Closing the African-American Startup Gap (Opinion)
Many African-Americans want to run their own businesses. Some surveys show that African-Americans are more interested in running their own businesses than whites. African-Americans are more likely to initiate the new-business creation process than whites although they are less likely to have an up-and-running business a few years later, according to the Panel Study of Entrepreneurial Dynamics, a representative survey of the adult-age population housed at the University of Michigan.
Despite entrepreneurial tendencies, African-American small-business ownership lags that of whites. White men run their own incorporated businesses at more than twice the rate of African-American men, and white women do so at more than three times the rate of their African-American counterparts, analysis by Bureau of Labor Statistics economist Steve Hipple reveals.
Policy makers have historically relied on targeted minority-lending programs when seeking ways to close this gap, but these efforts have met with limited success. Now would-be entrepreneurs can take advantage of the new equity crowdfunding legislation to try a different and potentially better solution.
Let's take a closer look at the problem. Researchers, policy makers and social advocates point to differences in social networks, role models, education, and occupational choice as reasons that African-Americans are less likely to run their own businesses than whites.
While all of these factors no doubt matter, research by University of California at Santa Cruz economist Rob Fairlie shows that the most important factor is a difference in wealth. Because most entrepreneurs finance their businesses largely from their own savings and personal borrowing, net worth has a huge impact on whether would-be entrepreneurs can turn their new-business dreams into reality.
The typical African-American would-be entrepreneur is much poorer than the typical white one. Federal Reserve statistics show that the median African-American household had a net worth of only $15,500 in 2010, as compared to $130,600 for the typical white non-Hispanic household. Because the capital requirements to start a business are the same regardless of the would-be entrepreneur’s race, that nearly 13-fold difference in net worth means that a much smaller fraction of interested African-Americans have the money to start companies than interested whites.
Loan programs targeted at minorities haven’t eliminated this entrepreneurship gap between the races. Only a small fraction of people starting businesses get loans. Consequently, loan programs cannot address the shortage of capital facing the vast majority of American-American would-be entrepreneurs, who, like most would-be entrepreneurs, don’t have credit-worthy businesses and need to self-finance.
What's more, to get a loan, you have to have adequate collateral. Lenders can’t allow African-American entrepreneurs to put up only one-twelfth the collateral of white entrepreneurs. It follows then, that even in the presence of targeted loan programs, many African-American lack the net worth necessary to borrow.
Finally, few start-ups can handle debt. To meet scheduled interest payments, a business needs adequate and consistent cash flow, which only a fraction of businesses have in their early years. Accordingly, even when debt is available to minority entrepreneurs through targeted programs, few African-American entrepreneurs have the types of business to take advantage of it.
The new Jumpstart Our Business Startups (JOBS) Act offers an additional, and potentially better, solution to the net-worth gap that holds back African-American entrepreneurship. The law, which was enacted in April, permits equity crowdfunding. If churches, community groups and other organizations interested in enhancing entrepreneurship in the African-American community set up equity crowd-funding efforts, they could aggregate small amounts of money from many individuals to provide capital to would-be entrepreneurs blocked from starting companies by their own limited net worth.
Related: 3 Rules for Successful Crowdfunding
Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).