A comparison of average revenue growth after the financial Crisis
Because women-owned businesses are smaller, with fewer financial resources, they are less resilient to economic shocks. It happened after the financial crisis of 2007-2009, and without intervention, it will happen again during the age of Covid-19.
What if a source of financing could help women entrepreneurs rebound faster and grow stronger, healthier businesses despite the pandemic?
There is. In 1994, with tremendous bipartisan support, Congress created Community Development Financial Institutions (CDFIs) to provide affordable financing to women, minority, and other underestimated entrepreneurs.
CDFIs are mission, not profit-driven. They have lower requirements regarding years in business, credit score (or no credit score), and collateral. Entrepreneurs still have to prove that they’re creditworthy, but CDFIs work with entrepreneurs whom banks typically turn away. CDFIs have proven that financing women- and minority-business owners are NOT risky.
Such investments are profitable because the risk is managed by providing technical assistance. Borrowers receive free guidance to help them succeed. Technical assistance may include helping develop a budget with projections, producing financial statements, business planning, and improving or establishing a credit score.
Recognizing that CDFIs are the economy’s first responders, government, banks, corporations, and philanthropists poured a historic amount of funding into CDFIs.
“CDFIs are very effective at both capitalizing small businesses and reaching diverse communities that sometimes are unable to access traditional financial services,” said Jenny Flores, head of Small Business Growth Philanthropy at Wells Fargo.
Wells Fargo donated fees it made from the Paycheck Protection Program (PPP)—$250 million—to CDFIs, commented Flores. The money was provided as a grant. Grants can be restrictive in the way the money is used. CDFIs know what their local communities need best. Wells Fargo led the charge in giving flexible non-restrictive dollars. Money was used not only to lend but as leverage to raise more capital, lower interest rates on loans to 3%, cover loan losses, and even provide direct grants to small businesses.
As the banking industry changes, the role of CDFIs is growing. “The community banking segment has been dramatically shrinking over the last two decades,” said Bailey DeVries, associate administrator, Office of Investment & Innovation U.S. Small Business Administration. This impacts small businesses. These small banks are more likely to approve financing to nonemployer and employer small businesses than large banks and online lenders, according to Small Business Credit Survey 2021: Report on Nonemployer Firms by the Federal Reserve Banks. CDFIs are filling the gap. “We’re seeing growth in terms of the number of CDFIs, particularly those that are pursuing bank thrift licenses.”
Importantly, better data and technology can and are changing traditional banking underwriting models and widening the parameters of who is considered loan-worthy, commented DeVries.
Debt is not well suited for most startup small businesses. They need time to generate enough cash flow to pay back a loan plus interest. Equity investments are usually for scaling startups that could generate hundreds of millions in revenue and provide liquidity to investors through an IPO or acquisition. “However, the vast majority of new businesses created in the U.S. today are Main Street businesses, not venture-backable startups. They don’t fit the revenue and growth profile for venture underwriting standards. Yet, many of these businesses would benefit from equity investment and need capital sources,” said DeVries.
“It’s important to ensure that we have a capital stack that reflects the needs of diverse businesses wherever they are in that growth curve,” said Flores. “There are systemic barriers that make access to capital harder for women entrepreneurs, especially those who are Black and Latina,” said Candace Waterman, president & CEO at Women Impacting Public Policy.
Women have less savings to bootstrap their businesses, their friends and family have less money to gift or invest, they’re less likely to own a home to use as collateral for a loan, and their networks are smaller, making referrals to funders less likely.
Capital needs are also very different depending on the stage of business or whether you are a solopreneur, small business, supplier to government and corporations, or high-potential growth firm. From traditional loans to funding CDFIs to providing non-dilutive equity financing to venture capital, Wells Fargo is looking at how it can fund every type of business run by women.
The federal government is looking at this, too. The Small Business Administration’s (SBA) Small Business Investment Company (SBIC) program provides money to funds dedicated to investing equity or providing loans to small businesses. Many SBICs are managed by community banks and a growing number of CDFIs. The SBA increases the available pool of long-term investment capital available to the SBIC funds by matching private investments from pension funds, foundations, banks, and high-net-worth individuals on a two-to-one basis.
“The return expectations from an SBIC fund managed by a CDFI or [minority deposit institution] MDI can be very different from a venture capital fund. While venture funds seek to invest for equity in businesses capable of producing doubled-digit revenue growth, an SBIC fund might invest in businesses with lower but steady and consistent revenues, and produce compelling returns with less risk for private investors as a result of the SBA funding and guarantee. ” said DeVries.
The SBA also offers other loan products which have affordable interest rates, long terms, and higher-than-bank credit limits. It doesn’t lend directly to entrepreneurs. Instead, it partners with lenders to guarantee loans to entrepreneurs through CDFIs as well as banks, credit unions, and online lenders to provide working capital and fixed-asset loans, making it more likely that the loan will be approved.
Even with all the attention that CDFIs are getting from policymakers and funders, awareness among entrepreneurs is low. “It’s going to take a concerted and collaborative effort to raise awareness of this funding source,” said Waterman, such as: