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Venture Capital

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Venture Capital

  1. 1. ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ Venture Capital ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ for Communities by Kerwin Tesdell, President, Community Development Venture Capital Alliance Community development venture capi- those that are environmentally fo- jobs that pay a living wage. To pro- tal (CDVC) is one of the fastest grow- cused. They invest in such businesses duce the financial portion of the double ing sectors in the field of community as new-economy manufacturing com- bottom line, CDVC funds must seek development finance. From a handful panies and promising new service-sec- out companies that hold the promise of funds in 1990, the industry has tor firms, which can offer good em- of rapid growth. Companies that are grown to more than sixty funds in the ployment to large numbers of low-in- growing and successful can afford to United States, and at least another come people. They seek to apply prin- pay higher wages than companies that twenty funds operating or in forma- ciples that have helped create unprec- are just scraping by. Successful com- tion in other parts of the world. In the edented economic growth in places panies tend to offer better benefits to last year alone, CDVC under manage- from Silicon Valley to areas often left their employees, as well as job train- ment in the U.S. has grown to $400 behind such as rural Appalachia, in- ing and opportunities for advancement, million, up $100 million dollars from ner-city Baltimore and Nizhny and to attract and retain the workforce the end of 2000. Almost $40 million of Novgorod, Russia. they need for expansion. this increase was raised by three es- By providing equity and near-equity tablished managers that have success- THE IMPORTANCE OF EQUITY investments to businesses that other- fully closed on second funds.1 CAPITAL wise would not have access to them, Equity capital is vital to all businesses. CDVC funds create a powerful engine THE DOUBLE BOTTOM LINE It provides a cushion against slow of economic growth. Equity invest- CDVC funds use the tools of venture business climates and is relatively pa- ments are made through the purchase capital to create jobs, wealth and en- tient and flexible. As any banker ana- of common or preferred stock, while trepreneurial capacity to benefit low- lyzing debt/equity ratios can tell you, near-equity investments might be made income people and distressed commu- without sufficient equity, companies through a subordinated loan that car- nities. They are mission-driven funds cannot borrow additional funds. Most ries an “equity kicker,” such as royal- that invest in businesses that promise important for economic development, ties or warrants to purchase stock. rapid growth. This growth creates not equity provides the seed funding to These investments each carry signifi- only financial returns for the fund and start new companies and allows es- cant risk of loss but are structured so its investors but also social returns in tablished companies to develop new that the fund will share the “upside” of the form of good jobs for low-income products or build new plants—activi- the business if the business does well. people—a double bottom line. ties that create signifi-cant new em- CDVC funds apply disciplined eq- ployment and economic opportunity. MORE THAN MONEY: uity investment practices in places Equity capital is difficult for any ENTREPRENEURIAL AND where other venture capitalists do not company to raise. Most entrepreneurs MANAGERIAL ASSISTANCE go: inner cities and distressed rural raise initial equity capital from their CDVC funds become part-owners of communities. They offer financing to own savings and those of family and the companies in which they invest, minority- and women-owned firms and friends, but this is particularly hard to tying their own success directly to the come by in low-wealth communities. success of their portfolio businesses. A ready source of equity capital can As a result, CDVC funds invest not just 1 This includes Silicon Valley Community Ventures of San Francisco, California, thus be an extraordinarily effective tool money but a great deal of time and which closed its second fund with a $10 for fueling the creation of new wealth effort in helping the companies in million commitment from the Califor- in economically distressed areas and which they invest succeed. They typi- nia Public Employees’ Retirement also new job opportunities for people cally take seats or observer rights on System—the first capital ever committed who need them. the boards of their portfolio compa to a CDVC fund by a retirement fund. CDVC funds seek to create good 24
  2. 2. nies. Fund staff may help with such vided a little over a third of the eq- raising money to start second funds and activities as raising additional capital uity capital to CDVC funds started two new federal programs have been or marketing a new product. Fund staff before 1998, banks provided about introduced that will further boost the may even fill the chief financial officer two-thirds of the equity capital raised field: the New Markets Venture Capital function for a company for a period by funds formed after that year. And (NMVC) and New Markets Tax Credit of time, then help recruit a new head the range of legal structures used by (NMTC) programs, both enacted in of finance. Extensive entrepreneurial CDVC funds offer banks a variety of December of 2000. and managerial assistance is central to investment options including the pur- In July of 2001, the Small Business the economic development function chase of interests in a limited part- Administration conditionally designated of CDVC funds and often proves as nership or limited liability company, seven new NMVC companies. The important to the success of portfolio the purchase of stock in a corpora- NMVC program provides capital in the companies as the financing itself. tion, straight debt, equity equivalent form of zero coupon debentures3 and Taking this assistance a step further, investments2 and capital grants. operating assistance grants to NMVC several funds have learned to act as Based on a survey of 25 CDVC funds that invest in small businesses in intermediaries between local funds, the average capitalization per low-income areas. NMVC companies workforce development programs and fund was $12.7 million at the end of must raise matching funds from the the businesses in which they invest. 2000 and the median for these funds private sector for both the capital and Adding value to portfolio companies was $6.2 million. However, newer the technical assistance grant. The seven by helping to recruit trained employ- CDVC funds are starting out larger. funds aim to raise between $5 million ees from distressed areas and disad- The three funds that raised capital in and $12.5 million in private capital and vantaged populations augments a 2001 each began life in the $12 to an additional $1.5 to $3 million in pri- fund’s social and financial bottom $13 million range. vate operating assistance grants. The lines. Likewise, some funds have Because most CDVC funds are rela- target date for a second round of NMVC learned how to help their portfolio tively young, it is impossible to quan- selection is the fall of 2002. companies use government tax incen- tify precise financial or social returns. The New Markets Tax Credit provides tives and other programs in empow- However, a sample of the older funds a dollar-for-dollar credit of 39% of the erment zones and other economically indicates that they have created ap- amount invested in a community de- distressed communities. In this way, proximately one job for every $10,000 velopment venture capital fund, spread the funds make it not only financially invested. These job creation numbers out over a period of seven years. A com- possible but also attractive for a busi- are particularly impressive in light of munity development venture capital ness to locate in a low-income area the fact that the funds surveyed were fund that wishes to participate in the and hire area workers. all operating in very depressed rural program would apply to the Commu- areas. And, of course, the money in- nity Development Financial Institutions FACTS AND FIGURES vested is not spent, but returned to (CDFI) Fund for an allocation of tax While CDVC funds share a common investors or recycled to invest in other credits. If such an allocation is awarded, mission, they take a number of legal companies to create more jobs in the the fund can go to the market to raise forms, including: limited liability com- future. capital with the tax credit as a strong in- panies; limited partnerships; regular ducement to investors. The NMTC pro- “C” corporations; and not-for-profit tax- OPPORTUNITIES gram will pump $15 billion into com- exempt corporations. Their capital AND CHALLENGES AHEAD munity development venture capital comes from sources that share their The environment in which CDVC funds and other investments in low-in- interest in a double bottom line re- funds and their investors operate has come urban and rural areas of the coun- turn, including foundations, banks ful- changed significantly during the past try with $2.5 billion available in 2002. filling their Community Reinvestment year. New funds are forming at a rapid These two programs together offer Act obligations, other corporations, pace, mature funds are successfully unprecedented opportunities to the government and wealthy individuals. Although foundations and other socially motivated investors led the 2 For more information on equity- 3 Unsecured debt backed only by the way in the development of the indus- equivalents (or EQ2s), please refer to integrity of the borrower, not by try, banks have now supplanted these Mark Pinksy’s article on page 10. collateral, and documented by an investors as the leading source of capi- agreement called an indenture. One tal for the industry. While they pro- example is an unsecured bond. Community Investments March 2002 25
  3. 3. community development venture difficult task of trying to define for in- ABOUT THE AUTHOR capital industry. At the same time, they vestors this unusual activity with few offer some challenges. The industry points of reference; now those raising must be careful that the regulatory funds have an entire industry to point definition of New Markets investing— to. Investing in CDVC funds is an es- based on geography—does not re- tablished activity and a number of place the more nuanced and power- larger institutional investors have staffs ful methods that mission-driven CDVC of people with expertise and budgets funds use to produce their social re- dedicated to that purpose. People are turns. These methods take into ac- building careers in CDVC funds, de- count not only the area in which a veloping a unique set of skills that KERWIN TESDELL is president of the Community business is located but also a com- combine those of venture capital fi- Development Venture Capital Alliance plex mix of factors including the types nance and economic development. At (www.cdvca.org), the trade association of com- of jobs the business is likely to create the same time, the CDVC field is munity development venture capital (CDVC) and the types of people who are likely changing rapidly, with an unusual funds. It provides training, technical assistance to take those jobs. spirit of experimentation and learning and consulting services to the field; operates a Perhaps more important than any that will serve it well in the search for Central Fund that invests in and co-invests with legislation is the fact that community innovative ways to produce double CDVC funds; performs and publishes research; development venture capital is be- bottom line results. CI and advocates for the field. coming an established and recognized Community Development Venture industry. Someone raising a CDVC Capital Alliance fund six or seven years ago faced a 330 Seventh Avenue, 19th Floor New York, New York 10001 212-594-6747 THE FEDERAL RESERVE BANK OF SAN FRANCISCO IN PARTNERSHIP WITH THE UNIVERSITY OF SOUTHERN CALIFORNIA LOS ANGELES BRANCH PRESENT THE NATIONAL COMMUNITY DEVELOPMENT LENDING SCHOOL JULY 21–25, 2002 Join Us for five days of intensive training on the key issues and current industry trends relevant to community development lending in today’s business environment. Training in five core areas—single-family and multi-family housing, small business, commercial real estate and community-based facilities lending—stresses the day-to-day mechanics of underwriting community development loans and ensuring their long-term profitability. A redesigned and challenging curriculum has been developed by an advisory committee of community development bankers, training professionals and representatives of bank regulatory agencies to focus on structuring and underwriting community development loans. Each course is developed to ensure that students receive the most current, relevant, challenging and applicable instruction available. In addition, students will have the opportunity to participate in evening roundtables and seminars that focus specifically on issues that have been raised during the day’s courses. WATCH YOUR MAIL ... A brochure and registration application will arrive soon. FOR PROGRAM AND REGISTRATION INFORMATION Check our website at http://www.frbsf.org/frbsf/events/index.html 26
  4. 4. REGULATORY OVERVIEW INVESTMENT TYPE: COMMUNITY DEVELOPMENT VENTURE CAPITAL Definition: Community development venture capital organizations (CDVC) use the tools of venture capi- tal to conduct community and economic development activities as defined in the CRA regu- lation. CDVC funds make equity and equity-like investments in small businesses that hold the promise of rapid growth and a “double bottom line” of not only financial returns, but also community and economic development benefits. CDVC funds come in many different forms, including not-for-profit, for-profit, and quasi-public organizations. Their structures encom- pass for-profit “C” corporations, limited partnerships, limited liability companies, community development corporations (CDCs) and Small Business Investment Companies (SBICs). CDVCs fund investments ranging from the purchase of preferred and common stock to the provision of subordinated debt with equity “kickers” such as warrants or royalties. Investments in CDVCs should be carried as investments on the investing institution’s balance sheet in accor- dance with Generally Accepted Accounting Principles (GAAP). CRA A lawful investment, deposit, membership share or grant to a community development ven- Applicability: ture capital fund that has as its primary purpose community development will be considered a qualified investment/community development investment under the CRA regulation. FEDERAL RESERVE SYSTEM CONFERENCE Please mark your calendars for The Federal Reserve System’s Sovereign Lending Conference “Banking Opportunities in Indian Country” A national conference to encourage initiatives and partnerships that increase access to credit and capital and strengthen local economies THE DOUBLETREE PARADISE VALLEY RESORT SCOTTSDALE, ARIZONA NOVEMBER 18–20, 2002 More information will follow 27