The Case for Community Investment Funds

The Case for Community Investment Funds

The following is an excerpt from “Community Investment Funds: A How-To Guide for Building Local Wealth, Equity, and Justice,” a joint project of the National Coalition for Community Capital and Solidago Foundation. The handbook can be downloaded in its entirety here.

The term “community empowerment” usually sparks images of sit-ins, protest, rallies, campaigns, elections, and a thousand other actions associated with politics. You’re probably not imagining a half dozen smart people sitting around a table and planning how to creatively invest the pool of several million dollars gathered from local investors. But look at the mission of funds like PVGrows or the Boston Ujima Fund, and you see a radical effort to help revitalize distressed neighborhoods by supporting struggling small businesses, often led by women and people of color. funds like these are increasingly being used to open grocery stores in food deserts, build affordable housing, launch work cooperatives, and enhance the energy efficiency of old commercial and residential structures.

Capital is a critical tool for community problem-solving. While money alone cannot solve every local problem, it’s a necessary component for any serious approach to community empowerment. An emerging generation of practical, intelligent activists are reinventing local financial systems, and creating a set of tools we call community investment funds.

To clarify, when we talk about community investment funds, we’re not referring to the nearly 10,000 mutual funds in the United States that invest primarily in Fortune 500 companies and are largely disconnected from community problem-solving. Nor are we referring to the thousands of economic-development funds or microenterprise funds that are underwritten by municipalities, large banks, and foundations, which provide virtually no role for the vast majority of us who are not wealthy enough to participate.

In our view, a community-friendly investment fund has three essential characteristics:

  • Local sourcing: Capital for a community investment fund should come from the people living in the community and, if possible, from grassroots investors. Yes, deep-pocket investors are welcome, but so is everyone else, including the 95% of us called “unaccredited investors.”
  • Local investing: The fund should put its capital exclusively into local people, projects, and businesses, with a mission of significant social change. Sure, part of the mission of investing is generating a rate of return for investors, but just as important is the social rate of return for the community. Particularly important is investing in people, projects, and businesses run by those with the fewest resources and the least power.
  • Local decision-making: A board of people broadly representative of the community should decide how to deploy the capital. Those without power or resources whom the fund is targeting also need to play a role in the decision-making.

One additional characteristic, essential to any fund, is that it should be designed to provide investors with a positive rate of return. Even if the fund is run by a nonprofit, as many are, it can and should pay something to the investors for the use of their capital. A successful community investment fund will benefit both the investors and the community.

A Grassroots Investment Revolution

Even though local businesses are responsible for 60% to 80% of the economy, with literally millions of them being profitable, the securities marketplace has all but shunned them. Americans have roughly $56 trillion invested in stocks, bonds, insurance funds, pension funds, and mutual funds, almost entirely invested in publicly traded corporations. Put another way, we are overinvesting in Wall Street and underinvesting in Main Street. Many of the challenges with which communities struggle — economic, environmental, social, or political — could be remedied, or at least made more manageable, if we changed how we invest our savings.

In a properly functioning marketplace, the 60% to 80% of the economy that’s locally owned would receive 60-80% of the investable capital. That would mean about $30 to $40 trillion moving from Wall Street to Main Street. Just taking the lower end of this range: A neighborhood of 1,000 would have $100 million more in capital for its local businesses; a town of 10,000 would have $1 billion; a city of 100,000 would have $10 billion.

The Role of Investment Funds

Investment funds are institutions where investors put their money into a pool, and the managers running it make prudent investment decisions on their behalf. Most of us are happy to put our retirement savings into mutual funds, because we prefer having a reliable expert make tough investment choices. We’re also put at ease by knowing that unlike investing in one company, where we can lose everything, an investment in a diversified pool is less likely to be wiped out. If one investment goes bad, 100 good investments in the pool will balance it out. (Or so we hope!)

But the evolution of community investment funds has been slow. While the JOBS Act made it easier for small businesses to issue securities to grassroots investors, no comparable legal reforms have been initiated for funds serving small businesses. And the existing law poses challenges.

As we detail in this section, the Investment Company Act of 1940 makes it exceedingly expensive to create and operate investment funds, especially if they accept money from any unaccredited investors. Just the set-up costs for a mutual fund, for example, could be hundreds of thousands of dollars.

Until recently, the number of funds investing in local businesses that were open to unaccredited investors could be counted on one or two hands. Some of the earliest examples are the Vermont Community Loan Fund, the New Hampshire Community Loan Fund, and the Mountain BizWorks Fund of North Carolina. Most took advantage of an exemption in the Investment Company Act for nonprofits. (If a nonprofit creates a fnd to provide modest loans in the service of its mission, it can set up a fund relatively easily and inexpensively.)

The small number of community investment funds is due to several factors. Because small business securities — the investments that could make up a pool — have been rare, small-business funds have been rarer still. And valuation of these securities is often difficult. You know the value of a small business loan, but what’s the probability of that business failing? And how can you know what the value of local stock is without local stock exchanges, which don’t exist?

But in just the last few years, the number of new funds opening with a community focus has accelerated, many with striking and promising new features. This reflects the growth of public interest in local investing, a growing distrust of Wall Street, and the emergence of crowdfunding alternatives. The rest of the Community Builder section details some of the most cutting-edge of these funds, and provides you with specific strategies for creating your own.