There were numerous programs that sprung up in 2020 for the purpose of increasing minority ownership of businesses, and many of these are directed at supporting startup businesses formed by underrepresented entrepreneurs.  The sponsors of these programs include governmental agencies, non-profit organizations (including universities) and for-profit organizations.  It is likely that the goal of having more minority-owned businesses could be accomplished more quickly and with a greater likelihood of success if these programs gave at least equal emphasis to the transfer of ownership of mature businesses, as opposed to focusing primarily on startups.

Particularly in the Rust Belt, there are many family-owned and other privately owned businesses that are facing ownership succession as Baby-Boomer owners move into retirement.  Many family businesses pass ownership through multiple generations, but there are many others that face a sale of the entire business in order to create liquidity for retirement, a distribution of wealth among family members and other reasons.  If a family business has sufficient scale to attract another business in the same industry (often called a “strategic buyer”) or perhaps a private-equity fund (often called a “financial buyer”) that is focused on the small or middle market, the buyer will often swoop in with plans that are inconsistent with the interests of most of the target business’ stakeholders, other than the owners who are cashing out.

A strategic or financial buyer frequently has plans that wreak havoc on the community where the target business is located.  In a macroeconomic sense, this might result in a more efficient use of a country’s fixed resources as assets are redeployed to other uses, but in a microeconomic sense, this often results in plant consolidations and layoffs with corresponding long-term job losses and death of a corporate citizen.  Communities could reduce this pain by providing organized support for sales of family and other privately owned businesses to minority entrepreneurs who are members of the same communities.

According to data from the US Census Bureau, Baby Boomers own over 2 million small businesses in the United States and employ over 25 million people.  If you assume that 25 million people equates to 25 million families, it is reasonable to project that there are about 100 million US citizens, or almost one-third of the US population, that rely on the Baby-Boomer business owners to maintain momentum and make succession plans that are consistent with their host communities’ best interests.  However, a recent survey by a financial firm revealed that almost 60% of these older owners do not have succession plans for their businesses, even though the overwhelming majority of them intend to use their ownership stakes to fund their retirements.

Startups get a lot more attention than mature businesses because most of us are suckers for the “shiny object syndrome.”  However, the cold reality is that most startups fail.  For every startup that a community trumpets for its grit and innovation, there are many more that fizzled out for various reasons.  An existing business deserves more credit for its staying power.  My brother and I were recently lamenting the closure of a popular restaurant in Johnstown recently, and then I exclaimed “but it has been around over 50 years!”

There are a number of ways for communities and organizations to support the purchase of small businesses by minority entrepreneurs, such as mentoring and networking.  The biggest issue, however, is always funding, but that issue is even more difficult with startups, where the investment risk is much bigger.  The various commercial banks, investment banks and venture capital funds that have been announcing their respective commitments to minority-owned startups could provide pooled or individual loan facilities for buyouts.  In the same way as lenders have been financing leveraged buyouts for many years, the lenders could provide term loans for the buyouts plus revolving lines of credit for operations.

There is no shortage of financial institutions that are trying to get more involved with minority businesses.  Goldman Sachs has its Launch With GS program that entails a $500 million investment strategy to “increase access to capital and facilitate connections for women, Black, Latinx and other diverse entrepreneurs and investors.”  In the fourth quarter of 2020, JP Morgan Chase announced an investment increase of $30 billion over the next five years “to provide economic opportunity to underserved communities, especially the Black and Latinx communities.”  Additional financial firms that have announced racial equity programs include Citibank, Bank of America, Morgan Stanley and Andreessen Horowitz.

With most of the money invested in venture-capital and private-equity funds coming from institutional investors such as college endowments, pension funds, and insurance companies, it is surprising that these investors have not applied more pressure to increase investments in minority ventures.  For example, only 1% of VC-backed founders are Black, and less than 2% are Latinx.  Some investment managers may argue that their primary duty is to maximize returns irrespective of the nature of the companies in which they invest, but there are plenty of studies to refute an argument that the investment funds would be sacrificing returns in order to “do the right thing” by promoting diversity.  Investors have used this clout previously—the Climate Action 100+ initiative comprises nearly 550 institutional investors representing over $52 trillion in assets under management that have organized to apply market pressure on companies to make more climate-friendly choices.

I cannot claim credit for the idea of steering minority entrepreneurs to family-owned and other privately-owned businesses as a means of boosting minority ownership of businesses.  Cincinnati’s Minority Business Accelerator recognized this opportunity (along with promoting less mature companies), and the director of the Metro Finance Lab at Drexel University has suggested that Philadelphia follow Cincinnati’s lead.

With all of that said, I am still a huge fan of startups as means to “grow the pie” by adding to the economy’s total jobs, but dealing with the massive transfer of Baby-Boomer ownership may be a quicker and more certain means of increasing minority ownership of businesses.

 

This post was authored by Tom Sharbaugh, professor of practice at Penn State Law, director of the law school’s Entrepreneur Assistance Clinic and former deal lawyer who handled many owner-succession transactions.