Partners (Second Quarter 2004)
Partners (Second Quarter 2004)
|Community Development Venture Capital Funds Sow Economic Opportunities|
Now community developers widely recognize that fostering economic revitalization and opportunity is the key to creating sustainable communities. To address this issue, the community development venture capital (CDVC) industry invests in businesses that provide jobs and wealth-building opportunities in distressed communities.
Explaining CDVC funds in terms of traditional venture capital funds is much like comparing apples to oranges. Both are the fruit of well-capitalized plans that stem from a solid business concept, and both are nurtured through infusions of equity and prudent management oversight. Furthermore, both usually reap a significant cash return after several years of investment, as well as nourish the economic health of the communities or industries they support. The flavors, however, are distinctly different.
Comparing traditional and community funds
Traditional venture capital funds aim to produce significant financial returns by offering high yields in exchange for assuming risk. In contrast, CDVC funds expand the definition of reward to include not only interest and dividends to investors but also new jobs and services for low- and moderate-income populations or distressed communities. This investment with a social mission results in a “double-bottom line.”
CDVC funds can be structured as for-profit, nonprofit, or “hybrid” organizations in which a for-profit CDVC fund is affiliated with a nonprofit organization. The latter approach has the distinct advantage of enabling access to grant funds, according to a 2001 study by Julia Sass Rubin in Changing Financial Markets and Community Development. All CDVC funds strive to engage quality management teams, who bring significant experience in the traditional private equity industry as well as strong relationships with bankers, corporations and other economic development engines.
According to a statement from the Community Development Venture Capital Alliance (CDVCA), an industry group for CDVC organizations, CDVC funds represent one of the “fastest growing sectors of community development finance.” The number of CDVC funds in the U.S. has grown from 52 funds managing $300 million in capital at the end of 2000 to over 80 managing $548 million, as of the second quarter of 2003. Research for a San Francisco Fed publication by Kerwin Tesdell and Charity Shumway in 2003 indicates that the CDVC industry grew by 38 percent over that same period, which marked one of the most difficult fundraising environments in the venture capital industry’s estimated 30-year history.
Not unlike their traditional counterparts, CDVC funds seek to invest in businesses with solid business concepts, good management teams and high growth potential. However, CDVC funds pursue distinctly different types of investment to achieve this goal compared to traditional venture capital funds.
Characteristics of CDVC investments
Unlike traditional venture capital funds, CDVC funds aren’t restricted to high-growth areas or a particular stage of business development. Rather, they are more likely to extend to all businesses in urban and rural low-income communities throughout a geographic region. For example, SJF Ventures in Durham, N.C., is concentrated in the eastern United States and invests in companies at all stages of development (see sidebar).
Another difference is that CDVC fund investments are not likely to be industry-specific. While private venture capital funds in the 1990s invested in technology-related firms, for example, CDVC funds focus on investments that will create quality entry-level jobs with good benefits and livable wages. Like traditional funds, they provide “patient capital”: that is, investors don’t realize a payment on their investment until the business is well-established, usually several years after the investment is made.
Unlike traditional venture capital funds that seek high returns on higher-risk investments, the financial returns on CDVC funds are usually more modest, with an additional payoff in the form of community benefits such as job creation or neighborhood stabilization. The size of the investment is also smaller than traditional venture capital funds. According to Rubin and others in a study presented to a 2003 Fed conference on Sustainable Community Development, the average investment is $186,000 per round and $393,000 per company as compared with the traditional venture capital industry’s average of $8 million per round of investment.
Finally, intensive technical assistance is critical to the success of both the CDVC funds and the businesses in which they invest.
In both types of venture capital funds, providers need to “harvest” or exit the investment to return a profit to investors and re-capitalize funds for new investments. According to Rubin, at the end of 2000, CDVC funds tracked in the study had exited 67 of their 237 total investments. More than half of exits as of 2002 were through acquisition from outside buyers, and 32 percent involved management and owner buy-backs.
Assessing the financial and social performance
Several factors make it difficult to evaluate how successful CDVC funds have been from both financial and community development perspectives. On the financial side, the majority of funds are less than seven years old and not many have exited their investments. The financial evaluation is further complicated because some of the funds received operating subsidies, used a combination of debt and equity instruments, or both.
Although the available data are limited, preliminary assessment of the industry’s social impact is encouraging. Rubin tracked the jobs created by businesses financed by three of the oldest funds and found that they created more than 4,000 jobs at an average cost of less than $10,000 equity invested in the company per job. These jobs were in economically distressed rural communities and provided higher than average (for the region) benefits and wages.
To learn more about the community development venture capital industry, visit the Community Development Venture Capital Alliance’s website at www.cdvca.org.
This article was written by Nancy Montoya, Regional Community Development Manager in the Atlanta Fed’s New Orleans Branch.