If carefully considered, all of these avenues could be used as a means to increase funding for Black entrepreneurs

Capitalism assumes market efficiency—capital flows freely to market opportunities unless there is market friction that leads to market failure. In such cases, there is the opportunity to intervene to correct the market failure.

Massachusetts has billions of dollars of assets under management. But can residents do more to increase the available funding for Black entrepreneurs? Are there legal ways to direct these funds on the basis of race that could withstand legal challenges?

Despite the fact that over the last ten years, venture capital investments have quadrupled nationally, only 1% of VC-backed founders are Black, with less than 1% of total venture capital funding going to Black founders. This may be due to a variety of reasons, including:

• The largely white investment community’s inability to understand market problems and solutions addressed by Black-owned businesses.

• Systemic racism resulting in Black founders’ disproportionate lack of access to professional networks and “friends and family” rounds of VC funding.

• Communication difficulties based on cultural differences between the largely white investor community and Black founders.

• Unconscious bias on the part of the largely white investor community.

The result: according to DealEngine, 77% of startup investment flows to those with connections, and 87% of those startups fail. In other words, those with connections get the money, even though they do not necessarily have better ideas or are better managers.

Below, we explore five ways to approach these issues via: public pensions and endowments; direct investment through quasi-public agencies; federal tax incentives such as new market tax credits and opportunity zones; and donor-advised funds.

In the private sector, there are a wide range of investment styles, including “socially responsible” or “mission-driven” funds that consider social factors beyond simple return on investment, such as issues of racial justice. However, when public or private dollars with tax benefits are conditioned on race, legal issues may arise. Given this context, this list seeks to summarize the legal routes available to funnel public and private charitable funds to Black founders of start-ups in Massachusetts.

If carefully considered, all of these avenues could be used as a means to increase funding for Black entrepreneurs.

Public Pensions & Public University Endowments

Public pension funds (“PPFs”) and public university endowments (“PUEs”) constitute a significant source of potential capital investment in Black Entrepreneurs. Increasingly, PPFs and PUEs have implemented, or been called upon to implement, initiatives to center diversity, equity, and inclusion in their internal policies.

Generally, this has taken the form of policies to increase the hiring of minority investment managers and advisors or contracting with investment management firms owned by minorities or women. Conceivably, PPFs and PUEs could also more directly invest in Black entrepreneurs by instituting policies that prefer investment portfolios with holdings in Black-owned businesses.

Amendment §23 of the Massachusetts state pension fund statute, M.G.L. Ch. 32, stipulates that it “shall be the policy of the [state pension fund] board to use minority investment managers … and to increase the racial, ethnic, and gender diversity of [state pension fund] investments to the greatest extent possible, consistent with sound investment policy” with the goal that “not less than 20 percent of investment managers be minorities … [and to] utilize businesses owned by minorities … for not less than 20 percent of total contracts awarded.”

Under M.G.L. Ch. 32 §23(2A)(h), the PRIM board must, whenever reasonably possible and in accordance with sound investment policy, invest in banks or institutions that provide capital for small businesses. This, coupled with the diversity mandate in §23(8), evinces clear statutory authorization to institute policies targeting investments for Black entrepreneurs. Such targeted investments in Black entrepreneurs by PRIM may be further facilitated by the creation of an asset class specific to Black entrepreneurs.

Finally, federal regulations of the Employee Retirement Income Security Act (“ERISA”) specifically allow pension fund managers to consider collateral social and economic benefits as “tie-breakers” against economically equivalent funds, as well as consider environmental, social, and governance factors in the economic analysis of the investment itself.

The bottom line: preference and authority already exist.

Direct Public Investment through Quasi-Public Agencies

MGCC was established in October 2010, under M.G.L. Ch. 40W (“Ch. 40W”) as an independent quasi-public agency whose purpose is to “create and preserve jobs at small businesses, inclusive of those owned by women, minorities, immigrants and veterans … [and to] promote economic development throughout the Commonwealth, with targeted attention to business needs in underserved areas … and low to moderate-income communities.” Massachusetts Growth Capital Corporation (“MGCC”) Ch. 40W §5 limits MGCC’s economic development activities, including making financial products available to small businesses, to those with a demonstrated public benefit, and which are necessary because funding is otherwise unavailable or infeasible in traditional capital markets.

Finally, and of particular relevance for our purposes here, Ch. 40W §6 states that MGCC “shall endeavor to participate in projects each year that provide financial products, which in the aggregate total not less than 20 percent of the total capital committed by [MGCC] in that year, to minority-owned or women-owned contractors.”

Given the recent experience of responding to and recovering from Covid, MGCC has demonstrated it is performing such activities.

Federal Tax Incentives: New Markets Tax Credits & Opportunity Zones

There is a potential opportunity for more targeted New Markets Tax Credits (NMTC) investment in Black entrepreneurs beyond those that operate in LICs. §45D(e)(2) requires the Secretary of the Treasury to issue regulations under which one or more “Targeted Populations” may be treated as LICs, where said populations are low-income persons or those that otherwise lack adequate access to loans or equity investments. To target Black entrepreneurs specifically, federal regulations could be issued that categorize Black entrepreneurs as a targeted population because of their historic and persistent lack of adequate access to loans or equity investments.

Federal regulations could parallel the language in the Small Business Administration’s 8(a) Business Development Program (“8(a) Program”), which sets-aside public contracts for businesses owned by U.S. citizens that are “socially and economically disadvantaged,” where Black Americans are considered socially disadvantaged under a rebuttable presumption. This rebuttable presumption of social disadvantage for Black Americans in the 8(a) Program has been upheld as constitutional under the Equal Protection Clause.

Thus, the Secretary of the Treasury could issue regulations that expand targeted populations for NMTCs to include those that are “socially and economically disadvantaged” in line with the 8(a) program and thereby increase the funding opportunities for Black entrepreneurs through NMTCs consistent with the US Constitution.

Opportunity Zones

There are virtually no limitations on what investments a Qualified Opportunity Fund (“QOF”) may make, so long as they are within a Qualified Opportunity Zone (QOZs). There is no reason Opportunity Zones would be of special benefit to Black entrepreneurs, even if they are located in QOZs, because investments are still driven by the investor community—which, as noted, has systematically excluded Black entrepreneurs. There is a bill at the federal level to change the legislation.

Private Foundation Investment

Private foundations may invest in Black entrepreneurs while enjoying a significant tax advantage. Private foundations are best known for grantmaking, but may also further their charitable purpose by issuing below-market loans or equity investments through program-related investments. Private foundations in Massachusetts already have this ability.

Donor-Advised Funds

A donor-advised fund (DAF) is a philanthropic-giving vehicle that provides an immediate tax benefit and allows the donor to grant funds to charities of their choice. Andreessen Horowitz started The Talent x Opportunity (TxO) fund, a (DAF) managed by the Tides Foundation, initially funded with $2.2 million from the firm’s partners, designed to invest in underrepresented and underserved founders. Since then, more than 100 individuals have made contributions to the fund via the foundation. 

This could be done in Massachusetts. There is an opportunity to improve legislation in the Bay State that would enable more capital to be available for Black entrepreneurs, but legislation is not the barrier. The barrier seems to be the willingness to use the tools we have to develop a more diverse, resilient Commonwealth with less economic disparity.