March 8, 2006

Chicago, IL

Remarks by Michael Moskow at  the Third Annual Conference on Access to Capital for Minority and Women-Owned Business Enterprises:

Thank you for this wonderful honor. I am proud to accept this award on behalf of my colleagues at the Federal Reserve Bank of Chicago. Many people at the Chicago Fed are doing important work in this area, and I'm pleased to recognize their contribution.

Receiving a lifetime achievement award allows me the opportunity to step back and assess both what we've learned about the growth and development of minority- and women-owned businesses and the challenges ahead. We're at an interesting crossroads in how we address this issue.

As I mentioned at last year's event, the Fed has an ongoing interest in the vitality of small businesses, both as a regulator of financial institutions and as part of our mandate to maintain maximum sustainable growth and price stability.

For more than a decade, minorities have been starting businesses at a much faster rate than non-minorities. Recent studies show that the number of minority-owned businesses grew by almost 35 percent from 1997 to 2002, as opposed to only 10 percent for U.S. businesses overall—though this still leaves minorities underrepresented among those who own businesses.

There are 21.5 million small companies that employ 5 or fewer people—called microenterprises—that account for 28 million jobs. Sixty percent of these microenterprises are owned by women and 53 percent are owned by minorities. We know that almost 50 percent of them continue in business for at least 5 years. However, the number of minority-owned firms with sales of $1 million dollars or more has remained stubbornly unchanged at approximately 85,000 for more than a decade. In fact, minorities consistently trail non-minorities in many business performance outcomes, including sales, profits, employment, and firm survival rates.

Although there is still much to be learned about the interplay of race and ethnicity on the one hand and business success on the other, three factors—assets, experience, and education—emerge as particularly important in explaining this gap. First, low levels of personal assets have historically inhibited minorities' ability to start businesses and constrained the growth of minority-owned firms. Second, a lack of experience in family-owned businesses is correlated with minority-owned business failures, perhaps reflecting a lack of access to professional, financial, and social networks, where business opportunities are identified and developed. And finally, education and prior employment in related fields are also associated with business success.

Understanding and closing the gap in minority business outcomes could go a long way to support the long-term economic health of our local communities, so I'd like to talk a little bit about how the theory and practice of business development initiatives have evolved. In 1994, the year that I became president of the Chicago Fed, business assistance policy and practice focused almost exclusively on access to credit for start-ups and very-early-stage businesses, just as it had in the 1960s and 1970s. Discussions about financial assistance for small businesses focused on the need for small loans for start-up companies and the need to be vigilant against race and gender biases or discrimination in the small business credit market. Technical assistance provided to businesses focused on educating individuals about how to write a business plan, the difference between balance sheets and profit and loss statements, and other business basics.

Over the 11-1/2 years that I have been with the Fed, we've learned some important lessons. Our research has shown that entrepreneurs from diverse ethnic and racial backgrounds gain access to small business financing in different ways. Entrepreneurs, across all categories, find creative—and sometimes expensive—ways to finance their businesses, including credit cards, trade credit, personal savings, and money from family and friends. But in comparing access to start-up and early-stage credit and capital for black- and Hispanic-owned businesses, those companies started by blacks use only about one-half as much start-up capital as comparable Hispanic businesses, which are more likely to use supplier-provided trade credit.

In 1999, the Chicago Fed convened the Small Enterprise Capital Access Partnership (SECAP) to examine the issues of small business development and access to credit and capital in historically underserved areas of Chicago. SECAP participants, while recognizing the credit and other needs of start-ups, also emphasized the demand for "patient capital" to grow businesses and a more sophisticated and comprehensive small business counseling infrastructure. Staff from the Chicago Fed and SECAP partners developed a publication, called TAP Basics, that is designed to improve the consistency and quality of technical assistance provided to small businesses. The SECAP partners also noted that financial institutions should continue to strive to expand their small business lending to underserved areas.

Recent studies also note the critical role of community banks in lending to this market segment, and by all accounts, commercial lending will remain one of the most important sources of financing for young firms. And private equity investments, such as venture capital, angel investments, and targeted equity pools, are forms of early-stage investment that can nurture the most promising minority entrepreneurs. But to expand the supply of "patient capital" that young minority-owned firms need will require additional sources of funds that recognize the financial opportunities from funding minority-owned emerging companies. Such specialized sources include other types of private equity investment, which I understand you'll be discussing later today.

While we have learned a lot about how to lend to and assist small businesses in general, and minority- and women-owned businesses specifically, there is still much that we do not know. For instance, we don't know what is inhibiting those minority-owned businesses from growing to be larger firms.

Some businesses, I'm sure, are started and not expanded beyond a certain size because the owners want to have manageable firms that avoid the complications of larger enterprises. They have found a profitable niche to fill and are comfortable at that level. Some minority-owned businesses—we don't know how many—may be successful enough to grow through the addition of venture capital partners. But if those venture capital partners are not minorities, then the companies would no longer be classified as minority-owned businesses or included in the data. So we clearly need to learn more about the impediments to growth for minority-owned companies.

Some approaches to these issues that I think are worth watching closely over the next decade are greater corporate involvement, new financing methods, and financial and technical assistance at every stage of growth.

First, let me discuss how greater corporate involvement in these initiatives is making a difference. Last summer, the Federal Reserve Banks of Chicago and Boston partnered with the Business Roundtable to host a national conference on corporate engagement in minority supplier development. Participants articulated several obstacles to more widespread adoption of best practices in minority supplier development by American corporations. But a highlight from the conference was a keynote address from Bill Davis, retired CEO of R.R. Donnelly. Bill made the case for his peers to become fully engaged in these issues, both because there are competitive advantages for the corporations involved and because our communities need it.

I also recently heard a presentation by a division of Milwaukee-based Johnson Controls, one of the 145 Fortune 500 companies headquartered in the five states that comprise the Chicago Federal Reserve District. Johnson Controls is a member of the "Billion Dollar Roundtable"—a group of 14 U.S. corporations that annually purchase at least $1 billion in goods and services from minority suppliers. Its Automotive Division is a national leader in minority supplier development through its history of responding to the requirements of the automakers for minority content in their contracts.

The Controls Division identified its future growth opportunities as being in the 50 largest metropolitan areas of the country. Recognizing the impact of demographic changes in those metro areas, it adopted a new strategy of engaging directly in the creation and development of minority-owned contractors and suppliers through mentoring relationships, partnerships, and, where appropriate, direct investment. This "Metro Strategy" also responds to the needs of the communities where it operates by getting directly involved in issues of community revitalization, education, and workforce development.

The second approach is the use of new financing methods. Community Development Financial Institutions are an example. CDFIs are private financial entities whose primary mission is to provide loans to or investment in underserved communities. The specific and unique nature of their mission puts CDFIs in a position to address the issue of access to credit in the areas they serve.

There are 70 CDFIs certified in the Chicago Federal Reserve District, including 38 in Illinois. Many of these CDFIs offer small business loan products, such as subordinated loans and credit to purchase franchise operations, and other support services. A few even offer equity capital. One CDFI that is headquartered here in Chicago has invested $2.5 billion directly in underserved communities throughout the country, including more than $30 million in equity funds to support small businesses.

CDFIs are also a principal conduit of the federal New Markets Tax Credit program, which supports small business development in low-income communities. In the last three years, over $2 billion in equity has been invested in low-income communities through these credits. The federal CDFI fund currently has $3.5 billion in tax credits to award, though they have received $28 billion in new requests for funding. The annual award decisions are expected this spring.

A final approach that I'd like to discuss is the use of financial and technical assistance at every stage of business growth. There are many organizations providing financial and technical assistance, but I would like to highlight a new model of such assistance created by a small group of local leaders in Milwaukee. This model is designed to develop a network of technical assistance providers that can counsel growing companies at any stage of development. It was recently designated as an Urban Entrepreneur Partnership by the White House National Economic Council. The Urban Entrepreneur Partnership is a national initiative of the White House, the National Urban League, the Kauffman Foundation, and the Business Roundtable to promote minority business ownership.

One unique aspect of the Milwaukee partnership specifically targets corporations in a strategy that actively seeks opportunities to spin off corporate divestitures to qualified, well-financed minority entrepreneurs. The corporate divestitures are not subsidized. They are existing business opportunities that are provided to entrepreneurs at fair market value. But the commitment of corporate CEOs from the divesting firms to the strategy and the financial and technical assistance of the Urban Entrepreneur Partnership reduce the risk of failure for these entrepreneurs. Importantly, the Urban Entrepreneur Partnership includes specific requirements to measure the impact of minority business development over time. This kind of quantitative and qualitative assessment has been lacking in traditional business assistance programs.

In a another effort closer to home, the Chicago Fed is assisting Chicago United's efforts to promote the use of minority-owned professional services firms by large corporations and other institutions and the analysis of that program. That analysis will be conducted at the Center for Urban Economic Development at the University of Illinois-Chicago.

These are just a few examples of important new efforts to catalyze minority business development efforts. These efforts move away from highly subsidized, government-directed strategies toward locally led, public-private initiatives that leverage resources from multiple sources and emphasize both creativity and accountability to address the issue.

In closing, there is much that we have left to learn about successful minority business development initiatives, but I am encouraged by the many innovative approaches that have evolved and the specific efforts to accurately assess their outcomes. Based on these new initiatives, it is my hope that, ten years from now, we will be able to talk about the answers more than the questions and point specifically to the successes of the people in this room.

Thank you again for this honor.