While Wall Street is booming, Main Street in America is just barely scraping by after a year of lockdowns and suppressed demand. According to estimates from Opportunity Insights, the number of small businesses currently open across the country has decreased by 32.2% compared to before the pandemic. In order for entrepreneurs and businesses to recover — and to have a recovery that provides fair opportunity for all — we need innovation in how we finance our country’s local businesses.
To help address this problem, we’re writing to announce a partnership between Blueprint Local and the Nowak Metro Finance Lab at Drexel University, with the support of the US Economic Development Administration. Our joint effort will identify, codify, and scale innovative financing models that can serve a broad mix of small businesses and entrepreneurs as the pandemic lifts and recovery begins.
We’ll explore strategies to leverage a continuum of capital in support of a continuum of enterprises, taking advantage of the volume of the private investment capital available and the potential for new federal policies, products and incentives.
This work comes at a moment of great urgency and even greater complexity for American policymakers, capital providers, small businesses and entrepreneurs. In its wake, COVID-19 has left a hugely variegated landscape of economic risk and opportunity. The central challenge through 2021 and 2022 will be threefold:
- The Rescue Challenge: Some of the businesses that have closed during COVID have been permanently driven out of the market, while those that remain have been buoyed by targeted federal aid, the last rounds of which will run out this month. This federal aid has been focused on targeted emergency relief. As we emerge from the emergency response phase of the pandemic, many businesses will require flexible restart capital as a bridge between current capital needs and when consumer demand comes back in full. Programs like PPP have been helpful bridges for some, but cannot keep the economy afloat forever. Even the new funding for these programs that opens this week will likely be exhausted in short order.
- The Growth Challenge: As more people are vaccinated and the country reopens, the economy faces a double challenge. On one hand, existing businesses will want to take advantage of the rapid return of consumer demand. They will need working capital – and they need it fast – to adapt and scale their operations, re-hire workers, and rebuild their companies in response to renewed consumer demand and the roll out of public investments. On the other hand, the surprisingly high number of entrepreneurs who submitted applications to start new firms will need capital to actualize these intentions and create real businesses. Both sets of entrepreneurs will soon be seeking flexible working capital to respond to the return of pent-up consumer demand. Traditional models of financing such as venture capital and debt, often fall short for many of these businesses and innovative structures for capital access are necessary for this moment more than ever.
- The Inclusion Challenge: It likely does not come as a surprise that during the pandemic, certain entrepreneurs and their businesses have fared worse than others. According to the Federal Reserve, for example, Black-owned businesses were more than twice as likely to close and minority entrepreneurs were often last to be served by government assistance. Minority-owned businesses in general were at a structural disadvantage as their businesses (on average) entered the pandemic with smaller balance sheets, higher concentration in low-wage sectors, and less-established banking relationships. These businesses were also disproportionately in sectors hardest hit by COVID-19 and were underserved by relief programs like the Paycheck Protection Program. The status quo means that a rising tide will not lift all ships in the post-pandemic recovery. New intentionally designed suite of public and private delivery mechanisms is required to help Black- and Brown-owned firms access capital, contracts and customers and participate fully in business recovery and growth.
If addressed strategically, these challenges also present tremendous opportunity to usher in a new era of American prosperity. The Biden Administration’s current and intended economy-shaping investments raise the stakes: in funneling public investment into certain industries (e.g., childcare, infrastructure construction, home healthcare) they could be truly transformative. Yet, if entrepreneurs — especially Black, Latino, and Asian entrepreneurs — do not have the opportunity to access the right type of capital, contracts and customers, this investment could fail to meet its full potential while further intensifying disparities that already exist.
Our joint effort seeks to develop strategies that bring together the public, private and civic sectors to develop replicable solutions that thread the needle between this threefold challenge. We elaborate below.
The Capital Problem: Water, Water Everywhere, But Not a Drop to Drink
In many ways capital access in America resembles the old poem about the sailor lost at sea who mutters “water, water everywhere, but not a drop to drink.” Like the thirsty sailor who is surrounded by salt water, America’s capital is plentiful but ill-suited to the needs of most entrepreneurs and businesses in 2021. We are still using the relatively blunt pre-pandemic tools of bank debt, government subsidy and private equity to respond to fast-moving and multi-faceted needs.
As a practical matter, the average entrepreneur who has a poor credit score after personally floating their business during COVID, and now needs $200,000 in flexible start-up capital to quickly grow their business post-pandemic, will not be considered “high growth enough” for venture capital, and will be seen as a poor credit risk for a loan.
Even prior to COVID, there were major disparities in access to capital. According to the Kauffman Foundation, more than 83% of entrepreneurs are “in the middle,” without the ability to access traditional bank loans or venture capital, and instead relying on their own personal assets or networks to finance their business.
And the funding that does flow is not equitable. While venture capital is only one small part of the financing picture, its funding disparities are illustrative: women get less than 10% of venture financing and Black and Brown entrepreneurs get less than 1% of venture financing. Venture investment also has major geographic disparities. As Steve Case, the founder of the Rise of the Rest initiative, often cites, 78% of venture capital goes to three states (New York, Massachusetts, California), and less than 1% goes to rural areas.
If pre-COVID-19 disparities in capital access are allowed to persist, entrepreneurs who have been historically excluded will yet again miss opportunities to innovate, bring in reliable income and build wealth in the post-pandemic recovery.
Emerging Models
Although the challenge is daunting, innovative models to support under-capitalized entrepreneurs were emerging pre-pandemic and grew rapidly during the crisis. The country can learn from and scale these models. These models include:
- Innovative structures for capital that fit the 83% of entrepreneurs: largely who are seen as “too risky” for a loan and “not high-growth” enough for venture capital. Structures include revenue-based sharing models, profit-sharing models, and employee ownership. The Kauffman Foundation launched the Capital Access Lab in 2019 as one such effort to seed these promising new concepts.
- Innovative bridges from rescue to relief in cities (Chicago and New York), states (Colorado) and regions (the Southeast-focused SOAR Fund), community lenders (CDFIs) and governments have come together to create new financing structures that are appropriately sized to meet the smallest firms’ needs and flexible enough to allow them to bridge from relief to recovery.
- Efforts to diversify fund managers Several efforts have intentionally focused on who is managing funds and making decisions, such as Illumen Capital (a private fund-of funds) and Living Cities’ Catalyst Fund (a philanthropically backed effort).
- Strategies to help businesses with customer development such as efforts that help minority-owned businesses to supply anchor institutions (eds, meds, and feds) in American communities.
Other models (and policy/product proposals) were part of the Big Ideas for Small Business report released last October.
Building Resiliency and Growth
These models, once implemented, are able to help entrepreneurs and communities build economic resiliency and grow.
As one example, the Kauffman Foundation and Rockefeller Foundation partnered to fund the Capital Access Lab, a pilot to seed these innovative strategies. One investee of the Capital Access Lab was Collab Capital, a fund founded by by several Black entrepreneurs in Atlanta to support the Black-owned business ecosystem locally.
With a clear focus on the 83%, Collab uses a unique profit-sharing model to help companies organically grow. Tracey Pickett, one of their investees, is the CEO of Hairbrella, a company that makes womens’ rain hats. During the COVID pandemic, used Collab funds to pivot Hairbrella’s manufacturing line to make “Hairbrella Pro,” domestically-manufactured Personal Protective Equipment.
As another example, Capacity Capital uses a revenue-share structure to invest in small and growing businesses. With Capital Access Lab investment, Capacity funded Charlie’s Barbecue, a growing barbecue restaurant in Tennessee, to pivot its business operations and infrastructure to takeout and delivery, and the company actually doubled its revenues in 2020.
Innovative financing structures help companies pivot product lines to respond to emergencies, weather economic shocks, and ultimately become stronger. There are hundreds of funds like Collab and Capacity, and thousands of companies that run a continuum from Hairbrella to Charlie’s Barbecue.
These strategies are promising at a local level, but have not yet reached scale at a national level. Even federal capital access programs like the $10 billion State Small Business Credit Initiative (SSBCI) — a federal pool of capital that allows states to develop unique capital access programs — require strong local leadership across the country to put capital to work.
As a result of this partnership, we hope to develop tools so that the large pools of capital committed to address our nation’s racial inequities are deployed in a way that is usable for these entrepreneurs — and which creates a sustainable wealth-building model for them.
What We’re Doing
This project aims to turn the Hairbrella or Charlie’s Barbecue stories into the norm emerging from a COVID economic crisis that has hit small businesses especially hard. We will develop a playbook and work with communities across the U.S. on these innovative financing models that better serve the 83%. This project will:
Support a cohort of six communities to develop innovative financing models to better serve businesses in their specific local context. We worked to select a geographic cross section of partners that effectively capture the market gaps in the US economy, including:
- Seattle, WA: NDC, a national CDFI focused on job creation and affordable housing.
- Salt Lake City, UT: The Utah Association of Counties, a non-profit economic development organization working with local leaders across the state of Utah
- San Antonio, TX: Velocity Texas & Alamo Angels, a network of investors working to provide capital to entrepreneurs across south and central Texas.
- Birmingham, AL: Opportunity Alabama, a nonprofit dedicated to connecting investors with investable assets across Alabama’s Opportunity Zones.
- Baltimore, MD: Baltimore Development Corporation, the economic development agency for the City of Baltimore, aiming to grow the local economy.
- Cincinnati, OH: The Minority Business Accelerator, an initiative of the Cincinnati Chamber of Commerce, aiming to support the development of sizable minority businesses in the region.
We have picked this cohort based on its diversity. The firms served by the intermediaries we’ve identified represent entrepreneurs across the continuum — from tech startups in south Texas, to manufacturers seeking succession plans in the Rust Belt, to firms populating commercial corridors across the Seattle metro. It’s our view that the wide variety of entrepreneurs and their emerging post-pandemic needs will inform a rapid feedback loop. We aim to amplify these lessons so that capital and contracts can be developed to thread the needle between the rescue, growth, and inclusion challenges that each type of firm is facing across these key geographies.
As we learn alongside partners on the ground and research existing efforts in the space, we will develop a playbook for key intermediaries (CDFI, venture fund, entrepreneur support organization, economic development group) that want to adopt one of these innovative financing strategies to support local businesses with capital better suited for this moment.
We aim to share the results and lessons learned across the way. It is our hope that the work we do together will provide a path for investors, fund managers, entrepreneur champions, and public officials to follow.
Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Ross Baird is Founder and CEO of Blueprint Local. Colin Higgins is a Senior Research Fellows at the Nowak Metro Finance Lab. Maegan Moore is Manager of Business Strategy at Blueprint. Ian O’Grady will soon be joining the Nowak Metro Finance Lab as a Research Officer.