Volume 10; No. 4; Fall 1998
Community Development Venture Capital: The Double Bottom Line
By Kerwin Tesdell, President, Community Development Venture Capital
Alliance and Julia Rubin, Doctoral Candidate, Organizational Behavior
Program, Harvard University
Kentucky Highlands Investment Corporation has worked for thirty-two years
to alleviate poverty in the heart of Appalachia. In Duluth, Minnesota,
Northeast Ventures has spent a decade tackling the economic devastation
brought on by dramatic reductions in the regions ore mining industry.
In 1996, Boston Community Ventures was established in one of the poorest
sections of Boston to foster the creation of quality jobs and the growth
of socially responsible businesses. Meanwhile, similar efforts have sprung
up in such diverse locations around the world as Nizhny Novgorod, Russia;
Zagreb, Croatia; and Lima, Peru.
What do these organizations have in common? They are all community development
venture capital (CDVC) funds, members of a new but rapidly growing field
of organizations that use the tools of venture capital to create good
jobs, productive wealth, and entrepreneurial capacity to benefit disadvantaged
people and economically distressed communities. They seek to apply the
powerful engine of growth that has driven the economic expansion in Silicon
Valley, and other hotbeds of business development, to communities that
the current prosperity has passed by.
CDVC funds make equity and equity-like investments in highly competitive
small businesses that hold the promise of rapid growth. These fast growing
companies produce a double bottom line of not only financial returns,
but also social benefits in the form of good jobs and healthier communities.
The investments typically range from $100,000 to $1 million, much smaller
than most traditional venture capital investments.
The companies in which CDVC funds invest generally employ between ten
and one hundred people. Investors in CDVC funds include foundations, banks,
insurance companies and other corporations, government, and private individuals.
They invest because of an interest in the social and financial returns
of the funds; they too are interested in the double bottom line.
The CDVC Industry
There are currently more than forty CDVC funds operating across the United
States and Canada. In the U.S. alone, such funds have more than $330 million
under management. CDVC funds have also become a powerful economic development
tool in economies in transition in Eastern Europe and in developing economies
in Latin America.
CDVC funds come in many different forms, including not-for-profit, for-profit,
and quasi-public organizations. Their structures encompass for-profit
C corporations, limited partnerships, limited liability companies, community
development corporations (CDCs), and Small Business Investment Companies
(SBICs). Despite this structural diversity, CDVC funds all share a commitment
to the creation of good jobs through business investment.
CDVC funds use a multitude of investment techniques to accomplish their
missions. These range from the purchase of preferred and common stock
to the provision of subordinated debt with equity kickers such as warrants
or royalties. CDVC funds, as compared with lenders, thus structure their
financing so that they enjoy the upside when a company does well, but
also the downside when a company does poorly. For this reason, CDVC
funds take a much more active role than a lender ever would in advising,
and sometimes even helping manage, an investees business, in order to
help it succeed and grow rapidly. This often-intensive entrepreneurial
and managerial assistance is the heart of the economic development impact
Why Community Development Venture Capital?
There are a number of reasons that community development venture capital
is a powerful tool for economic development.
- Equity capital is vital to the success and growth of small businesses,
particularly during their expansion stage when large numbers of jobs
and productive wealth are being created. Because equity capital is high
risk, it is very difficult to access.
- Equity capital is in particularly short supply in low-income areas
and among minority entrepreneurs. The primary source of risk capital
for most small businesses is personal savings and loans from friends
and family. In low-income areas, these tend to be lacking. Traditional
venture capital firms provide financing for only a tiny portion of businesses
nationally, and venture capital is almost completely absent from low-income
urban and rural areas.
- Equity capital leverages other financing. Banks and other lenders
will not make loans to businesses unless they maintain a prudent ratio
of equity to debt capital. An infusion of equity capital is often the
linch pin for assembling other financing for new or expanding businesses.
- CDVC funds target companies that are highly competitive and thus likely
to expand rapidly. These companies not only provide substantial financial
returns, they also create large numbers of good jobs and have the financial
resources to offer decent wages, employee benefits, worker training,
and opportunities for career advancement. This sector of small, competitive
businesses can form the backbone of a successful local economy.
- CDVC funds provide significant entrepreneurial and managerial assistance
to businesses. Unlike lenders, equity investors become partners with
their investee companies, sitting on their boards of directors and providing
other substantial assistance by identifying additional financing, making
contacts with customers and suppliers, and helping with executive recruitment.
For businesses in low-income areas, this assistance is often as crucial
as the financing itself.
- Some CDVC funds operate, or have relationships with, workforce development
programs that help place unemployed people in jobs that are created
by their financing activities.
- Some CDVC funds go beyond providing financing and technical assistance
to existing businesses. They start and nurture businesses, and then
recruit local business people to own and operate them. In this way,
CDVC funds are able to jump-start business develpment in even the most
economically distressed areas.
The Difficulties of the Double Bottom Line
A focus on social returns differentiates CDVC funds from traditional
venture capital funds. Like traditional venture funds, however, CDVC funds
must also deliver financially to remain in operation. This double bottom
line of social and financial objectives presents many challenges that
are different from those that traditional venture capital funds encounter.
Among the challenges that the CDVC industry faces are problems in raising
capital and reaching scale, difficulties in attracting experienced talent,
and high costs of operation.
Problems In Raising Capital and Reaching Scale
The pool of potential investors that share an interest in the social
component of the double bottom line is limited, and CDVC funds generally
do not offer traditional venture capital returns. For this reason, CDVC
funds find it difficult to raise large amounts of capital, and the average
size of a mature CDVC fund in 1996 was only $5.8 million. This is significantly
smaller than most traditional venture funds, and also less than the approximately
$10 million minimum generally thought necessary to help cover operating
expenses, attract experienced fund managers and allow for investment diversification.
Substantial new sources of risk capital must be found for funds in the
CDVC industry to reach an economic scale where the full power of the model
may be demonstrated.
Attracting Experienced Talent
Only a small number of individuals have the skills necessary to operate
a successful equity investment program. Most of them work for traditional
venture funds and are highly compensated for their work. Those with the
necessary skills and experience to produce the double bottom line of making
successful financial investments while also creating social benefits are
even more scarce. The relatively small number of CDVC funds currently
operating has thus far been fortunate in attracting extraordinarily talented
and dedicated people. Creating opportunities for training and apprenticeship
learning will be necessary to allow the CDVC industry to continue its
rapid expansion and retain its high quality.
Costs of Operation
The economics of CDVC funds are fundamentally different from those of
traditional venture capital funds: CDVC funds are generally more expensive
to operate, as a percentage of funds under management. Increased scale
would help this problem, but, for at least two reasons, costs will always
remain an issue. First, the size of the average CDVC investment is significantly
smaller than that of the average traditional venture investment, although
the cost of making a smaller investment is often as great as making a
larger one. Also, CDVC funds often become even more involved in providing
entrepreneurial and managerial assistance to their investee businesses
than do traditional venture capitalists, and this too is expensive. The
smaller investment size and greater business assistance are both integral
to achieving the social benefits of CDVC funds. For investment returns
not to be unduly reduced, a model must be developed that will help pay
for the social benefits produced by CDVC funds from a source other than
investment earnings alone.
Future of the Industry
Economic development professionals, as well as leaders in finance and
business, are increasingly turning to CDVC as an effective way to help
build healthy communities and make durable improvements in the lives of
disadvantaged people. While CDVC shows great promise, the jury is still
out regarding the full measure of its effectiveness. As existing funds
mature and newer ones are formed, they are sharing knowledge and best
practices with each other, and efforts are under way to measure the full
social benefit and financial returns of the industry. Together, these
funds are experimenting with and building a model that is different from
traditional community economic development, but is not quite venture capital
either. It is a new hybrid that borrows sophisticated tools of finance
and business development and applies them in promising new ways to some
of the most serious and intractable problems of our time. CI
|The Community Development Venture Capital Alliance (CDVCA)
promotes use of the tools of venture capital to create good jobs,
productive wealth, and entrepreneurial capacity that benefit low-income
people and distressed communities. CDVCAs members operate funds in
low-income urban and rural areas throughout the United States and
around the world. It seeks to build the field of community development
venture capital by providing training, offering opportunities for
peer exchange and learning, increasing members access to capital
and other resources, providing individualized consulting services,
developing standards and best practices, and advocating for the field.
It also encourages and facilitates involvement of the traditional
venture capital communities in community development finance.
For general information about CDVCA, contact Judy Burton, CDVCA Administrator,
700 Lonsdale Building, Duluth, Minnesota 55802, (218) email@example.com.
For more specific information, contact Kerwin Tesdell, President, CDVCA,
915 Broadway, Suite 1703, New York, New York 10010,(212) 475-8104, web
About the Authors
Julia S. Rubin is a doctoral candidate
in Harvard Universitys Organizational Behavior Program. Her dissertation
examines the field of community development venture capital. Formerly,
Ms. Rubin consulted for McKinsey & Company and worked in brand management
for Procter & Gamble and Eastman Kodak. She received her M.B.A.,
M.A. and B.A. degrees from Harvard University.
Kerwin Tesdell is president of the Community Development
Venture Capital Alliance and also an adjunct professor at New York
University School of Law. Formerly, Mr. Tesdell was a program officer
at the Ford Foundation and director of the Community Development
Legal Assistance Center in New York. He holds an economics degree
from Harvard College, law and business degrees from New York University,
and a certificate from the Venture Capital Institute.