Closing the Gap: Lending to Underserved Small Businesses

Business.com / Financial Solutions / Last Modified: February 22, 2017

Urban myths and realities about loan programs designed to help underserved, minority, and immigrant-founded startups.

Since the collapse of the housing market in 2008-2009, minorities in the U.S. have been hit disproportionately hard by lenders who are giving mortgages only to the strongest borrowers. The housing crash continues to have repercussions in the minority-owned small business community, for which business loans are increasingly unavailable.

Frequently, these groups of excluded borrowers refer to non-white, non-immigrant citizens with marginal to severe credit woes. In conjunction, the Federal Reserve also reported that 65 percent of domestic banks have tightened lending standards since July of 2008, with the majority of these domestic banks charging more interest for personal and small business loans despite the Fed’s insistence on a near-zero percent policy. The tepid gains we have seen in terms of economic recovery have come at the cost of increasingly tight money, and lending practices that are leaving more and more small and minority-owned businesses out in the cold.

How it affects business owners

For minority business owners, that adds up to roughly 4.1 million companies with little or no access to business credit. The Minority Business Development Agency recently released a statistic that minority-owned firms generated more than $661 billion in annual sales and employed approximately 4.7 million people in the U.S. The Minority Business Development Agency named this group the fastest growing business sector in the domestic Economy in a recent press release to the U.S. Department of Commerce.

Those minority-run businesses constitute a large portion of the market, and it's more important than ever to provide equal footing for all entrepreneurs to succeed. Nonetheless, the report notes that many minority entrepreneurs are forced to rely on expensive, short-term debt, loans against personal assets, or personal credit cards to bankroll their small businesses. While this course of action is always cautioned against by business advisors who insist on maintaining a strict division between personal and business finance, many are finding it the only option available.

Funding a small business on the back of your personal credit cards is never a good idea, but it happens, and sometimes with great success in the end. However, even that avenue of credit is often unavailable. According to a Forbes article by Wayne State University professor James Carr, “African Americans and Latinos, for example, are less likely to have traditional sources of credit, such as credit cards or mainstream consumer or business loans, all of which constitute the basis of outdated scoring models.”

Making funding available for minorities need not be seen as a political issue. Carr notes that such discussions are often framed as “loosening of credit standards,” which is misleading, and implies that lenders must be forced to accept the excessive risk, which is not the case. In fact, the dearth of minority business loans can be attributed to outdated credit scoring models. Credit reporting agencies Fair Isaac and VantageScore are beginning to change the status quo with newer scoring models that predict risk more accurately. VantageScore research actually shows that Fannie Mae and Freddie Mac could boost lending to minorities by a third, without loosening credit standards at all.

Positive immigration for business

Despite the dearth of available mainstream funding for minority businesses, dangerous myths about the subject continue to confuse people. First and foremost, a persistent urban legend is that the government provides outright grants to immigrants to start businesses, or that the SBA has special programs for loans to minorities or recent immigrants. This is not the case. While government agencies have a mandate to use minority/woman-owned/disabled veteran contractors or subcontractors, this doesn’t mean that your minority business will get that contract by default.

The benefits of creating a level playing field – where minorities and immigrants have equal, but not special, privilege is obvious. A new study conducted by the National Foundation for American Policy reveals, “Immigrants have started more than half (44 of 87) of America’s start-up companies valued at $1 billion or more and are key members of management or product development teams in over 70 percent of these companies.” These giant companies include examples such as Uber Technologies Inc., Planatir Technologies Inc., and Space Exploration Technologies Inc.

One perfect example of immigration working to benefit the global economy is the story of Garrett Camp, co-founder of StumbleUpon.com in 2002 and then Uber in 2009. Camp was born in Alberta, Canada and since has picked up residence in San Francisco. Both MIT and Bloomberg recognized Camp as one of the youngest and most successful young entrepreneurs back in 2013 for his creation level work on a successful new business model. The most recent project, Expa is described as an early stage incubator for start-ups with a growing list of high-profile investors totaling roughly 150M in the past two years alone.

Credit-building for emerging markets

The SBA has initiated programs to bridge the gap for underprivileged business owners by offering assistance with government contracts and holding. While SBA does not (contrary to urban myths) provide special privileges to minorities, they do take extra measures to make sure they are included and have access to contracts whenever available. Affected groups include service-disabled veterans, business locations in historically underutilized zones or HUBZones, women-owned businesses, and businesses owned by disadvantaged individuals.

Minority and immigrant entrepreneurs, finding themselves blocked by traditional lenders may turn to alternatives such as peer-to-peer lending, or alternative lenders with programs that specifically target these communities, and offer alternative methods of credit scoring. According to William Underwood, Public Relations Director at ezDinero Loan Solutions, Latino business owners in the U.S. represent an underserved population, largely due to outdated scoring models, and mainstream banks’ focus on larger loans at the expense of SOHO operators who need business loans of $50,000 or less. Nonetheless, he notes the minority/immigrant demographic has an impressive success rate in repaying business debt and in small business success. And while mainstream banks may be doing better at reaching out to minority communities, they simply have no interest in providing smaller business loans to anyone, minority or not. As a result, we are starting to see more alternative lenders offering this type of loan product.

 Photo credit: garagestock/Shutterstock

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