minority-Owned Firm Investments Are Competitive - Venture capital funds focused on investing in minority-owned firms provide returns that are comparable to mainstream venture capital firms. Funds investing in minority businesses may provide attractive returns because the market is underserved.
Minority-Owned Firms Have Lower Loan and Equity Investments - Investment disparities between minority and non-minority firms were larger for external debt (bank loans, credit cards) and especially external equity, compared to the disparity in personal or family loan investments. Minority firms averaged $29,879 in external debt compared with $36,777 for non-minority firms. Minority firms had the most trouble obtaining external equity with $2,984 on average compared with $7,607 on average for non-minority firms.
Disparities in Access to Financial Capital Grow after First Year of Operations - Non-minority businesses invested an average of $45,000 annually into their firms, while minority-owned firms invested less than $30,000 on average after the first year of operation. The disparity in financial capital between minority and non-minority firms was much larger in percentage terms for the next three years in operation than their first year.
Lower Wealth Levels Are A Barrier to Entry for Minority Entrepreneurs - Estimates from the U.S. Census Bureau indicate that half of all Hispanic families have less than $7,950 in wealth, and half of all African American families less than $5,446. Wealth levels among whites are 11 to 16 times higher. Low levels of wealth and liquidity constraints create a substantial barrier to entry for minority entrepreneurs because the owner’s wealth can be invested directly in the business, used as collateral to obtain business loans or used to acquire other businesses.
Experience, Geographic Location, Lower Sales and Industry Sectors Partially Limit Capital Access for Minority Firms - Minority-owned businesses had less business experience, lower sales, and less favorable geographical and industry distributions, all of which partially limited their ability to raise financial capital.