Why Black-Owned Businesses Struggle To Get Small Business Loans

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By Rohit Arora, Forbes

Small business owners have had a tough time navigating through the Covid-19 pandemic all across the United States. Black-owned business owners, in particular, have been hit especially hard by the pandemic and shutdowns. Many of them were operating with slim margins to begin with and did not have a safety net before the pandemic began.

Many places hit hardest by the pandemic are reeling concurrently from the health crisis, business closures, and job losses. Often these have been urban areas, and the effects of the pandemic on small businesses amid forced closings, modified re-openings, and weakened demand are disproportionately affecting communities of color, according to a new report by Claire Kramer Mills, Ph.D., and Jessica Battisto of the New York Federal Reserve.

The study found that the number of active business owners fell by 22% from February to April 2020 — the largest drop on record. Differences among closure rates across racial and ethnic groups are even more striking. According to the researchers, Black-owned businesses experienced declines of 41%, Latino-owned businesses fell by 32%, and Asian-owned businesses dropped by 26%. In contrast, the number of white business owners whose businesses were active fell by just 17%.

Using data on Covid-19 cases, Census information, Paycheck Protection Program (PPP) reporting, and data on small firms’ financial health from the Fed’s Small Business Credit Survey, the report found:

• Black-owned firms are more likely to be located in Covid-19 hot spots, whereas white-owned firms are less likely to be in the most heavily affected areas.

• Loans provided through the government’s Paycheck Protection Program for small businesses, administered by the Treasury Department and the SBA, reached only 20% of eligible firms in areas with the highest densities of Black-owned firms.

• Because Black-owned firms had shaky cash positions, weaker banking relationships, and preexisting funding gaps, they had little cushion entering the crisis.

A broader analysis of counties across the U.S. showed a geographic correlation between Black-owned business density and Covid-19 spread. This information can be useful when targeting stimulus packages for the businesses that have been hit the hardest by the pandemic.

The PPP distributed $521 billion to 5 million firms with an average loan size of $107,000. The SBA estimates that the program saved 50 million jobs overall. However, in the 30 counties considered particularly vulnerable to Black-owned business closures, most counties saw only 15%-20% of their total businesses receive PPP loans.

When the PPP program halted on August 8 with more than $130 billion in available funds remaining, the question became why did Black-owned firms not try to access the loans? It is possible that they were reluctant to apply for a PPP loan given uncertainty about the future and that they were nervous about being able to repay the loan if it were not “forgiven.”

There is also the likelihood that businesses that had been rejected for funding in the past were skeptical that they would be successful under the PPP. The Fed found that when the pandemic hit, Black-owned companies were less likely to have been in a strong financial position than white-owned firms were, since smaller percentages of Black-owned firms operated at a profit and thus had lower credit scores. Another undeniable fact is that many Black-owned firms lacked strong banking relationships.

“There aren’t a lot of Black bankers. It can be intimidating to walk into a bank for a loan,” said Gauntlett Eldemire, who owns a chain of coin-operated laundries in the Cleveland area. “It’s scary to go in and talk about your credit scores with a guy who is dressed in a suit and sitting behind a desk — especially if you never have gotten a loan before. Fear of rejection does play a role.”

“Once you have secured a loan and proven yourself, it gets easier,” Eldemire added.

The Fed’s 2019 Report on Employer Firms Small Business Credit Survey found that fewer than 1-in-4 Black-owned employer firms has a recent borrowing relationship with a bank. This number drops to 1-in-10 among Black non-employer firms, compared with 1-in-4 white-owned non-employer firms. Survey evidence also indicated that Black-owned firms apply for financing at equal or higher rates than white-owned companies, but are denied at higher rates, according to the Fed report.

The result is that Black entrepreneurs are more likely than white business owners to refrain from applying for loans because they believe they would be rejected; some 37.9% of Black employer firms reported being discouraged, compared to 12.7% of white-owned employer firms.

It is notable that Black business owners perceive a higher probability of funding success from online lenders and are more likely to turn to online providers for financing. Although Fintech providers were not initially authorized to lend PPP funds, many of them were granted the authority to process PPP loans, in part, to level the playing field for minorities to access PPP funding. However, after some delay in the process to getting those lenders up and running, it is likely that many Black-owned businesses had failed at the first attempt to get PPP loans and did not benefit from the authorization of online lenders.

Black-owned companies – even healthier ones – are much less likely to have obtained bank financing in the past five years. Instead, they relied more often on personal savings and funding from family and friends. In fact, according to the Fed, 33% of healthy black employer firms have an existing banking relationship, compared to 54% of stable white employers. This seems to indicate that factors beyond firms’ financial health impact the ability to access mainstream and affordable financing.

What is the lesson for the future?

The next round of Covid-19 relief should be more targeted geographically to focus on the hardest hit areas. Further, banks and other lenders must address the racial disparities in lending and expand access to credit in communities of color. Online lending solutions, such as digital lending platforms and Fintech companies, can be a significant piece of the solution to these problems by overcoming the typical infrastructural boundaries that often unfairly keep communities of color locked out of the best financial opportunities.

But it can’t just be the private sector that heeds this lesson. Government stimulus, including the expected “PPP 2” must ensure that minority business owners get access to capital. Otherwise, we may lose millions of small businesses along with the dreams of tens of thousands of non-white small business owners.

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