| February 18, 2005 |
| By Patrick Borunda |
|
Community Development Venture Capital Funds Bring Relief to an Equity Desert |
Summary : Loan funds are beneficial to the Native American community. But they are not sufficient. Without a source of equity ("risk capital"), loan funds alone cannot substantially affect whether Indian Country's public and private enterprises realize their full potential. Today, two sources of community development risk capital, Native American Capital, LP and The Pathfinder Fund, LLC, are committed to the Native market.
Introduction
Community Development Financial Institution (CDFI) loan funds are playing an increasingly important role in Indian Country. However, they have limitations. Using debt demands a source of equity (unencumbered funds/property used to secure the lender's financial interest). Without new equity sources, Indian Country's equity-poor environment confines lenders to limited new business projects and small scale new capital formation. Smaller investments yield smaller returns than the need -- and promise -- for economic growth in Indian Country.
The 2001 landmark CDFI Fund Native American Lending Study: Equity Investment Roundtable and Research Report, first described the “equity desert” subsequently cited in Mark Fogarty’s article in the July issue of American Indian Report. As Fogarty noted, CDFIs are a vital piece of the capital formation puzzle. However, the majority of CDFIs he mentioned are loan funds, which provide debt capital. Except for small "unsecured" loans, lenders ration debt according to the equity contribution and/or collateral of a borrower. Every industry has a "norm" for its debt to equity ratio. Even the most sympathetic lender is reluctant to lend beyond this norm. Doing so risks overburdening the borrower and possible write-off of a failed loan.
Private enterprises are especially affected by the absence of equity. Equity is the foundation capital for start-up, new product development, and accessing new markets. It permits leveraging debt to finance expansion during successful times. As the 2001 CDFI Fund report noted, the majority of Native-owned companies are small businesses. They have fewer than five employees and are financed with loans under $35,000. To be sure, small businesses are important employers. They make significant contributions to their communities. But the relatively small size of Native-owned businesses is too often a decision imposed upon owners, rather than a choice made willingly. The size reflects the well-documented "equity gap" in Native American communities. It frequently means that the businesses' possible contributions to the community and economy go unfulfilled. They don't reach their size potential nor do they generate experience managing substantial capital. Without adequate equity, businesses cannot take advantage of debt offers from the new CDFIs.
Equity Drives New Capital Formation
New capital formation is vital to the future of Native American communities. It is the foundation for resilient economic growth, as well as the means for conserving the rewards of economic effort. New capital formation means creating new resources (capital) that strengthen an economy or an enterprise. For example, investing a company's earnings in power generation or in an Internet service provider with enough capacity to service other businesses is new capital formation (technology infrastructure) as is investing in commercial or industrial space that emerging businesses can lease (business infrastructure). Training tribal members to be managers and technicians, able to make decisions that are both good business and culturally appropriate, also creates new capital (human capital).
Unfortunately, new capital formation has not been happening at the pace needed in Indian Country. Absence of "risk capital" and financial expertise have been nearly insurmountable problems, interfering with securing investment from capital markets for large projects and for leveraging long term debt. The result is that projects don't happen, and Native communities fail to get the experience needed to make them happen in the future.
Some large scale business investments have been made in Indian Country in recent years, particularly since the advent of gaming. However, many of these are in tribally-owned enterprises, making only modest contributions to new capital formation. Although there are notable exceptions, over the years tribally-owned enterprises have not convincingly driven new financial and human capital formation.
The fact is that accelerating new capital formation is the linchpin to helping Native communities gain economic parity with other Americans. Further, sovereignty is better protected by robust new capital formation than by the courts. The best way to maintain Native control over resources is to deepen the pool of managerial talent and experience in Indian Country. Developing new products and new markets earns revenues through export, replenishing the supply of capital circulating in Native communities. Diversified businesses are less vulnerable to a downturn in markets on which they've depended in the past. At the same time, developing new consumer-oriented businesses keeps capital from leaking into the larger economy – and keeps jobs at home. Adequate equity triggers the new capital formation process.
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