Catalytic Capital | August 25, 2020

How investors can blend finance for CDFIs to advance economic and racial justice

Bulbul Gupta and Jed Emerson
Guest Author

Bulbul Gupta

Guest Author

Jed Emerson

Community development finance institutions have long been “first responders” to small businesses in historically underinvested communities. The COVID-19 pandemic has in stark terms revealed the degree to which those same communities are subject to the impacts of systemic racism and an economy built on poor-quality jobs.

This moment in time requires each of us—community lenders, impact investors, and entrepreneurs—to respond to rapidly shifting circumstances. It’s not enough to simply do more of what we’ve done before; rather, we must bring all of our assets to bear upon the challenges before us to build back better and build a better world with racial and economic justice at its heart. 

For impact investors, funding CDFIs as an end-goal isn’t enough. Many CDFIs have worked to support clients by deferring payments, keeping access to capital open, extending the time horizon of our loans, and advising on ways to pivot business models or reopen safely. We need investors to look beyond what’s worked in the past and deploy their dollars into proven models that focus on the needs of Black and Brown entrepreneurs and communities, while also mandating the jobs created are good jobs with living wages and benefits.

In order to provide creative and flexible support to our clients in crisis, especially historically underinvested people and places, communities of color, and Native communities, CDFIs need investors to leverage the full potential of their portfolios. While much has been said about the growth of impact investing , too much of our community’s focus remains on the goal of generating “market rate returns” when in fact our focus should be the degree to which our capital not only generates financial returns but catalyzes community development and empowerment.

Blended finance uses relatively small amounts of donor funds to mitigate investment risks and rebalance risk-reward profiles of pioneering, high-impact investments so that they have the potential to become commercially viable over time. Blended finance bridges the divide between doing good and doing well. 

Racial justice

People of color start more businesses than anyone else, but because they have less collateral and lower credit scores, aren’t funded by banks or the SBA at the same level as white-owned businesses. This keeps communities of color from building wealth, resiliency, and creating good jobs. Black businesses owners apply for funds at a 10% higher rate than white-owned businesses, but their approval rates are nearly 20% lower. When Black entrepreneurs do get approved for financing, only 40% receive the full amount requested, compared to 70% of white business owners. 40% of Black business owners are so pessimistic about their chances of being approved for bank loans that they don’t even bother to apply. Beyond brick-and-mortar businesses, from 2009 to 2017 startups raised nearly half a trillion dollars of venture capital. Only 0.0006% of that went to Black women, and less than 1% went to Black people overall.

CDFIs are where entrepreneurs of color turn for fair loans when banks and the SBA turn them down. In recent years, large banks have closed more branches in majority-Black communities than elsewhere, an exodus that’s stymied the flow of credit into local small businesses, while Fin-Tech companies have filled the gap with big marketing budgets and sometimes predatory interest rates . That was amplified during the scramble for Paycheck Protection Program (PPP) loans, which Treasury relied on banks to disperse. Incredibly, the SBA didn’t collect demographic data on who applied for and received PPP loans. But a national online survey of 500 Black and Latinx business owners conducted for Color of Change and UnidosUS found only 12% of those who applied received the funds they asked for.

Given the severity of the challenges faced by businesses today, a powerful component of all investments in CDFIs needs to be the flexibility of invested capital. Now is not the time to constrain the most vulnerable businesses with rigid capital structures and terms. The ability of CDFIs to create the financial products that small business owners need right now when, according NBER nearly 40% of Black and Brown owned enterprises in California have closed, requires greater flexibility with terms and rates, and patient time horizons

For the businesses that have survived, their cash balances decreased by 26%. This places even greater pressure upon CDFIs to secure larger sums of blended capital to meet local businesses where they are. This is especially true for Black and Brown entrepreneurs and those based in lower income communities who are already most disconnected and discriminated from formal financial institutions. That reality requires us to center racial justice in our philanthropy and impact investing portfolios to ensure we shape an inclusive recovery. 

We know impact investors can generate competitive financial returns—the question remains whether they can generate compelling and sustained community and systemic impacts. The bar we must clear is that of economic and racial liberation of communities and entrepreneurs—reparative capital—as opposed to capital as simply finance.

Blended finance 

To attain the goals of racial and economic justice, we’ll need more than traditional approaches to lending and investing. We need a renewed commitment to blended finance as capital and community catalyst. Blended finance is essential to supporting CDFIs, yet capital is only one piece of the puzzle. Business owners also need mentorship to develop effective plans and address operational challenges through the recovery ahead. 

The U.S. Small Business Administration says half of all new businesses fail within five years. But for business owners with a mentor, the difference is striking: 70% thrive with revenues increasing an average of 20% each year. Surveys have found that 92% of small businesses agree mentors have a direct impact on growth and the survival of their business. By combining catalytic capital with mentorship and access to networks, investors are more likely to have a positive, transformative effect on businesses’ growth and impact. This is especially true for investors seeking to tackle racial and economic inequality, because entrepreneurs in underinvested communities often lack the connections and mentorship their affluent counterparts have. 

At Pacific Community Ventures, we’ve seen the multiplier effect that offering capital and advice can have on businesses. By pairing our entrepreneurs with pro bono advisors, offering resources and tools like the Good Jobs Good Business toolkit, and providing affordable loans, the business owners we serve had 53% job growth in 2019 (vs. the CA rate of 1.2%) and 68% grew revenues. To provide this much-needed advisory support, CDFIs require an essential component of blended binance: philanthropic capital.

Bridging the gap

We’re certainly not the first to call for a greater commitment for capital to be leveraged in the pursuit of justice as impact. What we are asking is that CDFIs and their investors go much deeper and with greater intentionality in our pursuit of racial and economic equity. The capital unleashed via various instruments of blended finance is essential to accomplishing the work of investing in Black and Brown business owners and ensuring community businesses have the greatest possibility of creating good jobs. 

In the wake of historic racial and economic injustice, this is our chance to invest with authentic intentionality, and affect systemic change. Bill Bynum, chair of the EBBC and CEO of Hope Enterprise Corporation, has said, “In these unprecedented times, when trillions of dollars are being invested in economic stimulus, we must proactively invest in Black-owned businesses to prevent further widening of — and, eventually, close — the centuries-old racial wealth divide.”

Examples of efforts to act on these words include:

  • Low-cost capital for CDFIs to invest in Black and Brown-owned businesses and community development initiatives. A new report from Opportunity Finance Network shows CDFIs need an additional $1.3 billion in the next four months to meet the demand from small business owners;
  • Grant support to enable CDFIs to keep their doors open through this crisis, cover loan loss reserves and keep the cost of capital affordable, and provide business advising to entrepreneurs who are facing a choice between pivoting their business or closing their doors;
  • Invest in and through organizations led by people of color – that is what we are doing year-over-year in our own impact lending portfolio. Investors should also commit 2% of their profits a year to funding CDFIs and minority-owned banks; 
  • Advocate to expand the Fed’s Main Street Lending Program, which provides subsidized federal loans to qualified small and medium-size businesses; and,
  • PRIs to invest directly into a fund or other intermediary that would purchase portions of loans originated by CDFIs. This would enable CDFIs to continue lending without negatively impacting their own financial viability by shifting some of the risk of these loans.

These are excellent starts with real promise, yet still, blended capital to the tune of billions of dollars is needed to support and grow Black and Brown businesses. Even now as more foundations and impact investors are starting to respond to the economic and racial injustice crises in this country, many are still prioritizing 2019-style market-rate returns over impact and social good. Its clear impact investors are having internal conversations on the need to respond and announce new investments; but sadly, rhetorical statements of “doing more” or “doing better” aren’t changing the way they do business in this time of crisis.

One example of foundations advancing real innovations in this area include The Heron Foundation’s work to democratize access to capital by decentralizing decision making to and through place-based efforts in select cities nationwide, and community leaders closest to the problems and solutions. Other innovations are needed if we are to attain our goal.

Capital as freedom

What is the world we’re envisioning? One where Black and Brown business owners are included and prioritized by capital markets. And that we as capital market intermediaries, along with our investors and supporters, use blended finance to offer a combination of affordable capital, advice, and access to networks that is essential to closing racial and economic gaps. Not because we’re willing to do “concessionary investments” – a term many social impact and entrepreneurs of color find insulting, but because we’re committing to centering equity as a key impact in the outcomes. 

CDFIs have been one of the best-kept secrets in the US financial industry, and it’s time for investors to show up in ways that allow them to realize the mission they began to pursue 30 years ago — to address historic discrimination and redlining by the financial system. Blended finance has the power to bring financial justice and economic freedom to support their success as our community’s entrepreneurs work to build wealth and create good jobs to the benefit of citizens across our nation; it is time we used it to our full advantage.

Bulbul Gupta is president and CEO of Pacific Community Ventures. Jed Emerson is a long-time promoter of impact investing and social enterprise strategy and practice and a member of Pacific Community Ventures’ Advisory Council.