Ecosystem of Stakeholders

Alternative capital solutions for entrepreneurs play a crucial role in the broad recovery efforts needed to rebuild and grow the US small business economy. While the most visible stakeholders in this arena might simply be entrepreneurs and their direct funders, several other crucial stakeholder groups exist in the broader ecosystem, without whom efforts to modernize and redesign the small business capital landscape cannot succeed.

Governmental organizations, ranging from well known Federal institutions to hyper-local economic development entities, shape the very nature of the small business finance industry — from setting the rules for capital markets to establishing incentives and disincentives for desirable or undesirable behaviors across the industry. Various other intermediaries also occupy an essential role in this space — providing the capital and resources required to establish and execute small business capital provisions. Finally, direct capital providers themselves — in their many shapes and sizes — are the crucial last-mile delivery vehicles that distribute capital to the entrepreneurs who form the backbone of our economy.

Each of these groups has an important role to play in the growth and evolution of the U.S. small business capital landscape.

Economic Development Organizations | Federal, State, and Local Government 

When it comes to supporting entrepreneurs with access to capital for their businesses, most people will think of the Small Business Administration — and with good reason. The SBA’s widely successful lending support programs including 7a, 504, and Microloans, form the backbone of the US support system for extending debt capital to small businesses. Of course, these aren’t SBA’s only successful programs in this area; the Small Business Investment Company (SSBCI) program is another standout SBA initiative, supporting investment fund managers who provide equity capital to American entrepreneurs.

Beyond the SBA, the US Federal government is rife with programming and incentives that impact financing outcomes for small businesses. The Department of the Treasury maintains the CDFI Fund with its thousands of registered entities across the country, the Department of Commerce has the Economic Development Administration which provides support to various institutions at all levels of the capital supply chain and through programs such as Revolving Loan Funds and separately, the Office of Innovation and Entrepreneurship; and even the Department of Agriculture, Veterans Administration, Bureau of Indian Affairs and many more Federal agencies have their own well established and highly regarded programs to support capital access. There are many programs and initiatives at the Federal level of the U.S. government to support the debt and equity capital infrastructure for small businesses and startups.

The same can be said for many US states, territories, and municipalities as well. Creative and hardworking public servants at every level of government have devised unique and responsive programs to support debt and equity capital provisions for entrepreneurs across the country — many of which are funded by Federal sources of capital. For example, at the time of writing this playbook, all 50 states — plus territories and governments — are planning for and eagerly awaiting their first distributions from the State Small Business Credit Initiative (SSBCI) program, the second, scaled-up iteration of a nationwide strategy to leverage Federal investment to incentivize private capital investments into small business capital offerings. While SSBCI is a program of the Treasury, administered at the state level, an even broader array of initiatives across the nation’s counties and cities are in motion, supported by the American Rescue Plan’s State and Local Fiscal Recovery Funds, supporting local small business capital markets with incentives to increase lending and equity investments.

Clearly, the vast array of entrepreneurial development agencies and support organizations across the US have a well-demonstrated ability to support and incentivize the mobilization of debt and equity capital to small businesses and startups across the economy. 

We have yet to see these institutions adopting and embracing strategies to support the provision of innovative and non-traditional capital products that reach a broader and more diverse set of entrepreneurs and small businesses they intend to serve. 

Federal agencies, state governments, local and regional economic development organizations don’t need to reinvent the wheel — they just need to broaden existing programs to include non-traditional capital providers that implement intuitive innovations that better serve their constituents.

As these various organizations become more comfortable with the definitions, parameters, and examples of the sorts of innovative financial products that we highlight in this playbook, it is our hope that these non-traditional capital products and the organizations that provide them to entrepreneurs will become increasingly likely to be included in existing and future access to capital initiatives – at all levels of government. For a glimpse of successful and ongoing efforts, take a look at the following examples: 

Washington State Department of Commerce & National Development Council/Denkyem: Revenue Based Loan Fund via State Small Business Credit Initiative  

When the US Department of the Treasury announced the allocation amounts for each state under the State Small Business Credit Initiative in 2021, the Washington Department of Commerce was faced with the daunting task of determining how best to spend more than $163M to mobilize private investment in Washington’s small businesses. Additionally, Washington Commerce also had to consider another important component of this capital: the SSBCI program’s incentives to reach very small businesses (VSB) and those owned by socially and economically disadvantaged individuals (SEDI).

After consulting with several organizations with deep experience providing capital to entrepreneurs in the state, the Washington Department of Commerce ultimately decided to structure a proposal which would spend approximately $13M of its funds to support the establishment of an innovative Revenue Based Loan fund, managed by the National Development Council (a longstanding national CDFI lender based in Seattle) and Denkyem Cooperative (an innovative platform providing non-traditional capital products to entrepreneurs). 

Together, NDC and Denkyem will raise an additional $14M in private capital to achieve the program’s minimum 1:1 public-to-private matching ratio, and will then begin making Revenue Based Loans — specifically focusing on Washington’s minority-owned businesses. Washington’s Department of Commerce didn’t have to do this, of course. Its programs from the first iteration of the State Small Business Credit Initiative did quite well at distributing capital to entrepreneurs, when compared to peer states. However, the state was convinced that at least a portion of its spending should be dedicated to non-traditional capital products that might better suit those VSBs and SEDI businesses in ways that traditional debt or equity products simply can’t.

Baltimore City, Maryland: Baltimore Development Corporation & “Baltimore Together” CEDS

With the publication of its most recent Comprehensive Economic Development Strategy (CEDS), titled “Baltimore Together,” the Baltimore Development Corporation outlined its commitment to focus on small business growth and recovery in the post-COVID economy, especially among the city’s BIPOC-owned businesses. Research from Baltimore Together shows that while over half of Baltimore City’s privately held businesses are BIPOC-owned, these businesses account for only 12% of Baltimore City’s total business revenue. To address this, the Baltimore Together report outlines a capital access strategy for minority businesses that includes non-traditional capital strategies.

While Baltimore Development Corporation is not a direct capital provider itself, it does have the ability to pool resources and establish incentives for existing, well-established small business capital providers to increase their lending and investment to minority firms. Specifically, the Baltimore Together CEDS plan calls for “additional city and state funds [for] a loss reserve and bringing together several CDFIs to administer a larger fund.” Along with offering traditional debt products for small businesses, Baltimore Together also makes special note of the “need to explore other, non-debt forms of capital for early stage businesses and others adverse to taking on debt burdens.”

For local CDFIs to participate in such a program, Baltimore Development Corporation plans to pool capital – starting with more than $3M in released EDA Revolving Loan Fund dollars – to serve as a risk-mitigating back stop for lenders and alternative capital providers, ensuring that they can take the risk of offering capital to historically overlooked entrepreneurs and issuing capital with non-traditional terms without having to bear the burden of this risk alone. 

Colorado OEDIT Venture Capital Authority, Greater Colorado Venture Fund 

At Colorado’s Office of Economic Development and International Trade (OEDIT) sits a unique state entity that has been, in recent years, the envy of many economic development professionals. The Colorado Venture Capital Authority (CVCA) is a political subdivision of the state, created by OEDIT, and a Special Purpose Authority, like the state’s Public Employees’ Retirement Association, exclusively used to invest in Colorado-specific investment fund managers.

One such investment fund that received an anchor investment from the CVCA is the Greater Colorado Venture Fund (GCVF). This, an innovative investment fund focuses exclusively on entrepreneurs in rural Colorado. Besides its unique focus on investing outside of the state’s urban corridors, GCVF makes use of innovative capital products for entrepreneurs. For some of its seed-stage deals, instead of using a Simple Agreement for Future Equity (SAFE) or preferred equity like traditional venture capitalists do, GCVF makes what it calls “redeemable equity investments.” These, essentially, are agreements that allow a company to sell equity to an investor but permit the entrepreneurs to buy back this equity based on a recurring share of revenues.

When the CVCA decided to make an investment in a flexible VC fund like GCVF, they opened the door for dozens of rural Colorado entrepreneurs to obtain capital that truly fits their needs in a way that traditional debt or equity may not have.

For more detailed information about Greater Colorado Venture Fund, see the full case study here

Indirect Capital Providers: Asset Allocators, Philanthropy, Corporations

Intermediaries such as foundations, corporations, and other indirect capital providers have historically supported capital access in many different ways. Banks and institutional investors have long supported and capitalized Community Development Financial Institution loan funds, dating to the mid-1990s. Foundations have generously supported small business ecosystem development, technical assistance, accelerators and capacity building through grant programs. Corporations have developed supplier diversity programs and participated in grantmaking and capacity building for small businesses in their communities. While this is not a comprehensive list and many of these efforts are effective and should continue to be supported, there is opportunity for these intermediary institutions to expand their strategies to support small business capital access and play a key part in advancing the innovative finance space.  

In order to increase the use of innovative products to get capital into the hands of more business owners, there is a need for risk-tolerant capital to seed such innovative strategies and the capital allocators who are using them. There are many fund managers and capital providers equipped to utilize innovative products but who struggle to identify investment capital willing to back an innovative strategy. Foundations, corporations, and other indirect capital providers can make a significant impact by writing Limited Partner (LP) checks to innovative fund managers, lending capital to innovative debt providers, or providing operating capital to last-mile capital provider institutions. In addition to investment capital, anchor institutions can utilize existing asset pools to leverage as guarantees for higher-risk new entrants or innovations within capital markets, e.g., a loan loss reserve strategy. 

Many innovative capital providers that are using alternative strategies — those that do not resemble traditional venture capital or lending have struggled to raise investment capital from traditional and institutional sources. The more these new products can be proved in the market, the more momentum will be behind the formation of new financing mechanisms that increase capital investment to underserved entrepreneurs who have been historically left behind due to their race, ethnicity, gender, socioeconomic class, and/or geographic location.

In addition to providing seed and investment capital to emerging funds, there is also significant opportunity to support this relatively nascent ecosystem through landscaping and research work, technical assistance and capacity building, and convenings and shared learnings. In this playbook, you will find a guide to understanding your local capital landscape— an important step to better understand what gaps exist in your local capital market and what strategies might be a good fit in your local context. 

We have seen several great examples of how foundations and indirect capital providers have leveraged their resources to further this space, specifically those that have provided risk-tolerant capital to innovative funds to support their launching or expanding into non-traditional capital products. Consider a few examples below: 

Calvert Impact Capital — Securitizing Small Business Loans via CDFI Lenders

Calvert Impact Capital partnered with the National Development Council (NDC), Community Reinvestment Fund (CRF) and dozens more CDFI lenders across the country. Their goal: to create various programs intended to capitalize regional loan funds and ultimately bring debt capital to the entrepreneurs who need it most. To date, these Calvert-managed programs have leveraged funds from private, public, and philanthropic investors and blended in a centralized loan purchase facility that is then used to buy a percentage of every eligible loan originated by a participating CDFI. 

So far, the CDFIs have made $240M in loans to 3,929 small businesses at an average loan size of approximately $59K. With a special focus on lending to chronically underbanked businesses, this suite of capital programs for CDFIs have yielded an overwhelmingly positive impact, with 90% of loans going to businesses with 10 or fewer employees (i.e., Very Small Businesses) and 67% of loans to businesses owned by women and/or Black, Hispanic, Asian, or Native Americans. 

Building on these programs’ successes, Calvert Impact Capital is now building state-based programs to leverage SSBCI, blending the state’s subordinate funds with private capital to purchase standardized loans originated by participating CDFIs. The funds will be borrowed by a state-specific special purpose vehicle (SPV) and will purchase 80% of every eligible loan originated. Calvert will arrange the warehouse line and, once there are sufficient assets across the warehouse vehicles, will sell the loans to another Calvert Impact, Inc. subsidiary to issue asset-backed notes to institutional investors. The objective is for the notes to be rated by one of the top three ratings agencies to drive the most efficient pricing in the market. Proceeds from the note issuance will be used to repay the warehouse line and replenish available state funds to recycle the funding and prolong the program.

Kauffman Foundation Capital Access Lab 

In 2019, the Kauffman Foundation seeded the Capital Access Lab (CAL) with a $3M grant that led to an additional $500K raised from the Rockefeller Foundation. CAL was launched with the goal of closing market gaps for entrepreneurs in populations systematically excluded from capital markets and overlooked communities across the US. To do so, CAL identified and funded innovative strategies to support the 83% of entrepreneurs who do not have access to traditional bank loans or VC. Since inception, CAL has invested in six funds that address the access to capital problem by deploying innovative financial products to underserved entrepreneurs and communities.

Over three years in, the results speak for themselves. Within 18 months since the first investment, CAL has mobilized $162M in private capital for its six portfolio funds as the anchor or one of the first LPs and serving as the “institutional stamp of approval” for follow-on investors. This has generated an impressive catalytic leverage ratio of 48x for a relatively small $3.4M fund of funds (FoF). Of the portfolio companies, 20 (87% of 23 total) are led by underrepresented founders, 65% are woman-led, 78% are POC-led, and 26% are based in economically distressed areas. 

Institutional investors with large assets under management and patient investment capital, especially foundations and endowments, should leverage part of their annual grant budgets to permanently seed the next generation of underrepresented fund managers through program related investment (PRI) and mission related investment (MRI) programs. CAL represents an innovative pilot program focused on addressing this challenge that foundations should build upon and replicate at a larger scale.

For more detailed information about Capital Access Lab, see the full case study here

Supply Chain Financing 

Some of the most pressing challenges that can be addressed by Supply Chain Finance (SCF) are in the construction sector. According to a 2015 study by PwC, construction and engineering is the industry with the longest period for sales outstanding, at an average of 73 days for firms to be able to collect on sales. Construction also shows the most potential for SCF innovation, as minority firms are concentrated in construction, and state and local governments are expecting hundreds of billions of dollars to flow from the Federal Bipartisan Infrastructure Law. 

The simplest and most founder-friendly form of SCF is early payment, sometimes discounted or with a fee, by the buyer. For example, Turner Construction Companies started its own in-house factoring facility for subs, using an online platform to quickly onboard and validate invoices. This kind of buyer and large purchaser innovation, while leveraging technology, simplifies processes, pays firms faster, and is critical for meeting contractor cash flow needs in fulfilling contracts and leveraging these opportunities to help diverse firms grow.

Direct Capital Providers: Fund Managers, Community Development Financial Institutions 

The overwhelming majority of capital or financing options for a business owner/entrepreneur comes from private institutional capital: bank lending and venture capital. And yet – according to the Kauffman Foundation’s Access to Capital report, at least 83% of entrepreneurs do not access bank loans or venture capital. The majority of businesses rely on personal and family savings for startup capital and the funding that does flow is not equitable. 

While many direct capital providers are working to expand access to their existing capital products, there is still a large gap in terms of entrepreneurs who are seen as “too risky” for a loan and “not high-growth” enough for venture capital. This is a major opportunity for innovation; for capital providers (new and existing) to experiment with structures that include revenue-based sharing models, profit-sharing models, and employee ownership all of which will expand capital access to businesses that are not currently a fit for traditional debt and equity.

Existing capital providers can use this playbook to explore new products and reach a new set of business owners and founders. Many of the innovative products discussed are incrementally different from a traditional product and would be a natural addition to an existing capital providers toolkit. New capital providers who are considering launching strategy should be open to an innovative or blended strategy. While there is still a strong need for technical assistance and high-touch support as this ecosystem matures, this playbook is intended to remove some of the barriers and equip a new capital provider with the practical information and tools needed to launch an innovative strategy. 

National Development Council 

NDC is a CDFI lender historically focused on traditional debt offerings with a unique focus on Revolving Loan Funds Like many CDFIs, NDC frequently comes across businesses that are not explicitly a fit for their traditional loan products nor a fit for venture capital funding. These local businesses have strong potential and a solid track record yet struggle to identify the right capital fit. 

NDC saw the opportunity to capitalize these businesses with just an incremental innovation of their products by piloting a revenue-based loan fund dedicated to Black & Brown entrepreneurs in the Seattle area — providing better tailored products to suit market demands. In Seattle, as with elsewhere in the US, many small businesses struggle to qualify for traditional loans, even from flexible CDFI lenders. Inconsistent business cash flow cycles, short business histories, and individual borrower variables all work against some small business owners in inhibiting creditworthiness. However, with the nuances of a flexible revenue-based loan, which takes into consideration the “upside potential” of a small business and decreases reliance on historical financial performance. NDC plans to at least partially capitalize and de-risk this fund with money or guarantees from the Washington.

State SSBCI 2.0 program(s); this was a key part of their ability to get buy-in for this innovation. We see NDC’s RBF strategy as a compelling blueprint for existing capital providers who are interested in re-tooling their team for new products to reach new businesses.

Collab Capital 

There are some great examples of first-time fund managers who are designing and reinventing capital products without having to re-tool an entire organization. The team at Collab Capital is one such example, with its focus on investing in Black-led businesses. “We were very adamant that the most important thing we wanted to solve was the funding gap for Black founders,” said Jewel Burks Solomon to TechCrunch. “So we were not willing to broaden the spectrum there because we saw that there were so many firms out there for diverse founders, and even in some of those, Black founders were still marginalized.”

And so they launched Collab Capital, an Atlanta-based fund that makes profit share investments structured with performance-based equity in seed-stage, Black-owned companies across the U.S. The team creates growth opportunities for their companies by connecting founders to corporate and social “influencers.” They will back companies that reflect their three core areas: future of care, future of learning, and future of work; then they will focus on supporting founders in US cities that have a high concentration of Black innovators and a low concentration of capital.

Founding Partners Jewel Burks Solomon, Justin Dawkins, and Barry Givens have each experienced how bias roadblocks Black innovation and entrepreneurship. Through their hard work and resilience, this entrepreneurship trio created Collab Capital — one of the largest funds for Black-focused investment — to help the Black community create wealth and increase business ownership.

For more detailed information about Collab Capital, see the full case study here

Minority Business Accelerator Fund 1

Housed at Cincinnati Regional Chamber, the Minority Business Accelerator has spent nearly two decades elevating outcomes for minority entrepreneurs. Since inception, MBA has increased annual regional minority business spending by more than 10x ($1.2Bn in total last year) and created more than 3,500 jobs. After providing support to dozens of minority-owned firms, the MBA team saw how access to capital remained an issue and decided to launch MBA Fund 1 to help capitalize such firms.  

In order to meet entrepreneurs in the “missing middle,” they decided against structuring their inaugural fund along the lines of traditional venture capital, private equity, or private debt. Instead, they created a fund that will reinvent the capital marketplace for Black and brown-owned businesses by offering alternative structures. 

Fund investors may share in the revenue of a growing firm, for example, instead of a highly illiquid equity investment that may not be the right fit for the vast majority of stakeholders. Additionally, the fund plans to serve as an innovative “search fund” or “business acquisition” strategy, where the MBA Fund will finance the acquisition of existing, non-minority-owned businesses for a new, racial-minority business owner.

This example creates a roadmap for how a nationally regarded regional accelerator might launch its own investment fund, designing capital products around the needs of local minority entrepreneurs it has served for decades.