What big banks can’t do

This post is one in a series by the Growthology team, where we will take a look at some of the topics discussed in State of the Field, a compilation of knowledge on entrepreneurship research written by the leading experts in the field.

Not just any bank will lend to a new untested entrepreneur. And I’m not talking about a hoodie-clad tech genius with a dream. The average age for an entrepreneur is 40—and most bootstrap their ventures.

Citi Bank, Bank of America, Chase and other big banks rely on hard information to underwrite loans, such as credit history, assets, account receivables, etc. All things that a young firm usually does not have when it first applies for a small business loan.

Lending local

While small local lenders also rely on hard information to underwrite loans, they are able to augment this process with information gleaned from social interaction. The local lender can get to know the entrepreneur’s personality, his or her reputation, who the entrepreneur has hired, and what kind of support network the entrepreneur may enjoy. This ability to determine credit worthiness from intangibles is only possible if the lender is in close proximity to the entrepreneur. As a part of the entrepreneur’s network, the local lender can and should be encouraged to access this data with the hope that it will encourage favorable loans to entrepreneurs.

This relationship is vital for a healthy continued relationship during the life of the venture. As the entrepreneur seeks to acquire new products or needs additional capital, the community banking institution can provide those at a more competitive price. The lender may also lower the cost of borrowing for the first loan with the knowledge that during the course of its relationship with the entrepreneur the bank will be able to recoup that “subsidy.”

The mutual benefit from location reinforces the Kauffman Foundation’s belief that connectivity might be the most important aspect to achieving a vibrant entrepreneurial ecosystem. More importantly, this relational contracting benefit might also help solve the persistent issue of access to capital for the entrepreneurs of color and women entrepreneurs.

Tapping into Social Capital

Traditionally, entrepreneurs rely on assets to acquire loans for their venture; assets like savings accounts and homes. However, entrepreneurs of color are far less likely than their white male counterparts to own homes1 or have sufficient savings2. Even if they do own a home, why should entrepreneurs of color risk their homes in recourse loans if other entrepreneurs can borrow on social capital?

However, is the problem for women and minority entrepreneurs the lack of assets or that these entrepreneurs are not in the same network as the local lenders? Could entrepreneurs use social capital as collateral? Perhaps, but this will require active outreach and creative lending practices on behalf of local lenders and probably substantive help from policymakers.

The Metropolitan Economic Development Agency (Meda) in Minneapolis, Minnesota, provides assistance to entrepreneurs of color and women entrepreneurs. In 2014, it helped create 15 new start-ups and made 55 loans for a total of $25.8 million. While Meda provides businesses access to capital minority entrepreneurs would not otherwise have, Meda leverages the capital to help the business in a number of other ways as well. The loan is made in conjuncture with the bank the entrepreneur uses, thus reinforcing the existing relationship, building toward the benefits realized only through a long healthy relationship.

Within Meda lies a solution for so many other entrepreneurs. This model could help millennial entrepreneurs, many of whom are graduating with increasing debt burdens and thus higher risk profiles. The lack of diversity within entrepreneurship, both in the socioeconomic representation and the hyper focus on one industry or cluster, is caused by a distinct lack of creativity in policies and shortsightedness. There are solutions, but the first action must be to build relationships and trust within the ecosystem among all participants.


1This same Census report demonstrates that those under 35 and families making below the national average income are even less likely to own a home.
2This report by the Federal Reserve claims that recession lowered the value of all financial assets, but those in the lower income brackets lacked the wherewithal to withstand the hit and have since not recovered at the rate of those in the upper income and wealth brackets.

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