Venture capital investment in minority business enterprise: an evaluation of MESBIC investment preferences

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1 Environment and Planning C: Government and Policy volume 7, pages Venture capital investment in minority business enterprise: an evaluation of MESBIC investment preferences R B McNaughton, M B Green Department of Geography, The University of Western Ontario, London, Ontario N6A 5C2, Canada Received 26 July 1987; in revised form 15 December 1987 Abstract. The encouragement of minority entreprcncurship is frequently advocated as a means of promoting social and economic development. The Minority Enterprise Small Business Investment Company (MESBIC) program pursues this goal by increasing the access of minority business enterprise (MBE) to both human and financial capital. This research provides an exploratory empirical description of the regional, industrial sector, and fundingstage preferences of MESBICs. It is concluded that these preferences are largely antithetical to the formation and expansion of MBEs in growth sectors that offer the market potential for entrepreneurial takeoff. The primary problem seems to be the small size of the majority of MESBICs. Policies governing licensing requirements and administration should therefore be reconsidered. Introduction The encouragement of minority entreprcncurship is frequently advocated as a means for social and economic development (Van Fleet and Van Fleet, 1985). However, the establishment and growth of minority enterprise is hampered in a large part by barriers to accessing both capital and information. Although these problems are common to the development of all small firms (Kiesnick and Daniels, 1978), the barriers for minority-owned firms are even greater owing to the additional problems of discrimination (Bates and Bradford, 1979; Dominguez, 1976; Garvin, 1971; Yancy, 1974). In an effort to reduce barriers to capital and information access, and to encourage minority entrepreneurship, the US government has established several programs that provide funding and act as financial intermediaries. One of the most enduring is the Minority Enterprise Small Business Investment Company (MESBIC) program started by the Small Business Administration (SBA) in The MESBIC program is an outgrowth of the Small Business Investment Company (SBIC) program initiated in 1958, and is subject to many of the same regulations. MESBICs differ from SBICs in that they generally have smaller capital bases, and their portfolios are restricted to investments in minority-controlled ventures. MESBICs are privately owned venture capital companies. A minimum private capitalization of $1 million is required to obtain a MESBIC license, with the capital usually coming from a combination of institutional and private investors. MESBICs are eligible to leverage their initial private capitalization with the SBA at 3% below the current treasury rate for the first five years (NAIC, 1985). MESBICs then use these funds to invest in promising minority firms through a combination of equity and long-term debt. The provision of managerial assistance is also an important input to most investments. In seeking to build a profitable portfolio, MESBICs consider several variables concerning the characteristics of their investments. The three most important of these are: (1) the location of the investee, (2) the industrial sector of the investee, and (3) the funding stage of the investee (Silver, 1985). In order to maximize their access to information about potential investees, thus reducing their uncertainty and

2 194 R B McNaughton, M B Green risk, MESBICs typically prefer to invest locally and usually specialize in a particular industrial sector or funding stage (NAIC, 1985). The locational, industrial sector, and funding-stage specializations of MESBICs arc important in terms of their potential social and economic impacts. For example, entry by minority entrepreneurs into growth industries, especially technology-intensive ones, is likely to provide the greatest benefit to the minority community in terms of market expansion, integration, and job generation. Further, emphasis on early stage seed and startup investments is necessary to promote diversification into these sectors. Thus, lor those who advocate the provision of assistance to the minority business enterprise (MBL ) sector as a means of promoting social and economic development. MESBIC policy should pursue two important goals: (1) the establishment of MBEs outside of traditional locations so that they can develop larger, more sophisticated markets, and interact with successful nonminority firms (Foley, 1968; Van Fleet and Van Fleet, 1985); (2) the entrance of MBEs into growth-oriented industries that offer rapid market expansion which will generate greater profits and create employment (Osborne, 1986). Consideration has been given to the problems that MBEs have in accessing longterm debt and equity (Dominguez, 1976; Garvin, 1971), but much of the existing research is now dated and differences in the regional, industrial sector, and fundingstage orientation of capital sources have largely been ignored. Further, the literature has failed to point out important differences between the investment preferences of minority venture capital investors and those of the venture capital community as a whole. These differences are particularly important in terms of assessing the success of the MESBIC program in promoting the establishment of MBEs in those locations and industrial sectors that are traditionally the domain of nonminority firms. This paper is an initial step toward filling this gap, and provides an exploratory empirical description of the regional, industrial sector, and funding-stage preferences of MESBICs. The status of MBE The US minority business enterprise sector is small in both absolute and relative terms. Recent data suggest that gross receipts of $26 billion1 accrue annually to some MBEs (Osborne, 1986). In 1969 there were MBEs with total receipts of $4.5 billion (Yancy. 1974). Dominguez (1976) noted that whereas the white to minority population ratio is 8.8 to 1, the white to minority business ownership ratio is 46 to 1. The white to minority business dollar ratio is even larger at 336 to 1. If the minority business participation ratio were proportional to population, one would expect there to be some MBEs with sales in the order of $170 billion. Clearly minority entrepreneurs are grossly underreprcsented in their share of business ownership. The ownership structure of MBEs is also significantly different. MBEs tend to be small single-owner proprietorships, whereas nonminority firms are more likely to be incorporated (Coles, 1969; Department of Commerce. 1971; SBA, 1984). The result is that MBEs have (on average) far fewer paid employees. MBEs are also concentrated in a few sectors such as retailing and personal services that offer little market potential for entrepreneurial takeoff. There have been numerous surveys of the status of the MBE since the Second World War. Pierce (1947) surveyed 3866 black-owned businesses in twelve cities. "> Billion = 10".

3 Venture capital investment in minority business enterprise 195 Six types of businesses accounted for over 70% of the firms: restaurants, groceries, hair care, laundries, shoe repair, and funeral parlors. Data gathered for a subsample of firms showed that initial capitalization was extremely small, and was provided from personal savings in 86.3% of the cases. The most frequently cited obstacles to the formation and expansion of firms were: (1) lack of capital, (2) lack of trained personnel, and (3) lack of black patronage. Coles (1969) surveyed 564 firms in seven cities with the aim of determining what resources were necessary to make them productive and self-sustaining. Some 29.9% of these firms were in general sales and services, and 17.9% in public services. Prominent industries were identified as groceries, restaurants, laundries, and service stations. Few of the firms had been established in the previous year. Coles attributed the lack of new business starts to the reluctance and unpreparedness of the black community to venture into entrepreneurial careers. The firms were generally small, and only 9% reported net profits in excess of $5000. In analyzing these results, Coles pointed out that black businesses are far too concentrated in industries that have little market potential, they are undercapitalized, and there are too many of them for more than limited success in the low-income neighborhoods they serve. Strang (1971) surveyed 100 failed black businesses through organizations which offered managerial assistance to these firms. Strang concluded that most failures could be related to a lack of managerial ability, business education, and experience. The lack of managerial ability was reflected in poor marketing and sales programs and through overly large inventories. Inadequate capitalization, another problem, was attributed to difficulties these firms had in obtaining capital from traditional sources such as commercial banks. A somewhat improved picture of the status of the MBE was presented by Bates (1978). Data obtained from the SB A were used to compare 284 black-owned firms, 270 newly formed black businesses, and 210 white-owned firms. Bates confirmed that whereas existing black businesses are concentrated in a few traditional sectors that require little capitalization, emerging black businesses were found across the industrial spectrum, and frequently required large capital inputs. Firms in traditional industries appeared overcapitalized, and those in emerging industries appeared severely undercapitalized. Although previous studies suggested that new and expanding black firms conform to existing stereotypes (for example, Brimmer and Terrell, 1971; Coles, 1969), Bates provided evidence that the erosion of segregation and discrimination may be opening up a new era of opportunity for minority entrepreneurs. Similar evidence was provided by Osborne (1986). He reported large increases in average sales for minority firms in distribution, wholesaling, retailing, and services. An emerging group of firms in nontraditional sectors, and an increase in overall size, suggested the development of economies of scale. Osborne was not optimistic about the overall state of the MBE, however. He noted the continuing difficulty of new minority businesses to attract capital. Further, he expressed concern for the paucity of firms in high-capacity industries with large market potentials. He also noted the continuing problems of inadequate management ability, inadequate compensation for competent professionals, and overconcern with maintaining control, all of which discourage equity investment. The literature on the status of the MBE creates a relatively clear picture. In terms of numbers and sales, MBEs are grossly underrepresented with respect to minority population. Traditionally, MBEs concentrate in retailing and service sectors that require little initial capitalization. Most MBEs are single proprietorships and have few employees. Recent gains have been made with the increased size of some

4 196 R B McNaughton. M B Green firms, the developing economics of scale, and the formation of firms in nontraditional sectors. However, MBEs still encounter undue difficulty obtaining long-term debt and equity, and have not yet entered high-capacity industries such as computers, electronic instruments, health care, and medical technology in significant numbers. The MESBIC program is aimed at improving the status of the MBE sector by easing access to both human and financial capital. Although its longevity in comparison with other federally sponsored MBE assistance programs would suggest success, the program has been soundly criticized for its lack of appreciable effect. Perhaps the most fundamental criticism is that of the size of the program and of MESBlCs themselves. Knight and Dorsey (1976) reported that in 1975 there were 73 licensed MESBICs with a total capitalization of some $68.1 million. They noted that even if these funds were fully invested as equity, only 3.5% of an estimated $2 billion demand for equity capital would be filled. Currently there are 146 MESBICs with a total capitalization of $88 million (NAIC, 1985). At full investment, they could still supply only 4.4% of the estimated demand in MESBICs themselves tend to be small, which presents several interrelated problems. First, MESBICs often experience problems of cash flow because of pressures to repay SBA loans and the extended periods before equity investments yield returns. As a result, MESBICs make a larger proportion of investments in the form of loans (SBA, 1984). This, of course, greatly reduces the leverage potential of the investee (Yancy, 1974). Second, smaller investments have a higher probability of failure than do larger ones (Dorsey, 1975; Parris, 1968). This is closely related to a third problem: smaller size restricts investment to traditional retail and service sectors that require little initial capitalization. Failure rates in these sectors arc particularly high for minority entrepreneurs (Domingucz, 1976). MESBICs have also been attacked for their lack of meaningful operation expense funds to obtain qualified managers, for ignoring an aspect of community control, and for having to rely on the charity and philanthropy of their sponsors (Karuna-Karan and Smith, 1972; Rosenbloom and Shank, 1970). Data The ensuing analyses employ data from a directory compiled by the editors of Venture Magazine (1985), cross-checked with Dow Jones and Irwin (1986). These directories provide information on office location, regional, industrial sector, and funding-stage preferences, and a number of other characteristics for a survey of 969 US venture capital firms. The firms in these directories were aggregated into three groups based on their affiliation: (1) MESBICs, (2) SBICs, and (3) other Table 1. Distribution of firm types. Firm type Number Percent MESBICs SBICs Other: Private independents Subsidiaries Investment firms Financial consultants Community Development Corporations Manufacturers Endowments Patented producers Total

5 Venture capital investment in minority business enterprise 197 private venture capital firms (table 1). This aggregation allows for comparisons to be made between minority and nonminority government-assisted venture capital firms, and privately sponsored venture capital firms. The number of MESBICs in these directories (119) represents 82% of all operating MESBICs, and SBICs are equally well represented (SBA, 1984). The private category may be less well represented because it is more difficult to identify these firms. It should be noted that preference data are not necessarily indicative of actual investment behavior. The characteristics of actual disbursements are influenced by both the investment philosophy of venture capital firms and the availability of sound business proposals that have an acceptable risk/ return mix. Preference data represent what venture capital firms would do if there were only limited constraints on the investment opportunities available to them. Data of this type are particularly useful in terms of program evaluation because they partially control for restrictions imposed by the external operating environment. With preference data there is a greater likelihood that observed patterns are a function of the aggregate decisionmaking behavior of firms, and not simply a response to external forces over which they have no control. Analyses Firm size The size distributions of MESBICs, SBICs, and private venture capital firms are described in table 2, where size is defined as total paid-in capital, including SBA leverage for SBICs and MESBICs. There are considerable differences in these distributions. First, the estimated size of the venture capital pool held by private firms is an order of magnitude larger, at $15.1 billion, than either that of SBICs ($2.2 billion), or MESBICs (S278 million). In fact, the largest venture capital fund under management by a private firm is itself a third larger than the total MESBIC capital pool. The distributions of all three firms types are highly skewed, though those of SBICs and MESBICs are much less so than that of private venture capital firms. As a result, the median is a better measure of central tendency: the median private venture capital firm has $10 million of paid-in capital, whereas the median SBIC has $3 million, and the median MESBIC has $1.5 million. Table 2. Capital under management by firm type (S million). Firm type Total Mean Median SD Range Skew Other SBICs MESBICs SD Standard deviation. Location and diffusion of firms The proportional representation of the three firm types in the ten urban centers having the most MESBICs is compared in table 3. Clearly there are differences in the aggregate pattern of office location choice. MESBICs have greater proportional representation in Washington (DC), Miami, Detroit, and to a lesser degree in Los Angeles and Chicago. MESBICs and SBICs are conspicuously underrepresented in two of the traditional hotbeds of venture capital investment activity San Francisco and Boston. 'Other' urban centers are home to a greater proportion of SBICs than MESBICs or private venture capital firms, indicating that the pattern of SBIC office locations is much more diffuse.

6 198 R B McNaughton. M B Green The spatial development of the MESBIC program over time is illustrated in table 4. The cumulative percentages, which are reported by year of establishment, give a crude indication of changes in the importance of urban centers as office locations. Only those firms surviving through to 1985 are represented, so as to allow consideration of net additions. Thirty-three firms were omitted because no year of establishment was available. Their spatial distribution was not significantly different from the distribution of the firms that provided their founding year. Row totals give the distribution of MESBICs among the ten most frequently chosen office locations. The overall pattern is concentrated. Together the ten centers account for 71% of MESBICs, with New York and Washington (DC) alone accounting for a third of the firms. Row by column percentages show the change in the importance of a center since New York, Washington (DC), and Los Angeles have the largest increases in MESBICs. The proportion of firms located in 'other' centers has also greatly increased. Although the absolute number of firms indicates continued growth and concentration in New York, Washington (DC), and Los Angeles, the relative importance of these centers may be decreasing as the number of MESBICs in other centers increases as well. Table 3. Distribution of firm types by city. City MESBICs (%) SBICs (%) Other (%) New York Los Angeles Washington, DC Chicago San Francisco Miami Detroit Houston Boston Philadelphia Other Number Table 4. Distribution of surviving MESBICs by founding year (cumulative percentages). City Number New York Los Angeles Washington, DC Chicago San Francisco Miami Detroit Houston Boston Philadelphia Other Number Note: Thirty-three firms were omitted because no founding year was given. Firm type and investment preferences Regional, industrial sector, and funding-stage preferences of MESBICs, SBICs, and 'other' private firms are compared in table 5. This table is the result of an analysis

7 Venture capital investment in minority business enterprise 199 of twenty-seven variables grouped into three dimensions and cross-tabulated by firm type: (1) preferred census region, (2) preferred industry, and (3) preferred funding stage for investment. The region variables are defined as the nine major US census regions with the addition of a category for firms preferring to invest anywhere in the USA. The industry variables are defined by the editors of Venture Magazine (1985) as computers, distribution, manufacturing, medical, natural resources, real estate, retail, services, and technology. Funding-stage preferences are also defined by Venture Magazine: (1) seed financing (to prove a concept), (2) start-up (product development), (3) first stage (to initiate commercial sales), (4) second stage (working capital), (5) third stage (major expansion funding), (6) fourth stage (bridge to go public), (7) acquisition Financing, and (8) secondary financing. The degree of preference a firm type displays for a particular region, industry, or funding stage is the number of times the variable was listed as a preference, divided by the total number of firms of that type in the survey. The degree of Table 5. Results of an additive model fit by the median polish procedure to account for variation in regional, industrial sector, and funding-stage preferences by firm type. MESBICs SBICs Other Row effect Region" New England Middle Atlantic West North Central Mountain Pacific West South Central East South Central South Atlantic East North Central All USA Column effect Industry Computer Distribution Manufacturing Medical Natural resources Real estate Retail Services Technology Column effect Funding stage' Seed Start-up First stage Second stage Third stage Fourth stage Acquisition Secondary Column effect * Model accounts for 73.5% of the variation in regional preferences. h Model accounts for 85.3% of the variation in industrial sector preferences. c Model accounts for 80.8% of the variation in funding preferences.

8 200 R B McNaughton, M B Green preference for each variable is thus standardized by firm type. However, as multiple preferences were allowed, and all firms did not choose an equal number of preferences, the measures are still not directly comparable. Some method of extracting the propensity of different firm types to make multiple choices, and the propensity of all firms to choose a particular preference, was needed. To control for these varying propensities, the median polish procedure (Tukey, 1977) was used to estimate column (firm type) and row (preference) effects. The median polish procedure fits an additive effects model of the following form: where Y = Mr, + cy + ^, Ytl is a data array element in row / and column y, / is a typical value, rt is a row effect, c; is a column effect, z,, is the residual effect of element if. The procedure begins by finding the medians of each column in the data matrix, and subtracting it from all elements in the column. This operation 'sweeps' a contribution from the column into the fit, producing a row of column medians and a new table from which a partial effect has been removed. This process is then repeated for each row, including the newly created one of the partial column effects. The sweeping of the data continues in an iterative fashion until the change in the sum of the magnitudes of the residuals reaches a specified amount; in this case a 1% change was used as the cutoff value. This procedure results in a twodimensional tableau containing a constant common effect, row effects, column effects, and residuals. Finally, the relative contribution of the independent row, column, and common effects are compared with the contribution of the residuals. To do this, the variation in both the original data array and the residual array are calculated. The ratio of these two measures indicates the degree to which the row and column effects have reduced (or accounted for) the variation in the table (McNeil, 1977). The median polish procedure is analogous to both the two-way analysis of variance (ANOVA) and the additive form of the log-linear model. The primary difference is that the two-way ANOVA uses the row and column means to estimate effects. The median is a preferable measure here because of its insensitivity to a few extreme values (Tukey, 1977). The additive model fit by the median polish accounts for 73.5% of the variation in the array of regional preferences, 85.3% of the variation in the array of industry preferences, and 80.8% of the variation in the array of funding preferences. The common value reflects the weight of the array, and is thus an indication of multiple preferences. The common value for the funding array is very high (41.5), in comparison with the values for the region and industry arrays (9.3 and 8.3, respectively), suggesting that, in general, firms had numerous funding-stage preferences. Thus, funding stage may be far less important than either industry or region to the investment decision. For each dimension, the row effects give an indication of the propensity firms have to prefer a particular investment characteristic. The column effects give an indication of the propensity of firms to have multiple preferences. Residuals indicate the unique departure of each element from the preference pattern that would be expected given the common effect and the effects of investment characteristic and firm type. In all cases, positive numbers indicate increasing preference, zero indicates ambivalence, and negative numbers indicate aversion.

9 Venture capital investment in minority business enterprise 201 In terms of their regional preferences, MESBICs display a preference for investment in the East South Central, South Atlantic, and East North Central regions, all of which have larger per capita minority populations. MESBICs are conspicuous in their aversion to investment in the New England, Pacific Mountain, and all USA regions. MESBICs prefer to invest in the traditional manufacturing, distribution, and service sectors, avoiding the high-technology sectors (computer, medical, and technology) preferred by private venture capital firms. MESBICs are highly averse to seed financing, preferring to fund second stage and secondary ventures. Private venture capital firms have a preference for funding much earlier stages (seed, start-up, and first stage) as well as acquisitions. Size and investment preferences The median polish technique was also used to analyze the investment preferences of small and large MESBICs. The results generated are shown in table 6. In accordance with the classification used by Venture Magazine (1985), small MESBICs Table 6. Results of an additive model fit by the median polish procedure to account for variation in regional, industrial sector, and funding-stage preferences by MESBIC size. Less than $1.5 million $1.5 million or more Row effect Region* New England Middle Atlantic West North Central Mountain Pacific West South Central East South Central South Atlantic East North Central All USA Column effect Industry* Computer Distribution Manufacturing Medical Natural resources Real estate Retail Services Technology Column effect Funding stage' Seed Start-up First stage Second stage Third stage Fourth stage Acquisition Secondary Column effect a Model accounts for 59% of the variation in regional preferences. b Model accounts for 70% of ihe variation in industrial sector preferences. c Model accounts for 62% of the variation in funding-stage preferences.

10 202 R B McNaughton, M B Green are those having less than $1.5 million of paid-in capital, and large ones are those having $1.5 million or more of paid-in capital. The $1.5 million figure is the median size of MESBICs. The additive model fit by the median polish procedure did not account for as much variation in the data as it did when investment preferences were compared between firm type. As a greater effect was thus attributed to the residuals, it may be inferred that there are greater differences in investment preference between the two size classes of MESBICs than between firm types. It should also be noted that the parameters of the residuals in table 6 cannot be directly related to those for MESBICs in table 5 as they do not take into account the preferences of other firm types. Considerable differences exist in investment preference by MESBIC size. The preferences of large MESBICs have greater similarities with private venture capital firms than do their small counterparts. They have a preference for investment in the New England and Pacific regions, the computer and technology industrial sectors, and the early stages of start-up and expansion. The primary differences are their lack of interest in nationwide investment, the medical sector, and acquisition financing. They also show a marked preference for funding the manufacturing sector, which private venture capital firms do not. Small MESBICs prefer the East North Central and South Atlantic regions, the distribution, real estate, and retail sectors, and later stage expansions. The interest in real estate is of particular note as both MESBIC and SBIC regulations limit the amount of investment in this sector to one third of a firm's portfolio (Noone and Rubel, 1970). Discussion The preceding analyses provide an exploratory empirical description of the regional, industrial sector, and funding-stage preferences of MESBICs. These preferences were compared (a) between firm types, and (b) between small and large MESBICs. The major findings of the analyses are as follows: {1) There are considerable differences in the size distributions of MESBICs, SBICs, and private venture capital firms. The estimated size of the capital pool for each type of firm is: MESBICs $278 million, SBICs $2.2 billion, and private venture capital firms $15.1 billion. (2) The pattern of MESBIC office location is significantly different from that of either SBICs or other venture capital firms. MESBICs have a greater proportional representation in Washington (DC), Miami, and Detroit. They are underrepresented in traditional centers of venture capital activity San Francisco and Boston. (3) The office location pattern of MESBICs is highly concentrated, though there has been some diffusion of firms to other centers in recent years. (4) In comparison with other types of venture capital firms, MESBICs have a greater preference for investment in the East South Central, South Atlantic, and East North Central census regions. They are averse to investment in the New England, Pacific Mountain, and all USA regions preferred by other types of venture capital firms. (5) MESBICs prefer to invest in traditional sectors (manufacturing, distribution, retail, and services) and avoid the high-technology sectors (computers, medical, and technology) preferred by other types of firms. They are highly averse to funding early stage deals, preferring to provide second stage (working) capital. (6) When MESBIC investment preferences are compared by size, the above characterizations are found to apply only to small MESBICs. The investment preferences of large MESBICs are similar to those of private venture capital firms. They prefer to invest in the New England and Pacific regions, in the computer and technology sectors, and in the early stages of start-up and expansion.

11 Venture capital investment in minority business enterprise 203 The pattern of MESBIC office location is highly concentrated in the largest urban centers, and strongly reflects the distribution both of the MBE sector and of the minority population. Proximity to the few minority-owned banks also helps to explain the number of firms in New York, Washington (DC), and Chicago. The concentration of office locations and the regional parochialism evident in investment preferences suggest that it may be very difficult for MBEs to obtain venture capital outside of the major urban centers. Thus, the direct effects of MESBIC investment on formation of new firms and expansion, and the indirect contribution of their portfolio companies to employment in the minority community, are spatially and hierarchically biased. The sectoral preferences of MESBICs, in comparison with those of other types of venture capital firms, are of particular concern. The traditional sectors of distribution, retail, and services simply do not have the capacity to expand significantly either the size or the scope of the MBE sector. Further, they tend to create fewer jobs per firm, and those that are created tend to require few skills and command little income. As Osborne (1986) and others have noted, entry by MBEs into growth industries, expecially technology-intensive ones, would provide the most economic benefits for the minority community. The finding that small MESBICs are actually averse to investing in these sectors is cause for concern. Not only is there little current representation in these sectors, one of the major financing sources available to the MBE is conspicuously averse to funding the future formation and expansion of firms in these sectors. To be fair, it must be recognized that MESBIC investment preferences are influenced by the availability of suitable investment proposals, and part of the problem may be the reluctance of minority entrepreneurs to venture into new fields. Discrimination in sales and managerial positions may deny potential minority entrepreneurs the experience and training needed to succeed. It has also been suggested that the need for achievement of minorities is too low for successful entrepreneurship in more innovative sectors (Bhagat, 1968; McClelland and Winter, 1969). The aversion of MESBICs as a whole to early stage seed and start-up financing restricts the formation of new firms, and thus the likelihood of diversifying the sectoral composition of the MBE sector. The emphasis on second stage (working) capital does help to ensure that more firms will grow to be large enough to benefit from the economies of scale starting to be experienced by some MBEs (Osborne, 1986). The analysis of investment preference by MESBIC size illustrates the underlying problem first identified by Rosenbloom and Shank (1970), Karuna-Karan and Smith (1972), Yancy (1974), Dominguez (1976), and Knight and Dorsey (1976). Most MESBICs are just too small. Their small size inhibits access to information on investment opportunities, thus contributing to their concentration in major urban centers (where information access can be maximized) and the regional parochialism evident in their investment preferences. Inadequate capitalization further restricts investment to traditional sectors that have lesser capital requirements. Risk aversion, extended periods before equity investments yield returns, and pressures to repay SBA loans lead MESBICs to make a large proportion of their investments in the form of loans, which limits their ability to meet the needs of early stage seed and start-up investments. The relatively few large MESBICs are less constrained by these considerations, and as a result their investment preferences are similar to those of private venture capital firms. The size argument does not account for the preference of MESBICs in San Francisco and Boston for both high-technology and early stage investments. Perhaps

12 204 R B McNaughton, M B Green firms in these centers have appreciably larger capital bases, or have developed syndicative relationships with larger nonminority investors. This hypothesis will have to await further investigation based on the availability of actual investment data. Clearly, however, the size argument does characterize the problems inherent in most centers reasonably well, and warrants further consideration with respect to improving the regulations governing the licensing and administration of MESBICs. References Bales T, 1978, "Profitability in traditional and emerging lines of black business enterprise" Journal of Urban Economics Bates T, Bradford W, 1979 Financing Black Economic Development (Academic Press, New York) Bhagat R S, 1968, "Black-white ethnic differences in identification with the worth ethic: some implications for organizational integration" Academy of Management Review Brimmer A, Terrell H S, 1971, "The economic potential of black capitalism" Public Policy Coles F, 1969 An Analysis of Black Entrepreneurship in Seven Urban Areas The National Business League, Washington, DC Department of Commerce, Bureau of the Census, 1971 Minority-owned Businesses: 1969 (US Government Printing Office, Washington, DC) Dominguez J R, 1976 Capital Flows in Minority Areas (Lexington Books, Lexington, MA) Dorsey T, 1975 Factors Responsible for Success in the Investment of Venture Capital PhD dissertation, University of Texas at Austin, Austin, TX Dow Jones and Irwin, 1986 Dow Jones-Irwin Business and Investment Almanac Dow Jones Company, New York, NY Foley E P, 1968 The Achieving Ghetto (The Washington National Press, Washington, DC) Garvin W J, 1971, "The small business capital gap: the special case of minority enterprise" Journal of Finance Karuna-Karan A, Smith E R, 1972, "A constructive look at MESBICs" California Management Review 14(3) Kiesnick M, Daniels B, 1978 Preliminary Research on Capital Markets and Economic Development (National Rural Center and Opportunity Funding Corporation, Washington, DC) Knight K E, Dorsey T, 1976, "Capital problems in minority business development: a critical analysis" American Economic Review McClclland D C, Winter D G, 1969 Motivating Economic Achievement (The Free Press, New York) McNeil D R, 1977 Interactive Data Analysis (John Wiley, New York) NAIC, 1985 A Handbook on the Association of Specialized SBICs National Association of Investment Companies, 915 Fifteenth Street, NW Suite 700, Washington, DC Noone C M, Rubel S M, 1970 SBICs: Pioneers in Organized Venture Capital (Capital Publishing Corp., Chicago, 1L) Osbornc A E, 1986, "Emerging entrepreneurs and the distribution of black enterprise", in Managing Take-off in Fast Growth Companies Eds R W Smilor, R L Kuhn (Praegcr, New York)pp Parris A W, 1968 The SBA (Praeger, New York) Pierce J A, 1947 Negro Business and Business Education (Harper and Brothers, New York) Roscnbloom R S, Shank J K, 1970, "Let's write-off MESBICs" Harvard Business Review September-October issue, SBA, 1984 Annual Financing Summary Small Business Administration, 1441 "L" Street, NW Washington, DC Silver A D, 1985 Venture Capital: The Complete Guide for Investors (John Wiley, New York) Strang W A, 1971, "Minority economic development: the problem of business failures" Law and Contemporary Problems Tukey J W, 1977 Exploratory Data Analysis (Addison-Wesley, Reading, MA) Van Fleet E W, Van Fleet D D, 1985, "Entrepreneurship and black capitalism" American Journal of Small Business Fall issue, pages Venture Magazine 1985 Venture's Guide to International Venture Capital (Simon and Schuster, New York) Yancy R J, 1974 Federal Government Policy and Black Business Enterprise (Ballinger, Cambridge, MA) 1989 a Pion publication printed in Great Britain