High-Risk Loans--From a Nonprofit

Community funds are filling a gap.

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Things were not looking good for Leo White. A longtime manufacturing executive, White was eager to acquire a Keene, New Hampshire, company called Bortech, which had been making welders to repair heavy equipment since 1989. Revenue at the company had never topped $5 million, but White was convinced he could increase that number considerably. His local bank seemed to think so, too, and had promised him a $500,000 loan backed by the Small Business Administration. But at the last minute, the bank backed out, and it looked as if the deal would fall through.

Then a friend introduced White to John Hamilton, who runs Vested for Growth, a program of the New Hampshire Community Loan Fund. Vested for Growth, a Concord-based nonprofit, finances New Hampshire companies that cannot get funding from banks or private equity groups. Hamilton thought White had the management talent to lead Bortech. Using a combination of debt and royalty payments, he was able to arrange half a million dollars in financing. Not long after, White had his company. "If John's organization hadn't stepped in, I thought I was out of luck," White says.

White was just one innovative program away from falling into what is known as a capital gap: a shortage of money for people who need $150,000 to $500,000 or so. Despite recent efforts by banks to reach out to small businesses, many are still loath to lend less than $1 million because the costs of managing a loan are much the same regardless of its size. The SBA is more flexible, but still avoids certain types of high-risk loans. On the equity side, angels and venture funds aren't necessarily shy about smaller investments, but they have little interest in businesses with projected growth rates of less than 30 percent. And of course, borrowing is always more difficult for people and companies that have little collateral, are in the early stages of development, or have less than pristine credit.

Fortunately for people like White, a new breed of community development financial institutions, or CDFIs, has emerged to fill this need. These organizations--which include community development loan funds, banks, credit unions, and community development venture funds--have been around since 1994, when Congress created the Treasury Department's Community Development Financial Institutions Fund. About 1,000 CDFIs operate nationwide, and while most focus on promoting affordable housing and home ownership, a growing number have begun financing small businesses. In 2005, the latest year for which data are available, CDFIs funded more than 2,000 small and medium-size businesses and held $739 million in outstanding loans and investments, according to the CDFI Data Project, which gathers data on the industry. Another 5,800 companies received microloans of $35,000 or less.

Some CDFIs specialize in particular industries, others in lending to geographic regions, such as the inner city or rural areas. The funds come from a variety of sources, including the government, investors, and private donors. In New Hampshire, Vested for Growth, which has more than $3 million to invest, works in partnership with banks, economic development agencies, and the SBA. It has funded seven companies, using combinations of subordinated debt, warrants, and royalty payments, which give the lender a percentage of revenue. Unimpeded by bank regulations, Vested for Growth, like other CDFIs, can make riskier loans than banks can. When making decisions, Hamilton looks for management talent and capacity over typical criteria such as credit scoring. And like an economic development agency, Vested for Growth devotes its resources to creating good jobs in New Hampshire. Toward that end, the organization puts as much effort into counseling entrepreneurs as in funding them. "Banks look largely at the past," Hamilton says. "They want to know, 'What kind of collateral do you have? What's the secondary way I'm going to get repaid if the business doesn't go forward as expected?' We're more like venture capitalists. The key question is, 'Do I believe in your growth proposition?'"

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