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Funding Local Businesses

January 13, 2020

What Economic Development Professionals Must Know About Funding Local Businesses

Economic development professionals are at the forefront of building sought-after communities. We do this in the face of intense competition. Often it feels like we are a cross between a hotel concierge, diplomat, technical expert, psychologist and marketing agency.

There’s so much to learn in economic development, from site selection, real estate finance, incentives and marketing to local, state and federal laws. Increasingly, our clients expect us to know more—or at least where to find the answers.

One way to be of service while adding value is to focus on the small-business market. There are 30 million small businesses in the U.S. The vast majority have between one and 20 employees: a market prime for growth.

Capital, Capitalism, & The Great Recession

Capital is essential. Entrepreneurs and small businesses need capital to launch, scale, grow and to pay suppliers and employees. This is your opportunity to become an indispensable resource in your entrepreneurial ecosystem by knowing what capital options are available and how the industry is innovating.

For decades, banks were the primary capital source for businesses. With thousands of banks and their branch networks stretching across the U.S., it was easy to find and meet with a commercial loan officer. And for most, it worked. Then the Great Recession hit, which led banks to drastically reduce lending to small businesses.

When the recession struck, loans under $100,000 came to a quick stop. In fact, all loans under $1 million declined, which is a proxy the Federal Reserve banking system uses to measure the health of the small-business lending market. Many businesses were devastated during this time and forced to close.

Capitalism doesn’t stop—it persists like a river eroding a rock

The banks’ pullback of credit created a market opportunity for startups. This void led to a new type of nonbank lender that focused on loans under $100,000.

On Deck Capital, Cabbage, Lending Club, BlueVine were some of the new online lenders that emerged. These lenders, called fintech companies, are a blend of internet-enabled technology and finance. Loosely regulated, these lenders can evaluate credit worthiness using bank statements, sales numbers, credit card swipes, credit scores and social media information to approve loans in hours. This was a game changer for small business.

The market opportunity was so enticing that Amazon, PayPal, Square Space, Square, and Intuit (the parent of QuickBooks) all offer credit products. Fundera, a loan marketplace, enables businesses to shop for a loan from many lenders, while completing one application. Square applied for a bank license, in an industry that had witnessed a cliff-like fall in the number of new applications. It seemed that almost overnight, everyone wanted to lend to small businesses.

Since the majority of new lenders are not banks, they don’t face the same regulatory scrutiny as banks, and their interest rates are often dramatically higher than comparable bank products, which poses a serious threat to some small businesses. Despite the higher borrowing cost, many businesses prefer the convenience of the speedy decision-making process over costs.

A solid alternative to banks and online lenders is a community development financial institution (CDFI). CDFIs seek to give underbanked communities access to capital, technical assistance and community development, frequently in the poorest communities across the country.

CDFIs come in different varieties. They can be small community banks, credit unions, or community development organizations focused on housing. The CDFI program, which celebrated 25 years in existence in 2019, is managed by the U.S. Treasury Department. Hundreds of these lenders are throughout the country, ready to support local entrepreneurs and small businesses, including Opportunity Fund, Accion, HEDCO and others.

The Small Business Administration (SBA) program is a viable option for some businesses, given its competitive interest rates. While some deals can be completed quickly under the SBA Express program, businesses want funds in days, not weeks. This program is an option worth investigating for businesses.

Other Capital Options

For fast-growing startup businesses that lack revenue and a positive cash flow history, investors may be the solution. These investors are looking for companies that can grow fast so they can be sold or go public in a few years. Keep in mind, most businesses are not going to meet the criteria an investor wants to see: large market opportunity, unique competitive advantage and an experienced management team. If you meet the criteria, find an investor.

Angel investors are wealthy individuals designated as accredited investors by the SEC. The SEC defines an accredited investor as a person who has made over $200,000 per year for the past two years,  $300,000 as a couple, or has more than $1 million dollars in assets, excluding their home. This is a high bar most people don’t meet.

Angel groups are found throughout the country. Search your state. In Connecticut, there is the Angel Investor Forum (AIF) and many individual angels. New York has Golden Seeds. Many angels use Gust to vet deals. Gust is a platform where investors and small businesses can meet.

Crowdfunding is receiving much-deserved attention. There are three types of crowdfunding: 1) Donation, 2) Reward and 3) Investment. The team at Cutting Edge Capital would argue that  Direct Public Offering constitutes a fourth type of crowdfunding. To keep it simple, we will focus on the three mentioned.

GoFundMe is a donation platform. Over $5 billion has been pledged on this platform since it was started in 2010. This is the website people use to raise funds for a funeral, pay for hospital bills, a wedding, or other need. Businesses that may have experienced a hardship, can now go directly to the most popular donation-based website in the world. GoFundMe may not be right for every business, but it is an option.

Kickstarter and Indiegogo, with over $6 billion pledged between the websites, are two types of reward crowdfunding platforms. In this type of crowdfunding, the business doesn’t give up equity or seek debt financing. The business provides a reward as an incentive for people to provide capital. It often means purchasing the product at a discount, prior to the public launch.

When I wrote, Get the Loot and Run I used Kickstarter to raise funds to publish my book. While it isn’t easy, crowdfunding is a great way to get people excited about your business and generate media attention, which is often more valuable than the funds raised.

The JOBS Act, passed in 2012 by Congress and signed into law by President Obama, opened the door to the masses for investing in private companies. A key part of the legislation, referred to as Title III, welcomed crowdfunding (sometimes called Reg CF) for businesses. However, the SEC did not approve the legal framework around crowdfunding until 2016. Now many businesses are offering investment crowdfunding to the public. Under the JOBS act, a business can crowdfund up to $1,070,000 a year. But you must be on a FINRA approved platform and follow the rules.

Investment platforms such as WeFunder, Republic and Start Engine allow small businesses to seek investments in the form of debt, revenue-sharing agreements or equity. New platforms continue to pop up such as Honeycomb Credit, which crowdfunds debt. Numerous platforms focus on residential and commercial real estate.

Pitch competitions are everywhere and offer a creative way to raise capital! In Connecticut, there is the annual Venture Clash competition where the top prize is $1,000,000. This competition offers up to $5 million in total prizes. CTNext, a subsidiary of Connecticut Innovations and the operator of Venture Clash, offers cash prizes of up to $10,000 for the pitch competitions it conducts throughout the state. Many colleges and universities have their own competitions, as do many chambers of commerce and other organizations.

Add national competitions from FedEx and UPS, popular TV shows like Shark Tank, The Profit, and Entrepreneur’s online Elevator Pitch, and you’ll realize there is no shortage of capital and potential exposure.

How to Keep Up

To be of service and value, follow the money. In economic development, if you don’t find a way to make yourself a trusted resource to small business, you could find yourself obsolete. The opportunity is where there is need. Here are some tips to make you the go-to person for capital in your community.

  1. Create Google alerts around a number of financial topics. This process is simple and will help your small businesses. Google alerts will send you daily or weekly emails about the topics you want to know more about.
  2. Read. Set aside at least 30 minutes a week to read what’s new in finance or economic development. The New York Times, Bloomberg Businessweek, Wall Street Journal, Fast Company and Inc. Magazine are all good resources. Find your favorite.
  3. Go to meetings where commercial bankers and other finance people meet up. They are paid to be in the know. Plus, they have loaned money to businesses in your community and can give you the inside scoop on how certain industries are doing.
  4. Schedule visits with local businesses. Learn what their needs are. Don’t forget that nothing gets the blood flowing in economic development more than telephone cold calls or drop-ins on businesses. This is essential to know the pulse of what’s happening in your community.
  5. Attend chamber events, seminars, and watch webinars. These are all excellent ways to increase your knowledge, network with top people, and show the business community you are serious about increasing your knowledge.
  6. Attend at least one economic development conference every two years. The International Economic Development Council (IEDC) is the largest organization serving economic developers. I spoke at the IEDC conference in Indianapolis in 2019 and met many great people from all over the U.S.
  7. Don’t pass up the opportunity to speak at business events, participate on panel discussions, podcasts, blogs, vlogs, or judge business competitions.

Anthony Price is one of the foremost experts in the U.S. on raising capital for small businesses. Price is the founder and CEO of LootScout, which counsels entrepreneurs on how to build a better business and raise capital. As a former economic-development executive, he is at the nexus of entrepreneurship, patient capital and community. Price is the author of the book, Get the Loot and Run. His second book, Free Loot: Win Cash, Prizes and Attention for Your Business, will be published in the spring.

Image Source: Adobe Sparks and Camoin 310