Closing the Capital Gap: Fueling the Promise of Latino-owned Businesses

At the $1 million revenue mark, just as businesses need a capital infusion to scale, LOBs face a Darwinian survival test that their white-owned peers do not face nearly as often.

Latinos are 1.7x more likely to start businesses than any other racial group (as of 2019)

The relative lack of interest LOBs receive in the funding community is not because they are not sound investments. In fact, there is ample reason to believe that Latino-owned businesses are on par with today’s landscape of WOBs. Latino-owned employer businesses report comparable revenue and employment growth patterns to WOBs. We know that Latino- and white-owned employer businesses have similar financial risk profiles and are similarly likely to have healthy business credit scores. In fact, Latino-owned employer businesses are approximately 11 percentage points more likely to have a business credit score above 680. They are also similarly likely to have very good business credit scores (above 760).

Latino-owned employer businesses do fall short of their white-owned peers in two important aspects: They are less likely to be profitable, and they exhibit lower profit margins overall (see Figure 2). Only 45% of LOBs are profitable, compared with 50% of WOBs, and profitable LOBs are about 5 percentage points less likely to see profit margins climb above 20%. And, at the aggregate level, we can identify at least one point where the two paths between WOBs and LOBs most clearly diverge: As LOBs reach that $1 million mark, they face relative funding barriers their white-owned peers do not, and their growth and profitability both begin to slow. LOBs have higher revenue CAGRs across all sizes compared with WOBs; once LOBs scale to $1 million, however, they become less profitable compared with WOBs and are less likely to fully scale to revenue greater than $5 million. LOBs are around 30% less likely than WOBs to ever hit $5 million in revenue. Yet there’s nothing to suggest that LOBs are somehow inherently incapable of growth beyond this level—those LOBs that do break through the $5 million mark are achieving rapid growth.

Latino-owned businesses face a steep drop-off in odds of profitability when they reach $1 million in revenue, which is likely the result of the high costs of accessing the capital needed to scale

Without access to the capital they need to grow—capital that is easier for employer WOBs to obtain at a lower cost—employer LOBs are forced to pay higher rates, sacrifice cash flow to debt service, and bootstrap as they scale. These high-cost sources eat into profitability, increase ROI thresholds, and require LOBs to act more conservatively compared with WOBs that can frequently access lower-cost funds, such as equity investments from family and friends and bank loans.

And therein lies the catch-22. Scaling is not working for employer LOBs. Just when they most need capital to grow, they face inadequate funding. Without reliable access to affordable capital, particularly equity capital, LOBs struggle with profitability and cannot afford to scale their businesses at the same pace as WOBs, creating a doom loop of underfunding from investors.

LOBs face a capital supply problem at every stage of their life cycle

The underfunding problem starts at the earliest stages of employer LOB growth, even from the first attempt to seek equity investments, or request a small business loan or line of credit. For example, over their entire life cycle, healthy LOBs experience lower odds of being fully funded by national banks (see Figure 3).