Race Matters in Funding Small Businesses

"... disparities at startup follow through the operational life of the firm, and they’re not disappearing.” Photograph by John Fedele/Getty Images

Black and Hispanic entrepreneurs start their businesses with less money than whites. Minority businesses rely more on the owner’s personal wealth than on outside lenders or investors. These companies are less likely to apply for bank loans for fear of getting turned down. When they do seek credit, black and Hispanic business owners are less likely to be approved than whites, even after controlling for characteristics like credit score or the type of business. The differences persist for years after companies are founded.

These findings, from a new research paper commissioned by the Small Business Administration’s Office of Advocacy, add to the growing body of evidence that the playing field for entrepreneurs is tilted depending on the color of their skin. “These disparities at startup follow through the operational life of the firm, and they’re not disappearing,” says author Alicia Robb, senior fellow at the Kauffman Foundation. Robb used data from the Kauffman Firm Survey, which followed about 5,000 companies started in 2004 over several years.

The difference begins with America’s wide gap in wealth between whites and Asians on one side and blacks and Hispanics on the other. The median net worth in black households in the U.S. was less than $9,000, compared with $114,000 for whites, in 2004, the year the firms in the survey were started. That gap has widened since the recession.

Despite starting with less wealth on average, black and Hispanic entrepreneurs rely more on their own money to start their businesses: On average owners and company insiders put up 56 percent of initial capital, with external debt and equity making up the rest. At white-owned businesses, which started with double the capital on average, internal funds made up only 39 percent. (These figures don’t account for differences such as credit score and type of business, which might account for some of the disparity.)

Even after controlling for credit score and type of business, however, Robb found that minority entrepreneurs were more likely than whites to avoid applying for loans because they feared they’d be turned down. This was significant in every year Robb studied, and her paper calls it “perhaps the clearest recent evidence of continued borrowing constraints for black and Hispanic business owners in the United States.”

The fear is justified. Blacks and Hispanics were less likely to have loans approved, even after controlling for credit score and other factors, a disparity that got worse through the financial crisis, Robb found.

It’s not direct evidence of bias (whether deliberate or not) in the financial system, and Robb is careful to note that there are always factors or variables which surveys can’t properly measure. But if the results are right, all else being equal, a white entrepreneur is more likely to get a loan than a black or Hispanic entrepreneur.

Robb also looked at how gender played a role. Like minorities, women entrepreneurs were more likely to be discouraged from borrowing for fear of rejection than men. When they did seek credit, loan applications were generally approved at similar rates as men, except in 2008.

It’s worth remembering that all the data about disparities in funding measure only the companies in business. Researchers call that survivorship bias. The survey doesn’t count the firms that shuttered when they couldn’t get a credit line, or the would-be entrepreneurs who never started companies because they didn’t have and couldn’t get the needed money. The companies in the survey “are actually relatively more successful than firms on average,” Robb says. Counting business failures, she says, “the downside can actually be worse and [it can be] the reason for why other businesses actually close.”