Small-business lending has a diversity problem

It is disturbing how easy it is to prove the large gap between lending capital available to male and/or white-small business owners and the capital available to women and minority small-business owners.

A 2016 study by Biz2Credit, an online marketplace for small-business funding, showed that female-owned businesses receive loan approvals 33% less often than male-owned businesses. There’s an even greater bias against minority-owned companies. Minority-owned firms are less likely to receive loans than nonminority firms and, in fact, are more likely not to apply for loans due to rejection fears, according to findings from the U.S. Department of Commerce Minority Business Development Agency. If they do get loans, minority-owned firms are more likely to receive lower loan amounts than nonminority firms and pay higher interest rates on business loans.

Faced with irrefutable evidence of lending and investment bias in the marketplace, the Small Business Administration embarked on an initiative last year to better understand the basis of the problem. The SBA’s research, in conjunction with the Library of Congress and economists at Pepperdine Graziadio School of Business and Management and Duke University’s Fuqua School of Business, found that the racial and gender makeup of investment boards directly impacts the investment decisions those boards make – especially with regard to race and gender of loan and investment recipients. In other words, we found diverse investment boards are more likely to invest in diverse companies.

Importantly, the SBA research also found that the problem of investing equality is likely to be even more pronounced in private equity, as the venture capital industry has not kept pace with investing in people of diverse backgrounds. A 2016 report in TechCrunch on active venture and microventure firms found that about 8% of investing partners are women, and about 7% of partners in the top 100 firms are women. The National Venture Capital Association reports that 87% of venture capitalists are Caucasian, while 89% are male.

Furthermore, a Future List analysis of ethnic and gender diversity among senior ranks at venture capital firms reports that firms have become “a little more diverse in the past 12 months while many all-white-male firms stayed that way.” Clearly, one of the root problems of investing disparities is lack of diversity among those who make investment decisions.

The takeaway could not be clearer: Lenders and capital providers need to recruit more women and minorities into investment decision-making positions to get more small-business loans to women and minorities.

Without access to small loans, women and minority business owners are at a competitive disadvantage. They must rely on personal savings, loans from friends, crowdsourcing and credit cards – when those options are available. Or, they have to seek capital from riskier lenders, increasing debt burdens and diverting funds from business operations.

These barriers are especially prohibitive for the next generation of entrepreneurs. An estimated 54% of millennials desire to start their own businesses, and interest among young people of color is about 10% higher. Yet many of these individuals already carry high debt, often due to student loans. When business loans are declined, these entrepreneurs are less likely to succeed in their endeavors. In turn, both they and their local communities are denied the economic and social benefits of a successful operation.

While lending parity can’t be achieved overnight, there are three immediate steps to encourage lending institutions to recruit more minority and women decision-makers and encourage policies that aid women and minority borrowers:

Increase SBIC management diversity

The SBA should encourage investors who participate in Small Business Investment Corp. programs to practice greater inclusiveness on their boards. Additionally, the SBA should consider creating policies to streamline participation for women- and minority-owned businesses, including greater involvement by community banks. Community banks, after all, are more likely to reflect the racial composition of their communities.

Embrace transparency

Lenders in the private sector should be required to participate in public reporting initiatives that promote greater transparency about the gender and racial makeup of decision-makers in the financial services industry. In the spirit of transparency, borrowers should also be entitled to know every step in the loan process, time horizons and full disclosures.

Incentivize lenders

Those who seek to transform access to lending, such as small-business owners and associations representing the interests of women and minorities, should promote scorecards on employment and lending practices to women and small businesses. This approach would give lenders incentive to compete for high scores, thus generating more diverse lending practices.

These are not revolutionary actions. But small steps can make a big impact if undertaken with integrity and commitment. To achieve equality in the business environment, we must first achieve greater diversity in lending practices.