barriers to capital

Spotlight

Innovators Face Challenges in Breaking Down Barriers to Capital for Underserved Entrepreneurs

Sarah Trent | June 2, 2017

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In just a few short years, MORTAR, a small business incubator in Cincinnati, has made impressive strides in helping longtime residents in fast-gentrifying neighborhoods start businesses and grow in tandem with their neighborhoods’ fortunes.

Since 2014, the incubator has expanded from its original location in Over-the-Rhine to include three other Cincinnati neighborhood programs as well as Brick, a 400-square-foot storefront for entrepreneurs to host popup shops. To date, 125 local residents, primarily women and African American entrepreneurs, have graduated from the 9-week course and gone on to create 141 local jobs (see photo above). MORTAR’s three founders have attracted high-profile allies and accolades in Cincinnati and beyond.

As the program has grown, MORTAR has recognized that access to startup capital is a major obstacle for the entrepreneurs it serves—most of whom, like the MORTAR founders themselves, come from communities that have faced systemic barriers to building the kind of personal wealth and family-and-friends capital needed to bootstrap a business. With few existing tools available to connect its entrepreneurs with financing, MORTAR set out to create its own.

Last November, it raised $200,000 through a crowdfunding campaign for its Iron Chest Fund, a loan fund to help its graduates grow their fledgling businesses. But like other innovative lenders trying to address critical funding gaps, MORTAR has found it can’t entirely escape the limitations of the conventional financial system.

“Cincinnati has been incredibly supportive of our work, but it has been challenging to find a partner with the capacity to service the type of loans we hope to deploy,” said Derrick Braziel, MORTAR co-founder and managing director.

MORTAR is one of a number of organizations across the country —including the Runway Project and Force for Good Fund—trying to create new tools both within and alongside a system that doesn’t serve under-resourced entrepreneurs,  especially people of color, very well. As they imagine and build tools that don’t exist yet, these innovators are running into roadblocks and trying to work around them as quickly possible to meet the urgent demand for what they offer: an opportunity to break the cycle of outright discrimination that prevents wealth building, self-determination and entrepreneurial success for more than a third of all Americans.

MORTAR Cofounders Derrick Braziel, Willian Thomas II and Allen Woods

“The traditional financial, philanthropic, and impact investing ecosystems are wholly deficient for supporting minority entrepreneurs,” says Rodney Foxworth, founder and CEO of Invested Impact, a Baltimore-based organization that works with a broad range of partners to fund and support social entrepreneurs of color.

“Efforts like MORTAR and The Runway Project are incredible,” he says. “They are herculean efforts that require substantive, long-term investment from philanthropy, government and impact investors to challenge the status quo.” Those partners, Foxworth says, should not shy away from supporting these innovators: research from Association for Enterprise Opportunity and Center for Global Policy Studies has shown that growing businesses founded by entrepreneurs of color will boost the U.S. economy and reduce the racial wealth gap.

“Deconstructing the racial wealth gap is among the greatest ‘impacts’ an investor or philanthropy can make,” says Foxworth.

The Need for New Models 

In Cincinnati, MORTAR has entrepreneurs ready to receive capital—and Braziel says they need it urgently. They are food makers, event planners, fashion designers, salon owners and others who need small loans to cover the costs of equipment, signage and other expenses to get their businesses off the ground.

MORTAR aims to provide loans of $10,000 to $50,000 that don’t have the traditional requirements of collateral or credit scores that would be an obstacle for these entrepreneurs. Instead, they’d like to rely on “social underwriting” – or community trust – combined with low interest, flexible terms and ongoing support from Mortar’s program staff to ensure each business has the wrap-around support it needs to meet its financial obligations.

Many traditional lending institutions, such as banks, just can’t make this type of loan within their existing business models, so partners have been hard to come by. As a result, MORTAR’s tiny team is doing everything they can to build the in-house capacity to make and service their first loan.

“We haven’t rewired the system yet. At every step, there’s something we have to out-think.” – Jessica Norwood

Banks, government programs and other conventional lenders have strict requirements to minimize the risk of a business borrower defaulting on a loan, such as minimum credit scores, extensive financial statements or collateral to secure the loan. Many small businesses struggle to meet these requirements, but few more so than entrepreneurs like those MORTAR supports.

Women and people of color typically have lower net worth than their male or white counterparts, and people of color in particular have faced decades of systemic discrimination leading to a well-documented, nationwide racial wealth gap. Entrepreneurship is a proven way to break that cycle—that is, if a business owner can access the capital required to start and grow their business.

Black households across the country average about one-tenth the median net worth of white households. In Cincinnati, the median income of black households is less than half (42%) that of white households.

So when the time comes to put up collateral for a small business loan, it just isn’t there.

New Approaches 

Alternative lenders like Kiva have helped address the challenges to funding small businesses in the U.S. The online platform crowdfunds small loans—typically $5,000 to $10,000—at zero percent interest to US-based micro-entrepreneurs.  To help vet borrowers, Kiva uses community partners and a “trust network” as a measure of creditworthiness, rather than relying on credit history or financial statements.

This trust network includes friends, family, and neighbors, as well as Kiva Trustees—partners like economic development centers and community-based organizations similar to MORTAR that publicly vouch for the business. (Kiva uses financial intermediaries to vet loans to micro-entrepreneurs in developing countries.)

Roughly 60% of Kiva’s domestic loans are to minority entrepreneurs, according to the company.

For all of its success, Kiva doesn’t address the root causes of the racial wealth gap. To be successful on a site like Kiva, an entrepreneur must have a broad social network of support that can afford to lend them capital at no return.  It also prevents a community from building wealth through investment.

A handful of nonprofits have created impact investment funds that at least in part serve under-resourced entrepreneurs. New to this scene is the Force for Good Fund, a crowdfunded investment fund and accelerator for B Corps, especially those run by women and people of color. The fund recently raised $400,000 through a crowdfunding offering using Title III of the Jobs Act, which allows anyone to invest, and is raising additional capital from accredited investors toward a $1 million goal.

Jenny Kassan, cofounder of the Force or Good Fund/Accelerator

To start, the Force for Good Fund aims to make investments in ten established, mission-driven businesses owned by women and people-of-color, filling a gap in the system to help these businesses grow beyond startup. Since the fund only plans to make ten investments at a time requiring annual rather than monthly payments, the loans can more easily be serviced in-house—avoiding a partnership obstacle—and each loan can be uniquely customized to fit the borrower’s needs.

Beyond the question of how to take this bespoke model to scale, which may become clear through their early pilot loans, Force for Good’s most notable hurdle, according to cofounder Jenny Kassan, has been policy and platform-related: the Jobs Act requires companies raising money to use an SEC-approved crowdfunding portal. Most portals charge a fee of 5% or more to issuers. WeFunder, which Force for Good used, charges 3%, but it also charges investors a 3% fee—a steep tariff when the fund itself is offering a 2.5% return.

Like other higher-risk lenders, Force for Good raised a loan-loss reserve from charitable sources to help make up any shortfalls or defaults.

Community Development Financial Institutions (CDFIs) are another type of alternative lender designed specifically to deliver various loan products to under-resourced people and communities. These institutions are recognized by the Treasury Department and are exempt from some of the strict regulations that stymie bank lending.

Many CDFIs do more than lend: they take a hands-on approach to nurturing their budding entrepreneurs. “Inherent in our work is that we do a lot of investing in the person themselves,” says Harold Pettigrew, executive director of the Washington Area Community Investment Fund (Wacif), which recently launched a startup accelerator.

The CDFI model relies heavily on low-interest loans from banks looking to fulfill their Community Reinvestment Act responsibilities as well as charitable grants to make the economics work. But although they have more flexibility than banks, in the end, CDFIs are still beholden to their own lenders, who expect an agreed-upon rate of return. Even if those returns are modest—say, 2% to 3%—the CDFI still must bake that return along with its own operational costs into the rates each small business pays on their loan.

In short, while many CDFIs are not profit-driven, they must still be profitable.

It’s a struggle that every lender faces, says Jessica Norwood, founder of The Runway Project. Without a diversity of capital available—including aggregated pools of investment capital and philanthropic dollars—CDFIs and others can’t fully addressing the needs of the market.

Building a New Kind of Runway

Norwood’s project offers an entirely new model—though she’s the first to admit that it’s built on the shoulders of many ideas and solutions that came before her, including the efforts of African-American churches, women’s clubs, and mutual aid societies that predate the Civil Rights movement and have long provided opportunities for African American communities to invest in themselves while they were shut out from public institutions.

Runway Project’s Jessica Norwood

This kind of grassroots capital—early money from friends, family and neighbors—is “the lynchpin to unlocking wealth distribution, equity, and agency,” says Norwood. And in a world where black communities don’t have that wealth in the first place, a broader solution is needed to fill the gap. Furthermore, she says, this capital must be part of a holistic ecosystem of support to ensure that the runway for a black business is free of potholes, the pilot prepared, the plane in working order, and the skies cleared for takeoff.

This means The Runway Project’s work is diverse – from building a national network of local partners and providers to creating brand new financial products and raising the philanthropic capital to provide an unprecedented 100 percent loan loss reserve fund so that entrepreneurs won’t need to provide collateral.

The network includes partners like Braziel and MORTAR in Cincinnati and Foxworth’s Invested Impact, which has raised $4.5 million toward a $5 million fund with Calvert Foundation (Ours to Own Baltimore) to invest in community and economic development in Baltimore.

The first product to come out of the Runway Project is a Certificate of Deposit (CDs) in partnership with Self Help Credit Union that are marketed to customers as specifically supporting black businesses in Oakland.

The tool itself is a riff on existing products in Self Help Credit Union’s portfolio, such as a CD supporting women and children. But in order for the credit union to make loans at the low rate the Runway Project wants, Norwood had to overcome a big obstacle: “Institutions have never loaned money to this group of people, and certainly not at this early stage,” she said.

Which is where the 100% loan loss reserve comes in: the figure is unprecedented in lending – 15% to 50% is more typical – and is a symptom of a broken system that discriminates against the circumstances black entrepreneurs are stuck in. It also means that she faces the challenge of raising typically slow-moving philanthropic dollars—to cover her operating costs and the loan loss reserve—at a rate that must match or beat the faster-moving investment capital that funds the loans themselves.

As difficult as it is, raising this large reserve fund allows Norwood to experiment within a relatively risk-averse financial system, and frees entrepreneurs from having to put up collateral on top of all the other hurdles they face.

Shifting the Culture

Building the financial instruments alone will not solve the challenges to getting capital to historically under-resourced entrepreneurs. What is required, Jessica says, is shifting the culture and approach of the whole system.

“I’m excited and proud of all our partners, Self Help included, who have been willing to try a new thing,” Norwood says. “But inherently difficult in all this is that we haven’t rewired the system yet. Even with best interests and figuring out ways to work within it, we still get tripped up by the system itself. At every step, there’s something we have to out-think.”

As the Runway pilot learns what kinds of returns and default rates actually occur with these kinds of early-stage investments supported by culturally appropriate wrap-around services, Norwood hopes that her program will help to influence the system itself to become more inclusive.

“Once we’ve started pushing the system more and more,” says Norwood, “we’ll be shaping it in the process.”

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