Diversity in Lending: How Banks and Venture Capital are Affecting Change
December 7, 2020 |
The C2FO Team
Generations of minority-owned businesses in search of funding have found the financial playing field tilted against them. This article examines recent efforts to address that inequality and the possible impact on future lending practices.
The nation’s financial systems have long presented an uneven playing field for minority-owned businesses seeking the funding needed to grow. As recent social unrest and the COVID-19 pandemic have led many companies to re-examine diversity and inclusion, financial institutions have pledged support and put programs in place to address inequity.
In this article, we look at some of these efforts and the effect they may have on future lending practices for minority-owned companies.
A history of inequity
In 1865, as the Civil War drew to a close, the U.S. government chartered the Freedman’s Savings and Trust Company to help formerly enslaved Blacks get on sound financial footing. Mismanagement and the financial panic of 1873 led to the bank’s closing less than a decade later, leaving over 60,000 depositors with losses totaling nearly $3 million. This event, followed by decades of discriminatory lending practices like redlining, left a legacy of mistrust among Black and other minority communities.
This strained relationship with banks has made it especially challenging for minority business owners to gain access to capital. According to a 2018 report by the US Small Business Administration, most start-ups are funded mainly by personal and family savings, with minority founders relying especially heavily on those resources. Notably, Black median net worth is only about a tenth that of White households. Business loans are the second most common source of capital, but minorities experience more loan denials and higher interest rates than Whites. Fear of denial keeps many minority founders from even applying for loans.
The economic downturn caused by the COVID-19 pandemic has had a disproportionate impact on minorities. The period from February to April saw a 41% decline in the number of Black-owned businesses and a 32% decline for Latinx owners, while White entrepreneurs experienced only a 17% decline. Of those minority-owned businesses applying for Paycheck Protection Program (PPP) loans, only 12% received the support they’d requested, while 41% received none at all.
In other words, those who needed capital the most found it most difficult to secure.
Black businesses matter
May 25, 2020 was a turning point in the dialogue on race in the United States. Following soon after the deaths of Ahmaud Arbery, Breonna Taylor and others, a viral video showed the death of George Floyd at the hands of Minneapolis police. Within days, the world erupted in protest.
As Americans of all ethnicities and backgrounds demanded racial justice, companies quickly responded with public statements condemning racism and vowing to do more to combat it. Among them were banks and venture capital firms pledging their support for minority businesses and communities. Many made initial commitments in the early weeks of protests and have continued to expand those programs throughout the year.
How Banks are addressing diversity
In a press release one week after the protests began, Bank of America announced a $1 billion, 4-year commitment to help local communities address economic and racial inequity. Building on the institution’s existing mobility and workforce development programs, the new initiative focused mainly on the areas of health, jobs, support to small businesses, and housing.
Wells Fargo, which earlier in the year had announced a commitment of up to $50 million in capital for Minority Depository Institutions, unveiled its Open for Business Fund, through which approximately $400 million in PPP processing fees would go to support nonprofits serving small businesses, especially those owned by minorities.
In another $1 billion commitment, Citi announced its Action for Racial Equity initiative to help address the racial wealth gap. The corporation stated its four main goals of improving access to banking and credit in communities of color, increasing investment in Black-owned businesses, raising the rate of Black homeownership, and promoting anti-racist practices in the financial industry.
JPMorgan Chase & Co. recently launched the largest of these programs, pledging $30 billion over five years to help close the wealth gap. The commitments include loans, equity and direct funding to promote and expand affordable housing, grow Black- and Latinx-owned businesses, improve access to banking, and build a more diverse and inclusive workforce. “Systemic racism is a tragic part of America’s history,” said JPMorgan Chairman and CEO Jamie Dimon. “We can do more and do better to break down systems that have propagated racism and widespread economic inequality, especially for Black and Latinx people.”
In November, Citi, JPMorgan and Bank of America announced a commitment to lower charges to Black- and other minority-owned companies that use supply chain finance programs to meet spending needs.
While leading banks have pledged billions, minority-owned institutions have played an important role in supporting businesses in their communities. Kevin Cohee, CEO of OneUnited Bank, the largest Black-owned bank in the US, told Fortune.com in June how his bank had worked to counter inequities in the distributions of PPP loans. Since the rules for sole-proprietorship businesses — a category overwhelmingly composed of minority owners — came out late, these groups were last in line for aid. Cohee said OneUnited “went the complete opposite way,” making its first PPP loan to an Uber driver.
Unfortunately, the number of Black-owned banks has dwindled in recent decades, and the few that remain are undercapitalized. When large corporations and financial institutions invest in Black-owned banks, the odds are greater of wealth flowing through the Black community. According to Cohee, there’s one simple way for Americans to support Black wealth creation: “Bank Black, even if you’re White.”
Representation for minorities in venture capital
While minority-owned businesses have had strained relations with the banking industry, minorities are even more underrepresented in venture capital. Only 3% of VC investors are Black, and 1% are Hispanic. In a BLCK VC survey of 638 firms with over seven investors, 90% didn’t have a single Black investor and only 15 had more than one.
In the wake of the George Floyd protests, VC firms joined the rest of corporate America in expressing their solidarity with antiracist causes. Benchmark, Sequoia, Eniac Ventures and others tweeted in support of the movement. The New York-based firm Work-Bench published a post in Medium promising financial contributions to civil rights groups and a commitment to supporting Black entrepreneurs and investors.
Meanwhile, minority VCs are showing the way. BLCK VC, founded by Frederik Groce, is a venture capital resource group dedicated to connecting and supporting Black founders. 1863 Ventures offers a business development program for women and people of color. Black entrepreneurs lead funds like Ulu Ventures and Cleo Capital, to name just two.
Alejandro Guerrero, a 1st-generation Mexican American fund manager for the Los Angeles-based Act One Ventures, created the Diversity Term Sheet Rider for Representation at the Cap Table. The Rider encourages firms to make commercial best efforts to include at least one Black person or a member of another underrepresented group as a co-investor. By early October, 22 firms had committed to the Rider.
An inspiring success story is the Impact America Fund, founded by Kesha Cash, which recently closed $55 million to invest in companies that serve the overlooked and underrepresented. The fund ranks as one of the largest ever raised by a Black female general partner. While the raise took two years to complete, it gained momentum in the later stages as companies contributed to minority causes following the death of George Floyd. Its investment portfolio includes such companies as Mayvenn, a hair styling service for Black women, and Care Academy, which provides training for home care workers.
William Towns, adjunct lecturer of social impact at Northwestern University’s Kellogg School of Management, argues that lending institutions need to rethink how they measure creditworthiness. Instead of credit scores and available credit limits, Towns argues that banks should focus on applicants’ credit and payment histories. BLCK VC’s Groce maintains that better relationships with banking officers can help Black entrepreneurs build capital and confidence.
Towns goes on to point out that diversity on boards and executive teams will be a key factor in helping minority-owned businesses get the funding they need. Achieving this won’t be easy in corporate cultures where these high-paying positions are normally filled through networks of referrals. Boards will have to be active in searching for and supporting minority candidates.
As Sarah Kunst, founding managing partner of Cleo Capital, told TechCrunch in early June, “Simply put, the talent has always been there. What’s left is for larger funds to follow that lead and make a real commitment to hiring Black VCs as well as funding Black founders and encouraging their portfolio companies to hire Black people into positions of leadership.”
Sources: Office of the Comptroller of the Currency, US Small Business Administration, CNBC, The Wall Street Journal, Fortune.com, BLCK VC, 1863 Ventures, TechCrunch, Northwestern University Kellogg School of Management