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Venture Capital
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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
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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
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
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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
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