Download NC3’s how-to guide on Community Investment Funds. Cutting Edge principal, Brian Beckon is a co-author and NC3 board member.
A venture (nonprofit or for-profit) can raise capital from their community either directly or indirectly. The direct approach is sometimes referred to as investment crowdfunding, a term that includes both direct public offerings (DPOs) and Title III Regulation Crowdfunding. Indirectly, a venture can be funded by a Community Investment Fund (CIF). CIFs help to empower communities by allowing community members, anyone of virtually any economic class, to invest in a community fund which in turns invests in ventures, revitalization projects or other mission driven enterprises. CIFs allow communities to build wealth through a cycle of investment, growth, profit (returned to community investors), and reinvestment. Read more about the power of community capital here.
Why we like Community Investment Funds. A CIF can be a particularly important component of a healthy local economy for four key reasons: Scale, efficiency, diversification, and liquidity.
- A CIF can be more scalable because it can potentially raise an unlimited amount of money and finance an unlimited number of local ventures. Note that we don’t use “scale” in the Wall Street sense of bigger transactions. In a CIF, the transactions should always be at a human scale, but we need a lot more of them to truly change the economy and to create a culture of community investment.
- A CIF can be more efficient because each investor only needs to do due diligence once on the fund, and then the fund handles due diligence on outgoing investments.
- A CIF is more diversified when compared to having each investor invest in one or a small number of local ventures.
- A CIF may be in a better position than individual ventures to offer its investors liquidity (i.e., a way to sell the investment). A CIF can be set up to redeem investors who need to exit the investment.
Aren’t funds heavily regulated? Usually, yes. However, Cutting Edge has identified several ways to structure a community investment fund that will be exempt from the regulatory burdens of the Investment Company Act and thus easier and more cost effective to implement on a community scale. A CIF still has to comply with securities laws to raise capital for the fund and can do so using community capital strategies such as direct public offerings or a Reg A+ offerings.
Types of CIFs. Types of CIFs that are are not covered by the Investment Company Act include the following:
- Charitable Loan Fund
- This is the most widely used CIF model because charities are exempt from the key federal securities laws. The fund is hosted by a Section 501(c)(3) nonprofit and can only offer investment notes to investors, and investors receive interest. The fund invests in ventures that align with the nonprofit’s mission.
- Real Estate Revitalization Fund
- This type of CIF takes advantage of an exemption from the Investment Company Act for real estate investments. Typically organized by experienced real estate professionals, this fund often has a goal of community revitalization (housing, neighborhood, main street, etc.). The fund can offer investors equity, debt or revenue share securities. The fund uses the capital raises to purchase and revitalize real estate (commercial, residential, mixed use or industrial), and then lease or sell it. Profits can be distributed to investors.
- Diversified Business Fund
- In this model a fund can avoid coverage by the Investment Company Act if it has some primary business other than the business of investing in securities; in other words, there has to be an existing line of business that is distinct from managing the investment fund. In addition, the fund can invest no more than 40% of its assets in “investment securities” — a term that excludes majority positions in other companies. It also excludes real estate, some secured loans, and other business assets. If those requirements are met, then the fund can offer investors an equity position in the business that runs the fund and the fund can in turn take equity positions in other business; and any profits generated can be distributed to investors in the fund. An example: An advanced manufacturing co-working facility that rents space, offers consulting services, rents the use of equipment and runs an incubator. This business can raise capital from its community to start a diversified business fund and invest in its incubated companies, as long as the company’s assets are sufficiently diversified to meet the 40% test.
Community investment funds can be powerful tools for communities. Contact us for a free one hour consultation to learn more.