The chicken and the egg: Why diversity matters in investing

Small businesses need investors, and investors need small businesses. These are facts of life in the business world. And just like the chicken and the egg, you can't have one without the other. But for businesses led by women, African Americans, Asian-Americans, Hispanics, and other underrepresented groups, sometimes the investors just aren't there. Thanks to a recent SBA report, we have evidence that explains why.

Today, diversity within the investment community is practically nonexistent - nearly 90 percent of investors are white men. SBA recently published a report conducted by the Federal Research Division of the Library of Congress. That report confirms what we have long known from experience: the racial and gender makeup of investment committees is tied directly to the investment decisions they make, especially with regard to the race and gender of the business owners of companies that they invest in.

This has produced a major blind spot for small business investing in the U.S. and the missed opportunities are stacking up.

Dr. John Paglia of Pepperdine Graziadio School of Business and Management and Dr. David Robinson of Duke University Fuqua School of Business, working with the Federal Research Division of the Library of Congress, found that diverse investors are more likely to invest in diverse companies. More specifically, when women are involved in investment decisions, they are two to three times more likely to invest in businesses led by women. Racially diverse investor groups are also more likely to invest in businesses owned by women, African Americans, Hispanics, Asian-Americans, Native Americans, and others. They are also more likely to invest in low and middle income communities than their non-diverse counterparts.

In other words, diversity is at least as important among investors as it is for individual companies and their employees. That's an important lesson for the future growth prospects of a U.S. economy that is increasingly driven by small business startups owned by women and underrepresented groups.

• 45 percent of U.S. firms have women owners, but just seven percent of investors in the 100 top venture firms are women.

• Nearly 30 percent of U.S. firms have racially diverse owners, yet we don't even know how many investors are from diverse backgrounds because no reliable data exists (what does exist are estimates that figure at less than 15 percent).

Remember the chicken and the egg? If we can get the U.S. investor population up to speed with the rest of the economy, we increase the chances that the nation's economy will flourish. And if we want our small businesses to enter new markets and compete in the global economy, we have to ensure that America's entrepreneurs - and the investors who fund them - reflect, and understand, the diverse world we live in.

Small businesses are the engines of our economy, creating two out of every three net new jobs. Today diverse businesses are forming at rates that outpace those without diverse ownership. Unfortunately, these diverse startups often face an even more daunting struggle to reach their potential as engines of job creation and prosperity because they lack the capital that they need to start and grow. And research suggests that's true in part because there aren't enough women and people of color making major investment decisions.

As SBA Administrator, I have made it a top priority to ensure that firms led by women and underrepresented groups are able to grow to their full potential. Since my arrival at SBA, our loans are up 42 percent to women, 36 percent to minorities, and 39 percent to service-disabled veterans and we're pulling every lever to ensure this trend continues.

To go further, together we must:

• Work harder to find and empower qualified diverse investors and support other investors who have committed to investing in diverse companies.

• Collect and report on levels of racial and gender diversity, from investment committees to board rooms to break rooms.

• Learn from the National Football League's "Rooney Rule" that requires women and underrepresented group to be interviewed for senior positions to ensure people with diverse perspectives are given a real chance to earn those leadership opportunities.

I like to say that talent is spread equally throughout the world, but opportunity is not. And finding that talent is getting easier with many organizations signing on to help. The Urban League, Congressional Black & Hispanic Caucus Institutes, SEO, Toigo Fellows, Gateway to Leadership, Management Leadership for Tomorrow, and the Kauffman Fellows are all identifying new pools of diverse, next-generation talent.

It's past time to diversify America's investor class. If we want to have a globally competitive economy, we cannot afford to leave large and growing demographic groups on the sidelines of business investment. Simple changes such as collecting and evaluating data and recruiting diverse people to guide investment decisions will make a difference.

Let's fuel the start up engine of the U.S. economy and focus on bringing women and members of underrepresented groups into the inner circle of investors.

Let's take the necessary steps to ensure that access to capital isn't a barrier for high-growth firms led by the full diverse profile of this great nation.

• Maria Contreras-Sweet is administrator of the U.S. Small Business Administration. Reprinted with permission of the SBA.