Community Development Institutions Offer Small-Firm Funding

While discussions about the nation's economic growth are often focused on big business, small businesses keep the nation diversified, act as an innovation engine and employ just over half of the private sector workforce.

From 1993 to 2003, firms with fewer than 20 employees accounted for almost 80 percent of net new jobs in the United States.

One source of financing for many small firms comes from Community Development Financial Institutions, or CDFIs, which exist to help boost low-wealth or distressed communities. At the end of 2006, CDFIs had given $105 million to firms with five or fewer employees with a maximum loan investment of $35,000. They gave nearly $4.2 billion in 2006 to firms with more than five employees in loan amounts greater than $35,000. The average CDFI loan size for micro firms was about $11,000 and for small businesses it was $93,000.

CDFI activities fall into five major categories: micro-enterprise, small and medium-sized businesses, community services, housing and asset accumulation and protection for individuals.

I recently interviewed a venture capitalist and talked to an expert who helps connect entrepreneurs with funding. Now, here's a look at another possible source of funding and an explanation of how CDFIs can help grow a business.


Mark Pinsky, president and CEO of Opportunity Finance Network (Courtesy of OFN)

I spoke with Mark Pinsky, president and CEO of Opportunity Finance Network, a network of CDFIs and other opportunity finance institutions. The network is working to create a financing system providing tens of billions of dollars annually to low-income and low-wealth people. Pinsky also serves on a variety of financial advisory boards and has counseled the Federal Reserve Board of Governors.

Small Business Blog: What is a Community Development Financial Institution, or CDFI?

Mark Pinsky: They are private sector financial intermediaries that have a primary focus on lending to low-wealth communities. In the current market that purpose has been expanded because we think of lending in terms of distressed markets...So many more people are in distress now, our target markets have expanded. We lend outside the margins of where conventional finance goes.

SBB: What is the Opportunity Finance Network?

Pinsky: The network was created to bind together institutions that were starting to do different kinds of financing. They were operating outside the margins of more traditional financing and it was scary and unfamiliar. I joined in 1995. The network was created to facilitate learning among practitioners, figure out how to create channels for national sources of financing to reach CDFIs, help create other national intermediaries, create a rating system of CDFIs and to create a public voice for a public policy agenda for the industry.

SBB
: How long have CDFIs been around?

Pinsky: Since the '70s. The Opportunity Finance Network is celebrating its 25th year next year.

SBB: Where does most of the funding for a CDFI come from?

Pinsky: Less than 10 percent of the capital CDFIs hold comes from government. Most of their capital comes from private sources like banks, faith-based institutions, foundations and individuals.

SBB: How is the current financial turmoil affecting your ability to lend?

Pinsky: We are seeing on the horizon liquidity pressure, and we think that's going to affect us. We're actively exploring ways to increase liquidity. There's a cost to serving some of the markets we serve, and we may not pay as much as a more conventional business lender would pay. The stress in our portfolio is pretty minimal, but we depend in part on philanthropic support and we expect to see less of that going forward. (In fiscal 2006, CDFIs managed $23.1 billion in assets while by Dec. 31, 2006, U.S. financial institutions controlled nearly $12 trillion in assets.)

SBB: The CDFI fund that feeds CDFIs was established by Congress in 1994. How much does it get?

Pinsky: They created a federal program unlike any other. Instead of directly investing in assets like a small business or a housing project, it says we're going to provide seed capital on the balance sheets of special financial intermediaries that can then help fund small businesses or another project. It allows innovation that didn't exist before.

The administration has tried to zero out the CDFI fund, but lawmakers have put it back in the budget. It got $94 million for fiscal 2008 and for fiscal 2009 the House says $100 million while the Senate is looking for $105 million. Our recommendation is $250 million.

SBB: What is "opportunity finance?"

Pinsky: It's defined as the application of capital-led initiatives designed to build wealth and opportunity for low-income or low-wealth places and people.... Opportunity finance is different from conventional finance in that it's profitable but not always profit maximizing.

SBB: Where are most of CDFI clients located and has that changed over the years?

Pinsky: CDFI clients are 39 percent in major urban areas, 32 percent from rural areas and 29 percent from minor urban areas. That's been pretty consistent for 20-plus years. Part of the reason it hasn't been more urban is because there tend to be more banks in more urban places. However, we could see a change because I think the current credit crunch will affect urban places more.

SBB: How does CDFI lending work in concert with programs like those offered by the Small Business Administration? Your new report, The Next American Opportunity, is critical of the agency's 7(a) loan program but pushes to increase funding for the SBA's microloan program.

Pinsky: The SBA 7(a) Loan Guaranty Program (which currently provides about 30 percent of all long-term small business financing) is becoming expensive for many small firms. Fees for the loans have gone up four times since 2005. (Small firms received $160 million less through 7(a) in the first six months of fiscal 2006 than during the same period the previous year.)

The microloan program provides some loans to CDFIs and it has dropped from about $49 million in fiscal 2001 to $33 million in fiscal 2007.

SBB: So let's get down to basics. If an entrepreneur or small business wants to explore a relationship with a CDFI, how do they start?

Pinsky: Our system is set up to encourage prospective borrowers and lenders. We're not working with some algorithmic formula to figure out who should get a loan. Everything we do is geared toward getting people into relationships....We are used to dealing with people who don't have full documentation. We also provide technical assistance to help explain why we think a business might work or might not.

A small business owner can go to the OFN's member locator to search for a CDFI in their area.

The also can go to the Treasury Department's CDFI's searchable award database.

SBB: I read your report. Who else do you hope reads it?

Pinsky: It's a message for the new administration, lawmakers and policymakers. You can download separate chapters of it online and that's led to some good meetings for us so far.

By Sharon McLoone |  October 15, 2008; 8:28 AM ET Tools and Tips
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