Overlooking small and medium-sized businesses is costing corporate America millions of dollars in potential investments. That’s especially true for venture capital (VC) and private equity (PE) firms. The main reason these small and medium-sized businesses are being overlooked is they don’t want to be billion-dollar companies or investors don’t believe the business can become a billion-dollar company, but that doesn’t mean they aren’t worth the investment.
Many of these so-called “too small to invest” companies are demographically a blind spot for many corporations and investors. Following the events of 2020 and the heightened awareness of economic and social disparities of minority (BIPOC) populations within the U.S., there has been a greater drive to invest in minority-owned businesses. However, large-scale investment firms are losing a golden opportunity to create goodwill through sweeping changes to corporate landscapes by driving directives and initiatives to diversify vendors’ supply chain, creating investment opportunities and offering representation at decision-making levels. Incidentally, these decision-making levels are typically devoid of such diversity in light of selling into or operating in such a diverse economy that is the U.S. This missed opportunity also means foregoing the chance to generate income and revenues from such sources of opportunity.
The cycle needs to change. America’s economy needs underrepresented businesses, especially those owned by women and minorities, to unlock at scale the opportunity that underpins such a large segment of the economy by demographic statistics as well as cultural influence.
Leaving Money on the Table
Reputation is a currency as valuable as cash, but large investment firms are leaving money on the table when they ignore small-market businesses. Yet, the attitude among large VC/PE firms is to ignore companies that won’t generate billions of dollars. That begs the question, are these SMBs not aiming to be billion-dollar companies because legacy groups refuse to invest in them? Or do investors need to have a billion-dollar company to meet their demands for investor returns, and the math is the math? If the math and the requisite ambition of having a billion-dollar-plus valuation trajectory are not in play for an opportunity, what is a startup or SMB to do? There has to be another way to get investment capital other than resorting to VC and PE companies.
One thing investment firms need to understand is that SMBs want and need to keep control of their own business. They are open to assistive help, and in some instances it can be quite substantive, but delivered in a founder-friendly way so ideas have a chance to see light of day with well-resourced investors contributing value beyond money. Legacy VC/PE firms can make money off the smaller firms through repayment of the capital, fee for services, profit-sharing or other agreements. There’s a disconnect in the investment world between investors and SMBs materially around size of the opportunity and where it could scale to leaving many good companies without strong investor partners that can help them realize their potential and beyond.
Oftentimes, these smaller companies feel like they just need a break — that they just need help overcoming a stumbling block or someone to believe in them. In fact, the break that is needed is for the investor to trade in currency with the SMB that is not equity-based capital but something that incentivizes revenue rather than another ephemeral metric that is hard to translate into revenue, profitability, EBITDA, etc., for a traditional investor focused on investment returns.
Implicit Investing Bias
The bias problem is especially significant for minority- and female-run SMBs looking for investors. According to a published report by Fast Company, male entrepreneurs are at least 60% more likely to get funding, even when a woman pitches the same idea. In addition to that, funding for female business owners dropped from 2.7% in 2019 to 1.8% in 2020. That’s despite the fact that female entrepreneurship is growing. In its Annual Business Survey, the U.S. Census Bureau reported that there were 6,861 more woman-owned firms in 2018 than in 2017, up 0.6% to 1.1 million.
The U.S. Senate Subcommittee on Small Business and Entrepreneurship reports that in the last 10 years, minority businesses accounted for more than 50% of the two million new businesses started in the United States. Despite there being more than four million minority-owned companies in the country with annual sales around $700 billion, many of these companies have a hard time accessing capital.
Fixing Inequities
What if these SMBs had better access to capital and support to scale effectively? Every business starts out small, and some of the most profitable publicly traded businesses started as SMBs. Smaller companies have the ability to be disruptive and adapt more easily to changing technology, allowing them to new markets faster than large legacy companies.
This model is outdated and it’s time to give smaller business, the fabric of America, the opportunity to succeed. In order to bring fairness to the venture capital system, a fundamental shift is needed. Innovators are ready to address the needs of the nation and provide equitable opportunities to businesses of different sizes.
The solution is to find larger companies with a similar mindset as the smaller ones to help them with financing, expertise and experience. Matching company founders with forward-thinking investors is a win for everyone involved.
America needs a universal translator for small and medium-sized businesses that may not speak the language of venture capital, expansion, digitization and automation. It’s time for SMBs to rise above this inequity they are forced to navigate.
Paul Ford is founder and managing principal of DS9 Capital, founder-friendly portfolio management holding company focused on building enduring and sustainable businesses in the insurance and healthcare technology space with capacity to scale. Ford and DS9 focus on frontier technology and service offerings largely leveraging cloud-based infrastructure and, more specifically, on applying their domain expertise to seed to nano-cap-sized businesses to expand the value chain for all stakeholders.
Did You Know: According to the 2019 Annual Business Survey of the U.S. Census Bureau, approximately 18.3% of all businesses in the U.S. were owned by minorities and 19.9% were owned by women.
