Who's behind all the "access to capital" reform?
Hey folks. This is the 4th edition of The Great Near. Today’s post is about the ways in which we’re failing small businesses owned by women and people of color. Mostly though, it’s also about the people and ideas changing the game. This is Part 1, so stay tuned for next week.
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Like everything exacerbated by the pandemic, access to capital—or lack thereof—gained attention as business owners everywhere struggled to survive. I’ve been thinking about this in relation to the news that Americans are starting new businesses at astonishing rates, driving a 24 percent increase in the total from 2019. Businesses don’t grow without capital, and if history tells us anything, we should pay close attention to who receives it.
Admittedly, this topic isn’t as sexy as dismantling corporate monopolies, but it’s fundamental to the promise of America—the idea that anyone with a good idea and a bit of entrepreneurial drive should have a fair shot at building wealth and financial stability. But this isn’t our America. People of color are disproportionately denied access to the capital they need to grow businesses, from venture capital to business loans and federal relief dollars.
The pandemic painted our two-tier financial system in stark relief. Black-owned businesses weren’t explicitly barred from accessing emergency loans under the Paycheck Protection Program, yet 23 percent of applications from Black business owners were denied by banks compared to 9 percent from white business owners.
We’ve accepted many policies by virtue of “the way things are done.” Our credit rating system, for example, often includes a subjective assessment of a borrower’s character and creditworthiness, which puts minority communities at higher risk of pricing discrimination. Expensive loans and hidden fees increase the chance of default for borrowers who are already on the financial margins, resulting in (you guessed it) damaged credit and even higher rates on future loans. We also know that it costs Black and Brown entrepreneurs $250,000 more to start a business than white entrepreneurs and that 35 percent of Latinx-owned established businesses report issues accessing credit. This isn’t only unjust, it’s bad for the economy.
(Credit: Kauffman Foundation)
One approach has been to pump money into underserved communities through entrepreneurship initiatives—even if the problem is less about increasing the pie than questioning who gets a slice. I’m encouraged to see that some programs have become more expansive (banks hiring community managers to build trust with borrowers, for example) but historically, nothing fundamental has changed from this top-down approach. Promises go unfulfilled with little more than a shrug. Commitments ballooned this past year, headlined by Goldman Sachs launching a $10 billion program that will provide greater access to capital for Black female entrepreneurs. JPMC will deliver $2 billion in loans to small businesses in majority-Black and -Latinx communities. Bank of America pledged $200 million in equity investments in minority entrepreneurs, businesses, and funds. Microsoft pledged $50 million to a fund that will provide loans to Black- and African American-owned Microsoft partners. “Minority entrepreneur funds” are basically a rite of passage.
But money alone won’t fix this problem—a problem that is systemic and structural can only be fixed by a solution that is systemic and structural.
Fortunately, there is a movement of leaders taking this approach; pioneering new financing structures, support ecosystems for entrepreneurs, and equitable public policy. They embrace the idea that access to capital is about “access” as much as it is about “capital.” It’s about strengthening the relationships between banks and communities; creating new terms for venture funding so that Black and Brown entrepreneurs keep ownership of their businesses; building alternative credit systems that acknowledge generations of discrimination in homeownership and employment — all of this and more.
Institutions would be wise to heed the advice of these leaders in every billion-dollar access to capital campaign. They must mirror these local efforts to become more expansive and creative in their definitions of access. What does it mean that Bank of America’s $200 million racial equity commitment is only .009% of their total assets? Compared to the $42.1 billion they provided in fossil fuel financing last year, it means that their priorities are showing.
Still, there is reason to be optimistic. This list is built around the people and ideas I draw inspiration from in Common Future’s network, finance, nonprofits, tech, and elsewhere. I’d love to hear from you—who/what else needs to be on this list? (caitlin@commonfuture.co)
10 ideas and individuals turning “capital access” upside down (part 1)
Jessica Norwood, RUNWAY
Melissa Bradley, 1863 Ventures
Revenue-based finance
Community Credit Lab’s new benchmark
Capital entrepreneurs
1. Jessica Norwood, RUNWAY
Venture capital gets a lot of attention with headlines like “Women-led Startups Received Just 2.3% of Funding in 2020,” but VC is a tiny slice of the problem. 83 percent of entrepreneurs don’t use bank loans or venture capital to fund their startups. Instead, 65 percent rely on personal and family savings. If an entrepreneur’s early success is often tied to the collective wealth of their community, growing up in a low-income neighborhood could mean you don’t have “friends and family” capital to lean on (in other words, that rich aunt who bankrolls your rent while you launch a vegan ice cream startup).
Jessica Norwood is changing that. No list about capital access is complete without RUNWAY, the organization that has invested millions in Black entrepreneurs to plug this friends and family gap. They take it one step further, offering entrepreneurs the coaching, mentorship, and emergency support that mirrors the safety net a family might provide. During the pandemic, RUNWAY also launched the first-ever universal basic income program for Black entrepreneurs. This no-strings-attached capital wasn’t only a form of financial support. It demonstrated as Jessica Norwood puts it, “what the economy would look like if it loved Black entrepreneurs.”
2. Melissa Bradley, 1863 Ventures
Melissa Bradley is one of the leading voices calling for structural change within finance and venture capital. She is the founder of 1863 Ventures, an accelerator program that is shifting the narrative around new majority businesses (those run by women and people of color) to drive more funding to these entrepreneurs. Bradley is also on the advisory committee of that big Goldman Sachs initiative, which is encouraging news. I’m excited about 1863 Ventures’ new fund, offering revenue-based financing to entrepreneurs who aren’t served by VCs, banks, and CDFIs. She talks about their thought process in shaping the fund here:
“A significant number of founders come to our 1863 programs because they need to reclaim the cap table, for example — they took venture capital too early, and now don’t own a majority of the company any more. We’ve certainly also seen debt become a big problem, as many of them are priced out due to higher interest rates charged to Black borrowers than whites.. We did this [launch the fund] because we have found that traditional capital markets are taking away ownership from the entrepreneurs, and the cost of capital was too high. Our research showed that Black entrepreneurs spend 1.5–2 percent more on capital than their white peers. Because of this, the options that were out there didn’t work. So for the 1863 fund, we are focused on revenue-based financing, with a small portion available for convertible debt. The idea is to be less cannibalistic around capital and equity. Revenue-based financing is based on what they make over a month, so we find that it is much more palatable for many of our entrepreneurs.”
3. Revenue-based finance
Speaking of revenue-based finance… More people are figuring out how to apply this old financing structure in new ways. This method of raising capital has been used for generations across industries, from oil to pharmaceuticals and book royalties, and it’s now being explored as a more flexible form of capital for entrepreneurs.
First, what is it? Revenue-based finance (also called revenue-based investing, royalty finance, or RBF) is defined as “a method of raising capital for a business from investors who receive a percentage of the enterprise's ongoing gross revenues in exchange for the money they invested. Investors receive a regular share of the business’s income until a predetermined amount has been paid.”
Put simply, it’s a flexible arrangement that ties loan repayment to revenue, which accounts for the ups and downs of running an early-stage business. Many believe that this dual equity-debt arrangement might better serve BIPOC entrepreneurs with “the upside of traditional VC, but some of the downside protection of debt.”
RBF could benefit so many businesses, but these “creative” terms aren’t enough. Not to mention, this tool isn’t always a great fit for early-stage businesses, unless they’re raising a relatively small amount of capital (here’s a great explanation from Aner Ben-Ami). While many people are talking about deploying RBF to small businesses, fewer are actually doing it. As the field pays more attention to this, Common Future’s Director of Capital Strategies, Eric Horvath, weighs in:
“Revenue-based financing, like more traditional lending, can also be extractive. To safeguard against RBF becoming a shiny alternative that shies away from transformation, borrowers should be meaningfully included in considerations around key deal terms such as percentage of revenue repaid per month and the multiple cap. Ultimately, if we truly want to center those we are trying to support, they have to be included in these fundamental decisions.”
Who to follow around RBF❗ Kim Folsom at Founders First Capital (just raised a $100M Fund), Melissa Bradley at 1863 Ventures, Flexible Capital Fund, VilCap Investments, Mission Driven Finance, Aner Ben-Ami at Candide Group, and Homestake Venture Partners.
4. Community Credit Lab’s new benchmark
This gets a bit theoretical, so skip ahead if that’s not your jam. The brilliant team at Community Credit Lab is calling for new community investment benchmarks.
First, imagine you’re an entrepreneur seeking a loan at your local credit union to open a salon. Your credit isn’t great and you don’t have much in savings, so the interest you’re offered is between 8% for a commercial loan (if you can get it) and 36% for a personal loan. Why so high? An impact investor lent capital to a local community lender under their “community investment portfolio,” and they’re expecting a return. That cost is passed along to you, the borrower, in addition to a markup from your lender to cover a portion of staff salaries and operating costs. Despite everyone’s good intentions, the borrower in this case ends up paying a “poverty premium” to access that loan. This graphic explains:
(Credit: Community Credit Lab)
Now imagine you’re a rich retiree and you want to give your granddaughter a loan for a down payment on a home. The interest rate to issue a loan above $10,000 within your family would need to be somewhere between .18%-1.01% depending on the loan term. This is what the IRS calls the Applicable Federal Rate. With these scenarios in mind, Community Credit Lab asks:
“If the Applicable Federal Rates are the interest rates used when transferring wealth to kin – shouldn't they also be proxy rates for building wealth and equity within our communities? We believe that it's unacceptable that wealth is transferred in our financial system via credit at rates as low as .18% when using AFR rates, but wealth is "built" at interest rates that are exponentially higher than this.”
It might be too costly for most CDFIs or Credit Unions to offer an entrepreneur a 1% loan today, but over time, lenders can get more creative with interest rates if they raise different types of investment to finance these loans. This means seeking out a lower cost of capital, in other words, choosing investor B over investor A from the graphic above. That includes impact investors who accept concessionary rates (or let go of that concept entirely), philanthropic institutions allocating program related investments, and family offices that want to think differently about supporting equitable growth. We need more organizations like CCL asking these hard questions and encouraging the field to think differently.
5. Capital entrepreneurs
So far we’ve talked about people developing alternatives to debt and equity (1863 Ventures and others), piloting UBI (RUNWAY), and developing new benchmarks to guide impact investors (Community Credit Lab). Kauffman Foundation—the leading funder of entrepreneurship and capital access research—has a name for the people developing these alternatives: capital entrepreneurs.
These are the people who ask: “how can we develop technologies to improve loan access?” Or, “can we develop a product for employees to buy ownership stakes in their workplace?” They navigate regulatory uncertainty in courageous attempts to shift the financial sector, which has lacked creativity when it comes to serving low-income communities (despite the fanfare around fintech).
My colleagues often remind me that the financial industry can turn on a dime—or at least a few decades. Blackrock was founded less than 40 years ago, yet it’s grown to become the world’s largest asset manager. Equity crowdfunding only became possible through the 2012 JOBS Act enabling non-accredited investors to finally buy stakes in local small businesses. Community development financial institutions (CDFIs) only began to take root 25 years ago. What began as an anti-poverty experiment to counter waning support for a government-sponsored social safety net has been a huge success by most measures. Non-fungible tokens are less than a decade old and a piece of digital art by the artist known as Beeple sold this year for $69.3 million. 🤷♀️
My point is, today’s crazy ideas are tomorrow’s NFTs and equity crowdfunding. In the meantime, you should follow these capital entrepreneurs❗ ICA, Mission Driven Finance, XXcelerate Fund, Native Women Lead, Social Impact Strategies Group, Mortar, Denkyem Coop, and Common Future’s Eric Horvath (he serves up great content on LinkedIn).
… part 2 coming soon
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What’s Up This Week? 👀 ✨
Caught my attention
Green investing ‘is definitely not going to work’, says ex-BlackRock executive 😬😬 “Investors have a fiduciary duty to maximise returns to their clients and as long as there is money to be made in activities that contribute to global warming, no amount of rhetoric about the need for sustainable investing will change that, he believes.” Maybe it’s the pandemic, but it’s encouraging to see people coming out of the shadows supporting the idea that systemic change can only be led by governments in partnership with Wall Street (not the other way around).
I’ve been loving the Spectrum Impact newsletter from Rehana Nathoo. It’s a great resource for all things impact investing (#impinv). Recently, she talked about rewriting our definition of fiduciary duty in light of the Biden Administration’s ruling not to enforce guidance from the Trump administration, which stated that environmental, social, and governance (ESG) indicators fall outside of the scope of fiduciary duty. This would have put trustees at risk for including ESG factors in their assessments (for example, if a risky “clean tech” investment were to underperform). With the Biden administration punting a decision down the line, Nathoo argues that rules like this will always fall short if the concept of fiduciary duty doesn’t change to reflect today’s greatest risks, which are overwhelmingly ESG issues (climate change, upholding democracy, etc.).
A deep dive
I’d be remiss if I didn’t direct you to this Kauffman Foundation report, Access to Capital for Entrepreneurs: Removing Barriers. It was a big inspiration for this post and the best resource for a capital access deep dive. It will walk you through the barriers, types of capital, the role of capital in a business’s success, and most importantly, efforts to help entrepreneurs access it.
Someone you should know about
You should know about Vanessa Roanhorse! Vanessa is the CEO of Roanhorse Consulting, an indigenous women-led think tank, and co-founder of Native Women Lead, an organization supporting native women in positions of leadership and business. She is an all-around expert in leading wealth-building efforts that directly invest in indigenous leaders with people at the center. This past year, her team led COVID relief efforts for indigenous-led small businesses, shifting their lending program to integrate PPP advising, PPE, and all kinds of pandemic support. Their high-touch relationships with businesses and advocacy efforts are informing the field of what works best to support indigenous communities. Gathering up all of Vanessa’s work would merit another full post, so just go ahead and follow her on Twitter and support whatever she is cooking up.
until next time,
-Caitlin