Capital Catch-up

Community lenders try to address the capital crunch faced by small businesses of color.

It was four years ago that Keba Konte’s plan to expand his coffee shop business in San Francisco started to materialize after he won a bid on what seemed like a sure-fire opportunity.

But shortly afterward, Konte, who is African-American, ran into an obstacle that blocks many entrepreneurs of color: a financing wall.

Konte was already making money at one location in the city when he received a nod to open an on-campus café at City College of San Francisco. It seemed a certain success: He’d now get to fan the aroma of his roasted java before the noses of some 90,000 students, not to mention a few thousand faculty members. Konte’s dream soon stalled, however, when he began looking for a $75,000 loan to help build and equip the new café. He approached Wells Fargo and sat down with a business banker there, but five minutes into the meeting, he was told it wasn’t worth his time to submit an application. A visit to a small community bank across the bay in Oakland was just as futile. Konte enlisted a small business development center which scouted down a community bank in Los Angeles that agreed to underwrite the loan. The catch was that he’d need to amass $100,000 in collateral. Konte’s own house was out of the question since the housing crash had pushed its mortgage underwater. At his wit’s end, Konte finally coaxed his mother to put up her house against the loan. “Mind you, this was a tremendous opportunity at below market risk, but the process was very frustrating—it was clear I was up against something,” he says.

Konte’s new café is up and running and has since branched off into a wholesale roasting business, Red Bay Coffee, yet his trials mirror a bigger crisis. A mountain of evidence shows that small business owners of color are just not afforded equal access to the financing they need to succeed, whether starting up or scaling up, as in Konte’s case.

Studies, in fact, show that both public and private efforts are coming up considerably short, especially when it comes to African-American and Latino entrepreneurs. According to a 2014 report released by the National Community Reinvestment Coalition, out of a total 44,300 small business loans made under the federally supported SBA 7a lending program, only 1,080 went to African-American businesses and 3,147 to Hispanic ones.

A 2014 Woodstock Institute Study that examined private bank lending in the Chicago metropolitan area between 2008 and 2012 found that “minority-owned enterprises” based in neighborhoods where people of color made up 80 percent of the population accounted for 8 percent of the businesses in those communities overall, yet received only 3.8 percent of loans issued in those areas. Stephen Cowan, the researcher who headed the project, estimates that just bringing the number up to proportion would have generated 34,800 more loans and some $1.5 billion in funding.

Borrowers and small business support organizations say there’s plenty of blame to dole out. Talk to community activists and the first culprit to come up in the conversation is the banking industry, which has historically redlined minority communities and businesses and been slow to change its ways. At the same time, there’s growing frustration that other initiatives intended to bring about change, such as community development financial institutions (or CDFIs), are making little headway. The thinking when CDFIs, which are usually nonprofit in structure, came into being in 1994 was that they would have enough flexibility to bridge the lending disparity gap by bringing capital to underserved markets at low rates and favorable terms.

And yet, there’s a sense that CDFIs as a group are coming up short when it comes to getting financing to small businesses owned by people of color. “Look at the loan portfolio of a typical CDFI,” says Jose Corona, CEO of Oakland small business advocacy group Inner City Advisors, “and it’s probably going to look very much like a mainstream bank’s in terms of diversity and inclusion.”

“The fact is that no one—the banking industry, government—is doing this well,” says Mark Pinsky, the CEO of Opportunity Finance Network, an industry organization that represents CDFIs. “We think more people recognize that CDFIs are doing a little better relatively speaking, but that overall the numbers aren’t good and it’s minority small business owners and their communities that are getting hurt.”

There’s one glaring problem that sits squarely in the path of CDFIs that want to make a difference: reaching entrepreneurs of color in the first place. CDFIs on the outside looking in need to gain entry into the communities, tap into local leadership, and make contact with business owners. Lenders often have to reach out to frustrated community leaders and business owners who’ve grown skeptical after being rejected time and again.

Once CDFI lenders manage to break through this first barrier, they’ve got to generate a roster of candidates. And at this stage, lenders frequently trip up on another flank of complications—the fact that many business owners of color, frequently still reeling from the 2008 Great Recession, are too strapped to offer up much in collateral. “People have to acknowledge that in the years leading up to the recession, and even afterwards, the African-American community was targeted by predatory lenders, and the impact of the fallout has been disproportionate,” says John Berdes, the CEO of Craft3, a Portland, Ore., CDFI. “There’s been a ripple effect … for many African-American entrepreneurs that has hit what they can offer in collateral and as a consequence any possibility to borrow.”

“There is a lot of evidence black entrepreneurs have stopped looking for credit, so part of the struggle is getting folks—small business owners—to the table,” says Berdes. “We’re finding that being at their table makes that job much easier.”

Lending from the Inside
Berdes says his organization knew it had to crack both of those barriers when it decided to take direct action to diversify its loan portfolio in 2012. For starters, Craft3 worked with local minority business support organizations in Portland and Seattle, the two major metropolitan areas in its region. Berdes explains that by partnering with groups such as the Tabor 100 in Seattle, Craft3 gained almost immediate credibility—and the trust—of minority business owners in the city. “We’ve found that the way you get capital on the street in by lending from within the community,” says Berdes. What’s more, Craft3 has relied on Tabor 100 to help screen entrepreneurs to find loan applicants that can benefit the most from the CDFI’s help.

Berdes says understanding better just what individual business owners have to offer has also helped his organization make key underwriting decisions on what risks are worth taking in the case of loan applicants with low credit scores or little collateral. As Berdes explains it, their process is a modification of conventional lending practices. “You don’t ignore credit history, but when you get to look from the inside, you can understand what an individual or company has gone through,” he says. “It’s then that you can substitute character for collateral and standing in the community for credit history.”

The effort has been successful to date: In 2012, Craft3 reported that it had extended $26 million to minority- and women-owned businesses, a 53 percent increase over 2008 numbers. In the first nine months of 2014, Craft3 had funded 19 minority-, women- and veteran-owned businesses, bringing its historical total to 298.

Training as More Than Pencil-Pushing
Small business owners of every ethnicity and hue learn a tough lesson early on: It’s one thing to perfect a product or service and quite another to run a successful business. New companies struggle to keep enough cash on hand to pay for overhead while they wait to collect on contracts. Running human resources and finding the right talent is another daunting responsibility that entrepreneurs have to learn on the fly.

On top of that, small business owners of color often aren’t immediately connected to a network of people—CPAs, lawyers, marketing brains, or human resource consultants—to tap for guidance. “In many cases, minority business owners are alone—they’re the first to start a business in their immediate circle or family,” says Bill Bynum, CEO of the Hope Credit Union in Jackson, Miss. Training programs offer up a way to level the playing field, says Bynum. They also make it possible for CDFIs to build a sense of community among minority entrepreneurs.

With that in mind, many CDFIs offer up some very basic training to at least expose some small business owners to the fundamentals—basic bookkeeping, record keeping, human resource management, and more. Alejo Velez, another Bay Area entrepreneur, finished a bachelor’s in business at the University of California–Berkeley before he started his mushroom-growing company, Back to the Roots. He says even with his diploma in hand he was in for a revelation when he started classes with Jose Corona’s Inner City Advisors. “We didn’t cover the type of cash flow regressions we did in business school, but got a more hands-on appreciation that cash is king, queen, and really everything to small businesses,” he says. ”We found out that the real world was in a lot of ways quite different from what we went over in college.”

The Black Business Investment Fund Florida (BBIF), a CDFI based in Orlando, Fla., set out with a mission to help African-American entrepreneurs when it started in 1988. In 2013, the organization reported that the previous year it had helped 40 client businesses and held an outstanding loan portfolio of $3 million. Additionally, by BBIF’s calculations, the organization provided 264 hours of training and helped nearly 3,700 small businesses.

BBIF CEO Inez Long links the organization’s successful track record in part to two things. The organization stresses strong connections with clients, particularly as a platform to build a broader community of business owners who share ideas. That close contact in turn has helped the organization come up with lending and financing ideas that fit the needs of the small businesses it serves.

BBIF’s training programs help improve communication. Marketing and development officer Jasmine Houston says the organization calls in client entrepreneurs for monthly meetings—not just as a way to collect payments, but to keep close tabs on how companies are faring and any new bumps or challenges they face. “Keeping in touch helps us help them succeed,” she says. “It mitigates our risks, too.”

BBFI’s Long says CDFIs that enter a community for the first time should opt to first work with stronger, more established companies. “Microlending tends to require more resources and taking on higher risk,” she says. “CDFIs that have never aggressively loaned to people of color will getter a better sense of a new community if they work with a business owner that has the basics and should already be working with banks but for whatever reason isn’t getting the capital they need. Over time, that makes for a stronger entry point that will make it possible to help weaker companies out in time.”

New Products
BBIF came up with a specialized loan product tailored to the business needs of contractors, which make up a big portion of the organization’s client base. Construction companies, electricians, and a host of other subcontractors often find themselves in a crunch trying to make payments on utilities, employee salaries, and other overhead when payments to them can lag completion of a job by 30, 45, or more days, says Long. BBIF listened, understood the challenge and started up its Contract Financing Loan Fund. Under one of the fund’s provisions, borrowers can secure their loan with a valid contract. “It helps us focus on what an applicant is doing and not their personal credit,” says Long, and therefore sidesteps any disparate impact that redlining and racially targeted predatory lending has had on credit scores.

Long recalls an African-American electrical engineer who had been working as a subcontractor for about a decade putting in electric systems in a number of commercial buildings that had gone up in Orlando. An opportunity opened to work on a performing arts center, but the engineer faced a cash flow pinch that had him thinking he might have to walk away. He had applied for $100,000 to $150,000 in loans from local banks, but had been turned away. Long says the engineer got in contact with a construction company owner who had worked with BBIF and partnered with that company to borrow $175,000 from BBIF. They were able to take on the job.

Inner City Advisors last year launched a funding affiliate called Fund Good Jobs (FGJ). The new venture was created with the help of grant money to aid companies that have worked through ICA to scale up by landing financing of $100,000 to $2 million, often through a combination of convertible notes and loans. “You could say we were funded out of necessity,” says Sean Daniel Murphy, president of FGJ. He says a lot of companies that had worked with ICA consultants were either too large for microlending or too small to garner interest from mainstream lenders. According to Murphy, the companies that fit the profile are well established and typically looking to grow with a capital infusion between $250,000 and $2 million.

Alejo Velez and his company Back to the Roots are members of FGJ’s inaugural class. Velez got started growing mushrooms and selling 100 pounds a week at East Bay farmers’ markets. In time, he developed a home mushroom-growing kit and later a self-cleaning fish tank which was ready for rollout last year. The new product, however, came with its own set of headaches, namely a cash crunch when a $500,000 purchase order came in from pet products retailer Petco. Velez had been working with ICA since 2010 and through the connection began discussions with Murphy to hammer out a solution. Fund Good Jobs came up with a $150,000 convertible note to make it possible to fulfill the order.

Meanwhile coffee entrepreneur Konte started talks with Fund Good Jobs to start rolling out a wholesale coffee business, including a dispensable brand of iced coffee that he’s contracted to sell to a number of big corporate headquarters in the Bay Area.

The Bigger Picture
While these and other solutions to funding disparity offer hope, the question now is how to unite them in a bigger effort, and what path private and public lenders can take to build on local successes.

“We’re talking about a systemic issue that has a long history,” says ICA’s Corona. “And many efforts are small, in a sense throwing crumbs at a population that is capable of doing so much more. The solution is going to take leadership, intentionality, and policy at the federal level in order to hold CDFIs accountable.”

“There are a lot of historical impediments that aren’t getting better, but a good first step is to admit there is a problem,” says OFN CEO Pinsky. “Change isn’t going to come overnight, but we’ve got to come up with a different approach and find reasons to say ‘Yes.’”

The bottom line is that a swelling, underserved segment of the economy is ready and raring for an opportunity to start, grow, or expand. CDFI success, in fact, could unleash a groundswell. “Even though our focus now is solely on Florida,” says BBIF’s Houston, “the word on our mission has gotten out to the point that we received calls from business owners in New York and California who wanted to know if we could take loan applications.”

This article was made possible by a grant from the Surdna Foundation to support increased economic development coverage.

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