Archive for June, 2010

Cheryl Sesnon at Washington CASH just passed on to me a new report done by an Evans School MPA Student for the Seattle Office of Economic Development : “ Using Small Business Technical Assistance to Preserve Diversity in Rainier Beach”.   Author Andrea Lehner does a great job of showing the disconnect between what happens at a community level in business and what happens at city and regional levels, as well as how much business opportunity and success is shaped by social networks.  In that report, she also captures why it’s particularly important to support minority-owned businesses:

“Research indicates that minority-owned small businesses are more likely to employ minorities and are more likely to provide goods and services for minorities that are ignored by the larger chains. In addition, there is indication that some minority-owned businesses do not move out of low income neighborhoods when they become more successful. Instead, they stay and continue to hire from that neighborhood, especially if there are other efforts to regenerate the area.”

Last fall I listened in on a webinar about a Kellogg Foundation funded initiative to develop Rural Entrepreneurship Development Systems.  One of the speakers was from North Carolina, where they took a top-down approach and tried to create a one-stop-shopping location for entrepreneurs in NC to identify resources near them.  I’ve been thinking I’d love to see something like that in Washington State.  Last year I tabled for Washington CASH at a small business assistance fair  held at Renton Technical College (The Renton Biz Fair) and I was fascinated by the array of services there – from government agencies to a program doing business assistance out of the Seattle School District, I think aimed at potential contract bidders.

Andrea’s paper does include a survey of Seattle area technical assistance providers on page 27, and that list strikes me as a good one for small and micro businesses.  She also notes that providers agree that there is little comprehensive information about how the various services combine to provide a coordinated spectrum.  Page 33 has a roundup of all the services and makes an assessment of their combined offerings as “Seattle’s Technical Assistance System”.

Looking beyond the Seattle area: earlier in the paper she references a conversation with someone at the Department of Commerce about survey work they did.  Turns out they’ve published it:  The Washington State Guide for Small Business, 2010 edition. However when I look at it, it’s much more at what I’d call a small business level, as opposed to the micro-business level that seems appropriate to Rainer Valley local businesses.

More appropriate is the  Washington State Microenterprise Association (WSMA) which I’m familiar with from my experience with Washington CASH.  Their member listing is a good assortment of service providers in the state who reach all the way down to microenterprise.

Andrea’s report concludes with a list of recommendations for the city.  The ones that resonate for me – creating a service provider roundtable to coordinate provision and having a 3rd party entry point to help entrepreneurs find the right set of services; focusing service provision on business owners as much as businesses;  and focusing evaluation on long-term outcomes (the holy grail!)  Great reading!

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Summing up where I think we are on doing local investing in the northwest, and adding one new idea.


A)      Corporate advisors (like lawyers) don’t like to do SCOR because they perceive it as lots of effort for small dollars, everyone says it’s easier to just fundraise from accrediteds.

  1. However I also think that pushes them into raising larger dollars and seeking faster growth which can be bad for companies…

B)      There’s not a network of brokers to sell local stock offerings, so it’s hard to sell

  1. Farm power curtailed selling their first offering because building that base was such a slow process that other funding alternatives moved to the fore.
  2. Drew Field (wrote the book on Direct Public Offerings) says the best candidate is a catalog company with a base of customers & their contact info
  3. I spoke to a lawyer at DFI last summer who said the most successful offerings have been groups of people that got together to fund something (like a brewery) and used SCOR as the tool to do it – so the buyers were already lined up essentially
  4. The small volume of stock offerings make it not cost-effective for brokerages to do the analysis, so they don’t bother with the stuff.

C)      As a non-accredited investor, there aren’t opportunities to buy local stock

  1. Not many companies do SCOR offerings or take their possible 35 non-accredited investors (see A)
  2. Difficult for unsophisticated buyers to buy what offerings there are because they don’t hear about them because of (B)
  3. What offerings do come out are not necessarily good investments because nobody is holding a quality bar (see (B))
  4. There’s no secondary market liquidity

It’s Chicken-and-Egg: Product-and-Market

Pieces of the solution:

1)      Securities.  For local companies, the SCOR cap of 1 million shouldn’t be a problem.  Companies could do SCOR offerings if they wanted to.

2)      Advertising/selling:  seems like a few advisors/brokers would be interested in carrying the stuff if someone could do the analysis for cheap/free.  Having periodic group reviews of what’s out there could be a fun investment-club type activity.

3)      Post-purchase liquidity: lots of you working on this one.  Farm Power will do their own trading and legally can, so maybe we come up with an easily replicable system that every company who offers through our network can set up, and then a central site points people to each company’s trading platform.

4)      Secondary market valuation:  if the market doesn’t support a market of analysts, we need simple metrics for stock valuation based on company fundamentals.  I think if we require companies to pay dividends that’s a clear value, and then have some format of audited financials and easy method for deciding a valuation.

My recent new thinking:

Start a traditional LLC pooled investment fund, most likely with accredited investors so we can a couple million.  Invest in local companies just like an angel pooled fund or the Patient Capital Collaborative is doing (so 100-200K initial investment with room for follow-on), but ONLY invest in companies who have done SCOR offerings.  So basically be the lead that makes it tempting/worthwhile for companies to do a SCOR (maybe do the due diligence first, and then get the company to do SCOR for the investment?) and then the non-accredited investors can follow.    So the fund will also do analysis that other folks can draft on.  Perhaps organize the fund GP as a nonprofit?  Doing SCOR stock analysis as a public service?

We’d need to do some market research and build up that network of potential follow-on investors and get a sense of the size of that market: if there are 10 folks out there with 5 K each so after 50K we’ll have tapped the market, then not worth it.  how big would that potential pool need to be?  Don’t forget many folks will come in on the secondary market, so maybe we could support one or two offerings a year?

There are some companies already that have local stock, what if we started by collecting them all together, getting them each managing their own trading and testing out some valuation formulas?

That’s what I’m thinking today.

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What’s the difference between an investment and a grant?  The obvious difference is that one is to make money and the other is to make change.  What happens in social impact investing where the goal is to do both?  That question has been on my mind lately as I look at a couple potential social impact investments.

The current investment I’m looking at is a non-profit aiming to spin out a commercial enterprise to run a potentially self-sustaining (and even lucrative) social business.  The trouble is that the project is so early stage at this point that it’s questionable whether it’s an investable enterprise or should be considered a research project – the kind that if they were coming from the for-profit world we’d all be trying to get grant funded.  However coming from the non-profit world there seems to be a bit of a pinnochial urge to be a real boy and they’re determined to incorporate.  As someone who could write a grant or could make an investment I’ve been pondering which I’d prefer they be at this stage.  There’s a level at which I myself want to be a real investor and that makes it far more comfortable to write a grant because then I don’t have to measure my success based on the return. Research projects can be successful by proving their hypothesis unfeasible but that’s less palatable in early stage companies.

As a social impact investor I’ve gotten comfortable in the space referred to as “a concessionary return” – but for me that means lending at 2.5% to CDFIs.  I’ve gotten some looks at anticipated negative returns – I know of a fund that lends at 0% and covers the cost of operations out of the fund so inevitably it consumes a low but steady % of the capital on an annual basis.  I haven’t “invested” in that fund and my understanding is the original investors established it with a grant, wisely enough.  That reinforces my distinction that for an investment there should be the expectation, at least the opportunity, of getting at least the original capital back. With this new opportunity it is at least technically possible for me to get the capital back – there are no structural or legal barriers, it’s just a question of risk.  So I cannot categorize this as a grant situation by my one bright line rule.

From a tax perspective there aren’t many differences to my portfolio between making a grant and writing off an investment.  If it’s a grant, I can control the year in which I take the write-off, with an investment I have less control.  If it’s a grant then it’s part of my total granting for the year which is subject to a maximum % of my Adjusted Gross Income (although there are few years that I’m close to that), if it’s an investment loss I don’t think there’s an AGI limitation.

What is becoming clear to me as I think about this investment is that, when it’s an investment, I am more invested.  I inquire more deeply about the capacity of the organization to fulfill the mission, and I will certainly be doing better followup – at a minimum I need to figure out when I get to write it off.  In the ideal situation (which I think is actually rare) I’m monitoring performance and able to add help along the way. Perhaps this means I’ve been a second-rate grantmaker to-date, and this is why grantmakers have begun using investment language: to distinguish what they do as including these sorts of practices standard in their grantmaking. If I were to make this investment as a donation it would be much easier for me to walk away shortly after writing the check. All I need is the receipt.

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A nonprofit I’ve supported for many years has been working on payday lending.  It has become a big issue nationwide – the Bush administration capped payday loans to military families at 36% APR and many states have followed.  An obvious thought is, if it’s such a lucrative business then why can’t a more socially motivated but still financially successful business undercut existing players?  One investor suggested to me that as a lending business you either have to be really good at screening (not the payday convenience model) or really good at collections (not the socially motivated model!)  The basic model seems to be that you do some screening and you charge huge APRs so the fund can withstand big losses.  What’s a big loss?   A bank loan fund might normally be designed with a 2% loss reserve. Nowadays banks are probably reserving 3-5%.  A Community Development Loan Fund might design for a 7-10% loan loss reserve.  A payday loan fund might be designed for losses up to 40%.  That means many good citizens paying high fees to cover their bretheren (as well as the costs & profits of the middleman).

Credit is more than just getting loans.  Folks of all income levels use credit for “consumption smoothing” – basically helping match lumpy inflow (bi-weekly paycheck or irregular investment income/liquidity) to lumpy outgo (monthly bills, unplanned expenses, opportunities).    Credit is usually provided by a bank, but a significant portion of the US population is not getting their needs served. Access to credit and financial services is a concern to the FDIC, in a 2009 survey they concluded that 7.7% of all households are unbanked and 17.9% of all households are underbanked. A 2005 paper for the FDIC describes Alternative Financial Services (AFS) as including check-cashing, pawn shops and rent-to-own along with payday lending.  This is in contrast to the Financial Services sector of banks, thrifts (Savings & Loan), brokerages and mutual funds.

The FDIC defines “unbanked” as no one in the household has a checking or savings account.  “Underbanked” means someone has a checking account, but has used alternative financial services at least once or twice per year.  To the above list they also include money orders, and FDIC also considers someone underbanked if they’ve used a refund anticipation loan at least once in the last five years.  Other reading I’ve done notes that overdraft protection can be regarded as a kind of payday loan in that it is a short term loan with very high fees.  The challenge with overdraft protection is that its not always consciously chosen but accidentally done! This is enough of a problem that in November of 2009 the Federal Reserve issued new rules for banks to require customers to opt-in for overdraft on debit and ATM cards.

It’s the fees when annualized that make short-term loans so expensive.  Part of the bad reputation comes from the assertion that customers end up being repeat borrowers and rolling their loans over repeatedly and so paying those high rates for long loans. Do they?  A Washington State Department of Financial Institutions study from 2008 shows that just under 20% of borrowers are one-time borrowers. However that’s for a total of 2% of all the loans, because from there there’s a very long tail of repeat borrowers that get up to borrowing 19 times in a year before any group accounts for less than 1% of the total.  Add them up and 60% of borrowers have borrowed 4 or more times in a year.

Convenience & less hassle seem to be the big market drivers for payday loans.  According to Moneytree, all you need is proof of employment via paystub, though in California and Colorado they must also require an active checking account.   I’ve heard that payday lenders don’t report on your loan so if it goes bad it doesn’t impact your credit score.  The application process is minimal and the turnaround can be less than an hour.  I suppose the mainstream financial system equivalent is a credit card. A quick browse of Moneytree’s website shows a company that offers a huge menu of financial services: check cashing, payday loans, prepaid cards, coin counting, bill pay and more!  It seems to be the interface to the mainstream financial system for people who need it, and that’s what the industry argues: they provide a valuable service to customers who need it and shame on us for turning up our noses and trying to regulate them out of business.

I recently re-connected with a high-school friend whose life has taken a very different direction.  She has much more experience than I with living on the financial edge.  She was really frustrated by the automatic overdraft protection and is the one who told me her bank switched to opt-in recently.  She married a guy who has bad credit and collection issues. They’ve solved that by putting everything in her name but I get glimpses of what life must be like if you have bad credit. She told me that most of the “free credit report” websites are basically honeypots to collect personal data and pass it on to collection agencies.  She made some other comment about things they can’t do, I think one related to travel, because it might get the hubby identified by collections.  They’re both gainfully employed and decent citizens, but I have this image of a twighlight financial/legal status that, while probably not that melodramatic, definitely sucks.

Yesterday I stopped into my local Wells Fargo where I got my 2nd pitch to change my current account setup and this time I decided to bite out of curiosity.  I sat at the desk with the banker and heard about how I could set up a different checking account that would give me some number of free cashier’s checks and money orders, and if I set up an automatic sweep into savings and kept the money there it could earn 3% interest! Kudos to Wells Fargo for creating a savings incentive and at this miserable time 3% is quite impressive. (Did I ever tell you about the 8% CD I had at Navy Federal back in the 80s? Those were the days….)  I was curious about the heavy pitching of money orders and cashier’s checks,  I can’t remember the last time I got one personally, so I asked.  He said that more and more folks are using money orders and cashier’s checks instead of regular checks because the money comes out of your account at the time the check is issued. Apparently that’s easier for people to manage though he added that it’s much easier to cancel a regular check if it gets lost (so I gather that’s an issue).  He also said that 150 checks is a lot to have lying around if you’re not able to be responsible with them ( I guess from a security standpoint – roommates, family members?  Possibly a self-control standpoint?)   As I walked in the door at home 15-minutes later and fished out a still-undeposited 7-week-old check from a relative (d’oh! I was just AT the bank)  I found myself thinking that yeah, if you’re managing very close to the line the uncertainty of personal check cashing and clearing could be a pain.

Based on the above, my thinking:  if you have bad or no credit score (I’ll lump “in active collection” under this), if you live in physically insecure circumstances where you want to have your finances with your person at all times (so no checks or cards you leave at home), if you are not comfortable with accrual accounting or managing your check register and so live on a cash basis (which I think LOTS of people do: that crazy bestseller Rich Dad Poor Dad is basically about getting off of a cash basis for looking at personal wealth)  or frankly, if you’re just tired of putting your paycheck in a bank where they find a dozen reasons to ding you for small fees because as a small customer they don’t make enough money off you – minimum balance fees, overdraft fees, holding deposits for days, clearing things in the order that maximizes bounce fees and then charging them repeatedly while being slow to notify you – then you are trapped living on a cash basis – little access to credit for the float we all use, little access to automatic bill paying or online purchasing.  No wonder the FDIC is concerned –  is it healthy for our economy to say 25.6% (the Unbanked + the Underbanked) don’t get to be full players?

Hmm, maybe that IS the problem, that in a for-profit banking system, some people are just not profitable enough.  I know a credit union working to serve folks better, but interestingly it’s not tax-deductible (and might even be taxable!) to donate money to them.  Much material for future thinking and blogging!

Mark Flannery & Kathryn Samolyk, 2005, Payday Lending: Do the Costs Justify the Price
FDIC studies on the underbanked
Federal Reserve announcement on overdraft protection
Wa State DFI 2008 Payday Lending Report
FDIC small dollar loan studies
A feast of services from our local Moneytree. Regarding Payday Loans: “As an analogy, while you would not choose to take a taxi from Seattle to San Diego or Denver to Las Vegas, it is common to take a taxi for a short distance, such as from your hotel to a nearby restaurant.”

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