David R. Evanson
Where’s the Money?, Winter, 1999
Community Loan Development Funds
RESUME: COMMUNITY DEVELOPMENT FINANCIAL INSTITUTIONS
Definition or Explanation: Community Development Financial Institutions (CDFIs) provide primarily loan financing to businesses in areas seeking economic development. CDFIs make loans that are generally “unbankable” by traditional industry standards.
Appropriate For: Start-up to established companies which can demonstrate the ability to repay a loan, but whose loan proposal is unbankable because of past credit problems, size of the loan request, limited equity from founders, or limitd collateral.
Supply: Good. There are hundreds of CDFIzzs in urban, rural an reservation-based communities with billions of dollars to lend. Unfortunately, despite their numbers, CDFIzzs can sometimes be difficult to track down.
Best Use: To start a new business or to expand an established one. But also, where the application of the proceeds can create a second bottom line in the form of community job creation, the introduction or preservation of a service which is vital to a community, or stabilizing a community in decline.
Cost: Relatively inexpensive. Most CDFI loans are priced according to risk, as opposed to the cost of funds. Since CDFI loans tend to be riskier than bank loans they tend to cost more as well. Typical pricing may be from a half to three percentage points higher than conventional loan rates.
Ease of Acquisition: Easier than commercial lenders but challenging, since for loans, a company must still undergo the scrutiny of traditional credit analysis. The challenge of securing CDFI financing is sometimes compounded by the relatively narrow focus and agenda which these institutions may maintain.
Range of Funds Typically Available: $25,000 to $500,000.
THE POWER OF THE PEOPLE
The idea behind a Community Development Financial Institution (CDFI) is simple and powerful. In a nutshell this idea is that a community will make viable loans to businesses which can help it grow and prosper.
That was certainly the case with two unlikely entrepreneurs from the Northwest. Sawmill managers Mike Brine and Dave Miles always had the itch to work for their own company instead of someone elsezzs. As a result, when the opportunity arose to take control of a closed down mill, and call it their own, the two didnzzt waste any time looking into it.
The only problem is when opportunity knocks, it usually wants money. In the case of the two rough hewn entrepreneurs, the opportunity required a capital commitment of $100,000.
There were plenty of risks. First, the business, despite its previous heritage, would be a pure start-up Second, operating a sawmill was a risky business. Mills had closed by the score throughout the Pacific northwest. By almost any yardstick, the deal which Brine and Miles had in mind was not bankable by any stretch of the imagination. But the Cascadia Revolving Loan Fund, a community development financial institution in Seattle had a different perspective.
According to loan officer Josh Drake, Cascadia, true to the credo of a CDFI saw its way through the risks and came through with the $100,000 financing package. The deal consisted of a $25,000 five year term loan, and a $75,000 equity investment. Drake says that the equity investment, though unusual for a community loan development fund by historical standards, is a growing trend, and a positive one, since equity investments do not carry the regular interest payments which can be so crippling to a new enterprise.
Cascadia and the surrounding community reaped significant rewards on its investment. The lumber company the two entrepreneurs started about 150 miles southwest of Seattle, turned in a profitable performance during its first full year in business and generated $5 million in revenues. In addition, the companyzzs payroll swelled from the initial two entrepreneurs with a dream to more than 50 hard-working saw men in the great Northwest.
A Good Deal: Although CDFI financing is generally more expensive than conventional loan financing, it is often still a good deal, because the alternative is often no financing at all.
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SIDEBAR:WHERE IT COMES AND GOES:
This chart shows where CDFIzzs get their capital, and more importantly, how and where itzzs disbursed.
Finzzl Institutions 16%
Religious Inst 15%
Uses By Stage of Development
Uses By Geography
Rural Areas 45%
Major Urban Centers 33%
Smaller Urban Centers 20%
Source: National Community Capital Association
REAL BUSINESSES, PLEASE
Donzzt be fooled into thinking that helping a community develop economically means the CDFIs will back any local entrepreneur with a gleam in his or her eye for a new business.
Donzzt Forget: Community Development Financial Institutions offer loans, not grants. As such, they are looking to finance companies which demonstrate an ability to pay them back.
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Quite the contrary. The way most loan officers at CDFIzzs see it, their capital is the dearest of all. Because without them, the surrounding communities wouldnzzt have access to hardly any (and in some cases not any) capital. As a result, they canzzt pick losers. They need their capital back so they can recycle it again into the community and jump start the process of economic development.
Testimony to the loan standards of CDFIzzs is their national loan loss rates. These rates measure the percentage of their loans lost to failure and nonperformance. According to the National Community Capital Association, the national loan loss rate is about 1.4%, a figure which rivals, and in some instances actually beats [italicize beats] the performance of traditional commercial lenders.
Shop Talk: Commercial lenders tend to think of loans in terms of being “bankable” or “unbankable”. Your loan proposal is not banakble if you cannot demonstrate a viable source of repayment.
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However, according to Mark Pinsky, executive director of the National Community Capital Association, a trade group of CDFIs, lenders at CDFIs tend to take more risk because they will look more closely at the present facts and circumstances rather than historical patterns. “More and more banks that make small business loans are using credit scoring systems,” he says. “These systems work great, but since they are numerically driven, a lot of companies get weeded out, that might otherwise be viable credits.”
CDFIs he says are different in that, “we deal with the entrepreneur, and with the specific opportunity at hand, not necessarily the fact that there is a blemish on his or her personal credit report.”
SIDEBAR: EVOLUTION IN THE AIR
The National Community Capital Associationzzs Pinsky says that there is a growing trend among CDFIs to provide equity financing as well as loan financing. In fact, the National Community Capital Association recently changed its name from the National Association of Community Development Loan Funds, because the membership, and the kinds of financings they were becoming involved with were changing. “The fact is,” says Pinsky, “our mission is more than to create CDFIs, we are really striving to create institutions which can use capital to create stronger communities.”
He adds that as part of this mission, many members readily recognize that debt financings do not address the needs of many small businesses because their cashflow is not stable enough to support regular interest payments. In short, debt, even when they can get it can prove debilitating. “As a result, many of our members are now putting equity into companies which generally do not attract the interest of traditional equity investors and venture capitalists.”
5 STEPS TO CDFI FINANCING
– Contact the CDFI and schedule an appointment. Not only are they willing to discuss your loan proposal, but many CDFIzzs also assist companies in getting loan financing from other institutions as well.
– Be ready to demonstrate your “second bottom line.” Specifically how will the loan result in job creation, the introduction of an important service in the community, or how will it help stabilize the local economy or community? For instance Pinsky recalls an urban neighborhood that did not have a Laundromat. It was a Latino community and many of the families did laundry everyday. With the closest Laundromat 20 blocks away it took all day. But then a couple of the residents got together to open a new Laundromat in the neighborhood, which was funded by a CDFI. The new facility, says Pinsky, spawned a small bodega, and eating establishment and a news stand. “In essence,” he says “this one small business helped stabilize the economy of the entire neighborhood.”
– Show you are committed to the community, and that your long range plans are to stay there, not grow up and move on.
– Set aside ample time. The CDFI loan officer will tend to spend more time with you than a traditional commercial lender. Give them their due, because it might result in the creative solution which will deliver your financing.
– Be ready to commit some of your own funds. If possible set aside some of your personal capital to put into the business as an incentive for the CDFI to make a commitment. Nothing gives a lender comfort more than a founder putting in everything he or she can.
Taking Action: To find out if there is a CDFI in your area. you can request a list from the National Community Capital Association (NCCA). Send a self self-addressed stamped envelope to the National Community Capital Association, 924 Cherry Street, Philadelphia, PA, 19107. 215-923-4754.
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