Spotlight

Community Capital: Impact Investing, By and For the People

Brian Beckon | December 17, 2016

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There’s a refrain we’ve been hearing recently at gatherings of community organizers: “Nothing about us without us is for us.”

While these words echo a centuries-old Latin slogan (“nihil de nobis, sine nobis”), they reflect a profound truth as relevant today as it has ever been. Their meaning is something like this: “Don’t try to solve our community’s problems for us. We understand our problems and their solutions better than anyone. We simply lack the resources and tools to solve our problems. You can help us by providing those resources and tools.”

The distinction is subtle, yet critically important. It’s about community empowerment.

In the world of impact investing, wealthy (yet conscientious) investors and institutions seek to invest in ways that help to improve the plight of others, typically while still making a good return on their investment.

And while this type of impact investment is certainly a good thing, the “impact” too often addresses the effects of underlying systemic problems without addressing the underlying problems in any meaningful way. By continuing to concentrate wealth (and reinforce the class distinctions between the haves and the have-nots), this type of impact investing could even exacerbate the very problems they seek to remedy.

The Community Capital Solution

What if there was a type of impact investing that had the power to solve some of the underlying systemic problems and bring about positive improvements in the economic structure of our economy? As my partner John Katovich explained in a Huffington Post blog, investing in institutions of community capital does precisely this. Community capital refers to community-focused investment opportunities that are open to the public, including both wealthy and non-wealthy investors; in other words, everyone can participate in community capital.

Why is this so important? It’s because most investment opportunities are available only to the wealthy, and investment opportunities beget more opportunities, and so on. The non-wealthy have very few options, and those few options typically pay a much lower rate of return than that earned by wealthy investors. But community capital is much more than just a way for a venture to expand its pool of potential investors. It is part of a revolutionary change in the structure of the local economy, because:

• It allows ventures to raise capital from their own community, rather than putting their fate in the hands of the wealthy institutions and investors who currently control the economy.
• It allows everyone everywhere to invest in their local community, in local ventures, in something that’s meaningful to them.
• When the community invests in local ventures, those ventures grow, hire local workers, generate profits locally, and pay those profits to community investors who can then reinvest. It’s a cycle that allows the community – any community – to build wealth.
• With broadly shared ownership and participation, the community can now channel resources to where they are most needed. The community is empowered to solve its problems, leveraging the abilities and experience of all its constituents.

Community capital might be thought of as a separate asset class and an essential component of any investment portfolio, because it serves as a counter-balance to the global gyrations of the Wall Street-dominated economy while contributing to a healthier local economy.

A CIF can be a particularly important component of a healthy local economy for four key reasons: Scale, efficiency, diversification, and liquidity.

Note that while we mainly use the term “community” in the sense of a geographically defined area, it could also be a dispersed community based around a common affinity or goal, such as renewable energy, biodynamic agriculture, or arts education.

What are the mechanisms for raising community capital? In general, a venture (nonprofit or for-profit) can raise capital from their community either directly or indirectly. The direct approach is sometimes referred to as investment crowdfunding, a term that includes both direct public offerings (DPOs) and Title III exempt crowdfunding. The indirect approach to community capital is where a community investment fund (CIF) aggregates investment from the community and then invests in local ventures. There are several models of legally compliant community investment funds, including the charitable loan fund, the real estate fund, and the diversified business fund.

While Cutting Edge Capital is best known for our work with DPOs, we also work with a number of CIFs, and we believe that a healthy local economy will feature a thriving mix of both. A CIF can be a particularly important component of a healthy local economy for four key reasons: Scale, efficiency, diversification, and liquidity.

• A CIF can be more scalable because it can potentially raise an unlimited amount of money and finance an unlimited number of local ventures. Note that we don’t use “scale” in the Wall Street sense of bigger transactions. In a CIF, the transactions should always be at a human scale, but we need a lot more of them to truly change the economy and to create a culture of community investment.
• A CIF can be more efficient because each investor only needs to do due diligence once on the fund, and then the fund handles due diligence on outgoing investments.
• A CIF is more diversified when compared to having each investor invest in one or a small number of local ventures.
• A CIF may be in a better position than individual ventures to offer its investors liquidity (i.e., a way to sell the investment). A CIF can be set up to redeem investors who need to exit the investment.

Community investment funds and individual DPOs (or other types of investment crowdfunding) are not mutually exclusive, and there will always be a need for DPOs, particularly for ventures who prefer a direct connection with investors. Indeed, CIFs could play an important role for organizations conducting a DPO by:

• Making a small short-term loan to cover the costs of a DPO.
• Lending to the business on the strength of the equity raised in the DPO.
• Providing a sounding board to the venture on pricing and other terms of their DPO.
• Investing in the DPO early to seed it and inspire others to follow.
• Investing late in the DPO process to backstop it and ensure its success.
• Providing liquidity to DPO investors by purchasing their investment if they need an exit.

A Problem of Culture

Even though the mechanisms to raise community capital are available, they are not commonly used. Cutting Edge Capital has specialized in DPOs for years, and we have helped build several successful community investment funds. And yet, these are the proverbial drop in the bucket compared to what is needed to significantly move the needle toward a more equitable and democratic economy.

What is standing in our way? In short, the problem is that in the US we lack a culture of community capital. Most investors (both wealthy and non-wealthy) are unfamiliar with DPOs and other legal strategies of community capital. Unfortunately, so are most investment professionals and lawyers. (After all, they don’t teach these strategies in graduate school.) This unfamiliarity breeds skepticism, which is probably the biggest barrier to widespread adoption of the strategies of community capital. And making matters worse, the non-wealthy (those who don’t meet the SEC’s definition of “accredited investor”) have been trained for decades to see themselves as unqualified to invest.

This is where visionaries, philanthropists and impact investors can make a big difference. To change the culture so that community capital is as ubiquitous as a corner convenience store, we need visionaries and thought leaders to help educate their communities about the game-changing potential of community capital. We need philanthropists to donate to nonprofit organizations who are seeking to promote community capital in their local areas. We need investors who will invest in the structures of community capital (for example, as founders of community investment funds), as well as investing alongside community investors to give credibility, strength and momentum to this revolution. And, of course, we need innovative leaders to make it happen.

Together, we can build an economy in which every community is served by a constellation of community investment funds of various types, along with DPOs by local ventures, which together contribute to a vibrant community capital marketplace in which all can participate on a level playing field, and together build a more equitable, prosperous, and empowered community. In other words, this is the ultimate impact investment.

Photo: Rajmata Krishna Kumari Girls’ Public School 

Brian Beckon is vice president of  Cutting Edge Capital in Oakland, Calif. This discussion is for informational purposes only and should not be taken as legal or investment advice. For more information about Cutting Edge Capital and the services we offer or to set up a consultation, please visit www.cuttingedgecapital.com or email us at info@cuttingedgecapital.com.

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