Minority business enterprises generated a collective $1.4 trillion in revenue in 2017, or about 7.2% of the year’s gross domestic product (GDP), according to the Minority Business Development Agency. By about 2045, the minority population will make up a majority of the US population and workforce. However, because of business funding gaps and the lag in minority business loans, financial equity and business productivity may not follow the same pattern.
How do we change this fate? We look at racial and gender funding gaps between different US populations, and how these gaps impact minority business owners, their credit, and their business’ chance of success.
What we’ll cover:
- The funding gap, explained
- How minority business funding differs between sources (from banks to fintech and more)
- Lending automation and its impact on minority small business owners
- The future of minority business loans
What is the funding gap and who does it impact?
Funding gaps are differences in business funding that exist between historically marginalized groups and those that have experienced privilege. They can exist across the lines of race, gender, ability, nationality, gender identity, and sexual orientation.
Heads up: We don’t have thorough data for all of these categories, but we’ll go into what we do know about how race and gender impacts business funding.
Funding gaps are similar to wage and wealth gaps that we hear about. For example, women earn $0.83 for every dollar men earn (a common statistic shared at least every International Women’s Day), but they own just $0.32 for every dollar a white man owns.
When looking at business funding gaps, we may see different results with different types of funding. Types of funding include:
- Bank loan
- Business line of credit
- SBA loan
- Microloan through a nonprofit organization
- Business credit card
- Venture capital and angel investing
So how big is the funding gap, and what type of business owners does it impact the most?
BIPOC (Black, indigenous, and people of color) receive less funding than their white counterparts. They also receive funding less often and are charged higher interest rates for credit products. The gaps are glaring.
Of business owners who requested funding via completed loan applications, a reported 80.2% of white business owners received some sort of requested amount while only 66.4% of BIPOC business owners did. Meanwhile, white people received a loan amount $30,000 bigger on average than that of BIPOC folks. Where non-minority groups paid 6.4% in interest, minority businesses paid 7.8%. The outcome of these disparities is a major gap in working capital.
Meanwhile, female-founded businesses received just 2.1% of venture capital dollars invested in the US in 2021. While women are not a minority in America, they are a marginalized group and an American business owner minority, owning 19.9% of all companies that employ people in the US (most of which are helmed by white women).
The funding gap is embedded in minority business lending
The state of minority business loans in the US can often feel discouraging. The fact is this: Historic racial and gender bias is baked into our lending criteria, even when automated. This makes sense when you look back at the history of credit:
- You may know Dun & Bradstreet as one of three major business credit bureaus—but in the mid-1800s, two businesses called R.G. Dun & Co. and Bradstreet Company were the leaders in commercial credit reporting.
- Consumer credit reporting came on the scene in the early 1990s. The Retail Credit Company (RCC) was founded in 1899; you may know it today as Equifax, a leading consumer and business credit reporting agency.
- Discrimination has been codified into credit reporting systems from the start. In 1970 under then-President Richard Nixon, the US passed the Fair Credit Reporting Act (FCRA). Then, In 1974 when RCC announced it would computerize credit files, then-President Gerald Ford passed the Equal Credit Opportunity Act. While these acts sought to criminalize racial and gender bias in the industry, neither of them eroded the bias our credit systems were built on.
- People of color still have lower credit scores than white people. In 2019, average credit scores were 677 for Black people, 701 for Hispanic people, and 734 for white people.
Credit scores directly influence lending decisions. This bias is not a moot point—it has tangible impacts that increase the wealth gaps between White males and marginalized groups, ultimately continuing cycles of financial inequality for minorities and underserved communities.
Consider the source: Funding options and the bias they carry
Different sources of business credit carry different baggage. Compared to their counterparts, more traditional lending solutions tend to pose larger gaps in credit approval between marginalized and non-marginalized groups.
Legacy financial institutions (banks and credit unions)
Banks, credit unions, and other traditional financial institutions have been around the longest and tend to pose the largest gaps in lending.
According to a study by New York University academics titled Automation and Racial Disparities in Small Business Lending, traditional banks tend to showcase more racial bias in lending practices. Banks—especially small banks—tend to have less automation and more human touch, giving space for bias to seep into the process.
The study notes that fintech (financial technology) and large bank lenders served PPP loans to the highest proportion of Black business owners because they employed more automation. Small banks used the least amount of automation and had the highest racial disparities in loan acceptance.
“Among traditional banks, PPP loan shares to Black-owned businesses increased with bank sizes ranging from 3.3% at small banks (the banks with the least automated systems) to 6.2% at the largest four banks (Wells Fargo, Bank of America, JPMorgan Chase, and Citi).” — Automation and Racial Disparities in Small Business Lending: Evidence from the Paycheck Protection Program, April 2022
For the record, these banks originated the vast majority of PPP loans (upwards of 82.6% of them).
The Paycheck Protection Program was basically a case study in minority business loans. Even though the US government incentivized firms to front these loans, discrimination still found its way in the system.
Fintech
Fintech lenders that rely on automation offer a much more hands-off approach. In this, you lose the human touch, which eliminates often-helpful discernment and technical assistance via person-to-person customer service. However, fintech provides a level of equity not found in legacy financial systems.
“Overall, fintech lenders were responsible for 53.6% of PPP loans to Black-owned businesses, while only accounting for 17.4% of all PPP loans. There are also some smaller differences across lenders in the propensity to lend to white-, Asian-, and Hispanic-owned firms.” — Automation and Racial Disparities in Small Business Lending
At the same time, Black-owned businesses are 26% more likely than businesses owned by another race to obtain a fintech-sourced PPP loan. Comparatively, all businesses have a 17.4% chance of getting a fintech loan.
These stark differences are not by accident. Fintech lenders do not follow the same rules that traditional financial institutions do, and are not rooted in an industry following aged norms built when women and people of color did not have basic voting, property, and financial rights. These firms have more control over credit factors and can avoid historically biased factors (like zip codes, which trace back to redlining and the racially charged NIMBY—not in my backyard—mindset).
Take Tillful, which uses four transaction data factors (overdrafts, cash flow stability, account balance trends, and account balance fluctuations) and four credit data factors (credit utilization, payment delinquency, debt-service ratio, and outstanding balances) to influence our business lending scores.
In many cases, automation is beneficial for marginalized groups. However, it’s not foolproof.
Fintech lenders are not bound by the same regulations as banks, so it’s crucial to find one that has its own set of standards in place and retains a level of transparency. Privatized operations need to operate within some sort of bounds, and some experts think federal government regulation is looming to protect entrepreneurs and consumers.
Alex Keller, data scientist at Tillful, says, “Because there’s no regulation, it’s even more important to scrutinize our models.”
Government-backed programs for minority entrepreneurs
While its process is imperfect, the US government does have systems in place to address funding gaps. Much like the HUBZones program (which provides businesses in underserved regions with the opportunity to secure federal contracts), the Small Business Administration (SBA) has government-backed funding programs tailored to minority business owners.
The SBA partners with lenders to provide small business financing in the form of 7(a) loans, 504 loans, and microloans. To access these loans, qualifying borrowers typically must adhere to small business size requirements, be a for-profit startup or established business, operate in the US, have already invested equity, and exhausted other financing options. Some of these loans are “targeted at minority and underserved communities” including businesses owned by Black, Native American, and disabled people as well as women, veterans, and those living in rural communities, the SBA says.
About a third of SBA 7(a) loans, which supply funding to small businesses, go to minority-owned businesses. The Minority Business Development Agency, a part of the Department of Commerce, also offers small business grant competitions and business development programs. The SBA microloan program and SBA 8(a) business development program also exist to foster business success.
While regulated government agencies are working to fill certain gaps, it’s not a panacea. The rest of the financial industry must simultaneously work to resolve long-standing, often covert bias against minorities.
Venture capital
One way businesses receive funding is through venture capital (VC). Rather than taking out a loan, entrepreneurs can attract investors in exchange for business equity. Like banks, fintech lenders, and other funding avenues, VC poses its own funding gaps.
VC firms injected a whopping $307 billion in startups over the course of 2021, almost double the previous year’s record. The pandemic didn’t quell VC funding; in many ways, it inspired it.
But it’s crucial to note that the pandemic impacted businesses owned by people of color differently than it impacted white-owned businesses. The Minority Business Development Agency says, “Firms owned by people of color reported more significant negative effects on business revenue, employment, and operations as a result of the COVID-19 pandemic.”
Did you know? 90% of Asian-owned businesses saw reduced revenue from 2019–2020, the most of any business owner group.
VC funding may have soared during the pandemic, but did it accurately reflect the needs of minority business owners experiencing increased headwinds? Not quite.
Disparities in capital access are nothing new. More than a decade ago, research found that minority-owned firms had less than half the average amount of recent equity investments and loans than non-minority firms. They also received fewer capital investments at startup and in the first few years of existence than non-minority firms.
Today, inequities in VC funding persist. Women-owned businesses received just 2.3% of all VC funding in 2020. Black-owned businesses received just 1.2% of all VC funding in the first half 2021, which was actually four-times higher than a year prior. That increase was spurred in part by the growth of the Black Lives Matter movement in the wake of George Floyd’s murder at the hands of police. If anything, it shows there is still work to be done.
How do we close the VC funding gap impacting minority-owned businesses? Having more minorities at the helm of VC firms would help. To be classified as a minority business in the US, your population group must retain at least 51% of voting equity, according to the National Minority Supplier Development Council.
For example, if you run a Black-owned business, it would be most beneficial to receive funding from Black-owned VC firms. Otherwise, you are limited to exchanging no more than 49% of equity to white-owned VC firms to avoid losing your official status as a Black-owned business in the US.
How lending automation impacts racial disparities in small business lending
Research suggests the more hands-off a lending source is, the smaller the funding gaps tend to be across populations.
“By enabling smaller loans, broader geographic reach, and less human bias in decision-making, process automation may reduce racial disparities in access to financial services.” — Automation and Racial Disparities in Small Business Lending.
When studying lenders that worked with the SBA to provide PPP loans, changes in automation led to changes in the share of loans going to minorities. Increased automation subsequently increased a bank’s share of PPP loans given to Black-owned businesses “by six percentage points, relative to a pre-automation share of 4.4%,” according to the study.
Why is this? Automation reduces human influence on decisions, including the order a firm processes loans when nearing capacity constraints. This human-removed process appears to actively mitigate racial discrimination.
Regions with higher reported racial discrimination saw an even bigger positive effect of bank automation on the lending rates to Black-owned businesses.
There’s also the factor that automated lenders may be more likely to provide smaller business loans, which tend to go more towards minority business owners. Still, ingrained—even seemingly unintentional—human bias is clear.
Tillful data scientist Alex Keller reminds us that automation has its limitations. After all, humans are the ones who implement automation, so we often bake biases into the automated systems themselves:
“Now those rules have been codified in the system,” says Keller. “Because [minorities] have been suppressed in the past, what's happening now is these automated systems automatically rule these people as not qualified for credit because they don’t have the historical background.”
Still, automation operating under fair, transparent, and evolving standards is a big step forward!
The future of minority small business loans
Looking back on the history of credit, what many view as the long-gone past actually wasn’t that long ago.
The Equal Credit Opportunity Act (ECOA) went into effect in 1974 and credit equality is still catching up. Lenders can still use zip codes to work around anti-discrimination laws, as certain zip codes often represent certain racial groups. Less than half a century after women were granted the legal right to receive credit card approval and build credit history, funding gaps still rage across gender lines.
All of this reminds us why the state of minority business loans is so unbalanced compared to privileged population groups.
While automation can be a solution for the problem of human bias in lending, it’s important to be critical about the automation we’re implementing. Keller says, “If we don’t explicitly intervene and understand the biases in the data, and start to be thoughtful about how the data was collected and what policies and social conditions went into the measurement, all we’re doing is just reinforcing patterns that existed already.”
For fintech lenders with set credit factors, evolution is key. Fintech regulation is all but imminent, and it’s possible these regulations could help address business credit and lending biases.
Last word on the funding gap for minority business owners
Closing the gender funding gap for US women-led businesses could increase the nation’s GDP by a whopping $2 trillion. Meanwhile, the economic benefit of reducing the racial wealth gap, in part born of business funding, could grow the GDP by 4–6%.
The funding gap is a major factor in the success of minority-owned businesses. The state of minority business loans differ depending on the source of the loan. While automation can reduce disparities across populations in small business lending, lenders must be transparent and critical of their processes. Otherwise, existing biases can become baked into automated systems, helping to perpetuate a system that has long been problematic.
If you’re a minority business owner, use this information to determine the best small business loan for you. At the end of the day, your success ought to depend on you, not longstanding disparities that existed long before your entrepreneurial journey.
