10 Nov Community Development Venture Capital
NorthStar Guide to VC in Wisconsin
Editors Note: The Wisconsin Technology Network has received an exclusive advance copy of NorthStar Economics 60-page report titled, the NorthStar Guide to Growth and Venture Capital in Wisconsin. This report contains a primer for Wisconsin companies seeking information about risk capital available in the state. David Ward and his team have agreed to excerpt their report in four-installments on WTN over the next three weeks the third installment is:
Community Development Venture Capital
Community development venture capital is a growing and dynamic arena that brings community development and traditional venture capital together in new ways.
The mainstream venture capital industry invests in about 1, 000 early-stage companies annually, but more than 500, 000 new firms are started each year in the United States. Thousands of promising new companies fall through the investment screen of the traditional venture capital industry.
Developmental venture capital funds offer a solution to this problem. The strategy is to apply professional venture capital disciplines to a broader range of investment opportunities. This strategy deploys venture capital on a smaller scale, making it possible to foster a whole tier of companies that were unable to be assisted previously.
The Community Development Venture Capital Alliance
The Community Development Venture Capital Alliance (CDVCA) is a national association of 55 member venture capital funds, community development corporations and others who promote use of venture capital tools to create jobs, entrepreneurial capacity, and wealth to advance the livelihood of distressed communities. CDVCA funds are mission-driven organizations established explicitly to benefit distressed communities and regions.
According to CDVCA, there are at least 95 existing Community Development Venture Funds (CDVC) and funds in formation throughout the world. There is more than $500 million under management domestically. The average fund size is $14 million for CDVC funds formed after 1998.
CDVC fund investments tend to be smaller in size and are made to smaller companies than mainstream venture capital firm investments. In 2000, the average CDVC fund investment into small businesses was $331,000 per company.
Community development venture capital funds operate in types of industries, investment sizes, and in other ways distinctly different than the traditional venture industry. Yet, they rigorously practice conventional venture financing disciplines to accomplish their purposes.
Can developmental venture funds meaningfully impact local communities?
The most prominent and oldest community development venture fund has been the Kentucky Highlands Investment Corporation (KHIC) .
Kentucky Highlands Investment Corporation is a widely recognized rural economic development program. KHIC has created more than 8, 000 jobs through providing venture capital and “hands-on” management assistance to its portfolio companies. KHIC attracts early-stage businesses to its nine-county Appalachian target area by offering developmental venture capital investments.
In a 1994 book, Of These Hills, Thomas Miller, former KHIC President from 1974 through 1981, prepared a 25-year review of the Kentucky Highlands Investment Corporation. Tom Miller began by asking the questions: “Should people remain among family and friends in the beloved hills and hollers, coping as best they can amidst economic depression and limited opportunity? Or should people move to unfamiliar and frightening but apparently greener pastures? ”
Mobility of labor plays a central role in guiding economic activity toward its most efficient production of goods and services. Unfortunately, human migration carries costs to migrants, the communities they leave behind, and society at large. Economists call such costs economic externalities (i.e., some costs are borne by others).
The Kentucky Highlands Investment Corporation (KHIC) was a child of the War on Poverty. With its initial $$14 million grants, KHIC invested and re-invested $33.2 million in 80 private enterprises – firms that created 22,300 years of employment, produced goods and services in excess of $1 billion, and paid $200 million in salaries and wages.
At least 68% of net growth in manufacturing jobs in Kentucky Highland’s nine target counties from 1970 to 1990 can be directly attributed to KHIC business ventures. This is a clear example of entrepreneurial capitalism unleashed by enhanced community venture financing availability.
RUPRI Rural Equity Capital Initiative
According to the Rural Policy Research Institute (RUPRI) , “Access to venture capital is recognized as important for new business startups and rapid business expansion. Consequently, the economic development prospects for communities and states are linked to the availability of venture capital for local entrepreneurs and businesses.
The RUPRI Rural Equity Capital Initiative was funded by grants from the U. S. Department of Agriculture (USDA). The purpose was to examine innovative institutions that are making venture capital investments in small market (e.g., rural, non-metro, etc.) communities across the country and develop lessons learned from these institutions.
During 1998, 1999, and 2000, the research team completed case studies of 23 nontraditional venture capital institutions.
Per capita venture capital investments for the United States were approximately $143 in 1999. Only six states exceeded the national average. Alternatively, 24 states had per capita investments less than $20.00.
The nontraditional institutions that RUPRI studied expect financial return on investments less than the 30-40% annual return anticipated by the traditional venture capital industry. They generally operate with a geographic focus such as a community, state, or region and may have a dual bottom line of acceptable financial returns and social and economic benefits.
The 23 institutions selected by RUPRI for site visits were not chosen to document “best practices.” The goal was to better understand the advantages and shortcomings associated with alternative program structures. The success factors for nontraditional venture institutions that RUPRI found to be critical for all the funds studied included:
Skilled and Experienced Management. Skilled management was important to the success of nontraditional venture capital institutions. However, RUPRI did not find that salaries comparable to those in private venture capital funds were necessary to attract good managers.
Focus on Generating Adequate Deal Flow. Although most funds were geographically restricted, the successful ones put significant resources into generating deals via marketing or deal creation.
Fund Size is Optimal for Projected Goals. Successful funds had access to their capital up-front, or at a predictable rate of disbursement. This enabled these funds to make both original and follow-on investments.
Public Oversight Limited to Monitoring to Insure Mission Fulfillment. Opportunities to pressure fund managers to make specific investments must be eliminated.
Attention Given to Fund IRR. Long-term sustainability (politically and financially) of a non-traditional venture capital institution requires that fund managers invest only in companies with good prospects for a positive rate of return on equity capital.
The RUPRI Rural Equity Capital Initiative found that $10 million is the preferred minimum capitalization size for a self-standing nontraditional venture fund.
Minnesota Rural Venture Funds
The Minnesota Investment Network Corporation (MIN-Corp) is a community development venture capital fund that focuses on rural (non-metro) communities in Minnesota. It is the only equity fund in Minnesota that focuses on rural businesses statewide.
MIN-Corp has an investment strategy targeting growth companies in the manufacturing and technology sectors located in Minnesota, but focusing outside the metropolitan area of Minneapolis and St. Paul. MIN-Corp’s investments span from early stage to regular expansions, to turnarounds and ownership transitions.
MIN-Corp is a Community Development Financial Institution (CDFI), enabling it to obtain $4 million of its $14. 8 million total capitalization from the U. S. Treasury Department’s CDFI Program. The Fund has also obtained $1.5 million from Wells Fargo and U.S. Banks and $1 million from a major regional foundation.
Since its inception, MIN-Corp has invested $11. 8 million in 25 smaller and mid-sized growth businesses in Minnesota with 85% located in rural communities spread across the state. MIN-Corp is an excellent example of how responsible venture-capital-based economic development is assisting local rural communities adjacent to Wisconsin.
End Note: This excerpt has been published with the permission of NorthStar Economics. Dr. David J. Ward, PhD is President of NorthStar Economics and co-author of the report. He completed a thirty-one year career in the University of Wisconsin System in July 2000. Ward held teaching positions at the University of Wisconsin – Green Bay and the University of Wisconsin – Oshkosh. James Patterson is a senior associate with NorthStar Economics. He served as the principal investigator and co-author of the. The 2003 NorthStar Guide to Growth and Venture Capital for Wisconsin companies that is now available for online purchase online at www.northstareconomics.com for $25 plus shipping and handling.
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