Is there a way to close the vast racial startup gap?
For almost 40 years, the rate at which Americans have started new businesses has been in a steady decline. This is bad news, since new firms drive the high-wage jobs and market competition that our economy desperately needs. Racial and socioeconomic disparities in business ownership further stifle entrepreneurship and threaten the long-term economic health of our cities and our economy.
But a silver lining may have come in one of the most unexpected of places: the Trump administration’s tax overhaul. A little-known provision in the final version signed into law enables states to establish “opportunity zones” that encourage investors to defer capital gains, so long as they invest in existing or new businesses.
The bipartisan Economic Innovation Group, a key proponent of the provision, has estimated that there are $2.3 trillion in unrealized capital gains. This could be used to create a pool of capital for investment in areas designated as opportunity zones, or census tracts that have a poverty rate of at least 20 percent and median family income no greater than 80 percent of the median for the overall region.
This new source of investment could make a difference in addressing the nation’s steady decline in the rate of new business startups. But it will only be effective if the fastest-growing segments of our population—people of color—are able to become entrepreneurs at exponentially increasing rates.
It is well established that businesses owned by women and people of color disproportionately lack access to venture capital and small business loans, which limits their ability to launch, expand and grow. But access to capital is just one part of the problem: The systems in place for identifying, fostering and supporting entrepreneurs favor white males from the start. A recent study from Stanford economist Raj Chetty and his colleagues at the Equality of Opportunity Project found that people of color, women, and children from low-income families become inventors at a fraction of the rate of white men, often despite demonstrating higher performance at a young age.
Recently, Living Cities, the nonprofit group in D.C. that I lead, looked into the entrepreneurial environments in New Orleans, San Francisco, and Albuquerque, in order to provide local leaders and opportunity zone investors with guidance on where these investment dollars should be deployed to increase business dynamism in their own backyards. We mapped the unique obstacles that people of color and lower-income and lower-wealth Americans face in launching and scaling new businesses, and looked at potential intervention points and strategies to overcome these barriers.
What we found was, in order to help new businesses thrive, cities need to have healthy local entrepreneurial ecosystems. Those are the policies, programs, organizations, products and services in a bounded geography that together shape the environment in which local business owners start, operate and grow. In the best cases, these factors interact to make a city a welcoming and easy-to-navigate place for aspiring entrepreneurs of all races and socio-economic backgrounds.
To build such an an ecosystem, leaders across sectors must proactively connect business owners of color with experts, networks, and resources in a seamless way. Based on the three cities we studied, here are four ways to make that happen.
1) Create new fund structures that replicate “friends and family” investments for lower-income and lower-wealth entrepreneurs. The majority of entrepreneurs draw on their savings to get off the ground, and one in five lean on funds from family members. Having sufficient capital at the outset is highly correlated with a business’ chance of survival. But the enormous racial wealth gap, coupled with the almost complete unavailability of venture and loan funding, means that capital is harder to come by for entrepreneurs of color.
A pilot fund in New Orleans launched by the Network for Economic Opportunity bridges this gap for small businesses bidding for public construction and infrastructure projects, providing much-needed capital to grow their capacity and take on larger city contracts with more stable revenue streams. During a recent evaluation of the pilot, one African-American business owner explained that he’d been denied a loan from three different banks, despite having a FICO credit score of 720. At the same time, a white colleague with a much lower score had walked away with a million-dollar line of credit.
2) Establish formal mechanisms that connect prominent entrepreneurs of color with emerging entrepreneurs of color and engage them as mentors. We know, based on rich research like Gallup’s Builder Profile, that the qualities that characterize successful entrepreneurs don’t discriminate by race. But from an early age, social networks shape perceptions of who can become a successful entrepreneur in the first place. Exposure to business owners in one’s own network is a powerful lever; it has been shown to boost the likelihood that someone will become an entrepreneur themselves, according to research from the Kauffman Foundation. Similarly, studies by Endeavor show that even a very small number of successful entrepreneurs in a single market serving as mentors to emerging businesses can stimulate an exponential amount of startup activity and growth.
3) Develop a coordinating mechanism to help navigate technical assistance services and the entire ecosystem. Each of the three cities we studied had an abundance of actors in their ecosystems. What they didn’t have was any rational way for entrepreneurs to navigate the different organizations and services. Often, if you entered the system through the wrong door—e.g. you went to an organization focusing on startups but you were a later-stage company—no one helped you get to the right place.
Places like Kansas City are intentionally working to solve that problem. With initial funding from the Kauffman Foundation, the city created a resource called KCSourceLink designed to help entrepreneurs connect the dots, via a searchable directory of more than 240 business-building organizations located in the metro area, plus other resources. KCSourceLink also runs a triage center for business owners to access the exact resources they need.
4) Intentionally identify and support existing companies with the potential to scale their business models. In every location, we saw entrepreneurs who simply didn’t have the expertise to recognize their own potential to be high-growth enterprises and then take the steps to grow. When they’re able to leverage opportunities to widen their customer base or shift into a new sector, entrepreneurs can transform their business from sustainable to thriving.
A local music store in Ohio, for example, had built up a business selling instruments, music scores, and lessons. With the support of a nonprofit startup accelerator, the owner identified a potential source of new online customers: saxophone players, who rapidly go through reeds. This pattern created an opportunity to develop an online subscription service for reeds that could not only serve existing local customers, but be available worldwide, online.
Similarly, a network of organizations dubbed the “Chicago Anchors for a Strong Economy,” or CASE, supports 15 local institutions in more intentionally using all of their assets, especially the money they spend on buying goods and services, to help grow local businesses and create more jobs for Chicagoans. A dedicated staff at CASE works to plays matchmaker, connecting institutions with the right local businesses to meet their needs. They also help participating small businesses navigate the procurement processes of larger institutions, and provide advisory and workforce development services out of the University of Chicago.
Investment of opportunity zone resources in these types of ecosystem-building activities could be transformational. By directly addressing barriers to inclusion and growth, they would help unleash extraordinary local business growth.
And these ecosystems are currently being built across the nation and ready for investment. Last June, the Kauffman Foundation convened the first-ever ESHIP Summit in Kansas City, bringing together more than 400 ecosystem builders from 48 states, Puerto Rico, and the District of Columbia, plus nine countries. Their digital playbook captures the resulting ideas, insights, and solutions—and is currently open for feedback.
Can the new resources soon to be available through opportunity zones finally enable us to harness the long-dormant power of lower-income and lower-wealth Americans and get America back to leading the world in startups? The proof will be in the pudding.