9 OTHER WAYS TO SOURCE LOCAL CAPITAL
BY MICHAEL WHELCHEL OF BIG PATH CAPITAL AND AARTHI BELANI OF JONES DAY
The key financial transactions of a company’s life, such as bringing in new equity investors or selling to new owners, have permanent effects on its future, for good or ill. And just as with, say, buying local produce or supporting local businesses, sourcing local capital in these situations has many benefits. It creates a more connected capital relationship between the investor and the company, helps promote a vibrant local economy, leads to a more dynamic community featuring a higher quality of life as more dollars are circulated within it, and results in a place where more of us would like to live. A local investor’s destiny is more intertwined with a company’s.
But when it comes to capital, local sourcing is not as easy to implement. New crowdfunding laws are opening some doors to local investors, but that’s not the only way to tap into your community for financing. We’ve rounded up nine other ways to source local capital so your investors are also part of your local ecosystem.
1. FIND LOCAL OR REGIONAL ANGEL NETWORKS
Most larger cities and many regions of the country have established angel networks. These are groups of investors who typically organize around geography (e.g., Detroit), social change theme (e.g., backing women entrepreneurs), or sector (e.g., sustainable foods). They pool pipelines and sometimes resources, share research and due diligence, and form complementary teams to provide advice to their portfolio companies. Their investments can range from $10,000 to $1 million. There are directories of established angel networks like Angel Capital Association, and you can Google search for more or contact your local chamber of commerce to find them.
Radhika Shah, co-president of Stanford Angels & Entrepreneurs, a group that provides seed funding to Stanford alumni, faculty, staff, and their family members, points out that even within angel networks, it’s critical that social entrepreneurs partner with seed-stage impact investors and/or philanthropists who are deeply mission-aligned — both on the core mission of the organization and on how much they value social impact versus profitability. “In the investor ecosystem,” Shah says, “investors and donors are on a spectrum, and connecting with those that have deep alignment can make all the difference.”
2. PRESELL YOUR GOODS AND SERVICES
Preselling allows businesses to bring in revenue early, before incurring the cost of goods, thereby allowing the company to use the cash for other purposes. For example, a cafe might raise most of the $100,000 it needs to open a new store by preselling its coffee on Smallknot, a platform for users to invest in small businesses in their local communities. Another upside of preselling is that businesses gain valuable insights about prospective product or service users in the marketing process.
Note: In some states, preselling is considered a form of securities issuance; check local laws.
3. DO AN INTRASTATE DIRECT PUBLIC OFFERING (DPO)
Crowdfunding (Regulation A+ created by the 2012 JOBS Act) is considered a DPO, but “intrastate DPOs” have been in use for much longer. Like crowdfunding, intrastate DPOs allow both accredited and unaccredited investors to invest in private businesses, but unlike with the recent crowdfunding legislation, the process is less burdensome and has lower associated costs. One catch with this approach is that all investors must be in the same state, along with a few other requirements, but there is no limit on the number of investors. Regulators require state-level registration, but it is not as burdensome or expensive as a federal registration. Ben & Jerry’s used this approach in the 1980s to attract Vermont-based unaccredited investors as a way to raise capital.
4. PLUG INTO PEER-TO-PEER FINANCING MODELS
While this sector has definitely been challenged by the management scandals that Lending Club, a big name in the space, faced in 2016, the higher transaction speed and lower cost of these platforms represent a fundamental disruption that will survive early operational bugs. Online portals such as Community Sourced Capital and the Grow Local Project, which match investors with local businesses seeking loans, take advantage of a locally-minded investor pool, low overhead, and high-tech business models to provide loans faster and at lower rates than brick-and-mortar banks.
Newer business models like ZipCap unlock “loyalty capital” by leveraging the loyalty of a business’s repeat customers to act as a kind of “underwriter” or credit to reassure lenders who may not themselves be part of the local community. The aim is to offer small retailers like restaurants and service providers access to loans financed by investors with a vested interest in supporting a local economy. Successful merchants have a network of repeat customers who give those businesses a predictable revenue stream, which in turn is a ready source of data for lenders on their ability to repay a loan.
5. TAKE ADVANTAGE OF COMMUNITY REINVESTMENT REQUIREMENTS
Banking institutions have to comply with the Community Reinvestment Act (CRA), a 1977 US federal law designed to incentivize banks to meet the credit needs of community borrowers. Since the CRA regulations were revised in 1995, banks and thrifts have been required to disclose information about their small-business and community development lending as part of the CRA compliance ratings process through the Federal Reserve. For 2014, about 5.6 million small business loans (originations and purchases) totaling $214 billion were reported, representing an increase of about 12 percent in reported loans and 2 percent in dollar amount over 2013. So banks in your neighborhood are worth contacting about promotional loan programs for local businesses, especially as the favorable lending environment continues and if there is any feature of your business, such as ownership by underrepresented minorities or women, that is promoted under the CRA.
6. NEGOTIATE BETTER PAYMENT TERMS
This source of capital couldn’t be any more local; it is simply your own company, courtesy of your vendors and customers. An often-overlooked tactic for a business seeking to raise capital is asking vendors to extend payment terms and customers to accelerate payments. For example, say your suppliers require you to pay 10 days after invoice, but you get paid by your customers 30 days after you invoice them. For every additional dollar in sales, you will need more capital due to working capital needs. Negotiating longer terms with your suppliers and shorter terms with your customers translates into real cash. Even a temporary extension from suppliers during certain critical timeframes can concretely help your financial situation.
7. SEEK REGIONALLY FOCUSED GROWTH EQUITY
Early-stage equity financing now comes in many more than 32 flavors, and increasingly, fund managers are responding to the demand for impact investments by setting up funds dedicated to social and environmental themes such as recycling, financial inclusion, diversity, and, yes, even local development.
While the deployment of venture capital investment is more concentrated in cities like San Francisco, San Jose, Boston, and New York, there are venture capital funds that have a regional focus. New venture capital and growth equity funds have been established to fund good companies that are not in top metropolitan areas. These see geographic diversity as an opportunity, because ability is equally distributed by zip code, whereas access to capital is not.
A few examples are SJF Ventures, Meritus Capital, and Advantage Capital. ImpactBase, a searchable online database of impact investment funds, can help you find a fund with a mandate that matches the mission of your company.
8. BRING ON REVENUE SHARE INVESTORS
Some impact investors are experimenting with revenue share interests, which occupy a space in the “capital stack” somewhere between debt and equity. Because of that “Goldilocks” risk-profile, these are increasingly of interest to the types of community investors who feel like they have good information about the revenue potential of a local business but not the risk appetite of an equity investor.
A revenue share is paid out prior to an equity share, and in theory could also be paid prior to debt, but they most often exist in circumstances where the venture has not taken on traditional debt due to its cost or unavailability. Like an equity share, a revenue share’s repayment is not fixed, but rather is usually set as a percentage of top-line revenues for either a certain period of time or until a certain return on investment is reached. One advantage of revenue share investment is that the expectation of return is also somewhere between equity and debt; some investors peg their expected recoupment at two to three times investment.
Tip: In negotiating a revenue share, it’s important to define the net revenues that the share will be based upon, and exclude from the definition of net revenue certain expense items you would want to be sure of being able to pay before the revenue share investor is paid.
9. CONNECT WITH A SLOW MONEY CHAPTER
Slow Money is an organization “connecting investors to the places where they live and promoting new principles of fiduciary responsibility that ‘bring money back down to earth.’”
It has 23 active chapters in the US that involve both professional investors and newbies. The members of Slow Money are generally interested in place-based investing, and looking for opportunities to invest to strengthen their local communities.
The virtues of going local for your personal purchases are self-evident at this point: a more connected, resilient community and a more satisfying model for both consumer and business. Finding connected capital and building a local investor base can be a source of prosperity for both your company and your community.
Michael Whelchel is co-founder and managing partner of Big Path Capital, an impact investment bank assisting purpose-driven companies in their most important financial transactions, including acquisitions, mergers, and capital raises. Learn more at bigpathcapital.com. Securities are offered through Intellivest Securities Inc., Member FINRA, and SIPC.
An attorney at Jones Day, Aarthi Belani focuses on M&A, social enterprise, and impact investment. Previously, Aarthi was in-house at Credit Suisse, where she was a member of a cross-divisional initiative to develop impact investment products, and before that, at Cleary Gottlieb, she was involved in innovative financing deals for global development, such as Product (RED), Liberia’s debt restructuring, and counseling the Grameen Foundation.