On July 31, 1996, U.S. Treasury Secretary Robert Rubin announced
the selection of the first round of the Community Development Financial
Institutions (CDFI) Fund awards. Among the community development
organizations selected to receive an award was Duluth, Minn.-based
Northeast Ventures Corp. (NVC), which received $1.25 million in
equity. NVC was the only organization based in the Ninth District
to receive funds.
NVC targets investments that create and
retain jobs, create local ownership and diversify the economic base
of northeastern Minnesota. The corporation was started by concerned
northeastern Minnesotans to counter the economic decline prompted
by the shrinking mining industry, the region's historical economic
base. NVC has achieved measurable success since its inception in
1990. It helps communities to achieve their social objectives of
identifying and investing in businesses with significant growth
In the early 1980s, a couple of things happened. Foreign ores
were being priced significantly lower than the ore mined out of
northern Minnesota, and at the same time, the national steel industry
was in trouble. As a result, we went from having a very low unemployment
rate to pockets of 100 percent unemployment. People who had been
paying on their mortgages all their lives were finding that their
homes were literally without value, and they were going to the bank
and dropping off their house keys. There was an attitude of hopelessness
during that period.
|Total CDFI Fund awards
|Northeast Ventures Corp.
||$1.25 million equity
||Community development venture capital fund
||Seven rural counties in northeast Minnesota
||Nick Smith, Chairman
||Greg Sandbulte, President
||Mary Mathews, President, Northeast Enterpreneur Fund
CD: What happened to change this attitude?
Smith: The Blandin Foundation from Grand Rapids, Minn.,
called community leaders to a series of meetings to devise economic
strategies for northeastern Minnesota, and I attended those meetings.
The meetings were an example of a crisis producing some significant
energy that wouldn't have been generated otherwise. We decided very
quickly that any economic solutions for northeastern Minnesota were
going to come from those of us in the region. We adopted a whole
bunch of strategiesall the way from working with the mining
companies to working with our educational institutions and transportation,
tourism and timbering industries. One strategy was to diversify
the economy, partly from home-grown, home-owned companies.
At that time, I had been practicing law for about 25 years, working
primarily with small- and medium-sized businesses. Much of my time
was spent trying to find equity adequate to capitalize my clients'
businesses. I would end up talking to my clients about their rich
uncle or aunt or friends. Financing a business was more a matter
of luck than a result of any kind of structured access to capital.
So I said that if we're serious about diversifying the economy,
we're going to have to have a structured source of equity capital
and it's got to be large enough to be permanent and have competent
CD: Were there any bankers at those meetings? If so, what
did they say?
Smith: Yes. They quickly agreed with this line of thinking
and echoed my experience with access to capital. So I started going
around the country looking for anyone who had used venture capital
as an intervention strategy in a distressed area. But there wasn't
a ready-made model for accessing venture capital that we could use.
I talked to a pretty exhaustive list of people: foundation executives,
economic developers, venture capitalists and bankers. Many of them
cautioned that if I tried to mix social motives with venture capital,
I was just going to waste the money.
It was my convictionand I think the evidence showsthat
if you apply traditional business discipline and skill, you can
apply some social motives and not waste the money. But you must
not allow "goal confusion."
CD: What do you mean by "goal confusion?"
Smith: Sometimes the number of jobs becomes the focus,
and you forget that what you're really trying to do is create sustainable,
CD: So tell us about your goals.
Smith: Our primary goal was to create an equity fund that
would be a permanent source of equity capital in the region, and
we wanted it to be large enough that we would be very competent.
A group of peopleincluding some bankers, a couple of economic
development people and a couple of foundation peopleformed
an advisory group, and I began writing a business plan. Out of that
plan came NVC, which has two completely separate parts. One is the
venture capital fund aimed at high-growth businesses in the region;
it is this fund that received the award from CDFI. The other part
is Northeast Entrepreneur Fund, a microenterprise loan fund aimed
at creating businesses that will provide a living for business owners
and their families. By providing a little bit of money and a lot
of training, this fund has helped start about 250 businesses.
CD: What are the goals you set out for the venture capital
Smith: Local creation of wealth is one of our major goals.
We want to leave behind us growing, prosperous, healthy businesses
that are providing quality employment for our citizens. We want
to help create an entrepreneurial environment. However, I want to
point out that we are but one of many community development efforts
in northeastern Minnesota; we alone are not a panacea.
At NVC, we do not focus on one type of industry or business. If
we did that in a large, rural region such as northeastern Minnesota,
we would not make a meaningful difference. We see about 150 deals
a year, and we invest in two or three. Ultimately, our capacity
will be about four deals a year, probably about the ratio of any
venture capital fund. So, you can see how we cannot narrow ourselves
down to a certain industry.
This business is about spotting a deal that you think has market
potential, doing a lot of due diligence on the markets and the management
team, and then writing a check and working extensively with the
company. What really distinguishes equity from debt is that with
equity, there should be intensive involvement with the company after
the investment. In fact, that's where we spend about three-quarters
of our time.
CD: How will the CDFI money be used?
Smith: These funds enable us to reach our desired level
of capitalization and move us closer to critical mass. We always
had a goal of $10 million of funds to invest. This $2.5 million
of additional fundingwhich is what it is with the match from
the Iron Range Resources and Rehabilitation Boardputs us at
$10.2 million, which enables us to do our job better and longer.
This money also allows us to do larger deals.
Sandbulte: Before the award, our policies restricted our
average investments to about $300,000. Now that amount can be $500,000.
The difference between $300,000 and a half-million dollars on an
initial investment is very significant. Often, it will mean that
we can be the lead investor, not so much as to call the shots but
to have a very strong influence in determining how that deal is
Ultimately, if our deals go the way we would like, we wouldn't
play the lead role forever. But as lead investor at the start, we
can exert more influence over the company when the culture is determined
and key management is hired.
Smith: We play a very active role in companies. Every deal
we do has to pass our regular financial screen and it has to pass
a social screen. It has to have the potential for creating wealth
and employment in northeastern Minnesota; it has to have good, sound
environmental practices; its jobs have to have benefits and it has
to agree to use the state's employment service as a first source
We never see a deal that is perfect. We may have to recruit the
CEO or convince the principal they need a CFO or that their management
team is flawed. At any rate, because of our mission, we do investments
in companies that a traditional venture capital firm would turn
CD: How do you help companies find competent senior management?
Smith: We've done it a number of different ways. We've
used professional head hunters and our own network of contacts.
If we can find a local person who has the skills we need, we prefer
that. If we can't find the right person, we use head hunters.
We've gotten a lot of help from the Twin Cities metro community.
People just want to help us. We are a business-social experiment.
A lot of people think community development venture capital will
be part of a core solution to some of the problems going on in the
rural areas and in the cities, and they want us to succeed.
CD: Overall has the fund been profitable?
Smith: Yes. However, when I talk about our performance,
I say that the signs are encouraging but the jury is still out.
As of now, we have invested about $5.5 million in 18 companies.
These companies directly employ 450 people. This figure is lower
in terms of employment than we would have expected at this point.
Harvard University became very interested in what we were doing
and wrote a case study about us. This case study said that, compared
to what we said we would do when we got a loan from the Ford Foundationone
of our original funderswe were behind. That's true. We are
almost exclusively invested in newly formed companies and that defers
the effect in terms of jobs. The other side is that Ford is very
happy with what we are doing. And by all accountsgood, bad
and indifferentwe have become recognized nationally as one
of two or three leading community development venture capital funds.
I am hopeful that at the end of the day, we and others like us are
going to be able to demonstrate that there are some predictable
returns that can come out of a competently managed community development
venture capital fund.
CD: What level of returns are you thinking of?
Smith: Everybody thinks venture capital earns 30 percent
to 40 percent, but the median return in 1995 on venture capital
firms was around 9 percent to 11 percent.
CD: Does the fund still rely on outside contributions?
Smith: Yes. Right now, we are dependent on philanthropic
and corporate "good guy" dollars. Ultimately, we have to go to pension
funds and other traditional funding sources.
CD: How will you "pitch" your fund to these traditional
Smith: We will tell them that we will not provide the highest
return on investment they might earn but that we will provide a
decent return and that what we're doing is very important.
CD: Do you think the success of the community development
venture capital industry will depend on tapping these funds?
Smith: Yes. What we are doing in northeastern Minnesota
is important, and it is my primary focus. But community development
venture capital can help revitalize a lot of communities in America,
and I think we have an obligation to try to help that happen. There
are not going to be huge government dollars. Considering that only
two other venture capital funds received an award from the CDFI
fund, we were fortunate. The fund barely survived the axe in Congress;
it had $400 million worth of applications and $35.5 million was
awarded. We need to tap the traditional venture capital funders.
CD: We understand there is now a national community development
venture capital alliance. Please tell us about it.
Smith: We started meeting other people with similar ventures,
and we realized we could be learning from each other. Furthermore,
each of us was getting a lot of calls from people around the country
who wanted to start community development venture capital funds.
We began to hold meetings with some training and discussions about
this idea called community development venture capital. We now have
a formal alliance, the Community Development Venture Capital Alliance
(CDVCA). One of CDVCA's purposes is networking so people in the
field don't feel unique and lonely. We also offer training for people
who want to go into the field, as well as for those of us who are
already in it.
The critical success factors for community development venture
capital funds are size and competence. If you only have one or two
million dollars, it is difficult to staff the company and you are
less able to withstand the almost unavoidable early loss or two.
This is a really hard business, and you have to have people who
know how to do venture capital.
There is tremendous interest in using venture capital as a means
for revitalizing both rural and inner-city communities. We had 75
attendees at the CDVCA meeting this past June and 105 attendees
this past December. At this point, however, there is a lot more
interest in community development venture capital than there is
funding and skill. Through the alliance, we hope to help address