Unlike research in public capital markets, research into private equity is held back by the lack of publicly available data. David Robinson, a finance professor at Duke University's Fuqua School of Business, is part of a consortium of professors from four universities trying to tackle that issue. As part of this work, Professor Robinson was asked by the U.S. Small Business Administration to analyze the performance of their Small Business Investment Companies program, which subsidizes the creation of private equity companies to invest in small businesses. The first of three reports from his analysis investigated diversity in private equity firms.
Robinson discusses his findings in this Fuqua Q&A.
Q: What was your goal in studying diversity in the private equity market?
Private equity in the U.S. is overwhelmingly a white, male world. This is a fact that many organizations, including the Small Business Administration, would like to change. Our goal in studying diversity in their SBIC program was to ask whether SBICs were more diverse than traditional private equity companies, and if so, whether these differences showed up in different patterns of investment and different returns. The ultimate objective is to see if the color of a person's skin affects their ability to raise capital for an idea. That's really what we were trying to analyze. We looked at whether SBICs led by minorities and women were more or less likely to invest in companies led by minorities or women. We found minority-led SBICS invested in minority-owned companies to a much greater degree than did other SBICS.
Q: Did that affect their performance?
No. This helped us dismiss two theories: first, that minority-led SBICs were taking advantage of great opportunities that other people weren't exploiting because of race, in which case they might dramatically outperform other types of investments. We didn't find that. The other theory was that if SBICs were being prompted to invest in minority-led companies and there was no economics behind it, you would expect these companies to dramatically underperform. We didn't find that either.
Given the performance is no different but the investment styles are very different, that tells you minority-led SBICs look at more minority-oriented deals and are potentially better able to do the due diligence on minority-backed companies. The minority-led SBICs told us the same thing. They said they had an edge on digging deep into the financials and kicking the tires of the business plan very carefully.
Q: What other aspects of private equity did your study address?
We also looked at whether jobs have been created as a result of the SBIC program. We found SBIC-funded small businesses created almost 3 million jobs between 1995 and 2014, and created or sustained almost 9.5 million jobs during the same spell. That's an average of $14,458 of funding - some of which is from the private sector - for every job created.
Of course we don't know how many of these jobs would have been created had the SBIC program never existed, or whether similar levels of job creation could have been achieved through other means. But this analysis suggests the ratio of investments to jobs is at least as attractive as is found elsewhere in the private equity sector. And because the program operates at a relatively low administrative cost, the government costs per job created are most likely outweighed by the subsequent tax revenues the firms generate.
The final report will study the gap filled by the SBIC. The SBI is in some ways the government filling a gap that was in part created by government intervention. For example, the Dodd-Frank and Basel III reforms make it more costly for banks to lend to small businesses. That created an opportunity for private equity because there are small business out there who are no longer being served by the banking community. The SBIC is involved in that through a loan-providing program, which thrives in a market where banks are constrained. So the government is solving the same program it created.
Q: How can this research affect the private equity market?
One goal is to speak to the broader investment community understand how diversity may expose them to a different set of investment opportunities that may be valuable to them. It also opens up more questions, because now we know these differences can be seen in the data, we want to understand more about why they're happening. There's a lot we don't understand about how perceptions of racism play out on both sides of the market. When we have data that speak to another capital market setting hopefully we can learn more.