Clarence Wooten needed $3 million to finance his new company that produced prefabricated Web sites for small businesses on tight budgets - and he wanted to do it debt-free.
He spent an exhaustive six months in 1999 making cold calls and visits to venture capitalists and angel investors, and even finagled his way to a seat next to an investor on a flight to Silicon Valley.
Wooten succeeded in wooing several angel investors, who got a 10-fold return within months when he sold his Columbia company for $21 million. He got no venture capitalists.
It doesn't usually pan out so well for minority companies.
Finding venture capital funding is difficult for any business, but the pool of money is especially shallow for minorities, who receive just 1 percent to 2 percent of such funding, according to various studies.
But venture capitalists are missing out on hefty profits by ignoring promising minority startups, according to a new study being released today by the Missouri-based Ewing Marion Kauffman Foundation and professors from Wayne State University and the University of Washington.
Despite misperceptions that minority companies are risky investments, the study found that many of these businesses are profitable and yield solid returns.
"This study does a great job of setting aside one important consideration for venture capitalists, and that is what is the return on my investment," said Rhonda Hollman, vice president of the Kauffman Foundation. "These investments really did yield respectable returns ... and that is the most critical message we want to send."
The study surveyed 24 funds that invest in minority companies and zeroed in on the 11 funds old enough to have made investments between 1989 and 1995. More than half of their 117 deals were profitable, it found. Through 2000, the funds reaped $124.1 million in gains on investments totaling $65.8 million, the study said.
Currently, venture funds that invest in minority companies have $2 billion under management, the study said.
The funds had an average rate of return of 23.2 percent. In comparison, the average rate of return for all venture funds, including those that invest in early-stage startups and mature companies, was 26.3 percent over a 10-year period ended in 2002, according to the National Venture Capital Association and Thomson Venture Economics.
The findings came as no surprise to many entrepreneurs, such as Wooton, who said the biggest problem for minority companies is getting the attention of the close-knit network of those who make the funding decisions.
"Typically, the people controlling the money don't look like us, so they have to have a certain trust before they'll make an investment," said Wooten, who now operates Wooten Ventures, which invests in small and minority companies.
Minorities face similar roadblocks when applying for traditional bank loans, but Wooten and others say venture capital investment is more desirable because it allows companies to grow and prosper without being saddled by debt.
"There's a stereotype that is rather pronounced in the world of investment that investing in minority companies is a social investment and yields in low returns," said Morris Reid, a founding partner and managing director of the Westin Rinehart Group, a Washington-based consulting group.
Venture capitalists may also think that minority firms are too small to invest in, the study's authors said.
The average venture capital investment is several million dollars, compared to the half-million the study found was invested in minority firms.
"The amount of time and energy it would take to do a $5 million investment is not significantly different in the time and energy you do in a $500,000 deal," said Hollman. "And your return on the $5 million would be much larger."
The study also found that the minority funds avoided the hefty losses resulting from the skid in technology and Internet stocks because they invested in a range of businesses such as restaurants, manufacturing, broadcasting and communications.
"Certainly the time was very good in that the whole bubble in technology is not something the minority firms were following to the same degree as the mainstream venture capital community," said study co-author Timothy Bates, a Wayne State University professor of labor and urban affairs.
Bates and William Bradford, a University of Washington professor of finance and business and economic development, also found that larger investments yielded larger returns. Returns also were better when fund managers played active roles in the companies in which they invested, such as serving on the board of directors.
Fund managers that focus on minority companies hope the study will encourage more companies to invest in their funds. The study found that public pension funds made up the largest source of these venture capital funds. Commercial banks and insurance companies and intermediaries were the next- largest sources.
Stanley Tucker, president of Meridian Management Group Inc., a venture capital fund targeting ethnic minorities, said the study's findings match what has been evident to him for years. "Hopefully, this will help us raise money for our industry," Tucker said. "It all boils down to talent, deals, and capital. There is definitely not a lack of talent and there are plenty of deals. We know there is a great market out there, we just need more money."
The study also found that the capital venture investing in minority companies is a widely changing field that will continue to grow, particularly as the minority population and minority businesses increase and the misperception of these businesses being underperformers dwindles.
"Hopefully, this will convince companies who provide capital that they should give minorities a second and third look," said Hollman of the Kauffman Foundation.