Capital Ventures.

Gaining access to existing sources of financing remains a priority for black-owned firms

CAPITAL. IF YOU'RE AN ENTREPRENEUR, THE EQUATION IS actually rather simple ... not at all in the same league with E=[mc.sup.2]. If you have it, you're in the game. If you have lots of it, you're a bona fide player.

It may be the new millennium and yes everyone around you is hyped over technology and the vaunted New Economy. One look at the growth and diversity of black-owned businesses provides proof that there is more than a bit of truth behind the hype: black-owned technology companies are growing in size and number; Old Economy businesses are using new technology products and services to increase productivity and profitability; and a hyper-focus on product and service innovation is the order of the day.

But the Old and New Economies do have one thing in common: both require access to capital in order to compete and exploit opportunities in the global marketplace. In fact, the cost of technology and labor has increased black business' demand for capital from both debt and equity sources. In real world economics 101, it still comes down to dollar bills.

The issue of capital--why others have it and why you (at least statistically speaking) don't--was the subject of the most recent BLACK-ENTERPRISE Board of Economists meeting held in New York. Present at the meeting were BE President and COO Earl G. Graves Jr.; Thomas D. Boston, an economics professor at the Georgia Institute of Technology in Atlanta; Andrew Brimmer, president of Washington D.C.-based Brimmer & Co.; Margaret Simms, vice president for research at the Joint Center for Political and Economic Studies in Washington, D.C.; Cecilia A. Conrad, associate professor of economics at Pomona College in Claremont, California; Gerald D. Jaynes, economics and African American studies professor at Yale University in New Haven, Connecticut; Darrell Williams, professor of economics at UCLA and a partner with Economic Analysis, a litigation-support consulting group, and William E. Spriggs, director of research for public policy for the National Urban League.

Also present at the discussion was Anita Cooke-Wells, the director of the Office of Capital Access at the U.S. Commerce Department's Minority Business Development Agency (MBDA). Through its minority business development centers, the MBDA assists start-ups and existing businesses in obtaining financing for their firms. Cooke-Wells is directly responsible for developing and administering programs to increase access to debt and equity capital for minority businesses.

Cooke-Wells recently worked in conjunction with the Milken Institute, a private, nonprofit research organization studying American economic growth, to produce the report, "Mainstreaming Minority Business: Financing Domestic Emerging Markets." Published in 1998, the report examines the capital access needs of minority-owned businesses and determined the following:

The market size of minority-owned business is approximately two million firms with total sales of $205 billion. From 1987 through 1992, the number of minority firms grew at double the rate of all U.S. firms, which was 4.7%. By comparison, black-owned firms are increasing at a rate of about 8%; with Hispanic firms at about 13% and Asian-owned firms at about 10%.

Add to the implications of the growth in the number and total sales of minority businesses the fact that the Milken Institute relies on figures from the Small Business Administration (SBA) Office. These figures do not account for minority-owned Sub-chapter C corporations, which tend to be larger than those businesses using other forms of incorporation, such as Subchapter S corporation, general partnership or sole proprietorship. Thus, the capital demands of black businesses may be even greater than suggested by the figures used in the Milken Institute report.

According to the report, minority businesses--despite record growth--remain underserved by the capital markets, because of "a lack of credit information and resulting perceptions of minority businesses as small, unprofitable and unfavorably located; minority firms' overdependence on bank lending due to low levels of net worth and net financial assets among minority entrepreneurs and a lack of access to alternative forms of finance; government policies that have focused on bank lending, while increased regulation, capital restrictions and consolidations have made commercial bank lending to small businesses less attractive; and SBA financing roles that have constrained equity financing in small minority businesses and that have focused on policy on the least profitable industry sectors and firm sizes."

In order to increase the total supply of capital accessible to minority businesses, lending markets should shift the emphasis from early-stage financing of these companies to equity investing. The report makes a number of proposals, including: promoting the use of the Community Reinvestment Act (CRA) of 1977 to encourage large bank lenders to provide capital to private funds that are focused on minority entrepreneurs, revising the rules governing tax policies and capitalization guidelines for the SBA's Small Business Investment Companies (SBIC) program and establishing industry-wide efficiencies in the small-business lending market through the development of standardized credit scoring, loan documentation and borrower education. (To read a complete executive summary of the Milken Institute's report, go to www.milkeninst.org/mod22/exec_summary .html.) In terms of the demographic trends, Cooke-Wells believes that 90% of overall business growth is going to emanate from the minority business community, with a significant percentage of that growth coming from young minorities.

"It's going to change the buying power of minorities in this country, and that is going to create inroads [for minority businesses] into markets that they are already aware of and knowledgeable about and that will be growing in importance to the overall economy," she says. "As minority businesses continue to grow at a much faster rate than the overall business community, it's going to provide a lot of demand for capital."

Access to capital for black-owned businesses is also a key element of the BLACK ENTERPRISE Black Wealth Initiative and its Declaration of Financial Empowerment. DOFE principle No. 8 mandates a commitment to building wealth for the creation and growth of profitable, competitive black-owned companies.

According to reports presented by Brimmer on the economic outlook for African Americans in 2000, "their relative employment and income position [will improve] somewhat. In step with these improvements, the job and income deficits they face will narrow moderately."

According to the reports, in 1999, African Americans accounted for 11.74% of the civilian labor force and 11.28% of total employment, for a job deficit of 3.8% (where the share of African Americans' total employment equaled their share of the civilian labor force). This is an improvement over the 4.6% job deficit of 1998. While black unemployment averaged a record low 8% in 1999, it remained just under twice the average for the country.

African Americans have also improved their relative income position over the last several years, Brimmer observes.

In 1998, blacks had $454.3 billion of money income or 8.30% of the total (estimated at $5,467.5 billion). This is an increase from 8.07% in 1997 and 8.26% in 1996.

The growth in employment in 1999 is estimated to have raised total money income to $5,788.7 billion, with blacks receiving an estimated $490.3 billion or 8.47% of the total. However, according to Brimmer, parity income for blacks (11.74% of the total) would have been $679.6 billion or $189 billion more than they probably received, for an estimated income deficit of 27.9%.

In 2000, Brimmer states that total money income in the U.S. may rise to $6,123.6 billion, with African Americans receiving $522.4 billion or 8.53% of the total. However, parity income for blacks (at 11.82% of the total) would amount to $723.8 billion for a deficit of $201.4 billion or 27.8%.

Closing this income gap, and in somewhat direct correlation, the black wealth gap, will be a critical objective for creating greater pools of venture financing for African American-owned businesses.

SHOW ME THE MONEY

COOKE-WELLS: Capital access is the largest problem for the development of minority businesses. We needed to get some assessment of what the capital demand was. What were the kind of strategies that could be followed to increase capital flows to the minority business community? In the interest of doing that, we pulled together a task force, in November of 1998, in conjunction with the Milken Institute to quantify what the market was and to really look at some of the innovative strategies that could be used to increase capital flow.

Particularly, from the perspective of the MBDA, we're interested in trying to get a sense of what is going on with some of the larger firms, because these are the firms that have the greatest economic impact. We're looking at firms with sales over a million dollars. We've got about 3,000 African American firms; 9,000 Hispanic firms; 12,000 Asian American firms. That's 24,000 firms, generating $106 billion in total sales, but the sales figure is about half of the overall sales of minority businesses. Obviously, it's these larger firms that have an enormous economic impact.

We also wanted to look at what equity sources were currently out there and Fairview Capital Partners [a black venture capital firm] estimates that there is about $2 billion in private equity focused on minority business enterprises (MBEs), through a variety of different venture capital vehicles. However, the estimates [indicate] that only 1% to 2% of MBEs obtain equity through these types of sources.

Then we went to the SBICs program and the Specialized Small Business Investment Companies (SSBICs) program to try to get a sense of how equity was being placed in minority businesses through that program. We found that $4.2 billion was invested through the SBIC and this includes both SSBICs and SBICs. But of that, $4.09 billion went to majority firms and only $128 million, which was 3% went to minority firms.

GRAVES: You say that the SBIC put out $4.2 billion and only $128 million of it went to minority businesses. I'm not so sure I understand the purpose and focus of SBIC. If its focus is to lend money to small businesses, I find it hard to believe that they were only able to find $128 million worth of "qualified or worthy companies" to put money into. One business can get $128 million, much less all minority businesses, in total. Is there an explanation of the vast inequity that you have in SBIC loans, where very little of it actually finds its way into minority businesses?

COOKE-WELLS: What we are told by venture capital companies is that they don't know the networks into the minority community. They will tell you that they don't know the minority businesses and that minority businesses don't know them. Also, what you hear is that for every company that gets funded, 100 applications for funding are turned down. So, whether people are coming in with the right types of proposals and business plans to obtain the financing is another issue and something that we need to look at as well. That's the official explanation on why it is that the funding levels [for minority businesses] are so low.

CONRAD: The part that strikes me as incredible is this notion that `we don't know this market' or `we can't tap into this market,' as if this market is someplace in another country. Many of these businesses are already mainstream businesses of the type that these banks are probably lending money to. It's hard to believe that if you want to make loans and you can make profitable loans, that you don't go out and seek the information.

GRAVES: And when you say they come in unprepared, I'm not in that camp. I think that you have a New Economy of businesses now, of African American and Hispanic entrepreneurs who are better educated and who clearly understand what they want, and they should be given [the same] opportunities [as] their counterparts. The problem is that if one minority loan fails, then the entire minority community [is painted] as a failure. However, 99 white applicants could fail but they don't paint the entire [white] community as failures.

WILLIAMS: The question is what exactly are the incentives of the lenders? Because if they can put a lot of their money in Treasuries, for example, and get a risk-free return on them that exceeds whatever the cost of the capital is, they just collect free money. They really don't want to lend the money, because they don't want to incur the risk. Is that a real incentive problem?

WILLIAMS: Moral persuasion won't help, if they don't have the incentive to do it. You are not going to talk them into doing something that is not in their interests, if their incentives are structured another way. If it's a regulatory problem, you have to change the incentive structure.

SIMMS: It seems there are missing parts of this information picture. One would seem to be what lenders know about good investment possibilities in the minority-business community. Another may be [that] minority businesses lack information on how to tap into some of these markets. We know that lenders don't seem to have comfort with minority businesses, in terms of the prospects that loans will be repaid.

COOKE-WELLS: It's not specifically that they have concerns about credit history or loan repayment. It's that they are not focusing their marketing efforts, to any significant degree, on this market because they don't understand the market. They generally tell us that they don't know a lot about the community.

JAYNES: Some of these points that the lenders are giving are inconsistent with what we are hearing about the growth trends. [The report states that] minority businesses are growing, the new minority-business entrepreneur is younger, highly educated [and] more in hi-tech business services.

SIMMS: More looking like regular businesses.

JAYNES: I think what is really going on here is trying to understand why the institutions and processes that are available now aren't doing a better job.

GRAVES: It's a little bit like the old saying, `I would love to hire some minority folk; I just don't know where to find them.' That is really an excuse. It's the same thing as saying, well we don't have the ability to get out in the community and understand. The first thing, hire some minority bankers to be the lending officers for your institution. Of course they don't understand because they're not in the community. You can't have only-white loan officers dealing with people of color as a clientele and say they don't understand the marketplace.

BRIMMER: If the issue is lending, reflect on how it is done in bank lending. The banks don't sit and wait for potential borrowers to show up. The principle marketing approach in commercial banking and lending is a calling officer who actually goes out and identifies prospective borrowers, shops the services and goes out to recruit borrowers. They literally recruit borrowers. From the point of view of the bank lending to minorities, they need to have more calling officers who go out into these minority communities and look for opportunities to lend.

BOSTON: The point is we are convinced because we know. We are in that market every day and when they are skeptical about it, we kind of laugh and say well, you're crazy or you don't really know what is going on. But we're there everyday so we see it and we know it. The people who are not, I think that's part of the problem. That's not the whole problem, but a part of the problem is that they are just not convinced that this market is growing as rapidly as it is growing. And we must continue to hammer and hammer this point out until our point is heard loud and clear.