Minority-Owned Businesses Present Opportunities for Online Lenders

Research consistently shows that minority-owned businesses have a harder time accessing capital than other businesses. Online financing has the potential to change this.

Most of the online funding process is based on objective factors such as your business type and revenue. When you apply for funds online, it’s harder to discern things like the color of your skin or your ethnicity—factors which research shows can sometimes play into the face-to-face lending process, even though it’s illegal and immoral. What’s more, applying for funds online eliminates the stigma that keeps many minority-owned businesses from walking into a bank to apply for a loan, according to industry participants.

“Many minorities are hesitant to go into a bank,” says Louis Green, interim president of The National Minority Supplier Development Council, which provides business development opportunities for certified minority-owned businesses. He says the growth of online lending platforms will potentially open more doors for minority-owned businesses to get much-needed capital to operate and expand.

“The beauty of things on the Internet is that it has the ability to take away discriminatory issues,” says Green, who is also the chief executive of Supplier Success LLC, a Detroit-based business that offers online business financing solutions.

Certainly, minority-owned small businesses are a large and growing market. There were 8 million minority-owned firms in the U.S. as of 2012, according to U.S. Census Bureau data. Minority-owned firms represented 28.8% of all U.S. firms in 2012.

Historically, however, minority-owned businesses have had trouble getting access to credit for a host of reasons, and recent research suggests the problems persist.

A report published in November by the Federal Reserve Banks of Cleveland and Atlanta examines the results of an annual survey of small business owners. The report found that while many minority small businesses were profitable, a significant majority faced financial challenges, experienced funding gaps and relied on personal finances.

Some of the trouble obtaining financing may have discriminatory underpinnings. For instance, a recent working paper by researchers at Utah State University, Brigham Young University and Rutgers University, among others, suggests that minorities were more highly scrutinized for loans than other applicants. For instance, African American “mystery shoppers” underwent a higher level of scrutiny and received a lower level of assistance than their less-creditworthy Caucasian counterparts, according to the study.

Also, African American testers were asked significantly more often about their marital status and their spouse’s employment. This “marks another and even illegal differential experience for these minority entrepreneurial consumers compared with the Caucasian shoppers,” the study finds.

To be sure, other factors are also likely to blame. For instance, the average credit score of a minority small-business owner is 707, which is 15 points lower than the overall average for small-business owners in the U.S., according to a 2016 study by credit bureau Experian.

Even so, the bias issue remains a stark possibility in at least some cases. A 2010 report by the Minority Business Development Agency (MBDA) offers data to show that minority-owned firms are less likely to receive bank loans than non-minority-owned firms. Among all minority firms, 7.2 percent received a business loan from a bank compared with 12.0 percent of non-minority firms, according to the report. High sales minority-owned firms were more likely to receive bank loans with 23.3 percent receiving this source of startup capital. By contrast, 29.2 percent of high sales non-minority firms received bank loans, the data shows.

To be sure, it’s very difficult to prove discrimination when a bank loan is denied. A few years ago, a mortgage banker who asked not to be named, says he suspected discrimination when an Asian couple he worked with was denied a small bank loan. While he didn’t have rock solid proof, he felt the bank’s stated reasoning for turning down the loan was unjustified and he tried going to bat for the couple. His efforts were rebuffed, however, and the loan was denied.

Based on the size of the loan and the couple’s finances, the banker says the loan would have easily been approved by an online provider that was looking only at objective factors. “They see the numbers they’ve been given and calculate risk and make decisions based purely on numbers,” he says.

Indeed, this is where online lending has already shown significant potential. Alicia Robb, a research fellow at the Atlanta Federal Reserve who co-authored the November report by the Cleveland and Atlanta Federal Reserves, says when controlling for credit score and other business-related factors, the data shows that minority businesses have a better shot at getting loans approved online than they do at a large or small bank.

Industry participants say the online funding process can be a boon for minority business owners because it strips subjective reasoning out of the decision-making process. Instead of presenting themselves, applicants are presenting what their business looks like financially, and funders are making highly automated decisions based on the information provided.

“Humans make terrible decisions. The more you can eliminate human bias in the process the better,” says Kathryn Petralia, co-founder and president of Kabbage. She says 95 percent of the online lender’s customers have an entirely automated experience, which includes validating their identity using digital processes. “We never see a picture of them or know anything about their ethnicity or demography,” she says.

Even funders who do ask for photo identification say that doesn’t happen until after applicants have been approved. And even then, it’s just to “make sure that the person you are funding is actually the person you are funding and no one is trying to defraud you,” says Isaac D. Stern, chief executive of Yellowstone Capital LLC, a MCA funder in Jersey City, N.J. “Online financing is colorblind. It doesn’t matter if [you’re] white or Hispanic or black,” he says.

Dean Sioukas, chief executive of Magilla Loans, an online search engine that matches prospective borrowers and lenders, has hope that the anonymity of the online funding process could eventually make the off-line process more equitable for all applicants. After accepting a number of solid proposals from viable lending opportunities—without knowing any personal information about the applicant—his hope is that whatever biases a loan officer may previously have had will dissipate, he says. Funding decisions should only be made on objective criteria, he says. “The rest has no place in the process.”

While in theory online lending should improve access to funds for minority-owned businesses, several industry observers say barriers remain.

One major challenge is getting the news out to minority business owners, many of whom don’t know about the online funding opportunities that exist, says Lyneir Richardson, executive director of The Center for Urban Entrepreneurship and Economic Development, a research and practitioner-oriented center at Rutgers Business School in Newark, N.J.

He suggests online lenders and funders need to do a better job of connecting with minority-owned businesses and explaining what they have to offer. He works with about 300 entrepreneurs, 70 percent of whom are minority-owned businesses. He’s held this position for 10 years, but says he’s never been approached by an online lending company to market its services, speak at one of his events, provide funding advice to business owners or in any other capacity.

“There is an opportunity for online small business lenders to market and make known, particularly to minority business owners, that they have viable, market rate lending products that can help them grow,” he says.

One caveat is that rates online are often higher than traditional bank loans, so there is a trade-off for minority-owned businesses, says Brett Barkley, a senior research analyst in the community development department at the Federal Reserve Bank of Cleveland, who co-authored the November report.

Other research from the Federal Reserve shows that satisfaction levels were lowest at nonbank online lenders for both minority- and nonminority-owned firms compared with borrower satisfaction levels at small banks and large banks, he says. The satisfaction levels seem to be related to higher interest rates and “lack of transparency,” he adds. While the study doesn’t define the latter term, the findings could “point to confusion regarding the actual terms of the loan,” Barkley says.

Some online firms have taken steps to make pricing more transparent by using the SMART Box disclosure agreement, a comparison tool developed by the online lending industry to help small businesses more fully understand their financing options. There are currently three different versions of the SMART Box disclosure –for term loans, lines of credit, and merchant cash advances.

This “is a really important metric,” says Petralia of Kabbage, which offers the tool to customers.

Green, the interim president of NMSDC, says that helping its 12,000 minority-owned business members gain access to capital is a major goal for the organization. While online financing is still a largely “untapped resource” for minority businesses, it makes borrowing money easier and more appealing. “It holds great promise for minority-owned businesses, but I think the reality hasn’t met that promise yet,” he says.