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Patterns of Financing: A Comparison between White- and African-American Young Firms

Patterns of Financing: A Comparison between White- and African-American Young Firms

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This short report from the Kauffman Foundation examines racial differences in access to financial capital. We focus on the role of capital injections—that is, injections of financial capital in the early, formative years after the business is started. Our results indicate that stark racial differences in capital injections after a business is formed are an important and under-studied component of the racial gap in new business formation.
This short report from the Kauffman Foundation examines racial differences in access to financial capital. We focus on the role of capital injections—that is, injections of financial capital in the early, formative years after the business is started. Our results indicate that stark racial differences in capital injections after a business is formed are an important and under-studied component of the racial gap in new business formation.

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Published by: The Ewing Marion Kauffman Foundation on Feb 28, 2009
Copyright:Attribution Non-commercial

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05/10/2014

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February 2009
Prepared By:
 Alicia M.Robb,
University of CaliforniaSanta Cruz
Robert W.Fairlie,
University of CaliforniaSanta Cruz
David T.Robinson,
Duke University
Fourth in a series of reports usingdata from the Kauffman Firm Survey
Patterns of Financing:A Comparison betweenWhite- and African-American Young Firms
Kauffman
Firm Survey
The
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Patterns of Financing:A Comparison betweenWhite- and African-American Young Firms
Fourth in a series of reportsusing data from the Kauffman Firm Survey
February 2009
KAUFFMAN FIRM SURVEY 4:PATTERNS OF FINANCING BETWEEN WHITE- AND AFRICAN-AMERICAN YOUNG FIRMS.
Kauffman
Firm Survey
The
© 2009 by the Ewing Marion Kauffman Foundation. All rights reserved.
The authors are grateful to the Kauffman Foundation for generous financial support and to the participants at the Kauffman/Cleveland Federal Reserve Bank Entrepreneurial Finance Pre-conference for helpful comments on an earlier draft.The views expressed herein are those of the authors and do not necessarily reflect the views of the Ewing Marion Kauffman Foundation.
 
KAUFFMAN FIRM SURVEY 4:PATTERNS OF FINANCING BETWEEN WHITE- AND AFRICAN-AMERICAN YOUNG FIRMS.1
Patterns of Financing:A Comparison betweenWhite- and African-American Young Firms
T
his short report examines racial differencesin access to financial capital. We focus onthe role of capital injections—that is,injections of financial capital in the early,formative years after the business is started. Ourresults indicate that stark racial differences in capitalinjections after a business is formed are animportant and under-studied component of theracial gap in new business formation. Althoughnearly three-quarters of all new firms inject capital ineither their second or third year of existence, weknow relatively little about racial differences infinancial capital use in the early years of operation.The lack of empirical evidence on this issue largelyreflects the lack of panel data with information onfinancial capital inputs in years after startup as wellas the demographic background of the businessowners. In this paper, we make use of detailedinformation on capital injections through theKauffman Firm Survey (KFS), a longitudinal study ofbusinesses that began operation in 2004. The KFStracks a panel of almost 5,000 firms from theirinception in 2004 through 2006, detailing capitalinjections, sales, employment, and ownercharacteristics. The richness of these data allows usto study capital injections in great detail.Understanding how African-American firms accesscapital markets for injections of later-stage capital isimportant for a number of reasons. Previousresearch indicates that blacks have substantiallylower levels of personal wealth, home ownership,bank loans, and startup capital (see Bates 1997;Fairlie and Robb 2008; U.S. Census Bureau 2005,Cavalluzzo, Cavalluzzo, and Wolken 2002; andBlanchflower, Levine, and Zimmerman 2003, forexample), but there is no evidence on access tofinancial capital in subsequent years among youngblack firms. We also know little about whether blackand white firms differ in the dynamics of financialcapital use—in particular, substituting betweenexternal and internal capital over time.The median level of net worth among blacks is$6,200, eleven times lower than the white level(U.S. Census Bureau 2005). Low levels of blackpersonal wealth may be detrimental to securingcapital because this wealth can be invested directlyin the business or used as collateral to obtainbusiness loans. In addition to relatively low levels ofpersonal wealth, previous research provides evidencethat is consistent with black entrepreneurs facinglending discrimination. Black-owned firmsexperience higher loan denial probabilities and payhigher interest rates than white-owned businesseseven after controlling for differences in credit-worthiness and other factors (see Cavalluzzo,Cavalluzzo, and Wolken 2002; Blanchflower, Levine,and Zimmerman 2003; and Cavaluzzo and Wolken2005, for example). Finally, black-owned businesseshave very low levels of startup capital relative towhite-owned businesses and these differencespersist across all major industries (U.S. CensusBureau 1997, Fairlie and Robb 2008).If new black firms are constrained in their accessto capital not just at startup, but also in subsequentyears, then this could have a detrimental effect ontheir long-term performance. Of course, it also couldbe an indication that external investors expect lowerlong-term performance, and direct their capitalaccordingly. The existing literature suggests that lackof black access to capital is a potential barrier tosuccessful entrepreneurship. Indeed, there is someevidence that racial differences in startup capitalaffect the relative performance of black-owned firms(Bates 1997, Fairlie and Robb 2008).
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