Recent research by our team at the Pepperdine University Graziadio School of Business and Management found that minority-, women-, and foreign-owned businesses have far fewer successes raising funds from venture capital and private equity investors than other businesses.
Our study examined single round venture capital (VC) or private equity (PE) financing in order to determine revenue and employment growth (or destruction) that occurs with PE versus VC financing at small and mid-sized establishments, and we looked at what business-owner characteristics were associated with increased rates of success in securing PE or VC financing.
We found that both PE and VC financing significantly and positively affect a business’s net sales and employment growth rates. However, we found that the positive impact of PE financing on a business materializes about a year after the company received funding and persists for three years after funding. Conversely, the impact of VC funding is realized immediately and lasts for about two years.
Thus, while the impact of VC funding on growth is immediate, its effects are shorter-lived than those of PE financing.
Overall, we were pleased to find that VC and PE financing could make a quantifiable difference in growth and employment to small and mid-sized businesses — especially since increasing percentages of businesses indicate that they will pursue capital and financing in the next six months.
However, we were alarmed at the extent to which a business owner’s ethnicity, gender, and nationality affect that owner’s chances of being funded. Minority, women, and foreign business owners were 22.2%, 18.7%, and 17.9% less likely to receive VC financing, respectively.
The low percentages are not because of a scarcity of women and minorities needing cash for their ventures. The U.S. Small Business Association indicates that women accounted for 36 percent of business owners in 2012, while minorities accounted for 14.6 percent.
A growing number of investment companies, startup accelerators, incubators, and mentorship-based programs that offer funding upon completion target women-owned and minority-owned businesses for financing. Still, the unquestionable difference in financing success rates raises the question: Does the low level of VC and PE funding reflect systemic discrimination, or does it reflect unique challenges and factors faced by these business owners, such as personal wealth inequality?
Regardless of the reasons, investors are missing a significant opportunity to better local and national economies if they continue to bypass funding opportunities for women and minorities.
American Express OPEN reports that there are 9.1 million women-owned businesses in the United States, generating more than $1.4 trillion in revenues and employing 7.9 million workers. Similarly, businesses owned by minorities produce nearly $700 billion in total sales and employ 5 million workers with an annual payroll of $120 billion. These jobs are located across the nation, with many of them in minority and economically-depressed communities.
By 2042, the U.S. Census projects that the U.S. population will be “majority minority.” It is incumbent on the investment community to recognize the disparities in accessing capital, embrace that innovation and growth are driven in great part by diverse business contributions, and remove the barriers to successful financing.
John K. Paglia, PhD, MBA, CPA, CFA is Associate Dean of Fully Employed Programs, Associate Professor of Finance at Pepperdine University Graziadio School of Business and Management.
Maretno Agus “Augus” Harjoto, PhD is Associate Professor of Finance at Pepperdine University Graziadio School of Business and Management.