Lessons Learned from Small Business Lending During COVID-19: A Case Study of the California Rebuilding Fund

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Executive Summary

As the COVID-19 pandemic forced California businesses to shut down in March 2020, the fate of small businesses, which often had fewer reserves to draw upon when trying to survive the shutdowns, became particularly concerning. Federal aid measures, including the Paycheck Protection Program (PPP), brought relief to many business owners, but their deployment also confirmed what many small business advocates feared: business owners in the most vulnerable communities and underrepresented business owners often struggled to obtain assistance. At the same time, small business lending capital dried up. Many banks and fintechs slowed their lending. Mission-driven lenders with experience serving underrepresented communities—like community development financial institutions (CDFIs)—received more applications than they could possibly fund and had limited established channels to attract new funding quickly. A coalition that spanned government, universities, small business advocates, lenders, and concerned private citizens came together to design a solution that would leverage public funds with private dollars to provide low-cost capital to small businesses that were rebuilding after COVID-19 via loans from CDFIs. The result was the California Rebuilding Fund (CARF). This report provides a brief history of the creation of the CARF; details its structure, loan terms, and application process; highlights lessons learned from its creation and implementation; and looks forward as this fund continues to operate in California and as other states or localities consider establishing similar funds.

Why was the CARF needed?

At the time the CARF was designed and launched, those interested in assisting small businesses in weathering the economic crisis prompted by the pandemic faced a particular set of problems and constraints: how could they assist the smallest and most vulnerable small business owners as affordably as possible with limited state funding? The CARF designers proposed an innovative solution: combine existing small business loan guarantees and a new infusion of state dollars with private capital to create liquidity for CDFIs to make small business loans. By coupling public and private funding, the CARF was able to leverage a more limited state investment with private funding. At the same time, the state’s involvement decreased the risk to private investors, which would increase the willingness of private actors to invest and allow small business owners to access the capital at a lower cost. CDFIs in California were well positioned to serve small business customers, particularly those that were most likely to be struggling to access federal relief efforts. But these institutions faced their own capital constraints that limited the amount of loans they could provide. By providing CDFIs with liquidity, the CARF facilitated increased lending to at-risk small businesses.

How does the CARF structure provide affordable capital to small business owners?

The CARF’s goal is to provide credit that is as affordable as possible to a broad array of small business owners. The CARF achieves this through a public-private partnership between the state’s Infrastructure and Economic Development Bank (IBank) and private investors, philanthropic organizations, and local governments. The CARF is designed to leverage two different forms of state subsidy: a COVID-19 Disaster Risk Loan Guarantee and a separate infusion of state funding into the CARF. This state funding is then supplemented by loans from private investors and philanthropic capital; in all, more than $100 million in government, private, and philanthropic capital has been raised to fund small business loans. In both cases, the public funds are the most at risk if small business borrowers default on their loans. This decreases the interest rate required to secure private capital in the fund, which then translates to lower interest rates for small business borrowers. Each infusion of public funds is held in its own structure, allowing for the parameters to change based on the source of capital (currently the guarantee program or the state’s investment of first-loss capital) and as lending needs evolve.

CDFIs were chosen as the small business lenders for the program due to their familiarity with serving small business borrowers, especially those that had been left behind in earlier pandemic-relief efforts. Participating CDFIs come from all parts of the state, ensuring that all communities are served by a participating lender. CDFIs have deep experience serving small business borrowers—especially women, minorities, immigrants, and low-income individuals, who were some of the most at risk of not obtaining other types of support during the economic crisis. The CARF also partnered with small business technical assistance (TA) providers to help spread the word about the program and aid small business owners in applying. Applications were routed through a centralized platform built for the CARF that matched small businesses with a participating lender.

What are lessons learned from the CARF?

The CARF (and other funds like it that launched during the pandemic) demonstrates a way to leverage larger amounts of capital through CDFIs to serve vulnerable small business borrowers. Even outside of economic crises, the smallest small businesses—along with those owned by people of color, women, veterans, immigrants, and low-income individuals—often struggle to obtain credit and capital. These businesses are an important part of the economy, and programs like the CARF may be able to continue to provide them with access to credit after the pandemic recovery. As governments and small business advocates across the country consider how to support small businesses and whether programs like the CARF are a match for their goals and needs, several lessons may be learned from the California experience.

The CARF provides a pilot case for leveraging public and private capital to increase the credit available to small businesses and to lower its costs.

By using public funds to lower the risk exposure of private investors, the CARF was able to lower the borrowing costs for small businesses relative to what is typically available on the private market. Although borrowing costs are expected to rise as the economy emerges from the most acute strain of the pandemic, the use of public capital can keep costs in line with lending typical of CDFIs while increasing the availability of capital for small business loans. The CARF also provides an example of a centralized platform that offers both investors and small business owners a single touchpoint while enabling a range of CDFIs to participate in the program.

Despite decreased risk, raising capital can be challenging.

The CARF was able to raise more than $100 million in private and philanthropic capital to provide small business loans. Nevertheless, participants noted that momentum for funding small businesses faded as the pandemic progressed, and the amount of time and effort needed to raise these funds surprised some participants. It is possible, however, that once these types of programs become more established (and less unknown to potential investors) and are able to approach capital-raising at scale, some of these challenges may be reduced.

Standardized loan products are possible for CDFIs, but determining appropriate fees may need further refinement.

The bespoke lending of the CDFI industry has often been cited as a barrier to reaching larger capital markets. Though CDFI participants in the CARF admitted that the loan parameters within the CARF could differ from their typical products and were, at times, more conservative, the CARF provides a test case that enabling CDFI liquidity through a standardized loan product is possible. However, one remaining potential barrier is ensuring that CDFIs earn sufficient income through origination and servicing fees to make up for the loss of interest income.

The structure of the CARF itself is flexible and allows for different funding sources and lending terms.

As a result, it can be adapted to new sources of capital or different economic needs. For example, additional 0 percent interest loans for San Francisco small businesses were made available through an investment of the City and County of San Francisco into the CARF. This structure will also enable the CARF to continue to add new lenders and update lending terms as the economic situation surrounding the pandemic evolves.

These structures are complex, will vary significantly based on state lending laws, and require partnership of a diverse group of actors; aligning terms can be challenging.

Though the CARF can serve as a model for similar efforts in other contexts, designing these programs for other geographies will still require considerable effort to align actors and comply with local lending laws. Additionally, as with many multiparty efforts, aligning terms to meet conflicting perspectives can be challenging. Operating from a common set of goals will mitigate these challenges.

It can be useful and important to coordinate and leverage with other existing government programs to provide a continuum of capital and complementary services without generating confusion for small business owners.

The CARF was designed and launched at a time when the state of California expected to have limited capital available to serve small business owners and the federal PPP funds had been exhausted. When the state found itself with a budget surplus, it allocated $4 billion in small business grant relief across several rounds of funding. The type and amount of aid offered varied from the CARF, and the CARF designers viewed these efforts as complementary, allowing small businesses to access grant capital earlier in the pandemic and then pivot to debt capital as they rebuilt for the post-pandemic economy. However, they acknowledged that the existence of the grant program, along with renewed 2021 funding of the PPP, complicated communication efforts surrounding the CARF and required small business owners to evaluate which program would best suit their needs.

Technical assistance (TA) is an important component of enabling small business participation in these types of programs.

The CARF partnered with a variety of technical assistance and small business advocacy organizations to educate small businesses about the program and assist them in applying. Several TA providers stressed that early coordination on assistance was important, rather than treating it as an afterthought. Many small business owners experienced challenges in applying, even though the program was targeted to them, and the work of these organizations was important to the program’s success.

The views expressed in this report are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of San Francisco or the Federal Reserve System.