September 15th, 2009 by Karl

SoCap09 was the second conference on financing for social causes.  I did not attend the conference in 2008.

 Prior to attending the conference, I was key word searching the Internet using ‘social capital’ and mostly came across articles and blogs using the broader term for ‘social capital’ – an undefined and often unquantifiable exchange of benefits without cash, not the narrower use of the term for financing for social causes.  This languaging issue is a significant problem.  Since there are two definitions and funding is the lesser known and used form of the two, a new name is needed. 

As I arrived at the conference, everyone was very friendly and open – a signature characteristic of people who have a ‘mission’ and want to make the world a better place.

The opening plenary session was keynoted by Sonal Shah – Director of the White House Office of Social Innovation.  For her part, Sonal Shah talked like one of us and not a bureaucrat or politician. Part of this was because she is short of resources like us – having a staff of only 4 people.  This led some to question whether the Obama administration is doing this for show or for substance.

The first panel discussion did not ignore the elephant in the room – mission over profit.  The statement was made that “We need to focus on doing good, not feeling good.”  This statement goes to the core of financing social causes.  The business world and the charitable world meet at this issue.  A social cause must be dependent upon charitable contributions for its continued existence unless it can become ‘sustainable’ by selling products or services in a sufficient amount to cover all of its costs.  My opinion is that the failure or unwillingness to understand this concept is key to the development and success of an industry of financing social causes.

I heard again and again the statement that “Mission trumps profits” – meaning that completion of the mission of a social cause organization has to take precedent over making a profit.  This statement is simply wrong for any organization other than a charity.  If a social cause organization cannot make a profit, it must depend upon charitable contributions just to survive.  Even if the organization can break even, it is dependent upon contributions to grow.

The failure to recognize economic realities does not make them any less real.  To distinguish between an organization that may sustain and grow itself and once that cannot, I will adopt the term ‘social enterprise’ as contrasted with a charity.

Yes, a social enterprise may be mismanaged or have bad luck or any of the other problems facing a business and it may fail.  However, the potential to survive without contributions makes it different.

Yes, a charity may and should sell goods and services to help it extend its ability to carry out its mission.  And, when it does so, it should implement good business practices to avoid waste and maximize the benefit from this activity.

Part of the confusion in this area arises from risk sharing.  If an investor takes an ownership position in a for profit organization, it is dependent upon that organization to earn a profit from its activities in order to get a return of capital.  The investor is at risk that the organization will not make a profit and will not return capital.

In any other forming of financing, the risk may be shifted to the organization.  In lending money, the lender may require personal guarantees or collateral to secure the debt.  The organization may fail to make a profit, but the lender is covered.

There seemed to be a preponderance of confusion over mission, profits and financing.

I found many people at the conference to be passionate, but without knowledge or experience in matters of running an organization, earning a profit, or management of investment.   At one point during the conference, I had stepped out to take a phone call.  When I came back into the main hall, I could see many people matched off in pairs.  Without hearing what they were saying, I could see one person talking about their passion, using significant hand gestures and body language to tell their story.  The other person was listening.  However, I was struck by the passiveness of the listening.  The person was sitting, almost without moving.  This seemed odd in that I knew that the listener had to be a caring person, but they were not getting into the story – not getting excited, not responding.  It was then that I realized that the listener also had a passion and it was not the one the other person was describing.  Therefore, although listening politely, they were not engaging.  It struck me that all 1,000 attendees of the conference had their own passion and were as different from each other as they might possibly be – only being together to discuss how they might obtain more funding for their passion. 

Everyone at the conference has a mission.  However, this mission must be placed in the context of economics and business if it is to succeed.  Ultimately, this means development of a language that allows everyone who may invest to understand the differences between one social organization and another in order to make a choice.  In part this will be driven by development of metrics.  I will take that subject up at another time.

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August 20th, 2009 by Karl

The first step in planning a seed capital fund, like in any endeavor, is setting your goals.  The better the job of setting the goals, the more likely you will achieve them.  More importantly, the easier it is to communicate those goals to everyone involved.  I answered a question on LinkedIn yesterday of a small business trying to identify the right seed capital fund from which to seed funding.  It was difficult answering this question, because many investment groups do a poor job of this, taking an attitude of we will look at anything.  However, this is inefficient in the operation of the fund and it is a major waste of resources by small businesses that are knocking on the wrong door.

The goal of the 2009 Colorado Seed Capital Fund is to stimulate the economy through small business generation of jobs.  Be definition, the Fund will be looking for small businesses (as defined by the U.S. Small Business Administration, although we will probably focus on businesses with far fewer than 500 employees) in Colorado (which raises questions about businesses with offices in multiple states – do we limit it to headquarters, location of majority of employees or simply having an office?) that will create new jobs (which excludes self-employment, people fixing and flipping real estate or reinvesting in yet another business). 

The idea of creating jobs is not simple.  A lot of government economic development programs I have worked with in the past have used this metric.  This often led to businesses receiving grants because they used two people to do the job of one instead of automating.  Some jobs have no future – there is no career track for the individual to follow to attain a better job.  This type of job may not be sustainable over time, which would not contribute to economic stability.  We will not support the employment of people illegally in the United States.  I can understand a person willing to enter the United States without authorization to make more money.  However, any employer of these individuals is typically taking advantage of these individuals by paying a lower wage.  Any of course, we are not interested in short term, summer type jobs like those recent reported by the media, that state and federal government agencies have used to pump up employment numbers for the sake of taking false credit for achieving stimulus.

The best jobs are those with small businesses that are solving a problem in the marketplace.  The job is in alignment with the business which is in alignment with the market.  Good jobs.

Other seed capital funds have some of the same or different goals.  Some seek to advance a particular industry as an economic cluster or hub.  This goal has been popular recently in medicine and environmental technologies.  Some funds seek to promote a geographic area such as a city, region or state as part of a larger economic development effort.  This is part of our goal, but our geographic boundaries are primarily the consequence of securities regulations (raising money and investing it within a single state is quicker and less expensive than doing so in multiple states).  A growing number of funds are promoting social causes – the environment, women, curing a disease, etc.  There are also a growing number of funds for small dollar investments – microfinance or pre seed – aimed at addressing poverty, economic disadvantaged groups and single parents (who often have to work while parenting).

Goals need to be stated in words and translated into metrics.  Our ultimate metric is jobs.  It has been projected by Scott Shane, author of You’re the Boss, (on July 6, 2009) that an entrepreneur can create one new job for each $31,169 of funding.  If we are successful in achieving our goals, the Fund will create 1290 new jobs in Colorado within 400 to 600 small businesses.  That will only put a small dent in the 14.7 million unemployed today, but we are not working with a trillion dollars.  If we can repeat the Fund from year to year and assist others start funds in other states, then we can do more.

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August 9th, 2009 by Karl

In finding investment money, the focus is on the money.  However, the true focus should be on the relationship between the business and the investor.  And the focus of that focus should be ‘values’. 

Over the duration of the investment, from the time of transfer of money to the business to the time of payback, there will be issues.  Even if everything goes right, which it never does, there almost always are issues over the cash exit.  When things go wrong, there will be issues of the right strategy, who is in charge, new investments or budget cuts, etc.  At times like these, it is good for the investor and the business to share common values.  Otherwise, they may and often do go to war.

So, what are values that are shared?  That’s a tough question.  However, a number of people are tackling this question in the context of investment.  Kathryn Alexander of Ethical Impacts was kind enough to share with me an analysis of values within an investor/business relationship.

Kathryn frames the conflicts as tensions:

• Collaboration versus exclusivity
• Dissenting or deceiving in the name of getting the job done
• Being effective or getting back at someone
• Being honest or loyal
• Being inventive or doing things the way they’ve always been done
• Taking initiative or being obedient
• Getting folks to go along because they want to or leaning on them

This approach is more of a psych profile – understanding how people will try to achieve their objectives.  Obviously, when things get tough, the different approaches if attempted at the same time may lead to disaster.

I have posted a copy of Kathryn’s analysis on the Documents page.

This is an issue I continue to struggle with.  I have adopted a few ‘rules of thumb’ in analyzing investors and business partners.  Do they have a pattern of contributing to their community (volunteer, non-profit board, civic leadership)?  Do they take personal responsibility for their actions (don’t shift the blame; don’t look to the government for a solution).  I recognize that I need to do better in this category and will continue to explore and read on this subject.

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August 7th, 2009 by Karl

My search for seed capital programs has taken me outside the United States.  So, I have set up a new page for programs in other countries and any international programs.  I have started with a description of London Seed Capital, a private fund that matches investments from angel financing.

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August 3rd, 2009 by Karl

I have been gathering information on seed capital programs in different states.  I have decided to create a new page on this website that will provide a summary of each program, the criteria for participation and contact information.  As information is obtained on individual state and local programs, I will update the page.

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August 1st, 2009 by Karl

An alternative to classical equity investments and debt financing is that of revenue sharing.  In this situation, an investor gives money to a business and is paid back out of revenues.  The payback is styled just like a royalty that might be paid on a book, music album, movie or oil project.  A percentage of the revenue is taken ‘off the top’ to pay back the investor.

We plan to use the approach of revenue sharing with regard to the 2009 Colorado Seed Capital Fund.  Under the current circumstances, this seems the only available approach.  The current scarcity of seed capital is not completely due to a lack of money to invest, but rather everyone who is still holding money has taken a wait and see attitude.  While still stinging from stock market and real estate losses, people with money are also trying to anticipate the negative impact of the Obama administrations proposed health care nationalization and petroleum taxes.  It is quite likely that if this legislation is passed, that they will create even more stress on businesses resulting in lower profits and higher failures.

The idea is to offer an investor a better investment that is sufficiently attractive that they will come off of the sidelines and get back in the game.  Revenue sharing meets this requirement.  It has the following advantages to the investor:

1. Payback comes from revenue and therefore payments start earlier than if paid out of profits in that most businesses will have revenue for a period of time before they actually earn a profit.  Commonly enough, highly successful companies may be even later to reach profitability since all earnings are plowed back into growth.
2. Revenue share is similar to profit pass throughs by partnerships and limited liability companies and Subchapter S corporations, in that the investor does not have to wait for a ‘liquidity event’ such as a public offering or a sale of the company in order to achieve a ‘cash exit’.
3. The valuation of the business is not an issue.  In the early stages of a business, the ability to forecast future valuation is impossible and at best is an educated guess.  An investor wants as large of a percentage of ownership of a business as possible to improve the odds that he or she will make a return on their investment.  The small business founders want to give up as low of a percentage as possible, asserting that the business will be wildly successful.  Attempts to resolve this issue commonly result in an expensive due diligence review and prolonged negotiations over price.  When investors are paid out of revenue, then valuation is not relevant.
4. The investor can get a higher rate of return on revenue sharing than is possible by making a loan.  Most states cap the legal interest rate at 40% per year because most of the risks are retained by the small business.  This is particularly true where the loan is collateralized by personal guarantees of the small business founders including their houses or other assets.  With revenue sharing, the investor has taken on more of the risks in that they are only paid if there is the sale of products or services generating revenue.  However, practically, if the business fails, from the perspective of the investor, it doesn’t make any difference if the investment is in the form of a loan or a sharing of revenue.  Therefore, revenue sharing provides a pay back that is more in alignment with the true risks of an early stage company.

Revenue sharing is also attractive from the perspective of the small business for the following reasons:

1. Everything stated above about valuation of the business being irrelevant to the investor is also true for the small business.
2. Revenue sharing is preferred over debt financing, because of the fact that it is based upon cash flow.  If there is no cash flow, there is no payment, unlike a loan, where the business may be obligated to make payments of interest and/or principal when there is no revenue.  Such a situation puts the business ‘upside down’ and typically leads to failure.  Few start up businesses can operate for long periods of time in negative cash flow.
3. If the business is highly successful, the founders of the small business will realize a higher rate of return on their investments.
4. Since the pay back is aligned with cash flow, the small business founders do not have to worry about distorting their business model in order to create an artificial ‘cash exit’ for investors.

The percentage of revenue set aside to pay back investors may range from 1% to 10%.  There is an upper limit on the percentage in that if it is too high, it will approach and possibly exceed the businesses profit margins.  If it is equal to the profit margin, then the business has no money for growth.  If it exceeds the profit margin, it is like paying back a loan.

I typically set up a revenue share to continue until a target return on investment is achieved.  With regard to the 2009 Colorado Seed Capital Fund, it is currently intended that businesses will pay between 5% and 10% of revenue until total payback is 500% of the original investment (a 400% ROI).   At that point, the pay back stops.

A revenue share can be designed to work in a variety of ways.  The payback can continue without stopping.  It can step down from the initial rate once certain pay back milestones are achieved.  Lower risk businesses may be able to obtain investments with a lower percentage of revenue and a cap on payback at 20% to 300% of the original investment.  Inversely, higher risk ventures may require longer or unending pay backs.

 Revenue share can be matched with equity investment and/or debt arrangements.  Because of the revenue share, the amount of equity can be substantially reduced, used as a hedge to reward the investor in the event the business is highly successful.

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July 31st, 2009 by Karl

Every small business can benefit from building a strong board of advisors.  In the scoring criteria used by the 2009 Colorado Seed Capital Fund, significant points will be awarded to a small business for having a board and the quality of its membership.

A board of advisors may be simply described as a special group of consultants who are on retainer to assist the small business.  These individuals are not part of the core management team and have no decision making authority.  Therefore they have no liability for the actions of the small business any more than would any other contractor or consultant.

There are many advantages to having a strong board of advisors:

• Access to specialized knowledge
• Endorsement by reputation
• Bridge to network of contacts

In forming your board of advisors, strive to optimize its makeup by finding individuals who:

• Are the best in their field
• Have a great reputation
• Are connected
  • To key customer candidates
  • To the media
  • To investor candidates

Too often boards are formed on the fly with little or no strategic consideration based upon who the small business founders already know or the first people they meet.  Instead, identification and recruitment of the best available board members should be a key strategy.

The relationship with each board advisor should be formalized in a written agreement.  There is high probability that the advisor may contribute to the intellectual property of a small business and that needs to be controlled.  In addition, there should be high detail in what work the advisor is expected to do and how they are to be compensated. 

Too often, small businesses treat advisors like it is a privilege for them to be associated with the business – like we’re cool and you should be happy to hang out with us – an attitude that leads to problems.  Another common mistake is to give each board advisor a fistful of stock with no clear work obligations – this leads to people standing around with a fistful of stock.  If they don’t perform, there is no way to terminate them easily and no way to get the stock back.

I like my advisors to have a regular work schedule with well defined responsibilities.  I like monthly meetings during the launch of the business.  I will have things that I want them to review and comment on at the meetings (this means I have to prepare for the meetings in advance and give each advisor a reasonable period of time to do their work).  I want them to publicly endorse my business.  I will draft press releases, set up interviews and do all of the ground work, but they need to brag about my business whenever the opportunity presents itself.

In compensating advisors, I calculate the average number of hours that they will work each month.  I then multiply the hours by their billable rate, giving me a price per month.  I then try to negotiate a deal that is part cash and part equity in the company, thereby reducing use of scarce cash and giving the advisor some upside potential. [Advisory note – sale of stock in exchange for services is a sale of securities subject to state and federal securities laws.  Ordinarily, no one cares about this, but sometimes when a private offering to non-accredited investors is reviewed, each of these consultants who is non-accredited is included in the 35 max head count.  In addition, any failure to disclose material facts not only may kill the agreement, but set the stage for a claim of securities fraud.)

Keep in mind that a board advisor may be able to help the small business beyond the scope of the advisory board.  They may consult and they may sell.  Therefore, the small business should be prepared to compensate the advisor for work above and beyond board services including payment of commissions on sales.  This is why it is important to be clear on what is expected for board service so it is easier to determine when that performance level has been exceeded.

An advisory board services agreement template has been posted up on the Document page.  When we get our first Fund advisory board member under contract, I will post up a full example.

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July 30th, 2009 by Karl

When a person is seeking money for their business, they often don’t know people with money.  A common approach to meeting people with money is to use an intermediary or ‘finder’.

AT THIS POINT, I NEED TO RAISE ALL THE RED FLAGS, BECAUSE USE OF INTERMDIARIES IS REGULATED BY FEDERAL AND STATE LAW.  SINCE THIS IS NOT A LEGAL TREATISE OR ADVICE, MAKE SURE YOU KNOW WHAT’S LEGAL BEFORE STARTING.  More on this later.

A template agreement has been posted on the Document page.

The rate for acting as a finder depends upon the amount of work and the amount of money.  An intermediary may:

            1. identify a candidate

            2. make an introduction

            3. pitch the deal (which may include creating the presentation)

            4. close the deal

The more work the finder does, the higher the fee.  The more work done by  you (the business), the lower the fee.

Identification of an investor candidate may be as little as turning over a list of names (not even including phone numbers or addresses) or may include detailed biographies with a complete history of the candidate’s investment preferences.

An introduction may be as little as an email to both you and the investor candidate or may include throwing a fully catered party at a mansion with a live band where a face to face first appearance is important.

Pitching the deal may be as little as an elevator pitch to as much as conducting a market analysis, building a business plan, valuing the business, creating a multi-media show and throwing the party described above several times in several different cities. 

Closing the deal may be as little as receiving a check in the mail to a series of presentations with negotiation with an army of attorneyrs on the terms and conditions.

Because of the great range in possible services, it is recommended that an appropriate level of detail be established and stated in a written agreement.

The amount of money involved in the deal dictates the amount of the fee.       Fees can range from 1% to 20% on the first million dollars.  Typically fees are decreased over 1 million dollars – the Lehman formula is 5% on first million, 4% on second million, 3% on third million, 4% on fourth million and 1% on everything above that amount.

The actual fee will depend upon the degree of your need and your bargaining power.

Fully licensed brokers commonly charge 10 to 15%, plus fees (to open your account and get up to speed), plus out of pocket expenses and often take options to buy stock at a later time.

Now back to the issue of legality.  The United States government and the government of all states requires any individual who provides brokerage services to obtain a license before they can be an intermediary in the sale of securities.  In most states, this applies to any service in which the compensation is in the form of a commission – payment is based upon success.

In some states, an individual can be a finder so long as all they do is identify a candidate and make an introduction, but do not pitch the investment.  You may want to find out if you are in one of these states.

Also, you can hire services to assist you in your sale of securities so long as payment is not tied to success.  This means an hourly rate or fixed fee that is paid whether you raise money nor not.  I emphasize the word ‘assist’; you must retain control and responsibility over the pitch and the close.

DON’T GUESS!  CHECK WITH YOUR SECURITIES ATTORNEY!

Finally, I have had numerous people offer to help me raise money over the years.  A lot of these ‘guaranteed’ that they could line me up with some money.  Then they ask for an upfront fee.  Invariably, nothing came from these offers.  A rule of thumb is that if the person is confident that they raise money, then let them take their fee out of the back end when you have raised money and can afford to pay them. 

Now, it is true that many businesses are not ready to receive capital in that they have not crossed their t’s or dotted their i’s or put together an effective presentation of their offering and doing these things will cost money.  However, this is not the same thing as ‘tweaking’ your existing presentation for big dollars to hide the fact that you are paying a broker’s fee.

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July 28th, 2009 by Karl

It is planned to use an objective scoring system in determining which small businesses will receive funding from the 2009 Colorado Seed Capital Fund.

The classical approach to picking winners and losers is highly subjective.  A person or a group of people look at a small business and form an opinion.  The basis for the opinion is difficult, if not impossible, to ascertain.  When asked, the person may respond by telling you it was a ‘gut decision’.  Many will give you a long answer that basically boils down to it was a ‘gut decision’.

This is why rejection letters typically do not offer any insight as to the reason(s) for the turn down.  There may be none that can be articulated.

This approach, which has no metrics, makes it difficult to improve the selection process.  Therefore, a form of insanity takes over as the same mistakes are made over and over.

From the perspective of the business that got turned down, there is complete frustration.  Without any explanation or direction to make improvements, the rejection seems personal.

I have been on both sides of this issue.  I have turned down businesses and I have been turned down.

I have studied this problem and talked with many people far smarter than I about their selection process.  From this work, I realized that I generally could find agreement on investment criteria that were based upon things known, but on projections, opinions, interpretations or anything speculative, everyone had their own personal ‘crystal ball’ that was often wrong.

A couple of years ago, I decided to approach this problem by limiting criteria to known facts that could be objectively assessed.  I worked with Herb Silverman and Cary Daniel with the Business District.  We studied everyone’s evaluation system that we could find and tried to sort out those factors that were truly factual.  Then we made a number of attempts to list and weight these factors based upon their level of importance (this is where subjectivity creeps in again).  The project was shelved when other business concerns took priority.

There were a number of lessons learned from this effort:

1. All of the factors that we identified are well known – there were no surprises
2. Most of the factors relate to the management team and their past experience
3. There may not be a right or wrong set of factors, although weighting should lead to better or worse results
4. Any combination of factors may be evaluated over time and improved, however hard data will require waiting up to 5 years to determine if and to what degree the business succeeded

We are currently working on a detailed scoring system.  When completed it will be an online application system that a small business will complete.  A score will be generated for each business along with a summary of items for improvement.  Any business turned down for funding will have an opportunity to make improvements and resubmit.

A simplified scorecard has been created and posted on the documents page for discussion.  In reviewing this document, keep in mind that only factual information may be used to answer the question.  For example, Question #8 asks “What percentage of total population might buy your product?”  The question seeks to determine the scope of the potential market.  However, the question cannot be answered with a guess, no matter how educated, because it would be subjective.  The question can only be answered if a true market survey has been completed.  The quality of the survey as well as the results may impact the score.  No survey – the score is zero.  If the small business wants to improve its score – do a survey.

When more work is completed on our scorecard, it will be posted for discussion and feedback.

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July 27th, 2009 by Karl

As I have been putting together the design for the 2009 Colorado Seed Capital Fund, I have talked with a number of people about the fact that the Fund will be a social enterprise.  From these discussions, it is apparent that some people don’t see how investing in small businesses represents a social cause, some people don’t understand the concept of a social enterprise and many people from the non-profit sector are still struggling with the concept of supporting a for profit entity.

The purpose of any seed capital fund is to enable a new business to start and to grow.  If the entrepreneur who founds the business does not have enough capital, then he or she must look to someone else.  If they cannot obtain the needed capital, there will be no new business.

I do not have the statistics for other countries, but in the United States, small businesses (as defined by the Small Business Administration – an independent business with less than 500 employees) represent 99.7 percent of all the employers in the country and employ half of all private sector employees.  Over the last decade, small businesses have accounted for 60 to 80% of all new jobs created on an annual basis.

With the award of the 2006 Nobel Prize to Muhammad Yonus for his establishment of a microfinance program through his Grameen Bank, the question of seed capital funds as social enterprises should be full answered.  Funds such as his enable wealth development by addressing Bottom of the Pyramid poverty.

While Yonus was able to make loans as small as $20, the cost of starting a small business may range over $2,500 in many developing countries.  Organizations like Kiva are working to fill the need for seed capital by organizing an international community of small investors.

Here in the United States, the cost of starting a new business is somewhat higher.  In a July 6, 2009 blog of You’re the Boss, Scott Shane calculated that a United States entrepreneur can create one new job for each $31,169 of funding. 

The latest unemployment rates for the Untied States were 9.7 % which translates to 14.7 million people.  If 80% of these jobs must come from small business, using Scott Shane’s calculation, we need approximately $460 billion dollars in funding for small businesses in the United States. 

I can tell you that this money is not standing ready to invest in small businesses and this is the reason why I am working towards the formation of the 2009 Colorado Seed Capital Fund and offering to help anyone who wants to create a fund in their backyard.

Back to the question of whether a seed capital fund can be a social enterprise, there are additional issues about whether it is a for profit or nonprofit entity, how it makes money available to small businesses, and what price it charges for money.

I have designed the 2009 Colorado Seed Capital Fund as a for profit venture.  I did this in order to enable the Fund to attract investors to place in the Fund our goal of $50 million in a very short period of time.  By allowing investors to participate in the profits of the Fund, I am able to reach out to a broader group of people than those who might make an investment through an international group like Kiva or through a local group like the Capital Good Fund of Providence, Rhode Island.  The target investor for my Fund wants to ‘do good’ and ‘make a return on their money’.  Individuals working through Kiva and Capital Good Funds are not necessarily seeking a return on their investment – ‘doing good’ is their primary motivation. I consider this approach to seed capital as a ‘sustainable’ model – one in which earned revenue matches costs of operations.  The problem with ‘sustainable’ forms of social enterprises is that they still need contributions in order to grow.  This means that a portion of their operating costs has to be allocated to development activities, which in turn reduces the net capital available for performing the mission of the entity.  I see nothing wrong with ‘sustainable’ social enterprises, I simply prefer a business model that allows for growth out of earnings.

Some people may want to use a different scorecard on whether a business is a social enterprise based upon the motivations of its investors.  I, however, am focused on the outcome.  I believe that earning profits and rewarding investors is a good thing.  People have a choice in what they do with their money (except when it is taxed and taken away by government) and I see it as a challenge to make their money work harder within a for profit social enterprise.

The 2009 Colorado Seed Capital Fund will make money available (between $50,000 and $100,000) to small businesses in exchange for a share of the small business revenue stream – a royalty.  This approach is intended to better align the pay back of the investment with the cash flow of the small business.  Often small businesses borrow money and find themselves ‘upside down’ when their installment payments exceed their current income.  With a royalty approach, no payments are due unless money is earned.

As currently conceived, small businesses would make royalty payments to the Fund until total payments equal 500% of the money invested by the Fund in the small business.  This amount is high when compared with an annual interest rate of 6% to 10% of a bank loan or microfinance loan.  However, unlike a loan which creates a legal obligation for repayment regardless of the performance of the small business, a royalty shifts risk to the investor.  If the small business does not succeed, the investor will lose part or all of their investment.  A royalty may also be cheaper than sale of equity in the small business.  A royalty of 5% may be the equivalent of a 10% to 50% ownership position.  However, in our case, when the payment cap is reached, the royalty payments end whereas an equity position will continue to pay out for the life of the company.  In summary, the amount of the royalty is intended to recognize the probable failure of many small businesses and still generate enough profit to make the Fund attractive to an investor.

Within the 2009 Colorado Seed Capital Fund, we will also seek to advance the social cause of higher employment through means other than investment in small businesses.  Like more classical for profit businesses (whose primary mission is not a social cause, but who still are committed to supporting their community), we will contribute a portion of our profits (10%) to charities that are also helping small businesses.  A portion will go to charities in Colorado and a portion will go to organizations like Kiva and Ashoka.  By this approach, we are doubling up our classification as a social enterprise.

Finally, we are designing into our Fund a requirement that every small business that receives investment will in turn make an investment in a micro business in a developing country.  This is a ‘pay it forward’ component, where money and mentoring provided to small businesses in Colorado will be passed along in part to smaller businesses somewhere in the world.  We expect this requirement to be both educational as well as socially fulfilling as small businesses must reverse roles and become the investor/mentors in yet other businesses.

Being creative, I assume that we will come up with more ideas on how we can work through the Fund to increase employment and make the world a better place.  I welcome any ideas or shared examples of how our Fund may do a better job of being a seed capital fund.

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