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Financing Minority Business Growth
May 01, 1999
Publisher: Controller's Quarterly

Controller's Quarterly

i? 1/2 Minority-owned businesses have grown explosively over the past 10 years' Nearly 25,000 firms have sales of more than $1 million. Nearly one third of these firms, (over 7,000) are located in California.i? 1/2

Minority-owned businesses have grown explosively over the past 10 years. In fact, they are growing at double the rate of all firms in the U.S. economy, both in numbers of new firms and total sales. Recent estimates place the number of minorityowned firms at nearly two million. Of these, nearly 25,000 firms have sales of more than $1 million. Nearly one-third of these firms, (over 7,000) are located in California.

In California, it is becoming quaint to refer to these as minority businesses (owned and/ or led by Asian-, African-, or Native-Americans) since they are rapidly becoming the major source of new business formation in this dynamic economy. Skill-intensive areas such as finance, insurance, real estate, and business services are the fastest growing kind of minority- owned enterprises.

Entrepreneurial business growth has proved to be the most successful avenue for wealth accumulation for lowerand middle-income groups. A growing pool of educated and managerial experienced minorities entered the labor force due to increased college attendance since the late 1960s. This pool of talent has reached an age cohort of 35-50, when entrepreneurial potential is at its peak.

Minority groups represent 26.1% of the population but own only 11.6% of the nation's businesses. This 11.6% share receives only 6.2% of total sales. Demographic projections show that by 2010 all minorities will represent one-third of the population. By 2050, the total minority share is projected to rise to almost 50% of the population.

Minority firms are more likely to employ minority workers and thus provide an important entry point into the labor market for these workers. Sustaining economic growth requires more financial and management support for these new markets. Despite high aggregate growth rates since the 1990-91 recession, income and wealth polarization patterns continue to be unmitigated. For the U.S. and its fuel pump of economic growth i? 1/2 the dynamic California economy i? 1/2 to maintain overall competitiveness and sustain lasting prosperity, economic participation must be broadened. Given current population trends, minority businesses and minority communities cannot continue to be marginalized.

Capital access is a prerequisite for increased participation in the mainstream economy. Minority businesses are underserved. New research on bank lending in the small business credit market sheds additional light on the business-financing environment that minority entrepreneurs face. Minority businesses are significantly more likely to be denied bank credit and, when successful, receive smaller loans relative to comparable non-minority businesses. Recent research contrasts business lending with mortgage lending in the black community. The unexplained gap between rates of denied loans for blacks and whites is 3.5 times greater for blacks in the small business credit market compared with the mortgage market. The difference can be attributed to the existence of special programs and regulatory incentives that encourage banks to increase mortgage lending in the minority communities and also to the well-developed secondary market for mortgage loans. In other words, pooling loans and then reselling them in the secondary market appears to reduce the likelihood of racial discrimination in credit lending. Due to the anonymity of markets, they appear to be more color-blind than institutional sources of capital over time.

Small business investment financing is very dependent on paid-in equity capital, borrowers' credit histories, and heavily collateralized bank financing. Minorities have significantly lower net worth and liquid financial assets. Thus, minorityowned firms are overly dependent on commercial bank credit and receive smaller and fewer loans. Existing minority financing programs focus largely on commercial bank lending. Yet small businesses require equity financing. Of the total amount of equity capital invested in the U.S., minority businesses receive 1% to 2%. New and existing minority firms are thirsting for capital resources.

The capital market gap in the minority business sector is largely due to financial structural factors that impede the flow of funds to both equity and debt capital. Equity-linked debt instruments are specifically lacking in the capital structure of these businesses. This situation presents an opportunity to carve a channel from growing capital markets to emerging domestic businesses by designing and developing innovative financial instruments and policy mechanisms.

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Glenn Yago is Director of Capital Studies for the Milken Institute.