BIPOC-Led Small Businesses Need Flexible Capital. Here’s Why We’re Betting On Revenue-Based Financing
- Essential Common Future
Meeting the financing needs entrepreneurs have told us they desperately need
Small businesses are the lifeblood of our economy. Despite headlines that dominate about cascading corporate layoffs, small businesses consistently drive new job creation and economic growth. According to the Bureau of Labor Statistics, small businesses have accounted for two out of every three jobs added in the past 25 years.
Yet despite their macroeconomic importance, the landscape for resources and support to small businesses remain persistently inequitable. Relative to their white peers, Black, Indigenous, and People of Color (BIPOC) small businesses are financially under-resourced and over-mentored.
Getting a small business off the ground costs an average of $30-$40,000—though costs can be significantly lower for microbusiness. However, even on the lower end of the spectrum, the racial wealth gap can often mean limited access to personal savings and family and friends funding, two usual sources for funding start-up business costs.
Other forms of equity capital, such as angel investment or venture capital tend not to be equitably or equally distributed across the country. Plus, due to their need for a major liquidity event—like the sale of the business—in order to pay off, this capital is often a poor fit for businesses looking to grow slowly and remain rooted in their communities.
As an alternative to equity capital, many businesses borrow money to support their growth. Unfortunately, for BIPOC borrowers, traditional bank debt may be entirely out of reach due to structural barriers that rely on historically racist practices that disadvantage borrowers of color, like unjust underwriting processes, a reliance on the Five Cs of credit, or predatory lending practices. Community Development Financial Institutions (CDFIs) or Minority Depository Institutions (MDIs), whose loans intend to be more accessible and favorable to BIPOC borrowers, aren’t always available.
According to the Federal Reserve, just 60% of BIPOC business owners receive the full funding they apply for at a bank, compared to 80% of their white peers. Even when small business owners are successful in securing any bank financing, traditional loans come with fixed terms that must be repaid on a regular schedule, regardless of the business’s revenue. And as mentioned previously, for BIPOC business owners with fewer personal or network financial resources to draw from in hard times, a stroke of bad luck or a market shock can be a death-knell for their business just as much, if not more than a bad idea or a mismanaged operation.
In order to ensure capital products for small businesses are equitably available and accessible, every element of the process that moves capital to the end user must be designed with inclusivity, trust-building, and justice in mind. We know from our experience with character-based lending, and other inclusive financial products that the most important way to design and implement such a process is to put communities and community leaders at the center.
Place-based, community-led entrepreneur support organizations understand the unique challenges faced by their constituents. These organizations have built trust and key relationships that enable them to work with local businesses. Community-based organizations can be excellent stewards of capital and trust, even if they are not traditional lenders. Empowering grassroots organizations to manage the investing process and make capital deployment decisions helps get capital into the hands of BIPOC entrepreneurs, increasing affordability of capital for communities that have been historically excluded and extracted from by the financial system.
Betting on Revenue-Based Financing
Broadly accessible revenue-based finance (RBF) has the potential to be part of the solution to the challenges BIPOC businesses face in accessing capital. RBF is an investment that has a variable repayment schedule, which fluctuates based on revenue. For example, if a business has $100 in revenue and a 5% revenue-based payment per month, it will repay $5. If it has $0 revenue due to a global pandemic, it will repay $0.
RBF combines the best parts of equity—more flexible repayment, so cash isn’t taken out of a growing business—and debt, which doesn’t take ownership away from the business owner. Versions of RBF already exist in other industries, and Founders First and 1863 Ventures have pioneered the way for large, growing BIPOC businesses. At Common Future, we’re inspired by their leadership and are building on their momentum and learning so we can develop RBF as a tool for community-based, BIPOC-owned small businesses seeking flexible capital. By prioritizing the borrower’s growth and success, as opposed to the predictability of returns for investors, we believe this approach can generate more impact than traditional forms of lending.
Common Future has committed to invest $500,000 into two RBF funds, both managed by local, place-based, community-led entrepreneur support organizations that have been committed to building BIPOC businesses in their respective communities for years. These partners have deep relationships in their communities built on foundations of trust and have designed their products and support services with community input and perspective integrated throughout.
The funds prioritize growing BIPOC small businesses that are part of their local ecosystem and which have expressed a need not just for capital, but for more flexible capital. We estimate partners to make 20 to 30 loans ranging from $10,000 – $50,000. By providing this capital to make revenue-based investments, we are amplifying their power to help businesses in their communities by adding a new, more flexible tool to their toolkits.
What’s most exciting is that our partners see this as a first step to transforming how their local ecosystems invest in BIPOC businesses. As these organizations grow and build their capacity to move more capital into their communities, successes they have will not only prove out RBF as a legitimate tool for investment in small business, but will further prove the case for community-controlled capital writ large as a key way to help generate economic growth, opportunity, and power for historically-excluded communities around the country.
Over the next couple of weeks, you’ll get to learn about our partners and join us for online discussions about revenue-based financing. Stay tuned and feel free to reach out.