Inclusive Economy | August 9, 2023

Lending on character, not collateral, to shift capital and power to Black and Native leaders

Ana Ramos and Eric Horvath

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Guest Author

Ana Ramos

Guest Author

Eric Horvath

In the aftermath of the Covid-19 pandemic, Common Future launched its Capital Strategies (now Impact Investments) body of work. We knew that we wanted to do things differently by incubating, co-creating, and funding investments that centered and empowered community expertise. 

That included a pilot to test character-based lending.

The idea of lending based on a recipient’s character and community ties was not new, but due to the lending industry’s history of inequitable practices  – such as a reliance on credit scores  – there was an imperative for improvement and innovation. We listened to what so many respected Black, Indigenous, and People of Color, or BIPOC, -led entrepreneurship support organizations were thinking about, which led to our first move in character-based lending

The character-based lending model considers the applicant’s relationship with the lender as a safeguard for the likelihood that they will repay the loan instead of credit scores, built to show that we can successfully shift power alongside shifting capital. Two years after our initial launch, we’re thrilled to share that the pilot will be fully deployed by the end of August this year. 

Character-based lending

Through this unique, trust-based partnership model, our local partners with strong community roots, Native Women Lead, ConnectUP! and MORTAR, will have deployed nearly $900,000 of relationship-driven loans to 18 BIPOC small businesses in Arizona, Minneapolis, New Mexico, and Ohio. 

Over the course of the pilot, Common Future acquired Community Credit Lab, which first partnered with us as the facilitating partner for the pilot, providing design support services to local partners, and the infrastructure to deploy and manage funds, allowing us more capacity to expand our impact-first investing work.

Our original mandate aimed to distribute loans to traditionally marginalized borrowers, at rates between 0% and 3%. True to that mandate, all borrowers identify as BIPOC, and 80% identify as women. To date, our partners have deployed 18 loans to BIPOC business owners, with a median loan size of $42,500 and interest rates below 2%. 

Intermediaries typically have to charge a higher interest rate to borrowers, if investors into the intermediary require a higher rate of return. This can lead to lenders offering extractive rates to the people we’re supposed to be supporting. We wanted BIPOC entrepreneurs to capture the upside, or at least not be subject to the downside (higher than helpful interest rates), rather than the relatively more privileged investors.

To do this, we intentionally set out to raise cheaper money, so that we could lend to borrowers at the lowest possible rates.

Shifting capital

Character-based lending’s alternative underwriting approach includes qualifiers such as values-alignment, founders working on the business full-time, and needing capital to scale. This unique approach not only got capital to emerging BIPOC businesses that wouldn’t otherwise have received it but also got it to them in ways they felt comfortable and confident to receive. 

Business owners said they had not thought about raising outside capital for their business’ growth and often dismissed applying to traditional financial institutions, given their perception that they would be rejected. Several businesses have asked our community partners about other funding sources, to see if they have relationships with them, not purely for a referral of funding, but to understand if they are a trusted and supportive partner. 

Character-based lending is so much more than providing loans to undercapitalized businesses, it so clearly illustrates the excitement – or trepidation – borrowers have for a capital provider that sees them as people, not a transaction.

Thanks to the model’s community-rooted approach, entrepreneurs – like TRSA’s Jordanna Saunders, who identifies as Navajo – have accessed external funds for the first time, and have grown confidence to pursue other sources of capital. Jordanna worked with Native Women Lead and leveraged her loan funds to help her get a state contract, which is resulting in fast growth. She now employs more than ten people to serve in her telemental health platform.

The unique trust-based approach also gives business owners access to capital without having to put personal collateral on the line. Ashley Barrow, founder of Re-Assist, originally tried to go through a traditional lender for funding. The lender told her she would need to put a lien on her house to receive funding. 

Character-based lending’s non-existent barrier to access gave her an option that would not put her in a financial bind as she continues to grow. Ashley is currently fundraising in the hopes of moving her digital healthcare platform into a pilot phase. Ashely leveraged funds from MORTAR to receive a matching grant from JumpStart to aid in her progress.

Shifting power

Our lending partners, who served as the bedrock for character-based lending, had the opportunity to truly direct capital on their terms, as they thought would be most impactful and financially prudent. The model leveraged their cultural competence and local expertise with BIPOC businesses to create sourcing channels and evaluation criteria that others would not be able to access or consider “too risky.” 

Character-based lending promotes a new, community-informed understanding of who is considered investable by empowering lenders around evaluation and decision-making.

Since this approach runs counter to many traditional lending practices, it requires deep partnership and trust from all parties. We rooted our relationships in reciprocity, providing encouragement and grace when the inevitable challenge came up with a lender’s staffing or borrower’s readiness. 

Rather than being punitive, we collectively troubleshot pain points to help each other get through tough times. We believe that this – oftentimes unspoken – agreement to how we engaged each other enabled greater motivation, transparency and success.

Our lending partners also learned and adapted their strategies and technical assistance based on the needs of the businesses. Connect Up!, for example, developed a diligence accelerator where founders work with a consultant to strengthen business’ infrastructure with support on things like budgeting, creating financial projections and strategic planning. 

CUP! learned that even though some of the businesses have gone through accelerators, a few were lacking the financial infrastructure to run a business, so they created a program to fill the gap. 

What’s next

We believe character-based lending has been a tremendous success. At the onset, we wanted to enable capital to get to places where it wasn’t, with a community-rooted approach, and empower our community partners to deploy capital on their own terms. Having done that, our collective confidence and audacity have increased, pushing us all to want to build on our successes.

Up next, Native Women Lead will keep offering its Creative Fund and Restorative Fund, with the hope to launch its Revolutionary Fund in late 2023.

ConnectUP!, thanks to testing and refining its process, has started to raise $1-5 million for its next fund, which will allow them to scale and have an impact on brown and black business growth in Minnesota.

And MORTAR, in Cincinnati, hopes that this unprecedented access to capital becomes a regular occurrence – one where financial institutions embrace both character-based lending and trust-based philanthropy to build into our communities.

We’re so grateful to consider Native Women Lead, ConnectUP! and MORTAR partners, allies, and friends, who we’ll continue to cheer on as they grow beyond this pilot stage. Through the pilot we shifted power to local partners who set underwriting criteria, decided on loan terms and chose borrowers. This project set the standard for our future investments to shift power and capital, trusting our local partners to know their community.

We’ll be sharing more about our trust-based investment philosophy in the months to come. We hope you’re inspired by their work and help us support their growth to make character-based lending a more accessible form of lending to underserved businesses. 

Ana Ramos is Common Future’s manager of impact investments; Eric Horvath, Common Future’s former director of impact investments, is the founder and principal of Untapped Capital Consulting, an impact advisory firm activating human and financial capital for good.