Why Philadelphia needs blended capital to address racial inequities

Systemic capital injustices and inequities for BIPOC communities are well-documented, including but not limited to predatory lending, implicit investment bias and the racial wealth gap. Moreover, diverse-owned businesses often struggle to access affordable capital because they lack proximity to capital networks, fail to meet traditional underwriting criteria, and do not trust capital resources when they are available.

What to do about it?

Working as an underwriter for five years at a private, small-business lender, I saw these systemic patterns show up in my everyday work. The women entrepreneurs I spoke with daily were less likely to apply for the amount of capital they actually needed (and could qualify for) out of fear of being rejected. And they weren’t wrong — multitudes of studies demonstrate that women are less likely to be approved for a small business loan and often charged higher interest rates despite statistically being a lower credit risk.

These sorts of disparities exist along the spectrum of capital, with women taking just a 2.2% share of the $130 billion venture capital market in 2018, a $1 billion improvement over 2017. It’s likely no surprise that these disparities are much graver for entrepreneurs of color. Black business owners are approved for small business loans at about half the rate of their white counterparts and, even when approved, receive less than half of the loan amount extended to their white peers.

When diversely owned businesses do not have equitable access to the capital necessary to start and grow businesses, economic growth is curtailed for the entire region.

In my current role with Philadelphia Anchors for Growth and Equity (PAGE), an initiative of the Economy League of Greater Philadelphia, I work with a team to ensure that the “eds and meds” in our regional economy provide diverse, local businesses with equitable access to pursue and secure procurement contracts. In addition to driving demand for diverse procurement spend, we also aim to enhance supply by connecting diverse business owners to capital and consulting opportunities that can grow their capacity.

However, the potential impacts of these efforts spill beyond the business community itself. How many more suppliers in Philadelphia could offer competitively priced, quality-consistent services to our anchor institutions if they had the working capital they needed to succeed? How many more opportunities could exist for local impact investors if more promising entrepreneurs had the initial capital to turn their ideas into prototypes? How many more family-sustaining jobs could we create for Philadelphia residents if thriving entrepreneurs had the capital needed to work on their business rather than in their business, focusing their efforts on expanding into new markets, growing their client base, and increasing the efficiency and efficacy of their operations?

When diversely owned businesses do not have equitable access to the capital necessary to start and grow businesses, economic growth is curtailed for the entire region.

Combining blended capital approaches and systems thinking can help address the lack of capital for underserved entrepreneurs by taking a holistic and collaborative approach to investment and support.

Author Melina Harris, analyst and capital access coordinator for Philadelphia Anchors for Growth and Equity. (Courtesy photo)

Blended capital approaches offer an important tool to address critical challenges to gender and racial equity. The term is used to describe a type of financing that combines different sources of capital, such as grants, loans, and equity investments, in such a way that leverages the strengths of each type of capital while mitigating the weaknesses. Blended capital models can be a powerful tool for supporting BIPOC- and gender-diverse entrepreneurs facing barriers to accessing capital due to the financial, cultural, social, educational, and other systemic barriers, creating a customized solution that addresses the unique needs of each entrepreneur or initiative.

Systems thinking encourages us to consider the interconnectedness of different elements in a system and how they contribute to outcomes, providing a toolkit to avoid the pitfall of equating correlation with causality. Said differently, a systems thinking approach offers us a way of understanding the world that frames current outcomes and disparities due to the complex systems that produce them rather than inevitable or circumstantial conditions. One of the key concepts in systems thinking is the idea of feedback loops, which are loops of cause-and-effect relationships within a system. These feedback loops can be either reinforcing (positive feedback) or balancing (negative feedback), and they can significantly impact the behavior of a system as a whole.

When considering the lack of capital for underserved entrepreneurs, a systems thinking approach would encourage us to look beyond just the lack of capital itself and consider the other systemic barriers that may be contributing to this issue in a reinforcing or positive feedback loop, such as historical and ongoing discrimination, lack of access to education and support, and limited access to well-resourced social networks.

A gap in the average wealth of Black and white business owners can reinforce and grow the racial credit gap we see in small business financing, further deepening the wealth gap.

Consider, for example, how a gap in the average wealth of Black and white business owners can reinforce and grow the racial credit gap we see in small business financing, further deepening the wealth gap. Data collected by the Black Wealth Data Center shows that the median assets of White individuals in Pennsylvania are $101,325, while the median assets held by Black Pennsylvanians are just $8,780. This means that it is often impossible for Black entrepreneurs to source the necessary start-up capital from friends and family to initiate commercial activity.

Moreover, household incomes and home values are lower for Black business owners versus white business owners, meaning less disposable income to invest in their businesses and a stunted ability to secure small business financing due to the need for assets to secure a business loan. During the pandemic, Pennsylvania, New Jersey, and Delaware lost 627 bank branches, mostly in low-income, non-white census tracts, further limiting opportunities for residents to access capital and accrue wealth. As the credit gap grows, the opportunities for Black businesses to own and leverage their personal assets are diminished, further reinforcing the wealth gap.

Blended capital approaches can be particularly effective in addressing these systemic barriers, as they allow for the kind of flexibility and collaboration that can provide wrap-around support for diverse business owners.

Blended capital approaches allow for the kind of flexibility and collaboration that can provide wrap-around support for diverse business owners.

One blended capital model approach might leverage a partnership between a foundation addressing the racial wealth gap and a local CDFI, using philanthropic dollars to fund programs like PAGE that provide training and mentorship for entrepreneurs of color, while sourcing market-rate debt capital from the lending community to fuel business growth amongst local entrepreneurs. This type of investment would catalyze the impact of the foundation’s philanthropic dollars by connecting diverse entrepreneurs directly to aligned capital resources, while mitigating the risk taken on by the community lender via the support offered to their borrowers as they operate and grow their businesses.

In another example, philanthropic dollars can serve to de-risk follow-on investment by an impact investor at a later fundraising stage, thereby unlocking unprecedented impact for communities of color and the regional (and even national) economies in which they live. This can address the risk aversion many investors may have towards investing in underserved entrepreneurs and provide critical early-stage support to help a business to scale and succeed.

At the Economy League’s PAGE program, we’ve attempted to implement this approach through a pilot grant fund called the Hurdle Fund. In partnership with ImpactPHL and the American Sustainable Business Network, we provided six grants totaling $125,000 to an array of local, diverse businesses working with several of our anchor partners needed to cover small, fixed-cost investments such as insurance, certifications, and equipment. By providing a strategic, philanthropic intervention at the point of a probable contract between institutions and BIPOC businesses, these grants allowed the businesses to capitalize on important opportunities that will lead to sustainable growth.

In three months, Hurdle Fund grantees reported over $1.9 million in contract revenue that would not otherwise have been obtained.

Within three months of the grant disbursal, business owners reported over $1.9 million in contract revenue that would not otherwise have been obtained without removing their requisite hurdles. In two cases, the assets purchased with Hurdle Fund dollars and the subsequent acquisition of multi-year contracts with reputable anchor institutions played a critical role in the business receiving follow-on capital from local lenders who noted a significant reduction in the risk profile of the firm. These sorts of chain reactions are just one example of the catalytic power of blended capital approaches to business growth.

What could the program’s success look like if we had additional resources to formalize partnerships with local lenders and investors who could reliably provide sizable follow-on capital to these entrepreneurs? We see such examples in other East Coast cities resembling Philadelphia’s demographic and socioeconomic patterns:

• In 2016, the Chicago Community Trust launched Benefit Chicago, a $100 million impact investment fund that provides blended capital to organizations and businesses working to address the city’s most pressing challenges, including racial and economic inequality. One such benefactor includes the Chicago Neighborhood Initiatives Micro Finance Group, which provides loans to small businesses in underserved communities.
• Baltimore Impact Hub, a coworking space and innovation center, has developed a blended capital model that combines grants, loans, and impact equity investments to support Black and brown entrepreneurs. The Hub also provides training and mentorship programs to help entrepreneurs build the skills and networks they need to succeed.
• In Washington DC, the DC Inno Fund is a venture capital fund that provides early-stage funding to startups led by underrepresented founders, including Black and brown entrepreneurs. The fund’s blended capital model includes equity investments and non-dilutive funding in the form of grants and convertible notes.

Implementing a blended capital approach at scale in Philadelphia would require widespread communication and the strategic coordination of resources.

In Philadelphia, there appears to exist a wealth of resources dedicated to providing capital and financial services to underserved businesses. However, several challenges prevent this capital from reaching the “right business at the right time” or prevent such businesses from accessing these services.

Could a blended capital model be the panacea we are looking for?

By considering systemic barriers that may be contributing to this issue and leveraging different types of funding and support, we can create more effective and equitable solutions that help to level the playing field for underserved entrepreneurs. The list of potential positive outcomes abounds; higher tax revenues for schools and roads, more wealth generation for local investors and local entrepreneurs, more jobs at every level of the economy, and the inherent reduction in risk for Philadelphians who would benefit from a supported ecosystem of localized supply chains.

Let’s make Philadelphia a leader in growing diversely owned businesses through a blended capital approach.

This essay was originally published via ImpactPHL Perspectives, a multi-part series exploring the many facets of the impact economy from the perspectives of its doers, movers, shakers and agents of change. This version has been edited for style.