Capital for Companies That Aid Communities

As an experienced manager of call centers for a big financial information publisher in New York, Mark Wilson knew why turnover in the industry was so high: people tend to quit low-paying dead-end jobs as soon as something better comes along. A little extra investment in them might pay for itself by making them more productive, he reasoned.

By:
Anne Field
New York Times in NASVF.org

Like a lot of corporate managers with an entrepreneurial instinct, Mr. Wilson, 43, saw a business opportunity in what he perceived as a flaw in the way things were being done. Two years ago, he started Ryla Teleservices in Atlanta with a plan to pay employees of call centers a decent wage and offer them a clear path to advancement. "I wanted to make sure they would feel respected and needed," he said.

But would such an undertaking make a profit? A lot of investors apparently had their doubts. A consultant hired by Mr. Wilson approached more than a dozen venture capital firms over four months about financing the start-up, and none showed interest. Then Mr. Wilson heard about SJF Ventures, a four-year-old venture capital firm in Durham, N.C., with a mandate to invest in companies that promise both a significant financial return and jobs for low-income people. Five months later, after reviewing his business plan and doing its own market research, the fund invested $700,000 in return for an equity stake. Today, Ryla Teleservices employs about 160 people, and Mr. Wilson says revenue, which totaled $4 million in the fiscal year that ended in July, could double this year.

Whatever the state of the economy, small businesses are always scrambling to raise money. Mr. Wilson had the good fortune to stumble on a new source of financing, a rapidly growing breed of investment capital providers called community development venture capital funds. Almost unknown a decade ago, their numbers have grown to about 60 in 2002, up from 40 two years earlier, with about 20 more in formation, according to the Community Development Venture Capital Alliance in New York. Last year, they had $485 million under management, the alliance said. The funds receive their financing from government agencies, including a Treasury Department community development program started under President Bill Clinton, as well as banks, insurance companies and foundations.

Unlike traditional venture capital funds, these newcomers generally shun high-technology start-ups, focusing instead on manufacturing and service companies that not only have a harder time finding money but are also more likely to employ low-income workers or be in poor neighborhoods. They also make smaller investments – typically $200,000 to $750,000 – than mainstream firms, which often make commitments in the millions of dollars.

"Doing good and doing well at the same time is totally possible," said Lynn Gellermann, a partner with Adena Ventures in Athens, Ohio, which concentrates on businesses in central Appalachia. "We can make a difference and make money."

For many of the recipients, the venture firms are a godsend. Drew Hannah, chief executive of Parker Guitars, a 12-year-old guitar manufacturer in Wilmington, Mass., for example, came up dry last year after two years of seeking venture capital from more than a dozen traditional firms. "They weren’t interested,” Mr. Hannah said. "We were too small, and we weren’t in a sexy sector." Then he got together with the Boston Community Venture Fund, which was just five years old. It liked the fact that Parker provided jobs to people from low-income areas, and invested $100,000 in the company in two rounds of financing, the fund said.

That might be relatively small change, but while community development funds rarely make huge cash infusions, they often bring in other investors willing to put up considerably more. Boston Community helped Mr. Hannah attract a total of $2.3 million from nine other investors, both by example and by contacting potential participants. "We would have had a very difficult time raising that kind of money without them in the lead," he said.

David Levine, the chief executive of Butterfly.net, a three-year-old company in Martinsburg, W.Va., that makes technology for multiplayer online games, had an even more lucrative relationship with a community development venture capital firm.

First, he turned to traditional venture capitalists and raised $790,000, mostly from Walker Ventures, a firm in Glenwood, Md., that he had dealt with when he was running a previous business, to pay for coding, product development and salaries for 10 employees. After running through that money, Mr. Levine searched for more, approaching as many as 100 funds around the country, all to no avail. To make payroll, he borrowed from his father, who took out a $100,000 home equity loan, and accumulated $50,000 in credit card debt.

Then, he heard about Adena Ventures. The fund liked the company’s potential to fuel growth in the area and invested about $500,000 in 2002 as part of $1.5 million the company raised. "Believe me, there was no other source of financing in the country at that point," Mr. Levine said of the investors. With financing and marketing advice from Adena, he negotiated a marketing agreement with International Business Machines and doubled his payroll to 15. In September, he closed an even bigger financing package of $7 million with investments from Adena, Cisco Systems and several other sources.

In addition to advising the companies they invest in about a variety of things, including marketing, legal issues, hiring and stock-option plans, as mainstream firms do, some community development venture capital funds also offer consulting services to companies that they have not invested in.

Three years ago, for example, Pacific Community Ventures, a four-year-old fund in San Francisco, offered to give business advice to Rick Philpott, president of Moving Solutions, an industrial moving company in San Jose, Calif. Mr. Philpott, who had been in business since 1984, jumped at the offer. Pacific Community Ventures advised Moving Solutions to reduce expenses by renegotiating its lease and finding lower prices on staples like boxes, fuel and uniforms. The savings let him squeak by without layoffs, he said. On the firm’s advice, he also hired a marketing specialist, who brought in enough new business to push revenues up to what he estimates will be $5 million this year. He also credits the venture firm with helping the company win a five-year, $5 million contract with HewlettpPackard.

The granddaddy of the community development venture fund industry is the Kentucky Highlands Investment Corporation in London, Ky., created in 1968 as a community development corporation. Community development corporations, an outgrowth of Great Society legislation in the 1960’s, were nonprofit organizations financed by the government that provided housing and social services in low-income neighborhoods. The founders of Kentucky Highlands, however, decided to move beyond those activities to introduce a fund to invest in and lend money to start-ups in eastern Kentucky.

Other community development organizations followed and began making equity investments in the start-ups. In recent years, a new generation of equity-only limited partnerships joined the ranks of these community development venture capital firms, and now account for 3 in 10 of them.

Just because the funds say they aim to do good does not mean their standards are lower than those of traditional venture firms. Companies seeking financing must submit business plans, as they would with a conventional fund, and must go through the same due-diligence process – but the firms will look more closely at how many jobs they are expected to create and what kind of benefits, like health insurance, they plan to provide workers.

"That’s one of our key metrics," said Rick Larson, managing director of SJF Ventures. "We need to see that employees can care for themselves and their families."