Venture-Capital Investment in Minority Business
Bates, Timothy, Bradford, William D., Journal of Money, Credit & Banking
IN 1992, THE ROPER ORGANIZATION POLLED 472 black-owned businesses to gauge how they viewed their own firms, as well as black businesses generally. Asked why there were so few black-owned firms in the nation, 84% responded that "Black-owned businesses are impeded by a lack of access to financing" (Carlson 1992, p. R16).
The notion that minority business enterprises (MBEs) have less access to financing than otherwise comparable majority-owned firms is supported in the scholarly literature. Applicable studies have focused, most often, upon black-business access to debt capital (Bates 1991, Cavalluzzo, Cavalluzzo, and Wolken 2002, Blanchflower, Levine, and Zimmerman 2003). Extending the analysis to Hispanic, Asian, and black-owned firms seeking both debt (Cavalluzzo and Wolken 2005) and equity capital (Bates and Bradford 1992), MBEs were found to have less access to capital than similarly situated white-owned firms. If MBEs indeed experience such restricted access to capital markets, then this market segment is being underserved and attractive returns may be available to funds choosing to specialize in financing this client group.
This study analyzes venture-capital (VC) funds that specialize in financing MBEs. Three interrelated issues are investigated: (i) What are the sources of funds and operating characteristics of minority-focused VC funds? (ii) When investments in MBEs are sold off or liquidated, what yields are earned on those investments and how do they compare to the returns earned by the mainstream VC industry? (iii) What fund traits and practices predict higher yields?
Empirical analysis reveals a diverse group of minority VC funds producing investment returns varying widely from fund to fund. The minority-oriented funds are typically small relative to the VC industry mainstream, starting out with a median capitalization of under $30 million. Portfolios reveal equity investments in a diverse range of industries and widespread participation in syndicated investments. Utilizing regression analyses to identify fund traits and practices that were associated with higher/lower returns on individual portfolio investments, we found that minority-focused VC funds generating above-average returns, relative to their peers, can be described as (i) making investments of $1 million or more per firm (well above the sector's overall average of $747,517 per investment), (ii) not being chartered by the U.S. Small Business Administration (SBA), (iii) investing in a range of different industries, and (iv) taking a highly active role in the affairs of their portfolio companies.
Overall, the measured investment returns generated by the minority-focused VC funds were broadly consistent with those of mainstream funds. However, our evidence describing investment returns do not prove the presence or absence of discrimination in business financing. The reality of small sample sizes and underlying databases--minority and mainstream funds--that are not perfectly comparable complicates possible interpretations of rate-of-return differentials as evidence of discrimination.
The issue of financial capital access is timely in view of the shifting demographics of business ownership in the United States. Minority-owned firms have been growing at a rate at least three times that of all firms, and the higher growth rate is expected to continue (U.S. Department of Commerce 1999, Yago and Pankratz 2000). (1) The degree to which venture capital becomes available to new and expanding MBEs will depend in part on a greater understanding of bow such funding supports works--or does not work--in reality.
The remainder of this study is organized as follows. Section 1 describes the financing patterns and operating characteristics of the minority-focused VC funds. Section 2 examines the investment performance of the minority funds, compares that performance to returns generated by mainstream VC funds, and reports the results of regressions that predict yields on investments in portfolio companies. …