As investors search for opportunities in the private markets, they may be overlooking the full potential of Latinx-owned businesses in the United States.
According to a recent report from Bain & Company, a management consulting firm, 50 percent of all net new small businesses created in the U.S. from 2007 to 2017 were Latinx-owned. Yet during the same period, only 1 percent of the investments from the top 25 venture capital and private equity firms were in Latinx-owned businesses.
“Clearly there’s a big opportunity there: Latino-owned businesses are growing faster, according to our data, than white-owned businesses, and they have better risk profiles,” Tevia Segovia, a partner at Bain and an author of the report, told Institutional Investor.
In fact, Latinx-owned businesses are growing in annual revenue at a rate of 10 percent, while white-owned businesses are growing at a rate of only 7 percent, the report said. Bain predicted a total of $1.4 trillion of revenue growth would become accessible if Latinx-owned businesses were able to achieve parity with white-owned businesses.
But the U.S. investment community has not yet recognized the potential of these minority-owned businesses.
For Latinx entrepreneurs, most of the imparity occurs around the $1 million mark. For Latinx-owned businesses, capital and resources are largely unavailable during the earlier stages of their development. As a result, Latinx business owners are more likely to rely on personal savings, credit cards, family and friends, or expensive forms of debt to jump start their businesses.
“There’s a broken cycle,” Segovia said.
According to the report, Latinx-owned businesses need to enroll double the number of investors as white-owned businesses to receive the same level of funding.
“The traditional supply chain of capitalism, in which promising growth opportunities are nourished by access to capital, is broken for LOBs,” Segovia and her co-authors wrote in the report. “LOBs face a Darwinian survival test that their white-owned peers do not face nearly as often.”
The Representation Problem
This disparity is nothing new, according to Lolita Taub, co-founder of and general partner at the Community Fund, an early-stage venture fund. Taub has written several blog posts about her work with Latinx founders, detailing the resources and opportunities available to Latinx business owners. According to Taub, the central issue for both Latinx founders and investors is representation: Currently, the venture capital industry is not representative of people across the socioeconomic spectrum. Taub said the inherent bias and homogeneity of the investor community play significant roles in which businesses receive funding.
“I believe a lot of this has to do with the ability to see opportunity across that socioeconomic spectrum,” Taub told II. “There’s so many people who are overlooked as investors because we haven’t traditionally come from super wealthy families who have invested literally generations into VC. If you have a diverse group of investors who are more representative of the country, I think there’s a huge opportunity.”
Right now, Latinx-owned businesses are underfunded at every stage of the growth cycle. According to the Bain report, only 25 percent of Latinx-owned small businesses are likely to be fully funded by smaller loans from local banks compared to 44 percent of white-owned businesses. When Latinx business owners turn to national banks for larger amounts of funding, they are “severely” underfunded compared to white-owned businesses, the report said. For instance, at a valuation of over $1 million, only 8 percent of Latinx-owned businesses received all funding sought from local and national banks for requests greater than $100,000. In contrast, 44 percent of white-owned businesses received the funding from banks.
Larger Latinx-owned businesses, defined as those valued above $1 million, also struggle with access to funding. These companies are three times less likely to seek funding from angel investors, and, if they do, they are 27 percentage points less likely than white-owned businesses to receive all of the funding they need. Segovia and her co-authors attributed these disparities to several factors, including cultural expectations, language gaps, and difficult loan approval processes.
But Samara Hernandez, founding partner at Chingona Ventures, said it all comes down to one simple truth: “The decision makers are not Latinas or Latinos.”
From Hernandez’s vantage point, much of the promising Latinx talent in the investment world is stalled at the mid- and senior levels. She said the industry lacks the resources for many Latinx employees to make the jump from mid-level and senior positions to C-suite roles. As a result, many Latinx employees who are qualified for major partner and board-level positions often end up leaving their firms to start their own businesses, Hernandez said.
“They cannot progress at their company, and they feel like they have a solution to something and they could run it on their own,” she said. “We need more people to help get these professionals to run their own businesses, to take board seats, and to be at the C-suite in many of these companies.”
As long as there’s a dearth of Latinx investors and decision makers, there will be a direct impact on Latinx founders, Hernandez said. “Many Latino entrepreneurs in the United States are not even given the opportunity to fail,” she said. “They have to find a way to make money from day one. They have to have cash flow from the beginning. And while this might be slower, they find a way to do it. Now, if they just had access to capital, if they just had the ability to get access to loans or VC, the trajectory could look very different.”
According to the Bain report, lenders and investors have recognized the opportunity in Latinx-owned businesses, including Latinx-focused small business debt lenders, Latinx-owned and Latinx-focused PE and VC firms, and social-impact firms, among others.
In the start-up space, Taub said a large challenge for Latinx investors and founders is a lack of social capital. In response to this issue, she and her husband Josh Taub, who is also a start-up investor, created a general partner and limited partner matching tool to introduce underrepresented fund managers to LPs.
Meanwhile, networks like VCFamilia, a group of current and future Latinx investors, are working to build a community for Latinx people in the capital markets.
“We need more Latinx check-writers and people who run their own funds,” Cheryl Campos, co-founder of VC Familia, told II. “It goes all the way up the capital structure.”
Last year, the National Venture Capital Association launched its Venture Forward initiative to address the lack of diversity in the industry. Maryam Haque, executive director for the initiative, told II in an email that the lack of Latinx representation in the venture ecosystem has led to missed opportunities for innovation and returns.
“More Latinx representation among check-writers in the industry will lead to more Latinx founders raising VC funding,” she said. “We are optimistic to see industry groups like Latinx VC and VCFamilia formed recently to help build community and resources to drive change.”
The Bain report also emphasized that, for change to happen, investors need to understand that the Latinx business community is not a monolith: “To start with, investors need to understand that there is, arguably, no single profile of a Latino-owned business,” the authors wrote. “Similar to any other group, LOBs are a diverse group of businesses with very different risk profiles, needs, and approaches to growing their businesses.”
Current equity providers and lenders can work to close the gap by seeking out more Latinx-owned businesses and helping them to scale, the report said. Latinx business owners can also seek more funding from angel investors, who may be more likely to provide funding to smaller businesses. Debt lenders, like banks, also have a responsibility to provide more loans to Latinx founders, Bain said.
“The way we are going to reduce the wealth gap is in getting access to capital,” Hernandez said.
In the near future, investors are also looking to expand beyond Latinx-owned businesses in the U.S. and tap into the opportunities in Latin America. In fact, Taub and her husband are currently planning a trip to Latin America where they hope to meet with people in the start-up scene and invest in unicorns. In her blog post, Taub wrote that Latin America is another untapped region for American investors. The region generates nearly $6 trillion in global domestic product and “is primed to be the next tech hotspot.”
“What I’m envisioning in my dreams is that I go and put a huge spotlight on all these incredible founders,” Taub said. “On a more personal level, one of my goals is to increase the dollars going into underestimated founders and underestimated markets, and LATAM fits there.”