Venture Capital With a Conscience
A few years ago, Cuddledown Inc., a Portland (Maine)-based maker of upscale bedding and comforters, faced a common dilemma for small companies: It needed more cash to grow. When the company's bank concluded it was already overleveraged and refused to issue another loan, CEO Chris Bradley turned to a local venture-capital fund, exchanging a 7% stake in the company for $550,000. The cash let Cuddledown secure a bigger line of bank credit, expand its catalog mailing list and buy an $80,000 quilting machine.
The result? The company's annual revenues increased from $14.6 million to $21 million, and its workforce jumped from 70 to 98 -- growth, certainly, but hardly at the pace venture capitalists typically demand. Indeed, most traditional VCs probably would have passed on Cuddledown altogether. Its core business -- manufacturing and catalog sales -- has little in common with the high-tech sectors they favor. Moreover, the company isn't likely to go public anytime soon.
"DOUBLE BOTTOM LINE."
But Cuddledown's investor, Coastal Ventures General Partnership, wasn't simply interested in the bottom line. The fund, part of a small, but growing niche, seeks to use venture capital to create social benefits -- primarily in the form of jobs for low-income communities -- along with financial returns. Those working in the field refer to the twin goals as "double bottom line." And if a new program run by the U.S. Small Business Administration succeeds, far more entrepreneurs in places such as Mississippi, Appalachia, and Ohio also may get a shot at this kinder, gentler form of venture capitalism.
Approved in the final hours of the last Congress, the New Markets Venture Capital program offers two incentives to fund managers committed to the concept. The first is a pool of $150 million in government-guaranteed funds that can be used to invest in small companies, then repaid over time. The second is $30 million in technical-assistance grants to help those entrepreneurs receiving the capital succeed.
To tap that money, however, qualifying investment companies (of which the SBA expects to designate 15 to 20) must raise matching private funds, both for capital and the technical assistance. (More details on the New Markets program are available on the SBA's Web site at www.sba.gov.)
QUESTIONS AND DOUBTS.
Yet for all its good intentions, New Markets is not without flaws. While grateful that the program exists, some of those using venture capital to promote community development are quietly raising questions about how effective the program will be, particularly in its first year. For starters, the deadlines for submitting an application to the SBA and raising private capital are extremely tight. Of concern, too, is the program's emphasis on geography rather than jobs.
In private, some familiar with the program also wonder about the SBA's ability to manage it. While adept at small-business finance, fighting poverty has never been central to the agency's mission. Moreover, it's unclear how supportive the Bush Administration will be, especially since a new SBA administrator has yet to be appointed.
Without question, the tight deadlines pose the biggest challenge. Investment companies wanting to qualify for the funds must submit a lengthy application -- the SBA estimates it'll take 160 hours to complete -- and a $2,000 fee by Apr. 19. In their applications, the companies must describe both their financial and social goals, and outline the area in which they want to invest.
Those picked by the SBA must then raise at least $6.5 million in capital and technical-assistance funds by Sept. 15. The reason? Congress appropriated the technical-assistance money for one year only. And because those grants will be distributed according to the amount of capital each fund raises, firm commitments must be in place by the fall. Meg Barnette, counsel to the Community Development Venture Capital Alliance, a trade group formed in 1995, describes the deadlines as "very challenging" even for those already working in the field. "Fund-raising is a difficult undertaking," she says. "And the short period of time only makes it more difficult."
The trade group also opposes some of the key rules of the New Markets program. The group had lobbied Congress to require that investments be linked to the creation of jobs for low-income and lower-skilled workers. Instead, lawmakers opted for ground rules limiting the bulk of investments to low-income areas. That means a venture-capital fund designated by the SBA could invest in a small company situated in a low-income area, but which does not hire local workers or create many jobs.
"There's a major distinction between putting money into depressed areas and actually doing good for low-income people," says Julia Sass Rubin, a Harvard researcher who has studied venture capital's role in community development for three years. A perfect example, she says, is San Jose, Calif., epicenter of the traditional VC industry. "It's a place that, 10 years ago, had tremendous poverty and now it's extraordinarily wealthy," she says. "You could argue they got rid of poverty, but they didn't. They just got rid of the poor people."
Still, there are aspects of the New Markets program that draw praise. Chief among them: the $30 million in federal grant money for technical assistance. That money is critical, experts say, because many of the entrepreneurs with whom community-development VCs work have less experience that those funded by traditional VCs. As a result, fund managers working toward a "double bottom line" often spend far more time with their portfolio companies than their Silicon Valley counterparts. And they also tend to stay invested in the companies for longer periods of time. The outcome: a lower rate of return on their investments. "It's not perfect -- but it's a lot better than no program at all," says Nick Smith, president of Northeast Ventures, a decade-old fund in Minnesota with $15 million under management.
Even without the New Markets program, the use of venture capital to improve depressed communities is on the rise. The field has grown from just a handful of funds in 1990 to more than 70 that are actively investing or raising cash for new funds today. Yet they're still dwarfed by the VC mainstream. At the end of 1999, such funds had a total capitalization of $300 million, of which $100 million had been invested, according to Rubin. And most are still too young to have a meaningful track record. By contrast, VC investments in emerging U.S. companies hit $59.4 billion in 1999 and topped $103 billion in 2000.
Indeed, that disparity is one reason socially active VCs say the best thing about the New Markets program may not be the actual dollars it provides, but the credibility and attention it brings to what they do. The hope is that a tax credit designed to encourage economic development in low-income areas will spur more individuals to invest in the funds, which draw most of their cash from banks, foundations, and family trusts. "The fact that the government is promoting it legitimizes it," says Nat Henshaw, president of Coastal Ventures Limited Partnership, which invested in Cuddledown. But whether low-income areas will truly be revitalized remains to be seen.
By Julie Fields in New York
Edited by Robin J. Phillips