Blast from the Past — Capital Investment Diversity?
Exactly 16 years ago — my last semester at HBS and enrolled in the Venture Capital & Private Equity class taught by none other than Josh Lerner. For the final paper I teamed up with Angel Morales to write about venture capital in the Latino-market, back then an elusive activity. I think we got a pretty good mark and Professor Lerner liked the paper so much that he encouraged us to submit it to the Journal of Private Equity. It was published and the editor titled it: “Hispanic-American Venture Capital: Financing the Growth of the Latino Market”. It was written eons ago but what was happening in the general market being fueled by the internet/dot com boom is not unlike to what is happening today. In under served markets capital formation gaps were big, sadly similar to those of this day. There are differences between the dynamics of these generational periods, no question. What stand out to me are the parallels across several dimensions of entrepreneurial economic development and investment cycle.
Specifically, what is striking about the piece is that almost nothing has changed regarding who is accessing capital, especially early stage capital. While it seems like a lot has changed (it has), the root causes haven’t. Those include things like lags in wealth creation, lack of absolute wealth, educational access difficulties, thin professional networks, and the blind spots of traditional credit and lending. These issues apply to all under served groups, not just Hispanics or African-Americans. I saw these issues first hand as a high-level government official overseeing billions of dollars focused on high-growth business capital formation and innovation. Inclusivity, both from a justice perspective as well as a purely commercial “its-good-business” perspective, was a big thematic construct underlying policy. Given the breakneck speed of change and innovation, one would want things to improve faster in the next 16 years when compared to the last 16 when it comes to broadly inclusive capital investment and access. This is critical to our country because its global economic dominance and competitiveness is fueled by the innovation capabilities of our small businesses — and we want them all out on the field.
Below are passages from the piece we wrote in the spring of 2000, they apply almost verbatim today:
ONE
“The solution lies in increased access to capital, particularly equity funding. Capital access is a prerequisite for increased participation in the mainstream economy. To sustain growth, Latino companies need greater access to supplies of capital at all critical stages of business development, including equity and seed capital. Difficulty accessing traditional debt financing, and the relative lack of personal/family wealth in the Latino community (which often serves as a measure of either explicit or implicit collateral for a loan), exacerbates the problem. Without dependable pools of equity capital to fund Latino firms in their early stages, the majority of these firms will continue to conduct business as ‘mom-and-pop’ operations. Like their ‘mainstream’ counterparts, Latino firms will need to access venture funds to finance expansion and to tap into the expertise and the relationships that often come packaged with venture capital.”
TWO
“Had many of today’s largest U.S. companies not been able to access the “right” pool of early-stage equity capital decades ago, some of them probably would not exist today, and many might not have achieved their present success. Venture funds often serve not only as the best source of financing available to new businesses because of the business expertise and contacts provided — but often as the only source of financing, as debt financing (until, perhaps, very recently) has been largely unavailable to early-stage companies. The key to catalyzing Latino businesses’ growth that will allow them to approach parity with other American businesses lies in venture capital.”
THREE
“Though the U.S. capital markets are as efficient as they come, often times fundamental changes in the way an industry conducts its business — whether it be the commercialization of a new technology or addressing a previously ignored market — can take many years to evolve. An appreciation of the Hispanic opportunity, and ultimately an enhanced degree of financing for its early-stage ventures, would represent a fundamental change in the U.S. private equity industry currently suffering from the ‘chicken-and-egg’ problem that so many movements endure before capturing critical mass. In order for financiers to provide dedicated capital to Latino firms, it must be demonstrated that the Latino market offers a sufficient number of profitable opportunities to justify dedicating such capital. Yet the primary hindrance to new Hispanic firms is the lack of capital. Clearly, the availability of dedicated capital and the existence of promising firms must coexist in the same entity — a condition that would, in essence, describe a ‘Latino incubator’.”
FOUR
“Despite much of the cynicism about incubators, proponents and detractors agree that entrepreneurs can only benefit from all the new incubation resources flooding the market. The most frequently cited advantage of incubators is that they allow entrepreneurs to ramp up their companies very quickly — an imperative for first-mover advantage in today’s super-competitive market. Not only do incubators eliminate the need to look for office space, equipment, and Internet services, but they also foster an environment that encourages the exchange of ideas. Another major benefit, particularly for entrepreneurs at VC-backed incubators, is a tight connection with their patrons. This supports and speeds them through rough patches, and speed is the operative word. The amount of time one can spend to seize a business opportunity has been drastically shortened — from two years down to just six months. The most significant advantage of incubators isn’t the services they offer but the fact that they actually work… It may give you the spit shine you need — plus a personal introduction — to find venture backing.”
FIVE
“For historical socioeconomic reasons, including a lack of access to relevant business networks, the early-stage “development gap” among Hispanic firms will have to be met by entities structured more like incubators than traditional private equity firms. If they are to demonstrate the explosive growth of their mainstream American counterparts, Latino firms will require truly active early-stage investors — not passive check writers with a commitment to attend board meetings once a quarter. In many critical respects, Latino owners and managers will resemble the management teams of today’s Internet firms. The entrepreneur of the 1990s embodied youth, intelligent and creative ideas, and non-traditional perspectives. But these characteristics alone did not create success. It was the harnessing of these ephemeral qualities by the right people and the right institutions, to create competent managers and viable business models, that produced the Internet revolution in the second half of the decade.”
SIX
“Furthermore… Latinos have not prospered economically to the same degree as has mainstream American society. For this and other related reasons, [Hispanic-owned businesses] will continue to be smaller in scale and scope than other U.S. start-ups, and Latino entrepreneurs will continue to suffer from inferior access to the relevant business networks…”
OK, back to the present day. The series of passages above from Y2K are definitely a blast from the past yet simultaneously back to the future. This slow changing landscape has arguably helped further concentrate wealth creation, push talent to the sidelines, and cause capital under investment. My point here is that there is a lot of opportunity to improve and. I really hope that these words soon look as dated as the Pets.com sock-puppet looks today.
