Capital: The Bucks in Your Backyard
Can't find money anywhere? Maybe you're searching too far from home.
Lewis Buchner knew he was looking for a needle in a haystack. The CEO and founder of Vida, an office-furniture manufacturer based in Brisbane, Calif., had grown his company to $6 million in revenues and 50 employees over 27 years. Now Buchner was ready to launch Vida's own branded product line, but he wasn't sure where to turn for the necessary funding to get the project going.
Though he was reluctant to take on any more bank debt, Buchner was completely realistic about his chances of finding equity financing. "It's extremely difficult for a company like ours to go to the VC market," he says. "We might as well say it's virtually impossible. We're a small low-tech company that is never going to go from $6 million to $60 million in two years. It's just not going to happen."
Yet five months after Buchner's search for capital began, Silicon Valley Community Ventures (SVCV), a firm that targets businesses in low-income communities in the Bay Area, invested $250,000 in Vida in exchange for a 6% stake. What aspect of the business caught SVCV's eye? Two very surprising elements: Vida's commitment to training and advancing its blue-collar workforce, and its socially responsible business practices, especially its commitment to sustainable forestry.
Those qualities may not seem as if they would be particularly attractive to a typical venture-capital firm. But SVCV is hardly typical. As one of some 50 funds involved in community-development projects throughout the country, SVCV seeks both practical and altruistic compensation -- referred to by those within the community-development arena as a "double bottom line." The dual goal: to see not only a financial return on an investment but also a return to the local community in the form of such things as jobs for low-income workers, inner-city property revitalization, or opportunities for women and other minorities.
Community-development funds are not an entirely new idea. Their roots can be traced back to the 1960s, when the federal government created community-development corporations, nonprofits backed by government money for the support of companies and community programs in inner cities and rural areas.
At the time the notion may have had merit, but the reality couldn't quite live up to the ideal. Since most of the original corporations didn't require a return on their investment, they needed continual infusions of capital to keep them going. Ultimately, a new self-sustaining iteration -- community-development venture-capital funds (CDVCs) -- evolved.
Since such funds rely on the success of their portfolio companies to underwrite subsequent investment rounds, they seek tangible financial returns -- for example, five times their initial investment over five years. Today, backed by capital from charitable foundations, the federal and state governments, and banks, CDVCs serve geographic regions as well as lower-tech markets neglected by the traditional venture-capital industry.
At present, some 20 U.S. funds are using the community-development model to make either equity or near-equity investments, while another 10 or so funds focus primarily on community-development lending or some other social-service provision and only occasionally make equity investments in companies in underserved areas. An additional 20 funds are in the initial fund-raising stage. All told, the funds are worth an estimated $300 million. (For a list of community-development venture-capital firms, visit www.cdvca.org, the Web site of the Community Development Venture Capital Alliance.)
Lewis Buchner's secret weapon in making his pitch to SVCV was his company's business plan itself. He drew up a traditional document, including an overview of the marketplace, a list of his company's competitive strengths and weaknesses, and what he saw as the market opportunities for his new product line. He also included information about Vida's diverse workforce and made forecasts about job-growth potential because he saw those elements as a critical part of his company's identity and thought SVCV would be particularly interested in his community-development commitment.
He was right, says Jacob Singer, senior portfolio manager at SVCV. "The thing that really caught our attention about the company from a social-return point of view was the willingness of the CEO to implement training programs for low-income workers within the company," he recalls.
After 60 days of due diligence, during which SVCV challenged Buchner on his financial projections and his expectations for the new product line, the CEO walked away with $250,000.
He also gained access to SVCV's advisory program, a free service through which SVCV links its portfolio companies with Bay Area executives who volunteer their time and expertise in such business-critical areas as finance, marketing, and strategic planning to companies that could otherwise never dream of being able to hire them. Vida recently received a convertible-debt round of financing from SVCV, and Buchner says he wouldn't hesitate to look to the firm to lead any additional funding rounds.
On the opposite side of the country, in Helenwood, Tenn., Container Technologies Industries LLC is so far removed from the fast lane that CEO and president Tom Reddoch can't get cell-phone service when he's in the office at his steel-container manufacturing plant. But although the rural company might not have made any venture capitalists swoon with its line of hazardous-waste storage and transport containers, its job-generation potential -- and the benefits that its products afforded the environment -- made the investment committee at Sustainable Jobs Fund (SJF) sit up and take notice.
In 1999, when Reddoch and a group of local angel investors were trying to raise the $600,000 they needed to purchase Container Technologies from its former owners, they approached SJF and asked for help in reaching their goal. SJF, which has offices in Durham, N.C., and Philadelphia, made a $266,500 preferred-membership-interest investment in Container Technologies in exchange for a 15% nongoverning stake in the company. ("Preferred-membership interest" indicates that SJF, as the biggest cash investor, receives the first income and potential capital-appreciation returns that Container Technologies sees. "Nongoverning" indicates that SJF has a nonvoting interest in the company.)
"They had a very explicit due-diligence process," says Reddoch of SJF's managers. "They looked at our management team pretty closely. They also looked at the integrity of the other investors."
In order to secure the investment, Reddoch signed a statement saying that the company would add 15 new jobs to its 28-person staff and agreed to pay a stipend to all employees for health-care coverage, which workers had previously paid out of pocket.
According to SJF managing director David Kirkpatrick, Container Technologies has come a long way since the manufacturer's initial period of scrutiny. "They are one of our best-performing companies," he says. "Their second full year of sales was about 60% higher than we had anticipated. This company is over on all metrics. When we invested, they had 30 employees, and now they have more than 90. They're the fastest-growing employer in the county."
Although Container Technologies and Vida are unlikely VC targets, they are attractive companies for two reasons: they have strong management teams and significant market opportunities. And therein lies the real secret to obtaining community-development venture capital. SJF's Kirkpatrick warns that his enthusiasm for creating jobs doesn't mean he'll fund just anyone. "It is not a challenge to find companies seeking financing that on the surface might qualify, but of the 60 inquiries we get a month, we probably visit maybe four to six companies, and we invest in one each quarter. So it's really a winnowing process," he explains.
Before making a visit, SJF's investment staffers usually conduct a conference call with the senior managers of the target company to get a sense of the team's strength. Kirkpatrick says that those conversations are critical. "A lot of it has to do with integrity," he says. "Are the people thoughtful? Are they believable? Have they spelled out the opportunity well?"
Community-development investors may not lead start-ups located in underserved areas to record-breaking public offerings, but they can provide financing to companies that might otherwise get overlooked by traditional venture capitalists. "The key word in all of this is access," says Buchner. "The world of venture capital is a world unto itself. SVCV is trying to open that door a little bit to smaller lower-tech companies like us."
The data on the community development venture capital market was provided by Julia Sass Rubin, Ph.D., a fellow at the Taubman Center for Public Policy at Brown University.
Kate O'Sullivan is a reporter at Inc.
At a Glance
|CDVC FUNDS|| TRADITIONAL |
|Total capital under management||About $300 million||About $134 billion|
|Average investment size per round||$186,000||$13.2 million|
|Typical time frame before exit||5 to 8 years||3 to 5 years|
Sustainable Jobs Fund (www.sjfund.com) director David Kirkpatrick spoke with Inc reporter Kate O'Sullivan about how CEOs should approach his fund for financing as well as about the criteria he uses in evaluating potential investments.
What's the best way for CEOs who are looking for funding to reach you?
It's best if they have a referral from someone who knows us or from another fund. I would poke around on a [fund's] Web site and see who else they've invested in and try to find a connection. And I'd call a couple of CEOs and say, "Hey, what do you think about this fund? Are they good investors?" I think that with the big funds you almost have to have a referral source to get anywhere. But if someone sends us a thoughtful cover letter and executive summary and says, "Here's our business, here's our job-creation potential," so we can see they're actually thinking about our fund, we're definitely going to give that a very serious look.
What do you do once you get a business plan?
One of our goals is to give some feedback on a business plan within a week. If the entrepreneur is willing to take advice and feedback, we try to explain why it didn't match for us or who it might match. We see a lot of entrepreneurs who are not ready for venture capital yet, even if they think they are.
What criteria do you use to determine whether you want to investigate the company further?
We look at the people involved. We look at the markets. We look at the upsides and the projections. We look for any red flags. For example, if the projections are really wild, then that shows they've never grown a company before and they don't really know how hard it is.
Is the job-creation component more important to you than the industry?
Yes. We would like to have the business in a sustainable sector, but we realize we can't have too many criteria or we won't make any investments. We won't do an investment with a company that won't create jobs with good benefits, some training, and a living wage.
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