Here Today, Almost Certainly Gone Tomorrow

Now that loopholes have been plugged in a program directing VC funding to low-income areas, the Bush Administration is poisedto scrap it

It's hard to bemoan a bust if you never benefited from the boom. Amid all the hand wringing over the high-tech downturn and the demise of the dot-coms, it's easy to miss the fact that the bubble pumped up by the venture-capital of the late '90s was largely a bicoastal phenomenon. Indeed, California captured 43% of all VC investments in 1999, and 80% of those went to Silicon Valley.

A soon-to-debut federal program aims to address the lack of access to venture capital in much of the rest of the country, particularly in low-income rural and urban areas. But before launching the effort, federal officials have done some last-minute tinkering to ensure the funds reach the entrepreneurs they're intended to help. And thanks to a two-month freeze by the Bush Administration on regulations issued in the final days of the Clinton Administration, investors and fund managers who wish to participate now have an extra month to apply. (The new deadline is 4 p.m. May 21.)

The initiative, called the New Markets Venture Capital program, offers a pool of $150 million in capital and technical-assistance grants to be invested in companies situated in low-income areas. The money is to be divided among 15 to 20 investment-company funds designated by the U.S. Small Business Administration, each of which must raise at least $6.5 million in matching funds by September.


  Created by Congress late last year, the New Markets program is modeled on the "double bottom line" that calls for both financial and social returns, and which is at the heart of the small, but growing, community-development venture-capital industry. Today, 19 funds are pursuing the twin goals of generating returns for investors and creating living-wage jobs for low-income individuals. Another 13 funds occasionally make such investments, while a further 20 funds are in the process of raising money. Overall, the industry is capitalized at more than $300 million, according to Julia Sass Rubin, a Harvard researcher who studied the field for the past three years.

Still, such capitalism with a conscience remains a tiny niche within the larger VC industry in the U.S., which invested roughly $59 billion in fast-growth companies in 1999 and more than $100 billion in 2000. (The total for 2001, however, is expected to be lower, given the lack of an IPO market and the sluggish pace of acquisitions.)

Changes made to the New Markets program in recent weeks focused on closing a loophole that, in theory, would have allowed funds to invest the bulk of their cash in wealthy high-tech hubs while making only token investments in pockets of poverty. Previously, the rules required funds to make 80% of their investments in low-income areas. But that referred only to the number of deals, rather than dollars invested. Under the rules re-issued by the SBA, funds must now invest 80% of their cash in low-income regions.


  The loophole left open the possibility that fund managers could "make investments in the low-income areas while putting all their cash outside the low-income areas," says Austin Belton, who oversees the New Markets program for the SBA. In other words, a fund with $10 million to invest could have divided $1 million among eight small companies in a low-income area, then poured the remaining $9 million into Silicon Valley.

Yet some within the field of community-development venture capital say the SBA's change, while well intended, may end up making their task more difficult by limiting the types of deals they can consider. "The danger that our member funds would abuse the program is not there," insists Kerwin Tesdell, president of the industry's trade association, the Community Development Venture Capital Alliance, which lobbied for the New Markets legislation.

The alliance's bigger complaint centers on the New Market program's focus on geographic areas, rather than job creation. "Simply because a business is located in a low-income area doesn't necessarily mean that it benefits low-income people," says Tesdell. "And the reverse is also true. A business may be located outside of a low-income area, but provide jobs for low-income people."


  Soon, however, the geography vs. jobs debate may be moot. The Bush Administration's proposed budget for the SBA includes no money for the New Markets Venture Capital program in 2002. A memo accompanying the budget describes the program as costly to administer and duplicative of other federal efforts to boost investment in economically depressed areas. Not surprisingly, New Markets proponents disagree, saying other programs lack the dual focus on low-income areas and venture capital-style investing. And they argue that if the current downturn and wave of layoffs continue, low-income areas will need new jobs more than ever.

With or without the New Markets VC program, one thing's certain: entrepreneurs in "fly-over" country -- as viewed by dealmakers in coastal high-tech centers -- will continue to face an uphill battle in getting the capital they need to grow.

By Julie Fields in New York

Edited by Robin J. Phillips

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