6.15.2023 - By Steve Hall, LISC Vice President of Economic Development. Also read the article at LISC Stories.
This week, I’ve been thinking about Juneteenth from the perspective of small business owners—particularly Black small business owners—and about the promise yet to be realized and the opportunities waiting to be built.
It is clear from years of data that conventional approaches to small business lending limit the prospects for many entrepreneurs of color. As a result, those owners aren’t able to access the capital they need to build, hire and grow.
What has been less obvious is what to do about it. Even as many financial institutions work to remedy historical discrimination, unconscious bias has remained a persistent drag on progress. It is a systemic thread in many aspects of marketing and underwriting, running through policies that may not be overtly tied to race or ethnicity but that nonetheless end up disadvantaging Black and Brown business owners.
To take on those challenges, lenders should take a lesson from programs and organizations that have successfully addressed these gaps. Particularly now, as economic conditions push the cost of capital beyond what many small business owners can afford, it is important for lenders to think creatively about what really constitutes risk and how it connects to diverse owners, enterprises and communities.
At LISC, we recently took a step back to evaluate some of the learnings from our Entrepreneurs of Color Fund, a program launched by JPMorgan Chase in 2015 that now includes partnerships with 24 community development financial institutions (CDFIs) and several technical assistance providers working in 10 cities. With them, we have helped direct capital to more than 4,000 businesses led by people of color, offering products and approaches that are specifically designed to break down racial barriers—especially for borrowers operating in low- and moderate-income communities.
Our lending support has three primary goals: to help owners expand their access to markets; to help them build their assets, workforce and financial track records; and to activate commercial corridors to expand economic opportunity more broadly. Importantly, our strategy is not just to fuel more loans but to also provide access to larger loans than might otherwise be possible for these owners. They need that capital to grow.
In all of this, being intentional about equity is critical. It is clearly possible to successfully implement equitable lending policies. But it requires a different way of thinking about the process and a willingness to step back from traditional notions about risk in order to identify new opportunities, both for lenders and for borrowers.
Key takeaways from EOCF’s experience:
Flexible, high-touch underwriting advances small business aims: Many of the conventional metrics related to underwriting work against inclusive finance goals. And experience demonstrates that those standards do not really relate to financial risk in the first place. Loans can be structured to mitigate a range of concerns related to repayment without requiring applicants to fit within narrow definitions, from capitalization and length of time in business-to-business location and personal history of the owner. There is also room for flexibility on other, often-prohibitive, requirements like high down payments and reserves for property purchases. These can be unrealistic for firms and communities that historically have had limited access to capital—and, just as importantly, based on the experience of CDFIs, they don’t necessarily connect to higher risk or lower financial performance.
Commercial real estate should be a priority: For small business owners, there is no substitute for property ownership. If a business can secure a real estate asset for its operations, it can avoid the risk of displacement that comes with renting—especially in gentrifying communities—while also positioning itself to access conventional debt in the future to promote long-term growth. Because real estate is a significant source of wealth-building for owners, EOCF and its lending partners have made more than 200 acquisition loans. We structure these loans so that they mitigate risk but do not automatically reject applicants based on traditional metrics, like low borrower equity or high loan-to-value ratios. Those measures do not necessarily connect to financial performance, but they do exclude historically underserved owners and, in the process, prevent valuable economic development strategies from moving forward.
M&A financing can address the “silver tsunami”: There are 11 million businesses whose owners are 55 and older. They need exit options that protect their employees and the communities where they operate, particularly in communities that are already facing economic headwinds. CDFIs are a natural fit for these transactions because they prioritize community-based ownership. Lenders can help new owners focus on buying assets versus just contracts, while at the same time helping retiring owners realize the wealth they’ve built over the years
Technical assistance is critical to “bankability”: In many communities of color, especially those that have long been working to recover from disinvestment, there is skepticism when dealing with lenders—even mission-driven CDFIs. One way to remedy those concerns is with technical assistance programs that help owners build their financial and management strategies to support success. In fact, business owners have told EOCF that technical assistance is nearly as important as capital to their ongoing efforts. Without it, entrepreneurs may not be loan-ready or able to effectively use the capital they receive.
Though EOCF has evolved to directly respond to deep gaps in racial equity, we have also found that more flexible lending strategies are better for the sector overall, offering a way to expand economic opportunity that has a strong ripple effect through communities.
We already know that Black and Latinx entrepreneurs are proficient at launching new enterprises, and we already know that they are well-represented among firms that grow organically. But they are underrepresented among firms with external financing, and that can cripple opportunities for growth. We can change that.
In communities across the country, CDFIs are demonstrating what works to support robust financing programs for underserved owners. Funders, investors and other financial institutions can learn from their experience as they look at their own footprints and build out their own strategies to support fair lending.