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Provide feedback on the strengths and weaknesses on the below work as well as recommendations to improve or strengthen it. A quality response is based on theoretically sound and empirically-supported arguments. If you agree or disagree with your colleague, you must articulate a plausible argument for the agreement or disagreement. Plan to use 150-200 words

Disparities in Capital Access and Impact to Entrepreneurship in Communities of Color

Entrepreneurship is key to Americas capitalist market driven economy; however, not all market participants enter on equal footing. The absence of generational wealth and its inherent ability to self-fund business ventures requires entrepreneurs to seek business start-up, expansion, and emergency capital from others. Entrepreneurs of color face a variety of persistent barriers to access both the traditional and non-traditional funding that they need to capitalize business ventures. Demographic trends of the nation and specifically Minnesota continue to show a population that is quickly becoming more racial and ethnic diverse (Dayton and Lee, 2020). If public policy leaders fail to acknowledge and address systemic credit failures by implementing public policy that supports permanently lifting up this increasing share of the population, then entire communities will not reach their fullest economic potential and share in the prosperity that entrepreneurship can provide successive generations.

Our research aims to quantify the impact on entrepreneurship due to disparities in credit access by comparing the rates of credit approval and business performance metrics of white-owned and black-owned businesses. The recent COVID-19 crisis exemplified the need for credit access equality; only 43% of black-owned firms that applied for the Paycheck Protection Program received the federal funding they sought while 79% of white-owned firms received their entire request (Federal Reserve Bank of Atlanta, Boston, Chicago, Cleveland, Dallas, Kansas City, Minneapolis, New York, Philadelphia, Richmond, St. Louis, & San Francisco, 2021). This research question is important to community based nonprofit organizations, local, state, and federal governments as well as ancillary industries such as banking, professional services, and higher education. The topic of minority entrepreneurship has well been studied throughout the last fifty

DISPARITIES IN CAPTIAL ACCESS AND ENTREPRENEUSHIP 5

DISPARITIES IN CAPTIAL ACCESS AND ENTREPRENEUSHIP 5

years; wealth inequality and a lack of trust in traditional banking serve as systemic barriers and contributes to disparities (Bates, Bradford, and Seamans, 2017). In a survey by the Federal Reserve (2021), black-owned firms were half as likely as white-owned firms to obtain all of the financing they sought despite both reporting good credit scores. Regulators, lenders, and public officials can use our results to collaboratively shape lending and public policy to tackle this wicked problem.

Hypothesis and Literature Review

Access to capital from traditional and non-traditional sources expands entrepreneurship opportunity in communities of color. Banking in the United States has relied on the art of salesmanship with a sprinkle of science to assess risk since the 1890s; this foundation of science was erected during periods of history marred with racism, redlining, restrictive covenants, and the great depression (Rotheli, 2013). Remnants of poor banking and public policy lingers on the personal balance sheets of entrepreneurs and potential entrepreneurs of color for generations. The banking industry today relies slightly less on salesmanship and more on data driven decisions rooted in data science and its cousin big data. However, it is unclear how predicative analytics in banking have led to equality in lending decisions by limiting the effect of personal characteristics when making credit decisions.

Communities of color are more often unbanked or underbanked exacerbating limited access to credit. According to data from a 1993 and 1998 survey, black-owned businesses were denied credit at nearly three times the rate of white-owned businesses (Blanchflower, Levine, and Zimmerman, 2003). And when offered credit they received less favorable terms resulting in their business paying more for the same capital leading to lower business profitability. Accepting less

DISPARITIES IN CAPTIAL ACCESS AND ENTREPRENEUSHIP 5

DISPARITIES IN CAPTIAL ACCESS AND ENTREPRENEUSHIP 5

favorable terms may have a compounding impact on businesses and limit their ability to grow its assets and sales through future expansions. In extreme examples the additional debt service cost may place such a burden on profitability that the business will ultimately fail. Blanchflower, Levine, and Zimmerman (2003) concluded that significant evidence of barriers exist for black-owned businesses far beyond observable differences in creditworthiness. The federal government through the Community Reinvestment Act and the Small Business Administration plays a vital role in access to business credit.

The Community Reinvestment Act requires that certain commercial banks collect and report data related to small business lending. Todays entrepreneurs of color are well educated, have acquired expertise in a variety of fields, and are well positioned to successfully start new enterprises with the assistance of financing. In a recent report, black-owned business had application rates twelve and nine percentage points higher than white-owned business in 2016 and 2019 respectively; however, approval rates in 2021 for black-owned businesses were nineteen percentage points loweran abysmal performance (Board of Governors of The Federal Reserve System, 2022). Economic commentary published by the Federal Reserve Bank of Cleveland hints at patterns of credit inequities; it also called out potential differences in business size and industry type that may contribute to errors (Meyer and Schweitzer, 2022). Industry wide effort to anonymize the use of data and focus on credit profiles and scores may have baked racism into the proprietary formulas used to grant credit thereby perpetuating disparities.

Newly formed businesses generally dont have credit profiles and lending decisions are often determined based on the credit worthiness of the principal entrepreneur. Lenders use this consumer credit behavior to help assess risk; however, if the borrower has not traditionally been the

target customer then they may not have credit scores or profiles traditional financers seek. With less generational wealth, lower homeownership rates, and a credit scoring system that only portrays to not disenfranchise minorities or women the outlook for credit equality is bleak. An analysis of business credit profiles published in 2015 supports claims of discrimination in credit scoring models and hypothesis the use of proxy data may be the culprit; the most disturbing observation was that when credit scores are equal, people of color were victims of a synergistic negative effect of being offered credit lees often, with worse terms, and received lower credit line amounts (Henderson, Herring, Horton, & Thomas, 2015).