Equity Seen as Aid to Urban Ills
Jorge Ramirez is a trailblazer. But if the buzz sweeping the country is to be believed, what he accomplished with 18 months of frenzied networking and nail-biting negotiation will soon come more easily to the nation’s minority entrepreneurs.
Ramirez, president of Integrated Circuit Development Co., pulled together a crucial cocktail of equity capital and bank debt to buy out his employer and propel his Montrose company--a manufacturer of pure heating systems for computer chip makers--to the next level.
Finding $1.2 million in equity financing from investors was a near-miracle, Ramirez said. But equity for entrepreneurs like him and others in more distressed areas has become the latest highly touted solution to the nation’s urban poverty problem, promoted as the key to success for tens of thousands of businesses that fall below the radar of traditional venture capitalists.
The argument goes like this: Minority entrepreneurs have launched businesses at record rates--many in neighborhoods plagued by double-digit unemployment. But without equity capital, they are destined to stay small. If investors would look beyond high-growth industries to these underserved “new markets,” they would discover a gold mine of untapped returns while helping to close the country’s stubborn wealth gap.
“The strong economy provides the vehicle and opportunity to finally invest in these places and try to bring them up,” said Housing and Urban Development Secretary Andrew Cuomo, whose America’s Private Investment Companies (APIC) initiative is part of a Clinton administration plan to leverage $6 billion in equity capital for underserved areas.
In addition to the Clinton plan--which awaits congressional approval--state Treasurer Phil Angelides and the Greenlining Institute are urging the state’s pension funds to shift some equity investments from risky foreign markets to underserved communities at home, and an Assembly bill would require similar investments from the insurance industry. Community development groups are also raising equity funds to bolster businesses that have gotten by on burdensome debt alone. Even Federal Reserve Chairman Alan Greenspan has weighed in on the issue.
“It’s almost a mantra now, that what’s missing is equity capital,” said Nick Smith, chairman of the New York-based Community Development Venture Capital Alliance, which has seen the number of community-based equity funds balloon to 45 from less than 10 five years ago.
Finding Equity Isn’t the Only Challenge
But behind all the buzz lies a mountain of challenges that must be surmounted.
Less than 2% of the venture capital in the country is controlled by minority-run funds that are combing minority communities for investments, according to a recent Milken Institute report.
Many minority-owned firms that would be good candidates for funding, moreover, are not plugged in to the networks of high-powered bankers, attorneys and accountants that can make deals happen and provide the skills crucial to success.
And funds with a community development focus generally face geographic restrictions, high costs and difficulty raising money from the institutional investors that contribute heavily elsewhere.
Most agree that equity capital is a necessary tool for the burgeoning class of underserved businesses. But what has been lost in the dialogue is the complexity of getting it to them.
“Where are you going to find these companies?” asked Jill Dominguez, now a private consultant with Irvine-based WRJ Group who helped Ramirez pull his deal together. “I look for minority [entrepreneurs] because that’s what I’ve chosen to do, but I have a hell of a time finding them. . . . Equity financing is not going to make all the difference unless you get the serious technical assistance to go with it.”
Apart from traditional venture capital from professionally managed funds, entrepreneurs can scramble--as Ramirez did--for individual “angel” investors or partners. Whatever the form, equity financing involves ceding some ownership or control of the business, which many entrepreneurs are loath to do.
Proponents of greater access to equity say it is crucial because it adds value to companies and can be used to leverage debt. While any form will do, most of the efforts underway call for equity capital to come through professionally managed funds.
But for equity financing to make a dent on the scale promised by the Clinton administration and other boosters, a new model is required, experts said, in which investors count some of their earnings in social returns.
“We’re talking about . . . investing in people who can provide solid returns but are not going to provide EBay-type returns,” said Jerry Carrington, general partner in Illinois-based Inroads Capital Partners, whose deals include financing for women- and minority-owned businesses.
While mainstream venture funds looking for big returns and quick exits are unlikely to accept those deals, the community development venture capital funds springing up across the country do. Many, however, are only beginning to understand how much expertise and expense is required, Smith said.
The cost of managing community development venture deals can run at 8%--more than triple the industry standard. Investors must also stay in longer, exiting through acquisitions or management buybacks because these companies are unlikely to go public.
“It’s so easy to throw money away in this business,” Smith said. “We believe that if a whole bunch of funds start that are too small and don’t have competent management and they blow the money away, everyone will be convinced it doesn’t work, which isn’t true.”
There is no doubt that a huge gap exists in the availability of equity capital, with the bulk flowing to an elite group of high-tech businesses. Of the record $217 million in venture capital that flowed into Los Angeles-area businesses in the first quarter of this year, for example, only $13 million went to non-tech companies.
In a business built on networking and relationships, many minority entrepreneurs have found themselves out of the loop, particularly those in the neediest urban communities.
Some of the plentiful Asian-owned technology firms have had access to Asian-managed equity funds financed partly by investors in Taiwan and Hong Kong, said Dominic Ng, president of San Marino-based East West Bank. But many other Asian American-owned businesses don’t know where to turn, said Joseph Jou, vice chairman of Rosemead-based First Continental Bank. When Azusa Pacific University recently tried to hold an Asian American Venture Forum, for example, organizers received only three proposals and canceled the event, Jou said.
Black and Latino businesses--less represented in the technology arena--have had even less success getting in the door of traditional venture capital firms.
Venture funds “are not really looking at food processing and manufacturing and other firms that are really growing and contributing to the economy,” said Jorge Corralejo, a Los Angeles businessman who is working with the Greenlining Institute to push for more equity financing.
And many funds that have expressed interest in minority markets--such as Latino-owned Bastion Capital Corp. in Los Angeles and Burbank-based Shamrock Holdings Inc.--entertain only large deals. Shamrock, which entered the Latino market four years ago with investments in Spanish-language media companies, doesn’t like to dip below $25 million per deal, said managing director Clifford Miller.
Ramirez was turned away by six venture funds because his deal was too small. Instead, he was forced to court and pool more than 10 individual investors, an exhausting feat of networking. The new management team has brought him needed savvy and contacts with corporate customers, and Ramirez said he hopes to double revenue by next year.
Culver City-based Fulcrum Venture Capital, the region’s only black-owned fund, finances deals as low as $250,000 for minority-owned enterprises but only expansions and buyouts and very few at that, President Brian E. Argrett said. In the last six months, 400 deals crossed Argrett’s desk, and he financed two, typical of the high-touch, low-volume business.
There’s Hope on the Horizon
But the barren landscape might finally be changing.
A Small Business Administration program that had bolstered firms such as Argrett’s that finance minority entrepreneurs is shifting to offer incentives to all SBA-approved small business investment companies that finance businesses in low and moderate income areas, regardless of ethnicity, said Don Christensen, SBA associate administrator for investment. The change should prompt larger funds to explore underserved areas, he said.
In addition, the Clinton budget includes an SBA New Markets Venture Capital Program, which would funnel $100 million and $30 million in technical assistance dollars to funds that take on higher-risk companies in poor areas. HUD’s program would focus on larger investments of $5 million to $50 million each in distressed areas and include real estate deals.
Community development venture capital funds are also in the works. The federally funded Los Angeles Community Development Bank, which has struggled with a troubled loan portfolio, has a $55-million venture capital program, $25 million of which is being managed by Zone Ventures--an arm of Silicon Valley-based Draper Fisher Jurveston. The firm is importing high-tech start-ups into the city’s blighted target zone and has approved $10 million in deals.
The bank has also committed $10 million to a fund run by FAME Renaissance--of the First African Methodist Episcopal Church--and Century City-based Hancock Park Associates. That fund will focus on later-stage manufacturing, service and entertainment companies in South Los Angeles and will begin taking proposals in three to six months, said FAME Executive Director Mark Whitlock.
The Van Nuys-based Valley Economic Development Center is also working to raise a fund to assist Pacoima companies, and another community development corporation is trying to raise a fund to target East Los Angeles.
Even With Ample VC, Future Is Uncertain
But whether the efforts will create a world in which equity financing flows more freely remains very much in question, said Harvard Business School associate professor Josh Lerner.
“People get a sort of glint in their eye--venture capital, this is really going to solve things--without thinking about how big a gap there is between the kinds of companies being funded, the resources brought to bear and the economic development situation in a more distressed area,” said Lerner.
“A lot of preconditions have to be met before venture capitalists are willing to look at people. Community development groups say we’ll relax these criteria and still get all the good features and the good returns. It’s an appealing statement, and one would like to believe it can work; but the jury is still very much out on it.”
* SPREADING INFLUENCE: Angels are investing more money than ever in fledgling firms here. C7
* AT ISSUE: Today’s hot ticket in financing is cold comfort for many firms. C7
