Although entrepreneurship is often touted as an arena of equal opportunity, there are major systemic barriers to realizing this ideal – one being access to capital. ICIC and LISC came together for an in-depth look at the small business financing industry and ways that business owners can use this knowledge to gain access to additional avenues of capital.

The landscape of small business owners in the United States does not reflect the demographic makeup of the nation. Although 12.6 percent of the U.S. population is Black, only 2.1 percent of small employer firms are Black-owned. Hispanic and Latino people are 16.9 percent of the population yet own only 5.6 percent of employer businesses. Additionally, women owned just 21 percent of small businesses in the US in 2021. In addition to being underrepresented among business owners, the financial situation of women and people of color who own businesses is often worse than average. In 2020, 77 percent of Black-owned firms and 79 percent of Asian-owned small businesses characterized their financial situation as “fair” or “poor,” compared to the national average of 57 percent.

Racial and gender inequality in entrepreneurship results in a large gap in revenue throughout the life cycle of a small business. Minority-owned businesses earn around $100,000 per year less than average in their first two years and this gap increases to around $700,000 per year after 11 to 15 years of operation (data based on 2014 estimates). This feeds back into the widening divide in asset ownership and wealth between communities of color and the rest of the nation. Working toward an equitable future in which entrepreneurship is a tool for building generational wealth will require working to repair exclusion systems in capital access and educating business owners about which forms of financing best suit their needs.

Download the full report to read the complete findings and recommendations.

Useful points about the finance industry for small business owners:

Banks

• Nationwide, local banks have been merging and consolidating into larger regional or national banks for the past 20 to 30 years. This has been a problem for local small businesses, which do better when the lending environment is responsive to their needs.
• Bank loans are relatively difficult to receive because of credit and collateral requirements but usually carry favorable interest rates. In 2019, small banks had around 78 percent borrower satisfaction and large banks had 67 percent borrower satisfaction.

Credit Unions

• Historically, credit unions have been devoted largely to residential mortgages and consumer loans. However, small business loans are making up an increasingly larger part of their lending.
• Credit unions consistently have borrower satisfaction around 80 percent, the highest of any major small business financing option.

Community Development Financial Institutions (CDFIs)

• Community Development Financial Institutions (CDFIs) are a class of smaller nonprofit lending and depository whose primary purpose is to promote the economic development of low- and moderate-income (LMI) areas.
• Banks, credit unions, loan funds, and venture capital funds all can qualify as CDFIs if they follow the federal conduct and reporting guidelines.
• The Community Reinvestment Act (CRA) has been an important regulatory and reporting tool for ensuring large financial institutions maintain a meaningful presence in communities with the most urgent financial needs. CRA data on quality of service, investments, and lending practices have helped organizations like the Greenlining Institute advocate for quality financial services in the U.S.’s most disinvested and vulnerable markets.

Minority Depository Institutions (MDIs)

• Minority Depository Institutions (MDIs) are a class of depository and lending organizations whose board of directors and served population are both more than half people of color.
• MDIs suffered the worst of the 2008 financial crisis, in part because BIPOC consumers and borrowers were disproportionately affected by the financial collapse, especially surrounding residential mortgages. Black- and multiracial-owned MDIs have dwindled since 2001.
• When MDIs merge, they usually consolidate their holdings into other MDIs.

Finance Companies

• Finance companies are a loose category of companies that provide loans on less stringent terms than traditional lenders. This group is primarily made up of credit card companies, equipment leasing companies, and insurance companies.
• Finance companies provide supply-chain finance, a form of lending for business-to-business exchanges that helps make up for short-term lack of capital.
• Small businesses increasingly use finance companies to meet short-term operating demands. Auto or equipment rental is becoming the most common application.

Fintech

• Short for “financial technology,” fintech includes any financing options that integrate digital technology into soliciting or distributing capital.
• Most fintechs fall into one of three categories: online balance sheet lenders (which usually fill short-term loans at high cost to the borrower), peer-to-peer lenders (which include all crowdfunding-type platforms), and lender-agnostic marketplaces (which group different financing options onto one platform for consumer comparison).
• Fintechs offer loans with loose credit requirements and short loan turnaround times but often have unreasonable repayment terms and do not provide counseling to borrowers.
• Online lenders have the lowest borrower satisfaction rates in the small business finance industry.

Small Business Administration (SBA) Products

• The SBA does not grant loans but rather insures loans distributed by its network of partner institutions, such as Small Business Development Centers (SBDCs), Women’s Business Centers (WBCs), and local community organizations.
• The Microloan program is designed for small, short-term infusions of working capital (funds available for renting equipment, buying inventory, payroll, and other everyday operating costs).
• 7(a) loans account for the greatest volume of SBA-backed lending and are geared toward helping middle-aged businesses with needs for working capital or modest expansion.
• 504 loans are larger, long-term loans designed primarily for helping well-established businesses with expansion.

Equity Finance

• As opposed to debt finance, where funds are loaned and repaid with interest over time, equity finance involves investment in exchange for some ownership share in the company.
• Venture capital is a kind of private equity investment that focuses on financing startups and small businesses with high growth potential, usually ones that offer a novel technology or innovation. Providers of venture capital may work individually or in venture capital firms. Individual venture capitalists are called angel investors.
• Community Development Venture Capital (CDVC) offers a more accessible, mission-driven form of equity capital, especially for businesses in underinvested areas or with owners from historically disadvantaged backgrounds. However, CDVC remains a relatively small market.