Barriers to Entrepreneurship in Low and ModerateIncome Communities

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Barriers to Entrepreneurship in Low- and
Moderate-Income Communities
Milken Institute October 2009
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Overview

• The importance of entrepreneurial activity to
  economic growth and social welfare.
• The state of lending to businesses in low- and
  moderate-income communities.
• A newly constructed measure of loan bias.
• A review of datasets and the empirical and
  theoretical literature.
• Regulatory stumbling blocks that impede
  entrepreneurial activity.
• An alternative approach to trying to identify
  those factors that help explain the differences
  in entrepreneurial activity across geographical
  region

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Economic Importance of Entrepreneurship
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Business Ownership Rates Vary Across Demographic
Groups
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Shares of Business Loans and Population
Uncorrelated
Loans to Businesses in Low- and Moderate-Income
Communities
Loans to Businesses in Low- Income Communities
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Measures of LI and LMI Loan Bias

• Deviation from proportionality of
• Share of loans to businesses in LI (LMI)
  communities in a MSA
• and the share of the total population in a MSA
  comprised by LI (LMI) individuals
• 1-(share of loans/share of population)

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Loan Bias Population and Business Loan Shares
Most Bias
Least Bias
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Shares of Business Loans and Income Uncorrelated
Loans to Businesses in Low- and Moderate-Income
Communities
Loans to Businesses in Low- Income Communities
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Measures of LI and LMI Loan Bias Income and
Loan Shares

• Deviation from proportionality of
• Share of loans to businesses in LI (LMI)
  communities in a MSA
• and the share of the total income in a MSA
  comprised by LI (LMI) individuals
• 1-(share of loans/share of income)

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Loan Bias Income and Business Loan Shares
Most Bias
Least Bias
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Entrepreneurial Activityin MSAs

• An examination of factors that may help to
  explain variation in entrepreneurship across
  geographic regions (MSAs)
• Data for 204 MSAs from all 50 states
• Size of firms is used as a measure of
  entrepreneurship
• We consider establishments grouped into four
  different size categories (0, 1-10, 10-100, and
  100 plus employees) as well as all establishments
  combined.

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Empirical Model

• ESTij a ß 1?Dij ß2?Pj ß 3?Fij eij
• ESTij establishments for MSA i in state j
• Dij demographic variables for MSA i in state j
• Pj tax rate for state j
• Fij financial variables for MSA i in state j
• eij error term

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Empirical ResultsDependent Variable Total
Number of Establishments in MSA

• The greater the total number of establishments
• the greater the share of population in the 25-44
  age group,
• the greater the homeownership rate,
• the greater the number of financial institutions,
  
• and the greater the total number of loans made in
  an MSA to all businesses.
• To the extent that a variable increases the
  total, any tradeoff between that variables
  effect on the size composition of establishments
  diminishes.

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Empirical ResultsDependent Variable Proportion
of All Establishments with 0 Employees in MSA

• The greater the share of total establishments
  that are 0 employee establishments
• the lower the share of the population aged 25 to
  44,
• the higher the household income,
• the smaller the percentage of the labor force
  with a college degree,
• the smaller the share of the labor force with a
  high school diploma or less,
• the greater the race/ethnic mix of the
  population,
• the lower the state sales tax rate,
• the larger the number of financial institutions,
• the lower the number of branches per institution,

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Empirical ResultsDependent Variable Proportion
of All Establishments with 0 Employees in MSA
(Continued)

• The greater the share of total establishments
  that are 0 employee establishments
• the lower the deposits per institution,
• the greater the number of loans,
• the lower the average loan size,
• the lower the share of the total amount of loans
  to businesses in LMI communities,
• the larger the share of the total number of loans
  to businesses in LMI communities,
• and the lower the share of the total number of
  loans made to businesses in low-income
  communities.

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Empirical ResultsDependent Variable Proportion
of All Establishments with 1-10 Employees in MSA

• The greater the share of total establishments
  that are 1-10 employee establishments
• the lower the share of the population aged 25 to
  44,
• the higher the household income, the higher the
  percentage of the labor force with a college
  degree (in two of six regressions),
• the higher the share of the labor force that has
  a high school diploma or less (in three of six
  regressions),
• the lower the state sales tax rate,
• the lower the average loan size,
• the greater the share of the total amount of
  loans to businesses in MI communities,
• the lower the share of the total number of loans
  to businesses in MI communities,
• and the greater the share of the total number of
  loans made to establishments with receipts of
  less than one million dollars.

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Empirical ResultsDependent Variable Proportion
of Establishments with 11-100 Employees in MSA

• The greater the share of total establishments
  that are 11-100 employee establishments
• the greater the share of the population aged 25
  to 44,
• the higher the poverty rate,
• the higher the state sales tax rate,
• the higher the number of branches per
  institution,
• the higher the amount of deposits per
  institution,
• the higher the average loan size,
• and the larger the share of the total number of
  loans to businesses in LI communities.

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Empirical ResultsDependent Variable Proportion
of Establishments with 100 plus Employees in MSA

• The greater the share of total establishments
  that are 100 plus employee establishments
• the higher the population of the MSA,
• the higher the share of the population aged 25 to
  44,
• the lower the household income,
• the lower the race/ethnic mix of the population,
• the lower the unemployment rate (this is a
  marginal result in two of six regressions),
• the higher the state sales tax rate,
• the larger the average loan size,
• the higher the share of the total number of the
  loans to businesses in MI communities,
• and the lower the share of the total number of
  loans made to establishments with receipts of
  less than one million dollars

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Key Findings and Policy Recommendations

• Researchers use different definitions and control
  variables in their analyses hampering an
  understanding of the factors that influence
  entrepreneurship and thus policy.
• One approach to addressing the problem of the
  use of different definitions and control
  variables is the construction of a single,
  multiuse dataset through the creation of a data
  consortium that pools information from different
  public and private datasets.
• Incentives provided through Capital Access
  Programs (in which lenders, borrowers and the
  government each contribute to a reserve fund to
  cover loan losses) and other credit enhancement
  programs may be appropriate to help decrease loan
  bias not explained by economic factors.

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Key Findings and Policy Recommendations

• The financing received by businesses in many LI
  and LMI communities diverges from what some might
  consider appropriate, even when accounting for
  income disparity.
• Incentives provided through Capital Access
  Programs (in which lenders, borrowers and the
  government each contribute to a reserve fund to
  cover loan losses) and other credit enhancement
  programs may be appropriate to help decrease loan
  bias not explained by economic factors.

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Key Findings and Policy Recommendations

• Financial variables are important to
  entrepreneurship.
• One potential way to increase small business loan
  origination across MSAs is to increase the
  securitization of such loans. This would allow
  small business lenders to sell portions of their
  loan portfolios and use the proceeds to originate
  more loans, as well as lower their capital
  requirements.
• Discrimination appears to persist, particularly
  as relates to capital access by black
  entrepreneurs.
• The continued difficulty of black-owned firms to
  gain financing suggests the continuing need for
  efforts to extend capital and other forms of
  support to black entrepreneurs.

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Key Findings and Policy Recommendations

• Taxes and regulations are clearly potentially
  important impediments to entrepreneurship
• High bankruptcy exemptions have been found to
  actually hurt borrowers by decreasing lenders
  willingness to provide capital and should be
  reviewed. The relationship found between lower
  sales taxes and greater entrepreneurship suggests
  one approach to mitigating this adverse effect
  would be decreased taxes.
• There appears to be consensus in the literature
  that individuals can learn to become
  entrepreneurs.
• Well-developed training programs, with targeted
  outreach, particularly to LI and LMI communities,
  can extend entrepreneurship to a wider
  population.