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External Financing and the Survival of Black-Owned Start-Ups in the US

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Abstract

Since black-owned businesses tend to have access to lower informal financing, we hypothesize that, obtaining commercial financing should play a compensating role and have a stronger marginal effect on black-owned businesses than on businesses owned by other racial groups. Unexpectedly, we find that, while the use of commercial financing reduces the exit rates of new firms in general, the reduction is not significantly different across racial groups. We attribute this result to unobserved heterogeneity linked, at least in part, to the owner’s start-up capital and to other beneficial externalities that access to informal investors produces.

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Notes

  1. Fairlie and Robb [2008] provide a comprehensive analysis of entrepreneurial trends across racial groups. Parker [2009, Ch. 5] provides a review of the economics literature on racial entrepreneurship.

  2. Following Robb et al [2009], we use the primary owner’s information for multiple-owner firms. The primary owner is defined as the owner with the largest equity share. When owners with equal share are present, weekly hours spent in the business are used to identify the primary owner.

  3. The average number of hours per week the owner spent on the business can be viewed as an indicator of whether this is a full- or part-time venture, and as a proxy for owners’ effort. It should also be noted that the risk classes are self-reported and may not measure accurately the objective exposure to risk of failure.

  4. Business credit card shares many features of commercial bank loans because of how credit worthiness is evaluated, and because of their debt-based nature and reliance on commercial banks and financial institutions.

  5. In an alternative approach, this problem could be addressed by re-arranging the data we use for our logit estimation. Namely, we could eliminate all observations after they switch from Y=0 to Y=1. In this way, the logit model is equivalent to a discrete time logistic hazard rate model [Jenkins 1995]. We chose not to proceed with this option to avoid losing observations.

  6. In nearest neighbor matching, a firm that did not use commercial financing is matched to a firm that used it if the absolute difference of propensity scores is the smallest among all possible pairs. In caliper matching, instead, a pair is found if the absolute difference of propensity scores is below a pre-specified threshold (0.05 in our case).

  7. Results from these logit models are not shown but are available from the authors upon request. In general, they show that black businesses, businesses of other races, and businesses owned by women are significantly less likely to use commercial financing than businesses owned by white men. They also suggest that an increase in the number of full- and part-time employees significantly increases the chances of using commercial financing, whereas higher credit risk lowers it significantly.

  8. Using data from the first year of the survey, we used socio-economic and demographic variable to predict the probability of using commercial financing. Compared to white business owners, black business owners exhibit 12.7 percent lower probability of using commercial financing after controlling for demographic and socio-economic factors. This self-selection effect may be explained by several reasons including discriminatory lending, lack of information, and fear of denial.

  9. Notably, an alternative and superior specification of the model would include a dummy variable for commercial financing, the race dummies, and two interaction terms (black*commercial financing and other race*commercial financing). The coefficients on the interaction terms would then indicate whether racial differences in the effects of commercial financing are present. We use the current and equivalent specification to maintain consistency across robustness checks.

  10. It should be noted that, when the actual amount of financing is used, the exact magnitudes of the marginal effect may be biased for two reasons. First, many business owners did not report the amount even though they reported using commercial financing. This under-reporting clearly affects the estimated marginal effect. Second, the amounts of commercial financing are highly skewed among recipients with some owners receiving very large amounts and others receiving very small ones. Given these problems, caution should be used when interpreting the results shown in the Panel.

  11. Due to space constraints, the tables displaying the results of our robustness tests are not included in the paper. They are available upon request from the authors.

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Acknowledgements

We are grateful to two anonymous referees, Susan Averett, Philipp Koellinger, Roger Koppl, and E.J. Reedy for useful comments and suggestions. We thank the Kauffman Foundation for granting use of the data. Finally, Yunwei Gai acknowledges support from the Babson Faculty Research Fund. An earlier version of this paper was presented at the 2011 AEA Meeting in Denver, CO. All errors are ours.

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  1. Babson College, Babson Park, 02457, MA, USA

    Yunwei Gai

  2. Syracuse University, 900 South Crouse Ave, Syracuse, NY, 13244

    Maria Minniti

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Gai, Y., Minniti, M. External Financing and the Survival of Black-Owned Start-Ups in the US. Eastern Econ J 41, 387–410 (2015). https://doi.org/10.1057/eej.2014.23

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