Talk to neighborhood-based start-ups around the country – from grocery stores to vintage clothing sellers – and you are likely to hear about problems accessing capital. Start-ups need capital to hire employees, rent space, fill purchase orders, and invest in marketing. Good ideas and businesses often fail because they are undercapitalized.
Early-stage start-ups usually rely heavily on family and friends for financing, while larger businesses typically seek financing through traditional banks or venture capital. Further complicating matters, minority and low-income entrepreneurs sometimes face particular difficulty in raising money from family and friends for financing because their networks lack sufficient capital to invest.
Later-stage start-ups and small businesses are often stuck between the two. They need more money than they can raise from family and friends, and they’re too small for traditional banks to take the lending risk. And, as venture capital funds are generally organized around investments in technology companies as opposed to neighborhood-based businesses, another financing gap emerges.
In some cases though, the issue is not a financing problem so much as it is a profitability and risk problem – banks, CDFIs, and other lenders are simply concluding that the business will not be profitable enough given the amount of risk involved. However, in many cases there is enough potential return for the risk involved, but the size of the deals are too small for traditional banks to show interest. Sometimes, it is simply that entrepreneurs are not prepared to present the right information required by CDFIs or banks.
As adequate financing continues to constrain growth for many neighborhood-based start-ups and small businesses, solutions to this financing problem are great for neighborhood development, especially in places like Detroit and other deindustrialized cities that see entrepreneurship as a way to bring vitality to under-populated neighborhoods.
A solution to this financing problem that is building momentum around the country is local financing through “community capital.” Community capital is money that is sourced locally and reinvested in the local economy, with an emphasis on democratizing access to capital, access to opportunity, and local economic control.
What makes community capital different is its focus on local sourcing and local investing. The local sourcing of capital and the emphasis on economic democracy differentiates community capital from financing mechanisms like impact investing, which sources capital from many places and does not tend to prioritize democratic decision-making. Donation and investment crowdfunding, lending and savings circles, and local peer-to-peer lending are some of the more well-known examples of community capital.
Community capital is relatively new: The federal government issued equity-based crowdfunding regulations in 2015 and 2016. The regulations allow small business and entrepreneurs to raise up to $1.07 million for their business, with states following suit and passing equity-based crowdfunding rules as well. For example, in Michigan the state government passed the Michigan Invests Locally Exemption Act (MILE) in 2014, which allows businesses to raise up to $10,000 from a single investor.
In theory, this relatively new financing mechanism should encourage neighborhood entrepreneurship by offering another way to raise money and alleviating, for some, a constraint to growth. But, despite a legal and regulatory framework in place that would allow equity-based crowdfunding and community capital to be deployed, it has not been widely used by start-ups to raise money. Small businesses may not know enough about equity-based crowdfunding as an option, or there may not be enough successful models for businesses to copy.
Many questions remain then about community capital, from how to generate interest among community investors, to gauging whether neighborhoods have enough capital to make a difference, to considering if communities can drive innovation. Until community capital advocates have more successful models to point to, it will be difficult to increase the level of adoption and the ability of community capital to make a big impact remains unclear.
Image courtesy of Flickr. Originally published by S&S on July 18, 2019.
