The Small Business Administration recently announced two new programs that will increase lending to businesses in disadvantaged areas and to those headed by minorities and women. Beginning in mid-March, Small Business Advantage and Community Advantage will allow mission-based financial institutions to issue SBA-guaranteed loans of up to $250,000. "These new 'Advantage' initiatives are aimed directly at getting more loans into these markets so these small business owners can get the capital they need …," SBA Administrator Karen Mills explained in a press release. While I agree with Mills that a lack of capital deters many minority business owners from starting businesses, I don't think further loan programs are the answer.
Far fewer blacks and Hispanics start businesses than whites, with combined incorporated and unincorporated self-employment rates at 11.6 percent for whites, vs. a mere 6 percent for blacks and 8 percent for Hispanics, according to analysis by Steve Hipple of the Bureau of Labor Statistics. Explanations for this gap include differences in interest in entrepreneurship, family background, and work experience, but I agree with the many economists who believe that the low net worth of minority households is one of the primary culprits. (The median net worth of minority households is $28,000, vs. $170,000 for white households, according to the most recent Federal Reserve Survey of Consumer Finances.) Here's where I differ from my peers: I say the solution to improving startup rates lies in improved access to equity investment—not debt.
Lending money to minority entrepreneurs to make up for the lack of capital they have to invest in their own businesses is problematic. Debt requires a borrower to pay a fixed rate of interest. In their early years, startups often lack the consistent cash flow necessary to cover interest payments. As a result, the substitution of loans for founder's equity makes startups vulnerable to failure.
Few Entrepreneurs Get SBA Loans
Besides, the lending programs that the government can influence—such as the Small Business Administration's 7(a) loan program—provide capital to too few entrepreneurs to even dent the gap in startup rates. (Less than 1 percent of small business owners receive financing through this program, for example.) Even if the new programs were wildly successful, the share of small businesses receiving loans through government programs would not exceed a couple percent of the total.
To address the substantial portion of the gap in entrepreneurship between minorities and whites that stems from differences in wealth, we need mechanisms that increase the amount of equity capital available to minority would-be entrepreneurs. Short of eliminating the wealth gap itself—a huge policy issue in its own right—the answer lies in providing a source of equity investment to potential entrepreneurs with low net worth.
Co-investment by churches, community groups, and groups of informal investors is one answer. Ironically, such entities can easily lend money to small business owners, both directly and through peer-to-peer lenders. However, these potential sources of capital quickly run up against securities laws when they seek to make equity investments in the same companies. Policymakers ought to find a way to deal with this asymmetry.