Venture Capital Foray Causes Stir for Nonprofit
The deal seemed irresistible, a perfect venture capital opportunity that would generate money for the cash-strapped Valley Economic Development Center while opening a door to the lucrative private sector.
It started last fall with a phone call to U.S. Rep. Howard Berman from Century City attorney Les Gold, who was representing a wealthy Japanese investor seeking legal U.S. residency.
Berman (D-Mission Hills) knew that foreigners who invest $1 million in a U.S. company can get a green card under federal law. He referred Gold to the Valley Economic Development Center, a prominent nonprofit group that helps small businesses.
A few months later, VEDC president John Rooney helped cinch a deal in which the Japanese businessman invested $1.2 million in a Canoga Park sign maker, Signs 2000.
To Rooney, the deal marked yet another trailblazing achievement for the VEDC. But it also triggered turmoil within the organization, culminating in May with the VEDC board calling for Rooney to resign.
Rooney refused, sources say, and the board backed down.
Board spokesman Wayne Adelstein said last week the board has reviewed Rooney’s performance and reaffirmed his authority.
Still, interviews with board members and others close to the organization reflect sharp divisions over Rooney’s leadership and his handling of the Japanese deal.
Speaking privately, some board members said they are concerned that venture capital-style investments are beyond the mission of the VEDC and the skill of its staff. Others were alarmed that Rooney and a VEDC consultant made hefty commissions on the Japanese deal at a time when the nonprofit is heavily in debt.
Of the $57,000 in fees generated by the deal, Rooney took a 10% cut, and Jim Jacobs, the VEDC consultant who helped negotiate with the investor, took 55%. That left only $20,000 for the agency, which as of last week owed its creditors $185,000.
“The board was incensed to pay such big commissions when the organization needs money so badly,” said one person with knowledge of the situation.
Rooney said commissions are common in venture capital deals. Jacobs, he added, was not a salaried staff member and paid only by commission.
As for his own cut, Rooney said such bonuses are included in his contract to encourage him to seek more private-sector work.
“Here we are, bringing $1.2 million to a local company in a depressed area,” Rooney said. “I was so proud, I wanted to issue a press release.”
Even so, the practice came as a surprise to VEDC allies like Berman.
“I had no idea. I thought the VEDC was here to promote economic development, and I assumed their people were salaried,” Berman said.
The congressman also questioned why Rooney was paid a commission.
“He didn’t find the investor,” Berman said. “I did.”
Alberto Alvarado, head of the local office of the Small Business Administration, said few nonprofits pay commissions to staff.
“It certainly reads like an unusual process and one that could be potentially problematic,” Alvarado said. “But if it works, it’s a good idea.”
Board chairman David Honda refused comment, along with other directors, and deferred to Adelstein, a member of VEDC’s finance committee.
Adelstein said the majority of the 17-member board supported the venture capital deal.
“You never know how secure government funding is,” said Adelstein, who runs a community newspaper. “That’s why we’re looking for ways to diversify, and venture capital may be one direction we go in.”
*
The VEDC has come a long way from when it started in 1976 with a budget of $2,363 and a mission to fix up the Van Nuys business district.
It’s now a regional player in the small business community, a well-known, primarily government-financed organization with a $2.8-million budget, a $7-million loan fund, and projects stretching from La Puente to Compton to Ventura County. Its staff of 50 includes former entrepreneurs and several Ivy League-educated MBAs.
It was the 1994 Northridge earthquake that brought the VEDC to the big leagues. The 6.7-magnitude quake damaged thousands of businesses in the Valley and left them in desperate need of financial help.
Almost instantaneously the VEDC responded, hiring more staff, opening disaster centers and holding seminars at high school auditoriums across L.A. to teach businesspeople, en masse, how to apply for government loans.
The VEDC’s annual budget nearly tripled in one year, from $800,000 in 1993 to $2.1-million in 1994. The city of Los Angeles, the city of Huntington Park, the U.S. Department of Commerce and the state all poured money into VEDC coffers.
At that point, the VEDC had no money of its own to lend and was strictly helping businesses apply for federal funds. But many of the businesses that were rejected by the Feds were important to the local economy, VEDC executives believed, and the organization searched for a way to help them.
Enter Ron Brown, the late U.S. Commerce Secretary. On Valentine’s Day 1995, Brown presented the VEDC a $6.25-million check to start a revolving loan fund.
From there, the VEDC shot out in all directions of the small business world. It set up the Economic Alliance of the San Fernando Valley and, at Mayor Richard Riordan’s request, a similar alliance of business organizations in Hollywood. It expanded its entrepreneur training programs, graduating more than 100 business owners each year. And it acquired a portfolio of micro-loans to fledgling businesses ranging from a Hollywood bistro to a Compton toy store.
“We’ve been very pleased with the work they’ve done in micro-loans,” said Alvarado, the SBA official. “When we pick an organization to partner with, we look at the whole structure, and we feel the VEDC is run well and maximizes the dollars that get to the street.”
For an organization that assists small businesses in nearly every aspect--training, marketing, strategizing, accounting and loans--the last missing piece for the VEDC was venture capital. Sometimes small companies are so heavily in debt that they can’t afford to take out another loan. But an equity investment can make sense because there’s nothing to pay back. To get the money, though, the business has to be willing to give up some ownership to the investor, who typically demands a hefty slice.
One of Rooney’s plans is to start a VEDC venture capital fund that would support promising local entrepreneurs by becoming partners with them. If successful, the fund would generate handsome consulting fees and equity profits, helping the VEDC--whose budget is 90% government-sponsored--become less reliant on public support.
Rooney said the fund would be incorporated separately as a for-profit entity, and its income would help pay for VEDC programs.
His idea is part of a growing trend nationwide in which community development organizations use venture capital to prop up fledgling businesses in struggling neighborhoods. Within the past five years, dozens of venture capital development funds have opened, ranging from $5 million to $30 million, according to the New York-based Community Development Venture Capital Alliance.
But venture capital is notoriously risky. It’s much less formulaic than making a loan, and since the investment is secured by ownership--not separate collateral--it can end in a total loss.
“It’s a very different business than loans,” said Kerwin Tesdell, president of the Alliance. “It requires a high level of financial expertise and a lot of money.”
The VEDC has neither, some board members have said.
“Our staff is great helping mom-and-pop businesses, but would you trust them with serious money?” asked one board member who spoke on the condition of anonymity.
*
By the fall of 1998, the VEDC’s finances were becoming a concern. Office expenses were rising because the VEDC had undertaken more contracts for business centers, and often government agencies paid the VEDC as late as five months after the work was done. As of last week, Rooney said, the agency was closing in on the $200,000 borrowing limit mandated by its creditors.
Several board members have urged Rooney to trim expenses and pay off the debt, sources said.
Rooney, however, said grant payments are often late and that he needs to borrow money to make payroll.
There was also disagreement between Rooney and some board members about paying an outside consultant to help with the Japanese venture capital deal. Rooney said he needed the consultant’s expertise. Others in the organization said VEDC staffers could have brokered the deal themselves--on salary--without taking any money away from the nonprofit.
To put the organization on a more secure footing, Rooney is exploring other private sector deals, including real estate projects and partnerships with developers.
But tensions continue to simmer on the board. Two board members, attorney Lee Alpert and Boys & Girls Club President Leroy Chase, resigned last month. Chase said he quit to spend more time on other projects. Alpert could not be reached for comment. Two other board members have told The Times they plan to resign because of the infighting and controversies at the VEDC.
Rooney, 38, said his pay will be cut from around $135,000 per year in salary, commissions and benefits to around $120,000 because he will be giving up some commissions.
But he is adamant that he will remain at the VEDC. A former consultant who specialized in minority businesses, Rooney said he wants to take advantage of the economy’s momentum and VEDC’s track record to build up small businesses across L.A.
“I want to stay here, I plan to stay here, I love this work,” he said. And acknowledging his detractors, he added: “No doubt that there’s a lot that’s exciting for us to do. But obviously not everyone wants to go there.”
*
HOORAY FOR SBA
The Small Business Administration plays a big role in the success of Valley entrepreneurship. B6
* MINI-MBA
The VEDC’s training programs teach participants everything they need to know to run a business. B6
