Community Development …Financial Infrastructure – Part One

Part One: Capital Providers

Any community or region wanting a strong business environment will start where many businesses start – finance.  In particular, growing businesses, as well as those in startup or turnaround mode need access to capital.  Without an array of capital sources, any community will be hamstrung in seeking superior businesses and entrepreneurs to locate within their boundaries and will be impotent to help its local businesses when they get into trouble.

To have a strong financial infrastructure a community must have exceptional resources in primary as well as secondary capital access sources.  Then there are fringe or innovative and unique capital providers.  Each of these sources are further broken into equity, debt and support/indirect.  We will deal with fringe and unique sources as well as the support and indirect sources in a later report.

We start by examining the debt sources first – why?  For most mid-sized and small businesses debt is the easiest and less costly of the capital sources.  Due to the shortage and/or cost associated with the equity sources (especially private sources) for these businesses groups, the reliance on debt sources is even more critical and devastating when they are altered or “dry up”.  For this reason any top notch region should also have strong equity or gap providers (equity or debt) so sustain and manage their business environment.

Primary Capital Providers – Debt Sources

Primary capital providers of debt are banks and other regulated financial institutions – the chief providers of capital to small and mid sized businesses, that is, after shareholder debt and equity.  Additional primary capital sources of debt are finance companies and factoring companies. 

Bankers, the lowest cost providers are also the strictest of all sources.  Bank margins are thinner than other sources of debt but availability of credit is not always dependable based upon other facets of the a particular lenders balance sheet, the current economic conditions, the regulatory environment, etc.

Finance companies are essentially asset based lenders.  They rely on and specialize in collateral based loans.  They are lenders to higher risk or specialized companies that cannot or will not be financed by commercial bankers.  Due to added risk the interest rates and fees are much higher than banks.  These lenders step in when banks “back out” or the financial risk of a borrower is higher than bank standards.

Factoring companies are the highest rate financing sources.  They are in the business of financing accounts receivable by the outright purchase of these assets.  They are considered lenders versus equity sources because there is almost always recourse to the borrower and/or guarantors.

Secondary Capital Providers – Debt Sources

Secondary capital providers of debt are local lending agencies, private/public lenders including municipal and state sources, and national sources such as those related to SBA 

Most if not all communities of size have unique lending programs.  Using federal block grants these lending programs involve direct lending, loan guarantees or enhancement of interest rates – or a combination of the three.  In most cases, they require participation of a private lender, most notably a bank, and are associated with job creation.  Some are tied to specific industries such as manufacturing or product development.  Unfortunately this excludes many businesses needing access to their support capital.  The lending programs for many states will mirror these types of local programs but likely are more limited and rely on local development agencies and bankers to make them work.

We purposefully avoided any comment on tax abatements since these are not necessarily capital providers but expense avoiders.  In other words no agency is actually providing direct capital, but providing a discount on taxation if certain condition, most notably job creation or asset addition occur.

Most popular among SBA programs are the 7a guarantee program and the 504 loan program.  The source of both relies on government intervention creating added political risk.  The key to a successful use of these programs is a local lending agency, but more important a commercial bank since the SBA relies on bankers to help distribute its resources.  The more successful SBA deals a does, the more it gets approved and the better off the region served by the bank will be.

Primary Capital Providers – Equity sources

For many mid sized and small businesses the primary providers of equity capital are friends, relatives, colleagues, and of course personal sources including a variety of personal debt and equity sources.  Access to public capital sources is virtually non-existent as government regulation and the related costs make this source economically unfeasible – shutting off a tremendous source of capital to these businesses.  Third party equity providers are centered on angel investors and venture capitalists.

Capital from friends, family and relatives are usually loosely structured with no defined exit strategy creating difficulties in later years.  Further, the capital providers are not likely to extend much needed additional capital when the business needs it and can be a block to other capital sources not wanting to dilute shareholder value.

Primary third party sources are not always available to many parts of the country.  Angel investors, if not structured as a group, are hard to find.  Without a personal relationship and trust in management, these investments are difficult to structure.  Venture capitalists are always looking for opportunities for fast growing, value enhancing businesses.  Their timetable is relatively short compared to other sources and the returns demanded are usually outside the ranges of most small and mid-sized businesses.

Secondary Capital Providers – Equity Sources

Secondary capital providers of equity include state and local governments and/or agencies, non-profit and for profit community owned businesses and federally supported agencies.  A good example of this is a Community Development Corp. (CDC).

Some communities have formalized investment vehicles to help with capital enhancement – mostly using non-profit organizations as such a vehicle.  These non-profits can accept public support and grants with following their charter to help create jobs and enhance a community especially where is certain defined needs such as high employment, minority disparity, etc.

A key element in secondary equity support is the Small Business Investment Corporation (SBIC) and the related minority investment arm of the same.  These organizations couple private and public money to enhance capital sources within the community.  Another key player in the secondary equity market is the Community Development Financial Institution.   This is a US Dept. of Treasury program geared to assist low income urban and rural areas and can enhance the availability of capital in these areas especially using a bank’s Community Reinvestment Act requirements.

Certainly there are other considerations such as grant sources, intrastate stock offerings, spin off real estate and equipment companies, joint ventures, community investment companies, business cooperatives, community owned businesses and sale leaseback transactions.

Summary

For any community or region to be successful and attract not only capital providers, but the capital users that inevitably provide added population and jobs.  A strong financial infrastructure will also need support providers, competent professionals and thinkers and dreamers.

A successful region should score high in the primary and main secondary debt providers and have at least three or four key providers of equity investment to be attractive to entrepreneurs and companies looking to relocate – such companies being regional, national or global.

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