AC: There’s a lot of flexibility in structuring local investments. Can you talk about some of the creative financing that you’ve seen in local deals?
MV: When a business, especially a start-up, looks for its first outside capital, its primary avenue is reaching out to angel investors and venture capital outfits. This requires a particular legal structure for the business (C-corp) and a rapid growth trajectory (the ubiquitous “hockey stick” pattern in business plan revenue projections), with the aim of achieving an “exit,” which usually means selling the business to a larger company or taking it public in a few years. Local investing is a way to escape this monoculture of financing options and explore creative ways to finance the business that are compatible with its mission and organic growth.
If a community is interested in investing in a local business, it is because it appreciates the goods and services the business provides. This creates the opportunity to offer some of the return to local investor in kind.
For example, a few years ago I invested in a brand new restaurant in Berkeley called Gather Restaurant, which would source from organic farmers and food artisans from within a 100-mile radius. The restaurant, structured as an LLC, raised almost $2 million from the community (for a 40% ownership stake) and got a $300,000 loan from a local bank. Investors will receive 95% of the distributable profits from the restaurant until their capital is repaid, and 40% after that. The investors, about 200 people in the community, also receive an annual credit at the restaurant of 1% of their investment – you can think of it as a 1% in-kind annual dividend. The restaurant is benefitting from this 200-strong guerrilla marketing force. Of course you would take your friends and out of town visitors to Gather Restaurant if you are one of the investors and owners!
In another example, a large agricultural enterprise in California with the largest CSA program in the state offered a 2-year loan to its CSA customers through a DPO (direct public offering). Interests are either paid in cash, or double the value in the form of a monthly CSA box.
I have taken the in-kind strategy to the limit with a loan I made to a local pasture chicken and egg producer. We converted the loan to a multi-year prepaid sale of chicken meat. Since I can’t eat 100 pounds of chicken a week, I had the farmer deliver the chicken meat on my behalf to Three Stone Hearth, a community-supported kitchen preparing delicious meals just two blocks from my house, for credit at the store.
At the end of the day, we invest or save money not because we like to accumulate money for its own sake, but to be able to pay for goods and services now and in the future. The creativity made possible by local investing allows us to shortcut the process and get some of the goods and services we enjoy as part of our investment return.
The Slow Money Northern CA network, of which I’m part, has also experimented with royalty financing—having the capital and interest repaid based on a percentage of the business’ gross revenues. We have made a number of low-interest loans with a royalty kicker on top. The business would pay the greater of the regular interest and principal payment or a fixed percentage of its gross revenues (typically ranging between 1% and 5%). In this way the business can get a loan at favorable rates and the investors can participate in the success of the business if it experiences strong growth in revenues.
AC: A big question people have about local investing is what kind of returns they can expect as investors. What’s your view on that?
MV: This is a question that is often posed, but one that is impossible to answer in a few words.
The concept of expected return is often associated with a particular asset class —a group of investments that share similar characteristics and risk profiles, such as U.S. stocks, U.S. bonds, venture capital, real estate, etc., or subsets thereof, for example, U.S. small cap stocks. The assumption is that investments within the same asset class have similar expected returns. More risky asset classes like venture capital are assumed to have higher expected returns than less risky asset classes like short and medium terms bonds.
“Local investing is idiosyncratic and spans a large and creative range of possible investments”
I believe that the whole world of investing has now entered a completely different paradigm and that the future of investing will bear very little resemblance to the past. We now have too much investment capital chasing financial returns around the world. And historical returns are no longer a valid guide to what we are likely to experience in the next few decades. Going forward, financial returns, far from being guaranteed by some sort of divine right of capital, might more aptly be characterized as a chimera.
It is time we take a closer look at the very concept of “return.”
An example might help clarify this concept. In her book “Financing our Foodshed: Growing Local Food with Slow Money,” Carol Peppe Hewitt tells the story of the Chatham Marketplace in Pittsboro, NC. The market is not only a well-established co-op grocery store committed to local sourcing, it’s also the social gathering place of this small town of 4,000 souls. Carol said that if you live in Pittsboro and want to meet someone, all you have to do is hang out at the Chatham Marketplace and the person you’re looking for will eventually show up.
The market received a large loan at nearly 9% interest from an out-of-state bank that helped the market get launched in 2006. But there was a $300,000 balloon payment for the balance of the loan coming due in 2012, and no one was sure where the money was going to come from. Carol, upon learning of the challenge to this beloved institution, organized a team of local investors and formed an LLC for the purpose of buying out the loan and refinancing it at 5 percent. By the fall of 2011, a group of 16 investors had raised $400,000 to buy out the loan, a year ahead of schedule.
Net of administrative fees, the investors receive a 4.5% return. The lower debt servicing cost greatly helped the Chatham Marketplace. And the interest payments that used to go out of state are now remaining in the community.
In this case, the “return” to the local investors is much greater than the 4.5% they are getting in interest every month. Without their investment, they might have lost a beloved market and a place to gather. They might have also lost access to the locally grown produce and locally crafted products they enjoy. The disappearance of the market could have also [harmed] some of the more than 200 local food producers in the area that counted on it as their primary distribution outlet. When we invest in local projects we can understand intuitively the non-financial returns of our investment – they are tangible to us even though they might not be precisely measurable.
Want to put your money close to home? See our How To Invest Local guide.
So, if we’re talking strictly about financial returns, the question is unanswerable, since local investing is not an asset class. Local investing is very idiosyncratic and spans a large and creative range of possible investments that do not share common risks and characteristic. A three-year collateralized loan to an established bakery looking to upgrade its equipment is a completely different investment than an equity position in a local start-up building a new nanotechnology-based coating to improve the efficiency of solar panels. A two-year loan to an established CSA with interest paid in the form a monthly box of produce is completely different than a royalty loan to a compost company still in the prototype stage. So it’s not possible to talk about expected financial returns for local investing in general terms.
AC: Was it unnerving to put all your money into local investments? Any advice for people who want to move some money into their communities, or are just local-curious?
MV: I moved 100% of my portfolio away from Wall Street and have invested it either directly or through aligned intermediaries like RSF Social Finance in business and projects that are building the world I want. The key is that I have complete knowledge of what my investments are doing out there in the world and I know they are financing companies and projects that are operating with integrity and respecting communities and ecosystems. For me it is about taking personal responsibility for my agency in the world expressed through my investments. About 25% of my portfolio is invested locally and the rest is invested in the U.S.
There are some CDFIs (Community Development Finance Institutions) or CDCs (Community Development Corporations) that have revolving loan funds in which the local community can invest and derive a modest interest. But most local investing is direct investing in businesses.
Investing in a local business, especially if it is at an early stage, is clearly risky and illiquid, meaning that there is not a secondary market where one’s investment can be sold to others as we can do with the stocks and mutual funds we buy from Wall Street. The risk associated with direct investing and the illiquidity of those investments needs to be considered when doing local investing. It is important to take a portfolio perspective when considering local investing, but the risk should not freeze us in our tracks. If we want to avoid all risk we would not get up from bed in the morning!
First, there is the issue of diversification, which our financial advisers have drilled into our heads and which has resulted in us being invested through stocks and mutual funds all around the world. One could argue that, for the purpose of diversification, we should have some portion of our portfolio that is invested close to home.
When financial advisers talk about geographic diversification, they are thinking in terms of nation states–the whole of the U.S. counts as a single bucket under the rubric of “domestic” investments. But what about our state, our region, our county or even our city? How much do we have invested there?
One idea is to allocate a small percentage of one’s portfolio to local investing – this could be anywhere between 1% and 10%. If we are planning to invest as little as 1% of our portfolio locally, the risk and illiquidity of those investments will be still very modest on a portfolio level. Heck, we might even realize that we might be fine even it that 1% never comes back to us in financial terms and comes back to us instead in terms of increased local economic vitality, a more diverse local economy and a healthy community.
My suggestion is to start small, maybe with 1% or less of one’s portfolio. In other words, start with an amount that you are prepared to lose. But the key is to start and learn along the way how to do local investing by doing it!