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April 5, 2021 Q&A

Why Black and brown entrepreneurs struggle to raise capital

Mariah Lichtenstern is the founding partner of DiverseCity Ventures and managing director of the Founder Institute, Sacramento Chapter. She is an Aspen Tech Policy Hub Fellow and author of the policy paper, “Removing Barriers to Startup Capital: Democratize Accreditation.”

Anthony Price

In a recent interview she discussed challenges minority entrepreneurs face in accessing capital and what can be done about it. Here’s what she had to say:

Q: What would you say is the state of raising capital for Black and brown company founders these days?

Well, I’m optimistic, but currently less than 1% of venture capital (VC) goes to Black and brown founders. That number has not increased even with all the attention that we’ve seen in 2020.

It’s pretty dismal considering the number of people of color in the pipeline. What’s even more concerning to me is how many people are excluded from the pipeline of VC fundability because they don’t make it through the friends and family round.

What do you mean by the friends and family round?

Usually, it’s expected that before a company is eligible for VC funding, it has a team, it has a product, it has some traction.

Ideally, what institutional investors want to see is that you’ve identified channels where once you receive investment, you can put fuel in the rocket ship and [you are] ready to go.

To arrive at that, you generally need a friends and family round to build your product, to do enough marketing, to identify your channels, and validate your channels. By channels, I mean sales channels, whether it’s Facebook ads or trade shows or whatever the case may be.

The average that it takes to build on to that stage is somewhere around $100,000. This friends and family round is when you raise capital. People who know you, trust and respect you, and are willing to put their money at risk.

Unfortunately, because of the wealth gap in this country, white households have 10 times the wealth of Black households and Latinx households, on average.

That is, in essence, what the wealth gap is. You see far fewer people who are able to invest in founders of color, especially when you consider the Securities and Exchange Commission (SEC) rules and the type of offerings that non-accredited investors can invest in.

You mentioned how white families have more wealth compared to Black families. How did we get to this point where there’s such a huge disparity in wealth?

I would say economic engineering, to be concise. Historically, Black people were disproportionately impacted by the economic devastation that was happening across the country. They had been left out from relief.

It was 1933 when the Securities Act came out. Then in 1934, the Securities and Exchange Act came out, which formed the SEC. In that same year, Franklin D. Roosevelt formed some other federal agencies, which included the Federal Housing Authority (FHA), Home Owners Loan Corp. (HOLC), and National Recovery Agency.

Within FHA and HOLC, they codified policy that excluded Black people from receiving loans to purchase homes within their communities, excluded them from owning or purchasing or building homes within white communities, and prevented people who were non-Black from owning, purchasing, or building homes in what were considered Black communities.

That has now come to be known as redlining.

When you look at the analysis of why we have this wealth gap at all, it points to redlining, essentially the real estate dynamics.

It seems like we have an apartheid of investing for Black and brown founders. Would you agree with that?

You hit the nail on the head in calling it a form of economic apartheid. It’s very nefarious, because it’s covert.

The SEC standards for what constitutes an accredited investor are $200,000 a year [for individuals], $300,000 for households for at least the previous two years, or a net worth of $1 million, excluding the personal residence.

When you look at who is accredited in America, only 10% to 15% of American households qualify — only 1.3% of these are Black and 2.8% are Latinx.

In 2020, the SEC expanded the definition of an accredited investor. It seems that these rules are having a disparate impact on people of color. What do you propose as a solution to this problem?

Yes, on Aug. 26, 2020, the SEC did revise the rules. It opened it up to venture capitalists like myself to be accredited and for people who hold a Series 7, 65 or 82 license. It doesn’t open it up to securities attorneys or to CPAs or CFAs or a whole host of other professions that are arguably sophisticated.

What I am proposing and petitioning the SEC to do is to allow people to complete a self-attestation form that says, ‘I am aware of the capital and liquidity risks of this investment. I am personally sophisticated or I have access to sophisticated advisors, such as attorneys, investment advisors, CPAs and the like, and I want to make this investment.’

I think if the SEC requires that issuers have their investors sign this attestation, then they can make sure that investors are aware of what the risks are.

Anthony Price is the founder and CEO of Connecticut-based LootScout, which counsels small businesses how to raise capital and publishes Mini Books.

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