May 18, 2006
The Case for Categorizing Community Development Venture Capital as a New Asset Class
by Bill Baue
A white paper by Pacific Community Ventures lays out the argument and identifies steps to promote
growth in community development venture capital, such as standardizing social return metrics.
Community development venture capital (CDVC) is a distinct investing style that seeks not only
financial but also social returns--measured by the so-called double bottom line. Pacific Community
Ventures (PCV), a
California-based non-profit affiliated with two CDVC funds with $20 million, argues in a recent white paper for
categorizing CDVC as a new asset within private equity. Such classification will not only attract
more money to the style (which PCV calls "development investment capital"), but also will boost
support for the low- and moderate-income (LMI) communities typically underserved by traditional
venture capital that CDVC focuses on.
"To expand, scale and fully realize the
potential of equity investment in underserved communities--in both financial and social
return--Development Investment Capital must become a bona fide asset class within private equity,
routinely recognized by institutional as well as individual investors," states the paper. Authors
include PCV President and Co-Founder Penelope Douglas, Senior Fellow Beth Sirull, and Managing
Director Pete November. "Given that with limited capital, funds deploying Development Investment
Capital have demonstrated that they can provide competitive financial returns and risk
diversification, along with community benefits, we must take steps to accelerate the pace at which
Development Investment Capital becomes an established asset class within private equity."
PCV recommends three steps toward establishing CDVC as a distinct asset class. First,
policymakers should create incentives and remove barriers to CDVC; second, investment managers
should fully and accurately assess social returns from CDVC; and third, small businesses in
underserved markets need help to build capacity and link with CDVC funds.
The second step
is perhaps the most relevant to the socially responsible investing (SRI) community. The authors
note that metrics for evaluating venture capital financial returns are standardized. They call for
greater standardization of metrics for evaluating CDVC social returns.
the paper does not point to the work that has been done in this area. For example, the Community
Development Venture Capital Alliance (CDVCA)
has created the Measuring Impacts Toolkit, a survey in Microsoft Excel format that standardizes
social return metrics for comparison among companies and between CDVC funds. What is particularly
odd is that PCV participated in the development of the tool.
The first step is perhaps
the most important to fuel the growth of CDVC. Although the amount of assets under management in
venture capital funds focusing on underserved markets has grown significantly (from $150 million in
1999 to $870 million in 2005 according to the Social Investment Forum), there remains substantial room
for future growth. One study pegs only two percent of venture capital devoted to underserved
markets (though the Milken Institute,
which produced the study in question, may define "underserved" differently than CDVC funds do, the
authors point out.)
"Regardless of how 'underserved' is defined, it is much more than 2
percent of the market," the PCV paper states. "According to the US Census' Survey of
Minority-Owned Business Enterprises, 11 percent of all C Corporations and 10 percent of all S
corporations in the United States were majority-owned by women or minorities in 1997."
"Approximately, 8 percent of the United States population and of all private sector jobs are
located in inner city or rural geographies, areas that are generally underserved," it continues.
The authors establish a clear precedent for action by policymakers to support CDVC.
"Many of today’s widely recognized asset classes were nonexistent or tiny niche categories as
recently as the 1970s," they write. "In almost every case, government action--either the creation
of incentives or the removal of barriers--was required to launch an asset class from near obscurity
to the mainstream investment portfolio."
For example, the amendment of the Employee
Retirement Security Act (ERISA) in 1979 to allow pension fund
investment in venture capital helped establish venture capital as a substantial asset class.
Of course strong financial performance will be a key driver to the growth of CDVC as well. The
authors establish a solid business case for CDVC. They cite a 2003 Kauffman Foundation study of 24 venture capital firms making
117 investments in minority businesses (which falls under the CDVC umbrella) that were fully
realized by 2000 for a mean internal rate of return (IRR) of 23.9 percent and a median IRR of 19.5
percent. This compares to the Private Equity Performance Index, which produced a ten-year trailing
average annual return of 20.2 percent as of early 2001.
They also cite performance of
other CDVC funds, such as those from Kentucky Highlands Investment Corporation (KHIC--18 percent average rate of return over its 21-year history)
and Maine-based Coastal Enterprises Inc. (CEI--17 percent IRR for 16 equity investments).
focusing on underserved markets, private equity and venture funds across the country are providing
significant community benefits as they produce financial returns that compare favorably to returns
across the venture capital and private equity spectrums," the paper asserts.
copy of the paper, please contact co-author Beth Sirull at firstname.lastname@example.org.