2015 CDVCA ANNUAL CONFERENCE

WASHINGTON, DC

HISTORY OF COMMUNITY DEVELOPMENT VENTURE CAPITAL

AN INTRODUCTION TO COMMUNITY DEVELOPMENT VENTURE CAPITAL

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THE EARLY YEARS OF VENTURE CAPITAL IN THE US

• Because of Glass-Steagall, a merchant banking industry did not develop in the US

• Until 1978, pension funds were not allowed to invest in VC because of the prudent person rule

• Venture capital (“development capital”) was the domain of wealthy families, such as the Morgans, Vanderbilts, Whitneysand Rockefellers

• The first “modern” VC fund, American Research and Development Corporation, was founded in 1946 with a social mission of funding businesses started by returning WWII veterans

• ARDC had the first big VC success: $70,000 invested in Digital Equipment in 1957 produces a 500x return after an IPO, yielding a 101% IRR over 11 years

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US GOVT HELPS CREATE THE VC INDUSTRY

• Federal Reserve Board report to Congress concludes that a major gap exists in the capital markets for long-term funding for growth-oriented small businesses

• Small Business Investment Act of 1958 creates the SBIC program

• Provides government-guaranteed debentures to leverage private capital

• The SBIC program is credited with creating the modern VC industry

• SBICs have funded numerous business successes, including Intel, Apple Computer, FedEx, and Staples

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SPECIALIZED FUNDS FOR MINORITY ENTREPRENEURS

• After Johnson’s War on Poverty, Nixon campaigns on a platform of “Black Capitalism”

• Minority Enterprise Small Business Investment Company (MESBIC) program is created in 1969

• MESBICs are renamed Specialized Small Business Investment Companies (SSBICs) to serve broader range of entrepreneurs from economically disadvantaged groups

• Congress ends SSBIC program in 1996

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FOUNDATIONS MAKE SOCIAL INVESTMENTS

• Taconic and Ford foundations create the Cooperative Assistance Fund in 1968 to invest in and lend to minority business enterprises

• Nine Foundations ultimately contribute $3.8 million

• Goal was to create assets for low income people

• This was the first Program-Related Investment, soon legitimized by the Tax Reform Act of 1969

• Foundations now make both PRIs and MRIs

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THE CDVC INDUSTRY IS BORN

• 1964 US Office of Economic Opportunity was created as part of President Johnson’s War on Poverty.

• Kentucky Highlands Investment Corporation is formed to fight poverty in Appalachian Kentucky in 1968.

• A community development corporation (CDC), KHIC adopts a venture capital investment approach to economic development

• Tom Miller hires Fred Beste to develop and carry out this strategy in early 1970’s

• Ray Moncrief joins KHIC in 1984

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PRIVATE CDVC FUNDS ARE CREATED

• CDVC is not a strategy invented in Washington, DC

• In 1989, Nick Smith, prominent local attorney and former board chair of CDVCA, formed Northeast Ventures Corporation in Duluth Minnesota

• Purpose was to create jobs in Northeastern Minnesota, devastated by decline in the iron mining and timber industries

• Capitalized with investments from foundations, banks, and wealthy individuals

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CDVDA IS FOUNDED

• A few CDVC funds begin meeting in 1993

• CDVCA is incorporated in 1995 as a member-led organization

• Blue Dot discussion at Sanabel Island; Woody Taschwrites the Blue Dot paper in 1996

• Kerwin Tesdell is hired as first staff member in 1998

• CDVCA develops programs in education and networking, public policy, research, and technical assistance and consulting

• CDVCA forms Central Fund in 2001 to invest in and with CDVC funds

• CDVCA now manages $90 million, soon to be $200 million

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CDCS AND CDFIS FORM FUNDS

• In 1993, Coastal Enterprises, Inc., a CDC and CDFI in Maine, receives grants from the Ford and MacArthur foundations to make equity investments in businesses

• CEI builds a portfolio of investments in 12 businesses; $1.2 million of investment returned $4.2 million in cash

• CEI uses this track record to raise a traditionally structured fund; has now raised four funds and is raising the fifth

• In 1997, The Reinvestment Fund in Philadelphia forms DVCRF Ventures and Boston Community Capital forms Boston Community Venture Fund

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US GOVT REDISCOVERS CDFIS AND CDVCS

• In his campaign, Bill Clinton promises to create “100 development banks”

• In 1994, the Riegle Community Development and Regulatory Improvement Act creates the CDFI Fund

• The Fund provides capital and other assistance to CDVC funds, as well as CD banks, CD loan funds, CD credit unions, and microenterprise loan funds.

• Since its inception, the Fund has made $ 2 billion in awards

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TRADITIONAL VCS GET INTO THE ACT

• In 1999, Rick Defieux, partner in Edison Ventures, teams with David Kirkpatrick to found the Sustainable Jobs Fund. Renamed SJF Ventures, the team recently raised $90 million for its third fund

• In 2000, Bud Colligan, founder of Macromedia and partner in Accel Partners, teams with Penelope Douglas to found Pacific Community Venture Fund, now on its fourth fund managing $60 million

• In 2002, Sir Ronald Cohen, founder of Apax Partners and the “father of British venture capital, teams with Michele Giddens to form Bridges Community Ventures in the UK, now forming is fifth fund and its first in the US

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NEW MARKET TAX CREDIT PROGRAM

• Idea for tax credit is born in a conference room at Rapoza Associates

• In 2000, Congress creates the NMTC program to spur investment in and lending to businesses in low income communities

• Since inception, the program has made 836 awards allocating $40 billion in tax credit authority, approximately $3.5 billion per year

• While NMTC was to “provide patient investment capital to small businesses,” the tax credit has not lived up to its promise of encouraging true venture capital financing

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NEW MARKET VENTURE CAPITAL PROGRAM

• Structure of NMVC program is developed at a CDVCA Peer Group meeting

• In 2000, Congress creates the New Markets Venture Capital program

• Operated by the SBA and based on the SBIC program, the NMVC program encouraged development of venture capital funds that invest in low income communities

• NMVCs receive debenture leverage plus operational assistance funds

• Six NMVC funds are licensed and still opearating, but new funding was immediately ended as Republicans take over Congress and Presidency

• Promise of NMVC working with NMTC was never realized

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RURAL BUSINESS INVESTMENT PROGRAM

• 2002 farm bill creates RBIP

• Based on SBICs and NMVCs, RBICs receive leverage and operational assistance funds

• Until recently, there was only one RBIC, Meritus Ventures

• Like NMVC, appropriations were terminated by Republican Congress

• In 2014, new life was breathed into the program with the ability to tap capital from the Farm Credit system and the licensing of a new $150 million fund managed by Advantage Capital Partners

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IMPACTING INVESTING EMERGES

• In 2007 the term “Impact Investing” is coined at a meeting sponsored by the Rockefeller Foundation in Bellagio, Italy

• A new set of investors, including individuals, foundations, and corporations, develops centered to a large extent on the West Coast

• Emphasis on products that solve society’s problems, rather than jobs; international, rather than domestic

• Impact investing grows somewhat apart from older community development finance industry

• New field of social impact bonds

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HEYDAY OF CDVC INDUSTRY GROWTH

• 2000 to 2007

• Number of funds increases from 45 to 70

• Funds under management more than quadruples from $400,000 to $2 million

• Banks take over from foundations and other social investors to fuel industry growth

• Funds become larger in AUM and geographic scope

• More professional management

• Most funds adopt traditional VC fund structure, many with not-for-profit affiliates

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EFFECT OF GREAT RECESSION

• US enters severe recession in 2008

• Investors, particularly banks become extremely risk averse, compounded by regulators emphasizing safety and soundness over Community Reinvestment Act obligations

• Ability to raise new CDVC funds essentially ends for 3-4 years

• Volker Rule prohibits banks from investing in venture capital funds, with the exception of Part 24 “public welfare” investments

• CRA regulators recently tell the big banks they will not get “outstanding” ratings, decreasing incentives to provide innovative financing

• The market has revived in the past 2-3 years, but still is not where it was in the early 2000s

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STATE SMALL BUSINESS CREDIT INITIATIVE

• In 2010, Congress creates the State Small Business Credit Initiative (SSBCI) program as part of the Small Business Jobs Act of 2010, in response to the recent recession

• $1.5 billion is awarded to states to support lending to and investing in small businesses

• Despite the name, states request about one third of awards for venture capital programs

• Legislation to provide additional appropriation for program has been introduced in Congress, but its future is uncertain

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SBA IMPACT INVESTMENT INITIATIVE

• SBA launches Impact Investment program in 2011, providing special treatment to funds seeking SBIC licenses to invest in low income communities and in socially positive businesses

• Early Stage Investment Program is also created in 2011

• Impact Fund Program changes announced in 2014

• Allow funds to pursue their own, self-defined impact investment strategies

• Incorporate reporting and measurement best practices

• Lift $200 million hard cap on annual commitments

• Allow existing SBICs to opt in

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JOBS ACT AND CROWDFUNDING

• In 2012 Congress enacted the JOBS Act, intended to encourage funding of small businesses through “crowdfunding” by easing certain securities law restrictions on the offer and sale of securities

• Limits contained in the law and further restrictions imposed in SEC rulemakings have dampened initial excitement

• SEC may have given up on creating rules for Title III crowdfunding involving non-accredited investors

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LOOKING INTO THE FUTURE

• A number of CDVC funds have proven that it is possible to earn market rate financial returns while achieving social goals—the experiment is working!

• Several experienced CDVC fund management teams have raised third, fourth, and fifth funds

• Jobs are at the top of the national agenda, and CDVC funds create jobs

• But will severe risk-aversion of capital markets subside?

• Will the pendulum swing back with regard to banks and CRA?

• While federal government seems paralyzed, states have shown strong interest in fostering job creation through venture capital investment

• Crowdfunding created initial excitement, but so far is not living up to the hype

• PRIs are more popular than every, and a few foundations are investing some or all of their endowments in impact investments

• Impact investing is all the rage, but will the big checks be written?

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SHAMELESS ADVERTISEMENT

Trainings Supported by CDFI Fund

Capacity Building Contract:Expanding CDFI Coverage in Underserved Communities

• Baltimore Fed. June 16-17 – Formation

• Denver Fed. July 22-23 – Cultivation (how to become a CDFI)