Investing in Start-up Puerto Rico

Ernesto Villarini Baquero evillarini@cdvca.org

I was happy to read about Parallel 18’s latest group of startups and listen to each company pitch during their recent virtual kickoff event. Generation 8 is the accelerator’s first all Puerto Rican cohort and it surfaces as a hopeful sign amidst a sea of small businesses that have shut down due to the COVID-19 pandemic. Half of the Gen 8 companies stem from parallel 18’s pre-acceleration program, which speaks to their strategic approach to nurturing business growth at an early stage.

Parallel 18 is one of a handful of business incubators and accelerators on the Island. It is a program of the Puerto Rico Science, Technology and Research Trust. Similar programs are offered by Grupo Guayacan, PRTEC, and Startup.pr, to name a few. As tax-exempt entities these organizations receive both governmental and philanthropic support to finance the grants, services and support they provide to participating startups. This activity should prompt some questions from taxpayers and investors alike: What role do startups have in economic development? How are they financed? What else do they need to grow? And do start-ups have a place in an investment portfolio? The Kauffman Foundation reports that because of their high-growth nature, successful startups account for up to 50% of new jobs created in the U.S. They also expand the commercial base by adding new business locations and encourage direct and indirect employment growth. For most startups, immediate financing needs arise as they try to prove their concept (product or service) and test their target market. At the so-called pre-seed stage, capital is sourced mostly from FFF (Family, Friends, and Fools), business angels and the accelerators themselves.

Startups able to raise this initial financing look to grow a product that can start generating “traction”; a company’s first purchasing commitments or sales. Simultaneously they look to consolidate their core team, the members who will then be referred to as the founders. The right team and getting traction are key in obtaining additional capital from angels with deeper pockets and early-stage venture capital (VC) firms. Reaching the seed stage does not guarantee that the

busines will have success, but growth will not occur if risk capital is not secured early on.

Many startups will be unable to find a profitable product-market fit and fail to meet growth expectations. Forbes magazine reported a few years ago that up to 90% of startups fail to meet their market potential or promise for financial returns. Those that fail to grow exponentially will sometimes evolve into lifestyle companies or keep operating “under the radar” waiting for market conditions to improve. An entrepreneur that fails at this stage usually goes back to the drawing board to figure out how the market opportunity can be better addressed.

The few survivors of the seed stage pass on to series A and B financing rounds where founders usually give up a significant stake in their company in exchange for the capital needed to scale. VC funds are the main source of financing at this stage, and investors will fund start-ups through these funds to gain exposure to a high-risk / high-reward asset class unmatched by the public markets. Capital is not all that matters at this stage. The top VC firms standout because of their ability to add value to the companies they invest in in the form of market access, technological know-how or operational prowess and efficiency. While the founders’ stake in the business decreases through this process, they are usually compensated by the growth in market value of their stock.

Does this startup investment scenario play out in Puerto Rico? The truth is that venture activity has been scant at best in our jurisdiction over the past 30 years. With the exception of Advent-Morro Equity Partners, it wasn’t until 2014’s Act 185 – Puerto Rico Private Equity Funds law – that other private investing options popped up. By 2017 the Office of Puerto Rico’s Commissioner for Financial Institutions had reported 14 funds registered under this law, and other options have risen since. Currently, there is a much wider spectrum of funds providing alternative financing throughout the capital stack.

Some of these funds were created to target individual investors mostly interested in the tax advantages of Act 185 (now part of Act 60). The jury is still out on the impact of these tax incentives, but it is nice to know that this financing space is not as empty as it once was. Local tax-exempt institutional investors have also invested in Act 185 funds to increase diversification in their portfolios. Many of them have also recognized the potential for these investment portfolios to contribute to the

local economy by providing jobs, innovative products, and additional commerce and contributions to the local tax base.

So, what businesses do these funds invest in? That is the piece of the puzzle business incubators and accelerators seek to address. Today there are many young sophisticated entrepreneurs, that first learned about entrepreneurship in their school, thanks to multisectoral efforts, such as Banco Popular de Puerto Rico’s Echar Pa’ Lante initiative. Puerto Rico has quietly been investing in the next generation of entrepreneurs over the last two decades and they are now creating profitable businesses hungry for investment dollars that can fuel their growth. Parallel 18 200+ international business graduates prove this, as do the alumni from Guayacan’s EnterPRize Business Competition, and the many startups moving into new co-working spaces on their own.

So, if there are startups in Puerto Rico doing business internationally and ready to grow, and we have local risk capital funds with investment management experience, where are the investors for these high risk / high reward opportunities? They are out there, but still quite shy about investing in Puerto Rico. Our economy has been taking a beating since 2006, and hurricane María stretched out our recovery even further. Local investors are still going through a toxic experience with the Puerto Rico bonds, while U.S. investors have focused on “safer” investments in public markets. However, we have seen some exceptions which we can tap into and hopefully build on. For example, the Calvert Foundation (now Calvert Impact Capital) investing in the Lift Puerto Rico Business Impact Fund, managed by Acrecent Financial, to provide alternative financing to local businesses.

Before the pandemic, we had witnessed close to $200 million raised in commitments to private equity and venture capital in Puerto Rico between 2015 and 2019. The Puerto Rico Fund for Growth, which the Community Development Venture Capital Alliance (CDVCA) manages, is almost a quarter of that amount. However, this is a far cry from the total investment dollars in Puerto Rico pension funds, insurance reserves, corporate reserves, foundations and endowments which surpass the $30 billion mark, but, it is a good start for investments with a mandate towards our jurisdiction. If our recovery continues to provide opportunities to our courageous entrepreneurs and savvy investment managers, investors will continue to have options to make market-rate financial returns while providing much-needed financing for businesses in our economy.

While relatively new to Puerto Rico, the placed-based investing phenomenon is quite common elsewhere. Pacific Community Ventures, which is also part of the CDVCA investment portfolio, recently published a Catalog of Economically Targeted Investments by Pension Funds showing that 30% of the 118 investments made in the private equity space were also meant to finance growing innovative businesses and create jobs. KPMG, one of the world’s “big 4” accounting firms, recently reported how the private equity industry is increasingly raising funds designed to “marry” financial returns and positive societal outcomes. These investors are key for growing startups and essential in moving towards an economy that can rely on innovation for value creation, growth, and employment.

Under our current circumstances, investors might think that a responsible approach obligates them to invest all their assets abroad, and they would be 95% right. Through hundreds of lawsuits, we have learned the hard way the importance of diversification in mitigating risk. However, it could also be argued that it is our responsibility to allocate investment dollars locally, where jobs are created, income generated, and taxes paid to the local treasury to support government services, infrastructure development, and public works. A 5% allocation could provide $1.5 billion to finance local businesses and help us continue to build Puerto Rico’s wealth. If investors are key in supporting our burgeoning startup ecosystem, shouldn’t we be our own first investors? I hope you agree with me that we must.

The author is Vice President of the Community Development Venture Capital Alliance and member of the Puerto Rico Fund for Growth investment management team. Questions or comments can be sent to evillarini@cdvca.org.

Covid19 Economic Crisis and the role of Community Development Venture Capital (CDVC) in supporting the recovery.

“What is the role of Community Development Venture Capital (CDVC) in supporting entrepreneurs and small businesses and supporting a recovery that is inclusive of all communities and people.”

This is a very uncertain and trying time. On a daily basis the goal posts change, impact metrics become more profound and re-opening of the economy moves to an accelerated pace but marred by an abundance of caution. The impact felt in low income communities and on low income people is even more acute, risking the economic development gains of the past years with rapid increases in unemployment, loss of job quality characteristics and limited workforce development opportunities and job accessibility.

Companies today, be them small or large, will have significant constraints going forward. Potential areas of impact include:

·       Laying off staff and workers

·       Reductions in 401K or other wealth generating benefits

·       Reductions in coverage or total loss of medical and healthcare benefits

·       Loss of opportunities for skills training programs

Many companies, particularly in manufacturing and industrials, may accelerate strategies about the future of work and introduce more automation, robotics and AI in the workplace, displacing even more workers, many at entry level or on the front lines.

For fund managers, particularly those in the Community Development Venture Capital (CDVC) space change is afoot too.

·       What could this mean in real terms for fund managers?

·       What will the new reality be of raising a new fund?

·       How will we deploy capital in this economic climate and in low income markets?

·       Will there be increased limitations in calling capital from LP’s who may not be liquid themselves, or who have readjusted their portfolios to de-risks or reduce over exposure in private equity markets?

·       What levels of dry powder will fund need to manage and keep for future trends?

·       How will funds manage and work with portfolio companies and their burn rates as they struggle to survive?

These are all issues we need to grapple with in the coming months, and maybe year ahead.

Funds and fund managers need to begin a thorough risk assessment of the damage Codiv19 has brought to their portfolio companies, their own fund and their relationships with LP’s. Secondly, we need to diligently assess the financial and social impact of the crisis on LIC’s and LIP’s in the communities we serve.

As Vice President at Community Development Venture Capital Alliance (CDVCA), the trade association for Community Development Venture Capital (CDVC) in the United States, we are working with partners and leading the charge in supporting funds and portfolio company’s strategize how together we plan for an inclusive recovery, monitor and prepare for what dynamics new demand from consumers, investors and communities will look like. From manufacturing and industrials (for example will we see a rise in the demand for onshoring pharmaceuticals and other sectors in the US), will we see an increase in consumer goods and on-line services from Tele Medicine to online communications. (what shape what a new normal may look like and how will we respond to it).

A further consideration.

·       What will the new normal be with trillions of Government and Federal Reserve dollars circulating the in the economy?

·       Will market dynamics change with the role of Government (Federal, State and Local) subsidies?

·       Will there be added incentives offed to manufacturing and industrial sectors as we seek to onshore production in the US of vital supply lines?

·       Will these incentives increase investments in low income communities where factories and production will reside?

As we progress through the crisis and recover, how will we assess the systemic and long-term damage to underserved and low-income communities and low-income people. Will there be a tightening of LP’s appetite for Impact Investing and higher risk investments, even if they bring with them social impact at scale?

CDVCA is interested in assessing the wide scope of the Covid19 crisis on the CDVC eco system, across LP’s, GP’s, Portfolio Companies, Job Quality, Workforce Development and Social Impact. Investments in Low Income Communities, and in entrepreneurs of color or minorities are at serious risk of drying up, affecting low income people and minorities the hardest. Investments will dry up precisely when we need it the most, to keep these vulnerable communities strong, alive, and prosperous.

Many of these same communities were ravaged by the financial crisis and are still struggling with high Opioid usage, long term unemployment issues, lower than average labor participation rates and above average poverty rates. The needs of capital inflows in these communities is critical for an equitable recovery of the US. (And to which lessons should have been learned in the post financial crisis recovery).

Cost of Turnover Tool

How much does worker churn cost your business? A large and growing body of research shows that turnover is a significant expense to firms. But how do you calculate this cost, and what do you do with what you learn?

Putting a dollar figure on the annual financial impact of losing and rehiring workers at your company may help you make the case – and find the resources – for investing in strategies to improve retention. One important retention strategy, investing in the education, training and development of your workers, is also good for your bottom line. Companies that provide upskilling opportunities report reductions in their rate of turnover. Investing in upskilling could save your business money in the long term.

Aspen Institute has a useful publication to help your business

https://www.aspeninstitute.org/publications/cost-of-turnover-tool/

IRIS+ makes it easier for investors to translate their impact intentions into impact results.

All investors and companies create positive and negative effects on society and the environment. Impact investors seek to maximize the positive and minimize the negative by using the IRIS+ system to integrate social and environmental factors into investment decisions alongside risk and return.

Credible, comparable impact data are needed to inform impact investment decisions and drive greater impact results. IRIS+ solves for this by increasing data clarity and comparability, and it provides streamlined, practical, how-to guidance that impact investors need, all in one easy-to-navigate system. It is a free, publicly available resource that is managed by the Global Impact Investing Network – the global champion of impact investing.

https://iris.thegiin.org/

Big Investors Need to Change the Way They Do Business as the Impact Investing market is sized at $502 Billion

A Q&A with the GIIN’s Co-Founder and CEO, Amit Bouri

Amit Bouri is the CEO and co-founder of the Global Impact Investing Network (GIIN), where he has championed the cause of impact investing over the past decade. Today, the impact investment market is sized at USD 502 billion.


https://nextbillion.net/big-investors-need-change-amit-bouri/

How to Ensure Opportunity Zone Investments Strengthen Local Communities


For two years, investors and neighborhood leaders in cities around the country have responded to economic Opportunity Zones (OZs) with hope and hesitation. The policy, part of the 2017 Tax Cuts and Jobs Act, provides tax incentives for long-term investments in low-income census tracts. These incentives are meant to help disinvested neighborhoods, hungry for economic growth, attract new financial opportunities. Heeding this call, nearly 90 OZ funds have dedicated more than $2 billion for investments in OZs.

https://ssir.org/articles/entry/how_to_ensure_opportunity_zone_investments_strengthen_local_communities

Thinking About 2020: CDFI and NACA Program Pre-Application Webinar

As 2019 comes to a close, now is a great time to start thinking about preparing your organization for a fiscal year (FY) 2020 Community Development Financial Institutions Program (CDFI Program) or Native American CDFI Assistance Program (NACA Program) Application. The Community Development Financial Institutions Fund (CDFI Fund) is tentatively planning to open the FY 2020 Financial Assistance and Technical Assistance application round in early 2020.

There are steps your organization can take now to get ready to apply. Join CDFI Fund staff for an informational pre-application webinar on Wednesday, December 18, 2019, to learn more. Topics covered will include setting up your critical SAM.gov and Grants.gov accounts, adjusting your organizational profile in the Awards Management Information System (AMIS), and other ways your organization can prepare in advance for the FY 2020 application round.

https://www.cdfifund.gov/news-events/Pages/news-detail.aspx?NewsID=363&Category=Updates

Tune in: Podcast on Small Businesses and First-time Fund Managers as true drivers of Economic Growth

As a guest on Impact Alpha’s Return on Investment podcast, Village Capital President, Ross Baird, discusses his new book, “The Innovation Blind Spot,” making the case for small businesses as the true engines of economic growth and pointing to smaller funds and first-time fund managers that are outperforming their mainstream counterparts. To listen to the August podcast, click here.