Last week’s election settled control of the Congress for the next two years, with profound implications for the focus and functioning of the federal government. With Washington headed for a return to a heightened level of partisan gridlock, responsibility for progress on a broad array of national challenges will largely revert to networks of public, private and civic leaders at the local and metropolitan scale. These leaders will be on the front lines of not only deploying unprecedented federal investments but also responding to complex market dynamics. Organizing capital, in novel ways, will be the order of the day.
To that end, we are writing to introduce the Innovative Finance Playbook, the product of a multi-year collaboration between Blueprint Local, the Nowak Metro Finance Lab at Drexel University and the U.S. Economic Development Administration (”EDA”). This was an ambitious undertaking born out of the pandemic, to rethink how capital reaches entrepreneurs, address the inequities laid bare by the Paycheck Protection Program and other emergency interventions in reaching underserved and most affected entrepreneurs, and go back to the drawing board to redesign capital products and support systems that better reach the many underserved entrepreneurs untouched by traditional banking and financial services.
The good news is that there are a growing number of “capital entrepreneurs” who are innovating not just in what America’s businesses are building, but how they are financed.
The final product released this week involved and reflects countless conversations with dozens of funders and founders, all aimed to remake how entrepreneurs access capital.
The need for a new paradigm for entrepreneurship
Even before the Covid pandemic, entrepreneurship in America was in crisis, wrought by inequities and inconsistency. The creation of new firms, our economy’s engine for job growth, had hit a 40-year low. Technology, specifically FinTech, showed promise for bringing credit to left-behind communities but, in many cases, opened new pathways for predatory capital. And the post-Great Recession boom in venture capital proved highly unequal: 78 percent of all VC went to three coastal states, less than 3 percent went to women, and less than 1 percent to Black founders. Latino founders were similarly underrepresented.
As is true for talent and opportunity, entrepreneurs are evenly distributed, but capital is not. More than 83 percent of businesses do not access “traditional” capital, according to the Kauffman Foundation; the share that Black-owned businesses constitute of all employer-owned firms has only ticked up from roughly 1 to 2 percent of all firms since 1970, while the share of revenue for Black firms has decreased and Black household income has flatlined. Latino-owned businesses have also been left behind on many fronts and tend to be concentrated in sectors with low profit margins. According to a recent McKinsey study, the gap in Latino-owned firm revenues compared with non-Latino white Americans now stands at $2.3 trillion.
Covid broke open the fractured system, further demonstrating a need for capital innovation — a broader continuum of capital offerings (and capital providers) for a broader diversity of entrepreneurs and firms, many untouched in our current system. The pandemic accelerated and reinforced multiple preexisting dynamics that impede small business growth: 1) businesses were forced to close, operate at limited capacity, and rely on credit; 2) the Paycheck Protection Program (PPP) unveiled the failures of traditional small business finance in reaching communities of color; 3) business moved online, subject to the Digital Divide, while e-commerce giants enhanced their position; and 4) private investors, large and small, moved into disadvantaged neighborhoods, buying up swaths of single family homes and further reducing the ability of entrepreneurs to use the ownership of housing to help finance their business ambitions.
Yet this disruption also created an opportunity to rewrite the story of American entrepreneurship. Over the past two years, the number of new firms skyrocketed and record investment flowed to rebuild and restructure our economy, with a particular focus on communities long excluded and hit hardest by the pandemic. Furthermore, the murder of George Floyd drove financial institutions to reassess and reprioritize where they invest, who is included, and whether decisions, programs, and practices advance or hinder racial equity. Now, the critical question is whether hundreds of billions of dollars in commitments, private and public, to equitably serve more Americans, are having their intended, enduring impact in communities that need investment most.
With Washington headed for a return to a heightened level of partisan gridlock, responsibility for progress on a broad array of national challenges will largely revert to networks of public, private and civic leaders at the local and metropolitan scale.
Perhaps the largest challenge that the Innovative Finance Project has encountered — in contrast to other policy areas — is that there is no unified small business support system. Sectors such as affordable housing or infrastructure are overseen by uniform state agencies and local authorities and departments, have standardized channels for local delivery, and interface with the private sector in predictable ways. Private sector developers know how to qualify for Low-Income Housing Tax Credits; public authorities that deliver transportation and other infrastructure know how to access federal and state funding and leverage this funding with local tax revenues and private capital.
Despite a collection of agencies such as the EDA, the Small Business Administration (SBA), the Minority Business Development Administration (MBDA) and entrepreneur support groups in every state, infrastructure support for entrepreneurs — and the capital intermediaries and innovators who help them — is much more fractured. Entrepreneur support, rules, and funding are highly fragmented, siloed, and local in nature, often leaving the private sector, CDFIs, community banks, universities, local chambers and nonprofits to go it alone with one-off government funding or private resources to help entrepreneurs grow and start their businesses.
This system fragmentation is best exemplified by the 40+ small business capital programs scattered across six federal departments, from SBA to Interior, with disparate offices and coordinators out of sync even within the same metro, as documented in the Playbook.
The need for standard-setting
With no unified system, there is no single language or touchpoint for reform. There could be a “30-year mortgage” for small business lending — a policy breakthrough that redefines our country’s economy — but it would first need to be standardized, vetted, and distributed across a multitude of local and national, private, and public actors. This fragmentation ultimately hurts America’s entrepreneurs. That’s the bad news.
The good news is that there are a growing number of “capital entrepreneurs” who are innovating not just in what America’s businesses are building, but how they are financed. Whether it is through innovative strategies to source and support more underrepresented entrepreneurs, alternative structures to VC-style equity or more traditional, rigid debt to support the 83+ percent who cannot access mainstream financing, or thoughtful approaches to reaching entrepreneurs who face systemic market gaps, there are innovators — such as CDFIs, emerging fund managers, and angel investors — often working in isolation, who have expressed a hunger for routines, standards, and a community of practice.
Our small business investment and support system has not significantly changed in decades, and it continues to fall short in reaching entrepreneurs who need capital most. But we also find in virtually every community there is an overwhelming appetite for change.
One such successful capital entrepreneur is Denkyem Coop, a Seattle-based cooperative capital provider focused on new and emerging Black-owned businesses in King and Pierce Counties. Denkyem is an early implementer and leader in revenue-based lending (RBL), one of six innovative capital products the Playbook spotlights, and is a lending partner of the National Development Corporation (NDC), a CDFI and Innovative Finance cohort member, to pilot, improve, and scale RBL as a tool to reach underrepresented founders. Situated between rigid debt and dilutive equity, RBL repayment is set at a small, fixed percentage of monthly revenues, flexibly matching the ebbs and flows of starting a new business, instead of collecting fixed monthly payments like a term loan.
Karl Hackett, owner of Jacob Willard Home, a Black-owned, mid-century modern furniture and vintage store in Seattle’s Hillman City neighborhood, shared his success with the RBL model: “Denkyem does lending in a way that’s never really been available to my community and because of them, I’ve been able to expand my business and confidently chart a course to our future.”
And for Efrem Fesaha, Founder and CEO of Boon Boona Coffee, an exclusively African Coffee Roaster based in Renton, Washington, also a Denkyem client, more flexible RBL investment also opened doors, “Revenue based financing can be beneficial to small businesses who are looking for a runway while generating cash and to then maintain cash flow.”
The US needs a wave of financial innovation, across a spectrum of products and funds, to give more entrepreneurs the quality capital they need to start and grow firms. The Playbook distills these bright spots into key terms and definitions essential for replication and larger-scale implementation.
Introducing the Innovative Finance Playbook
This Playbook aims to serve as a touchpoint for this wide array of “capital entrepreneurs” to organize. Our goal is to help diverse founders and funders understand the breadth of resources, details of particular types of innovative models, and the best ways to support inclusive entrepreneurship. This Playbook provides a guide, examples, and common language for:
- Innovative financial products that show promise in reaching more entrepreneurs;
- Funders of any type looking to use capital and provide resources to grow these innovative finance models to create and scale proof of concept; and
- Policymakers at all levels so they can support capital entrepreneurs and innovative small business finance, making public sector efforts more concentrated and accessible to founders and funders
More specifically, grounded in a new focus on investments and delivery systems, the Playbook identifies promising innovative financial products that can iterate and scale to better reach more entrepreneurs and move beyond the strict dichotomy of debt and equity products and overly narrow risk and growth profiles to more flexible and even sector-specific possibilities and opportunities for impactful investment.
We spotlight six innovative financing products ready for broader implementation: Revenue Based Loans, Redeemable Equity, Profit & Income Share, Alternative Underwriting, Employee Ownership, and Supply Chain Finance. In particular, we believe capital providers, policymakers, and other funders are ready to more broadly use and standardize Redeemable Equity, to the benefit of diverse entrepreneurs with strong ideas and businesses poised for growth; implement Revenue-Based Loans, as mentioned above, to provide more flexible lending options in terms of flexible repayment and collateralization, thus reaching more firms; and Supply Chain Finance, which focuses more on firms’ potential for future revenue, a critical departure from rigid asset-based lending and opportunity to support diverse suppliers.
We also include a user guide for how to diagnose potential for innovative finance in your community. As a starting point for local leaders and aspiring innovative capital entrepreneurs, the ‘Landscape Your City’ chapter highlights available data sources and frames of analysis for identifying capital gaps and opportunities for growth by business size, sector, and ownership demographic, then mapping these gaps to relevant innovative capital products.
Call to action: new paradigm, policies, products
Our small business investment and support system has not significantly changed in decades, and it continues to fall short in reaching entrepreneurs who need capital most. But we also find in virtually every community there is an overwhelming appetite for change. With the right products, capital entrepreneurs can seize forthcoming opportunities and what we expect to be a impending wave of innovation — from the Inflation Reduction Act and the coming revolution in climate finance and green banking, to the State Small Business Credit Initiative and its tranches of flexible small business credit to states flowing over the next decade, to our current imperative to onshore critical industries including semiconductors, and continuing financial and technological advancement — to fully leverage American ingenuity across all communities, remedy deep structural barriers, and unlock more entrepreneurs’ potential.
To learn more: The Innovative Finance Project will be hosting a launch webinar on Wednesday, December 7 at 1pm ET via Zoom. Click here to register.
For updates and more information, or to get in contact with our team, visit our website at Innovative.Finance.
What’s next?: The Innovative Finance Playbook is fully online and interactive, detailing the nuances of these products, complete with example deals, term sheets, and case studies, also available for PDF download. The Playbook is a living document, and will continue to be updated with more information as these products progress.
Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Ross Baird is Founder and CEO of Blueprint Local. Maegan Moore is Manager of Business Strategy at Blueprint. Ian O’Grady is a Research Officer at the Nowak Metro Finance Lab.
