Nov 1 2023

American Enterprise is In Danger from Recent Court Ruling

This article is cross-posted from The New Builders Dispatch, a publication founded and run by my New Builders co-author, Elizabeth MacBride. 

A few weeks ago, the American Alliance for Equal Rights won a legal victory in Atlanta when the 11th U.S. Circuit Court of Appeals temporarily blocked a small venture capital fund, Fearless Fund, from running a grant contest that awards $20,000 grants to small businesses led by women of color. The victory may or may not be temporary (this was a temporary stay, not a full adjudication), but the point has been made – there are those like the Alliance who live in fear of a changing world and far too many who support them.

We’ve seen the American Alliance for Equal Rights before: the man behind the Alliance, Edward Blum, brought the successful lawsuits against Harvard University, The University of North Carolina, and The University of Wisconsin that ultimately eliminated race-conscious college admissions programs in the landmark Supreme Court decision, Students for Fair Admissions v. University of NC, et al. But because of the lack of knowledge about how the financing system for small businesses and startups works (or doesn’t) in America, many people may miss the significance of the decision by the three-judge 11th circuit panel. The Alliance is striking a blow at the heart of private enterprise in America.

It’s not the Fearless Fund or the dozens of other interesting experiments in early-stage finance going on across the country that are imposing simplistic race-based thinking on America, it’s the Alliance.

A Profit-Driven Business Model
Fearless Fund, as well as other venture capital funds and accelerator programs, are private enterprises doing what private enterprises (including nonprofits) do: they are serving a fast-growing market for the purpose of making money. In this case, since they are investment companies, they are seeking first and foremost to make returns for their investors. Women and people of color are the fastest-growing groups of entrepreneurs in America. And since the pandemic, people are starting companies at near-record rates. While Fearless Fund is a 501(c)3, it exists to make money for its investors if its management and investment decisions are smart.

It’s not the government’s business, or the legal system’s, to dictate how entrepreneurs or venture capitalists invest their time or money. When the government dictates how capital should be apportioned and to whom, that is the definition of another economic system: Marxist communism.

Not A Zero-Sum Game
In the lawsuit, the Alliances alleges that some of its members – small business owners – were harmed because they could not apply for the Fearless Fund’s grant program. But this betrays a fundamental lack of understanding about how small businesses and financing work. (In reality, we’re sure the Alliance understands perfectly well how all this works).

Unlike college admissions or jobs, funding for startups is not a zero-sum game. A White entrepreneur didn’t get funding because a Black woman did. Indeed, the statistics suggest the system of small business and innovation financing is still working reasonably well for the people it was set up in the 1950s to serve: White men. (Though it could probably work even better). America still remains by far the largest venture capital market in the world.

This system isn’t about perfect fairness: It’s about measured risk-taking based on the unique insights of investors and entrepreneurs working together.

By Their Actions, You Can Judge Them
Venture funds that aim to fund companies led by people of color, or women, or veterans (or any number of other criteria) expand the number of total startups. It only benefits the country if an investor and an entrepreneur make a match that creates jobs, economic energy, and innovation – all of which we need.

The Alliance’s challenge frames the work of venture funds as giving underrepresented groups a boost in their “careers,” probably because the Alliance’s ultimate target is large companies’ workplace policies. But venture funds don’t employ entrepreneurs.

Unfortunately, many journalists covering the case have picked up the Alliance’s framing.

The Alliance purports to support a race-blind society and belongs to a conservative coalition that includes nominal adherents to the idea of free markets. If they were true to this philosophy, they would be working on the two fundamental problems with the financing system for small businesses. First, is that the majority of today’s entrepreneurs are women and people of color.

Fearless Fund and others aren’t set-aside programs. They’re addressing a need in the market that the historically white-dominated system hasn’t moved fast enough to meet. It’s as simple as that – and every dollar an investor feels motivated to risk in the system boosts everyone.

The second, and probably even more important reason, falls squarely in the wheelhouse of people who purport to care about free markets: Changes in the banking sector, including government regulation that helped produce consolidation, have made it unprofitable for banks to lend to small businesses. Government isn’t the enemy, it’s a regulator that can in some cases do more harm than good, as arguably it has in this one.

Twitter-Era Doesn’t Belong in the Real World
The Alliance’s challenge is black-and-white, oversimplified thinking that is more a product of the social media-driven political system than the complicated and nuanced real world. Applying this kind of thinking to the world of messy early-stage finance is potentially deadly. Early-stage finance works precisely because it is messy. Experiments like Fearless Fund have to be given a chance to work – and if they don’t, there’s a great mechanism that will shut them down: It’s called profitability.

The profit-driven business model that the Alliance is attacking is more likely than any other motivation to solve issues surrounding systemic racism in America. Could that be why the Alliance is attacking private enterprise?