News & Update

Meaningful support of small businesses requires remedying capital flow at all levels

By Norris Williams, Assistant Director of Business Ownership and Santiago Carrillo, Assistant Director of Business Ownership at Living Cities

May 10th marks National Small Business Day – a time set aside to encourage consumers to spend their money with local business owners instead of big box stores. This simple message can be applied to the financial industry, urging us to look deeper at where capital is currently going and where intentional shifts in capital allocation decisions could spur growth for underserved businesses.

While supporting existing small businesses is important, in truth, many small businesses remain mere seeds in peoples’ dreams. The elusiveness of owning a business is real given the widely documented biases within the traditional financial services industry – with Black, Indigenous, Latine, Asian and People of Color (BIPOC) business owners routinely denied the necessary capital to grow and sustain businesses.

Racialized barriers to business ownership, and therefore to wealth, go beyond a discriminatory banker denying someone a loan based on the color of their skin. Most obstacles are discreetly and systemically built into the flow of capital – which is why we must interrogate every stage of funding existing and the obstacles potential BIPOC business owners face, and the opportunities we have to be part of their success.

One way that traditional financial institutions can play a role in increasing the strength and number of small businesses is by changing the risk assessment models they use for financial intermediaries who allocate capital to their proximate small business community.

Our organization, Living Cities, has spent years advocating for these “capital allocators” to deviate from traditional parameters for assessing risk, because we found that capital decision-makers have been taught to value, underwrite, and make recommendations about business applicants through a biased lens, resulting in BIPOC business owners being disproportionately rejected. To counter these rejections – which stemmed from issues like BIPOC founders often having less personal net worth or no wealthy “friends and family” network – we worked with capital allocators to come up with alternative strategies. They began asking questions like: “What’s a meaningful amount of your liquid net worth you can contribute?” and “What other structural means of mitigating risks can we explore?”

Credit: Photo from RDNE Stock Project

Through our work to make capital allocation practices more equitable, we found that financial institutions are more hesitant to distribute money to capital allocators who are run by people of color, and/or have a track record of supporting BIPOC business owners – organizations Living Cities has coined Community-Based Capital Allocators (CBCAs) – including Community Development Financial Institutions (CDFIs), Minority Depository Institutions (MDIs), Small Business Administration (SBA) microlenders and Certified Development Corporations.

In fact, one of the biggest barriers in getting more capital to these local CBCAs is the risk assessment tool financial institutions use to measure whether a CBCA is fit to on-deploy, variations of the five C’s of credit (character, capacity, capital, collateral, and conditions). The traditional makeup of this tool places undue burdens on CBCAs who must navigate racially-biased stereotypes to “prove” they will provide a social and/or financial return. Often, using these models allows financial institutions to feel justified in denying certain people capital or giving them a smaller share, without feeling obligated to take a second look.

While it will require intentional effort and practice, the solution mainly lies in shifting our mindset. If financial institutions apply the same standards to measure risk associated with CBCAs as they do with white-run allocators, then CBCAs can raise more capital and deploy more robust resources to business owners. In turn, these business owners have a greater chance at success and are seen as less risky by all financial institutions.

Opening more pathways in the flow of capital will have a ripple effect beyond individual BIPOC business owners having a better shot at success. Seeing neighbors, friends, and family members with thriving businesses will likely inspire more people to make their own entrepreneurial visions a reality – which, with more equitable resources available, will ultimately build wealth in BIPOC communities.

Further, with more self-sufficient economies and brick-and-mortar shops fulfilling neighborhoods’ needs, people would have more political power and therefore leverage to decide what their neighborhoods look like.

We must all do our part to address decades of racial harm by addressing barriers to capital imposed on local capital allocators, including by looking closer at who is being denied capital and why. As the saying goes – a rising tide lifts all boats. We just need to open the dam first.

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