Identifying Capital Sources

The “return profile” an equity investor gets is highly dependent on how cheap debt can be, and how much incentive a project can attract. Conversely, the amount of debt a project can attract is related to how much equity and incentives it has. At the end of the day, capital stacking comes down to capital sourcing – where can you find the right mix of debt, equity, and incentives to actually make a deal work?

To help you identify some potential sources of cheaper debt, better equity, and project incentives, we’ve created the list below.

WARNING

Blending debt, incentives, and equity to achieve desired outcomes gets extremely difficult when you start layering incentives on top of each other.

You are most likely to succeed if you work with a local expert or a knowledgeable group like Opportunity Alabama or the Council of Development Finance Agencies. The information below can help you think critically about capital stacking partners you can engage with on various projects.

If this discussion appeals to you, see the Capital Aggregator role for a deeper dive.

Sources of Debt

Summary

There are three big “buckets” of institutions that provide debt – traditional lenders (primarily banks), alternative lenders (primarily community development financial institutions, or CDFIs), and governmental sources (like HUD or USDA). In addition to traditional banks, there are a few specialized programs that can reduce the cost of debt by lowering the interest rate, extending the term, or removing the need to provide personal guarantees or collateral.

SOURCE 01

Traditional Banks

Traditional banks have programs that may offer you cheaper debt. Most of those programs are focused around one of the targeted subject matter specific areas discussed under “Special Consideration Categories” below. When discussing your project with a traditional bank partner (local, regional, or national), make sure their Community Reinvestment Act (CRA) Officer is a part of the conversation as traditional banks have more flexibility to take on unique lending opportunities if they qualify for CRA credit.

To find banks in your area, you can view publicly available lists from multiple sources, such as the Office of the Comptroller of the Currency’s (OCC) Financial Institutions List, Federal Reserve Board (FRB) Lists, Federal Deposit Insurance Corporation’s (FDIC) BankFind Suite, Consumer Financial Protection Bureau’s (CFPB) Institutions List, and more.

SOURCE 02

Alternative Lenders

CDFIs are certified by the U.S. Treasury Department as a special kind of financial institution uniquely suited to provide capital to low-income places. CDFIs make loans that traditional banks won’t. They can be more flexible in underwriting both real estate developments and operating businesses, and – thanks to government-backed programs – can oftentimes offer longer terms and lower interest rates than a traditional bank ever would. Many even have a long track record of working with higher educational institutions on catalytic local projects.

CDFIs have access to dozens of lending programs across multiple areas (including specialty rural programs, housing programs, community facilities programs, and others). Best of all, they are typically experts at stacking capital – so they can oftentimes help you attract the Incentives and Equity pieces of the capital stack too. You can typically find CDFIs active in your area in one of two ways: by searching the Opportunity Finance Network CDFI Locator or the CDFI Fund’s Certified CDFIs List.

In many places, CDFIs are supplemented by local revolving loan funds. These funds offer low-interest loans that can be used to cover anything from business operations to predevelopment expenses. They have a much more flexible underwriting process than traditional loans, making them ideal for more unique (but typically smaller) investment opportunities. They are administered by a variety of public and private entities, but start by looking for them within city or county government, regional planning commissions, local economic development organizations, state development finance authorities, Main Street groups, and local electric cooperatives.

One interesting alternative lending source that has arisen over the last few years is debt-based crowdfunding – unlike a traditional Kickstarter campaign, this model comes with some expectation of repayment – but unlike equity crowdfunding (discussed below), the repayment structures are much easier, and the compliance obligations are far less strict. Sites like Kiva and Honeycomb Credit offer partnerships to launch debt-based crowdfunding campaigns if you’re interested in this being a part of your overall strategy.

Finally, some community foundations and other nonprofits maintain “program-related investment” (PRI) programs that typically go to the highest impact projects. PRIs are typically structured as interest-only debt with long maturities and balloon notes – and they can even be forgiven under certain circumstances (effectively converting them into grants).

SOURCE 03

Governmental Sources

Governments may be the single biggest source of specialized loan products. State and local governments and development finance authorities have a bewildering array of loan programs at their disposal. Most federal loan subsidies are indirect – i.e., the federal government backs a loan made by a private lender (like SBA 7(a) loans) or provides a local entity with capital for the loan (e.g., HUD 108) – but there are a few direct-to-project programs offered by HUD, USDA, and other agencies.

Sources of Equity

Summary

Because equity investors own a percentage of the assets of the business and the cash flows coming out of it, they are best categorized by what kind of “return profile” they need in order to justify an investment. For the purposes of understanding what these “return profiles” look like, we will focus on three specific criteria: (1) how much an investor is being asked to invest, (2) how much the business (or development) will increase in value over time, (3) how much net cash flow the investment can produce over time. To provide “apples to apples” comparisons of different investment opportunities (e.g., real estate and operating businesses), investors use a handful of metrics that tie each of these three variables together to provide return profile numbers:

METRIC 01

Cash-on-Cash Return

Annual Return on Investment

This metric compares how much an investor invested to how much cash the investor receives over time. For example, a $100,000 investment that produces a $12,000 a year net cash flow (after paying expenses and making debt service payments) has an annual cash-on-cash return of 12%. Cash-on-cash returns take (1) and (3) above into account – but ignores (2) (how much the business will increase in value over time).

METRIC 02

Equity Multiple

Overall Return on Investment

This metric looks at total net profit over the life cycle of an investment, divided by the cost of that investment. For example, if you hold the same $100,000 investment producing $12,000 a year for five years ($60,000 total), then sell it for $140,000 (resulting in a total sum return of $200,000), your equity multiple would be 2.0x because you doubled your initial $100,000 investment. The actual formula is $140,000 (sale) + $60,000 (cash flow) divided by the original $100,000 you invested. This equity multiple is helpful because – unlike cash on cash – it looks at overall appreciation of the investment, not just how much cash it produces.

METRIC 03

Internal Rate of Return

Discounted Overall Return on Investment

An important principle that the equity multiple does not consider is that a dollar in hand today is more valuable than the hope of a dollar in the future. “Internal Rate of Return” (or IRR) addresses this principle by applying a “discount value” to future cash flows that increases the further out an investment sells. In other words – a deal that produces $200,000 in total return over three years will result in a higher IRR than the same deal that produces $200,000 in total return over five years. The full IRR formula is complex – even top investment professionals typically use spreadsheet formulas to auto-calculate it – so we won’t go into the formula here (unless you really want to know). Rather, to best assist you in understanding how IRR works (and how IRR is affected), we recommend experimenting with the GroundUp tool. It illustrates how changing sale dates, and assumed cash flows over time, impact the IRR.

Different investors will prioritize different return metrics to define a “successful” investment – and each investor will have their own unique definition of what “success” looks like under each metric.

Market Rate: “Market rate” investors, for example, typically want to see IRRs between 12 and 20%, equity multiples of 2.0x or better (and higher with longer holds), and/or 8-12% cash-on-cash returns.
Impact-Oriented: There are other investors who may be more “impact-oriented” and are willing to trade return for social good (or for alma mater growth). Impact-oriented investors want a “triple bottom line” return – that is, they want cash flow out of the investment (profit), but they also want some kind of social good to come from it (people and planet). The form that social good takes varies significantly from fund to fund and investor to investor, but includes broad categories like affordable housing, job creation, environmental health, supporting rural places, promoting racial equity, and more. This is especially true for banks that have created investment funds to satisfy their obligations under the Community Reinvestment Act, which requires banks to make loans and equity investments to community-oriented projects in certain low-, moderate-, or middle-income census tracts. To learn more about impact investing from today’s leaders in the field, please visit Sorenson Impact Center, Beeck Center for Social Impact & Innovation, Novogradac, and The US Impact Investing Alliance.
Downside Protection: Some investors – particularly larger, more institutional investors – care more about “downside risk” than the potential upside of an investment. In other words, they would rather earn a lower return, but be better protected against losing their entire investment amount because of the collapse of the underlying business.

REMEMBER

Unlike debt, equity investors are typically not collateralized by the assets they invest in, so if their investment fails, they may lose all of their invested capital.

Sources

Equity can either enter a deal directly (individual investors investing directly into an underlying business or real estate opportunity) or indirectly (via a fund, where multiple investors pool their money under common management, then invest that money into a deal).

There are a few broad categories of potential equity investors:

● Private Equity Funds

Private equity funds are groups of individual investors that have put dollars into a common pool under a common manager. These funds take multiple forms – some are Opportunity Funds, some are Small Business Investment Companies (SBICs), some are impact-oriented, but most are market-rate funds without any kind of special tax advantages that are looking at investment. They typically have dedicated management teams and are looking at a national or regional pipeline of potential investments.

● Qualified Opportunity Funds

Qualified Opportunity Fund (QOFs) are distinct investment vehicles which investors must invest their capital gains through in order to receive Opportunity Zone tax benefits (see the Opportunity Zones Guidebook for more information). There are hundreds of institutional-level, multi-million dollar QOF’s across the United States seeking OZ investment opportunities, and each has its own set of specific investment criteria. Though there are many large QOFs active in the marketplace, any individual investor with a capital gain can create their own QOF via IRS Form 8996 – however, before doing so, we highly recommend individual investors consult their accountant and legal counsel so they can make the best decision for their respective situation. To view comprehensive directories of institutional-level QOFs, please see the below hyperlinks from the following institutions:

● Small Business Investment Companies (SBIC’s)

Small Business Investment Companies (SBIC’s) are privately-owned investment companies licensed by the Small Business Administration (SBA). SBIC’s can provide qualifying small businesses with equity and/or debt financing, usually in the range of $100,000 – $250,000. Because SBIC’s are matched two dollars by the SBA for every dollar of capital they raise, SBIC’s are able to provide more favorable terms to the small businesses they allocate capital to. You can find a comprehensive list of SBIC’s at the following SBA link:

Small Business Association’s SBIC Directory

● Impact Funds

Impact funds seek investments that provide both a desirable financial return, and measurable benefit to society or the environment. Some impact funds focus on investing in specific impact niches (affordable housing, workforce development, clean energy, affordable healthcare, etc.), while other impact funds have a broader impact focus that creates a wider spectrum of investable projects. You can find impact funds in the comprehensive directories listed below:

● Infrastructure Funds

Infrastructure Funds: Infrastructure funds invest in assets that are necessary to further develop and/or help maintain society (e.g., bridges, energy, railroads, broadband, etc.). Infrastructure assets are gaining more popularity from investors in recent years due to their favorable risk/reward profiles, income generation ability, and investment return performance. You can find an online directory of infrastructure funds below:

Infrastructure Investor’s Directory of Funds

● Clean / Green Technology Funds

Clean technology (often referred to as either “cleantech” or ”greentech”) funds invest in businesses that reduce negative environmental impacts through energy efficiency improvements, environmental sustainability processes, environmental protection activities, and more. Universities often collaborate with cleantech companies to reduce or eliminate carbon footprints in their institutions, reduce energy costs to operate their facilities, and provide experiential learning opportunities for students. Examples of universities embracing collaboration with cleantech companies include Clemson University, University of Iowa, California State University, and many more. For comprehensive directories of cleantech funds, please see the links below:

● Minority and Women-Owned Business Enterprise (MWBE) Venture Funds

Minority and Women-Owned Business Enterprise (MWBE) venture funds have been created to address the inequity in the investment community. These funds are managed by under-represented groups (to create more agency for historically marginalized communities), take investment from all investors but typically include under-represented investors (to support equitable wealth building), and/or invest in businesses and projects owned or managed by under-represented individuals (to create more equitable access to capital). Here are a few resources for those looking to work with MWBE managers, investors, or projects/companies.

● Institutional Investors

Institutional investors are organizations like corporations (like insurance companies and banks), trusts, and family offices (wealthy individuals who have someone else managing their investment portfolio). As with private equity funds, these investors skew towards market rate, but may be influenced substantially by their mission or their broader philanthropic outlook.

● Local and Regional Individual Investors

Depending on where you are, there may be an existing pool of potential investors in your own back yard. “Local-vesting” movements have started all over the US, and tapping into these investors using creative tools (like crowdfunding) could make or break a deal. There are some logistical challenges in corralling individuals into investment opportunities, but – because they have no overhead – they may be able to provide cheaper cost of capital than professionally managed funds.

● Alumni Investors

This is the biggest untapped market within the resiliency-oriented investment space. We believe alumni have enormous potential to provide cheap equity to the deal flow you’ve decided to support because of their strong connection to your institution. It’s just a matter of finding them and slotting them into an investment vehicle.

● Equity-Based Crowdfunding

This form of crowdfunding allows small dollar value investors to own actual equity in the investment opportunities listed on the hosting platform. As a result, it means investors can receive a return on their investment – and it could provide a vehicle for corralling your alumni investors or your local folks. However, equity-based crowdfunding comes with intense state and federal securities regulation, creating huge compliance hurdles and ongoing reporting obligations. You’ll almost certainly need a partner who knows the landscape to effectively access this equity source. Here are several options to explore and their area(s) of focus:

Fundrise (real estate)
Crowdstreet (real estate)
PeerRealty (real estate)
SmallChange (real estate)
Equitynet (real estate and operating businesses)
Fundable (real estate and operating businesses)
AngelList (operating businesses)

● Foundation Investors Program-Related Investments and Mission Related Investments

These are either sourced from a Foundation’s grant pool, a Program-Related Investment (PRI) or from their endowment, a Mission-Relate d Investment (MRI). Foundations can also provide unfunded Loan Guarantees to help attract private capital.

Sources of “Free Money” / Incentives

Summary

When properly deployed, incentives can be the most powerful tool in the capital stack. As above, there are dozens of federal, state, local, and private programs that could provide incentives as part of the capital stack. We have described the general categories you should consider, knowing that your state or locality may have specialized programs that differ from their federal counterparts.

Sources

● Grants

This is the truest source of “free money,” but it isn’t always the easiest to obtain. Grants exist for both private real estate projects and private operating businesses, if you know where to look. The key is in finding projects that check one or more of the categories above.

Federal & State There is a dizzying array of federal grant programs for project development. You’ll find the full slate on www.grants.gov or under Assistance Listings on sam.gov. There are far more for real estate than operating businesses, but as nonprofits, universities are typically eligible applicants for just about all of them. State grants will vary, but tend to prioritize similar areas to those described above.
Private Foundations: There is an equally dizzying array of private foundation grant opportunities available. These are typically more flexible in use, and it’s likely that someone in your Advancement Office already has a list of private foundations that have a strong relationship with your institution.

● Donations

This should always be the first stop when it comes to recruiting alumni dollars. Free money is always better than equity because it doesn’t carry any cost of capital. That means you should always start an initiative by asking alumni – and other individuals in the community (like large corporate players and foundations) – for donations, not return-seeking investments.

● Grant-Based Crowdfunding

The close cousin of “donations,” this is the most common and widely discussed form of crowdfunding, popularized by groups like Kickstarter, GoFundMe or IndieGoGo. Investors here are really just donors – they contribute without expectation of return (other than the occasional tee shirt or coffee mug). However, this can be a great way to raise small amounts of money to go get deals done – perhaps to fund predevelopment work, or to fund a pocket park next to one of your projects.

● Tax Credits

Investment into certain kinds of activities – like low income housing, historic buildings, or renewable energy facilities – generates federal tax credits. Each of these tax credits has a certain value. For example, federal historic tax credits (HTCs) are equal to 20% of the qualified rehabilitation costs of a project, meaning a building with $5 million in qualified costs will generate $1 million in tax credits. As a nonprofit institution (private or governmental), you can’t use these credits yourselves, so you will create a deal structure where a third party investor that does have income tax liability “buys” the $1 million in credits from your project at a discount (say $850,000). That cash – net of transaction costs – is the “free money” that shows up for your project. Depending on the credit, these tax credit acquisition structures get pretty exotic. For more on tax credit transactions, see the Tax Credits Guidebook.

● State & Local Incentives

State and local incentives can mirror the incentive structures above. For example, states and localities are able (in some places) to make up-front grants to community-oriented real estate development projects. Other project types generate tax credits, which are sold to generate “free cash” as described above. The most common types are:

Abatements: Abatements mean no sales or property taxes on purchased materials or land. Abatements, when combined with creative public-private structuring (to allow university-supported projects to benefit from the university’s tax-exempt status) can make or break a deal – particularly on-campus public-private partnerships. This is where your general counsel and knowledgeable local lawyers can be particularly helpful.
Revenue Sharing: Revenue sharing (sometimes referred to as tax-increment financing) comes from the idea that a project will generate new tax revenue for the city or state over time (e.g., a vacant parcel generates $0 in tax revenue, but one with a retail center on it will generate millions annually in sales and property taxes). Some or all of that new “increment” of tax revenue can either be (a) “shared” with the project – meaning ongoing cash subsidies over time – or (b) borrowed against to provide an up-front cash incentive at no cost to the project. Local economic development officials and real estate attorneys will be good guide through this process.

Blending Capital

Sometimes, the best way to facilitate access to capital is to combine one or more of the sources above. You can do this at two levels:

At the project level (see Building a Capital Stack Guidebook), which you’ll need to do on just about every deal; or
At the fund level – in other words, creating a separate vehicle that can combine multiple capital sources into a standalone entity that can then invest in multiple projects at once.

As most of this section has focused on project level capital stacks so far, the remainder of this section will focus on fund level blended capital solutions.

Discussing blended capital requires a critical shift in mindset from the rest of this section. While most of this Guidebook content focuses on getting deals done, this section assumes that you are working with a fund vehicle – one that you establish yourself or in conjunction with a partner like Arctaris. That discussion presupposes two things are true:

You have a whole pipeline of investable projects, instead of just one (which you can generate from sponsoring your own deals, backing community deals, or assembling a pipeline of community-oriented projects); and
You have a management team with a proven track record that can invest the capital you attract, and all the infrastructure that you’d need to manage a fund (e.g., legal and accounting, investor reporting, diligence process, etc.)

Most universities are in a position to assemble a pipeline, but raising, managing, and deploying third party capital is often a bridge too far. We discuss this process at length in the Capital Aggregator section, so if your interest in blending capital at the fund level to get deals done is more than academic, make sure you focus on that section.

A “blended capital” fund will have two or more of the following buckets:

BUCKET 01

Market Rate Capital

This bucket is made up of market-rate investors expecting low to mid teens returns that are not receiving any incentive for investing in the fund (and are investing exclusively on the strength of the pipeline and/or management team). This might be a large percentage of your alumni base (and those return expectations might be adjusted down a bit if so).

BUCKET 02

Guaranteed Capital

Foundations (and even some states) have decided to pick certain fund managers that have a strong impact focus and offer them a pretty powerful incentive – the ability to guarantee investors that they will not lose money. Here’s how it works:

A foundation decides that a fund is going to do incredible, community-oriented work, and that its projects are likely to make money – but that some of its projects are high risk, high reward style projects (like a new grocery co-op in a rural college town that lacks one, or a student housing complex at an HBCU facing financial difficulties).
To ensure that investors have enough confidence in the fund manager and its pipeline to commit their capital, the foundation promises the manager that it will reimburse losses – either at the fund level or on particular projects that don’t work. If foundations pick strong fund managers who make great investments into high-impact opportunities that work, they’ll never have to actually pull a dollar out of their endowments to honor the guarantee – meaning they’ve been able to leverage millions in private investment without spending a dime.
Because investors have their downside risk covered, they are far more willing to take a below-market return (assumed at 6% in the diagram below).
Some examples of working guarantee pools include Kresge-Rockefeller’s OZ Guarantee Pool and the Community Guarantee Pool.

Colleges and universities with large endowments are in a unique position to leverage them to create exactly this kind of incentive structure. If you’re interested in starting that conversation, reach out to us. If you do not have a large endowment, work with your local community foundation or others who might have access to a large endowment to discuss whether creating a guarantee pool may be a good local strategy for you.

BUCKET 03

Cheap Debt Facilities

These can come from any of the “alternative” or “governmental” sources mentioned above (as banks typically do not provide cheap debt unless it is part of a structured Community Reinvestment Act-motivated program). Program-related investments (PRIs) are the most common vehicle for cheap debt – so make sure you are either (a) engaging with local foundations or (b) engaging with your own endowment / foundation management team to determine whether this source is available.

BUCKET 04

Grants and “First Loss Capital”

As demonstrated in the diagram above, guarantee pools and cheap debt facilities help a fund manager raise more equity – meaning they are able to do more deals – at an overall lower cost of capital. Ultimately, however, nothing beats free – and that’s what the final bucket of a blended fund provides. If fund managers can attract grant funding (typically from state or federal agencies), subsidies like New Markets Tax Credits, donations from a crowdfunding campaign, or “recoverable grants” (e.g., grants that are only paid back if there’s enough revenue to do so), they can have a built in “buffer” that can absorb losses even without a guarantee pool.

Special Consideration Categories

There are certain categories of potential real estate and operating business investments that work well with a capital stacking approach, and others that do not. The list below, while not exhaustive, provides you with a good sense of what kinds of projects (and in which locations) will trigger special cheap debt, provide access to tax credits, or be eligible for grants and other equity infusions.

● Rural

Depending on your definition of rural (typically, communities smaller than either 20,000 or 50,000), this unlocks a host of USDA grant a n d loan programs. For eligibility, see the USDA Eligibility Tool and Map.

● Small Business

The Small Business Administration (SBA), state government, and (oftentimes) local government support formation of small businesses through flexible programs (primarily loans) offered through traditional and alternative banks (more on that below). Definitions and additional state/local incentives vary, and your best bet may be to find your local Small Business Development Center and ask them to join your coalition if small business will play a big part in your strategy.

● Commercialized Research / Innovation

The SBIR/STTR program provides federal grant funding from multiple agencies to for-profit businesses who are commercializing certain kinds of technology that will ultimately help the federal government or drive the American economy. This is huge for commercialized research.

● Food Systems / Food Insecurity

USDA and state governments offer a wide array of lending-based subsidies at a number of levels along the supply chain (from production to distribution). Contact your local CDFI, agricultural extension service, USDA field office, or state department of agriculture for more on available grants and loans.

● Underrepresented Group Involvement

If your project creates better outcomes for minorities and women (by providing ownership, housing, business development opportunities, or otherwise), it is a likely candidate for a number of federal and state programs. Local CDFIs may be your best resource here.

● Nonprofit or Governmental Involvement

If a nonprofit or government entity (like a college!) is the biggest tenant of a building, it is sometimes possible to borrow, using creative structures like tax-exempt financing, at much cheaper interest rates. The experts here will be public finance attorneys at your local law firms, but local and state governments and traditional banks may have specialty lending programs here as well. Grant programs and New Markets Tax Credits are a potential source of “free money” here,.

● Veteran Involvement

Various federal and state agencies have special loans and grants for veteran-owned businesses or housing projects.

● Clean Energy / Efficiency

Programs like property-assessed clean energy loans (which combine bank debt with public approvals) can leverage savings created by energy efficiency improvements to “pay for themselves.” Renewable energy tax credits exist at the federal level (and in some states too). The Department of Energy provides a helpful overview of how grants and other programs can stack together to make projects greener, cleaner and (potentially) cheaper.

● Community Facilities

If your project involves a community center, public building, or other civic space, it may be a community facility eligible for tax-exempt financing and/or other special grant and loan programs like New Markets Tax Credits or the USDA Community Facilities Program (administered through CDFIs like HOPE Credit Union).

● Public Infrastructure

If your project is providing water, sewer, roads, bridges, parks, or anything else that could be loosely described as public infrastructure, it is a candidate for tax-exempt financing, and there is likely a specialty program that can finance your project at an even cheaper interest rate. Some of these will be direct (e.g., through USDA), but make sure that you bring your local officials in early, as they might pay for some of these costs directly.

● Housing

From HUD 221(d) loans for multi-family complexes to single-family housing loans facilitated through the Capital Magnet Fund (accessible only by CDFIs), specialty lending programs for housing abound, particularly when coupled with one of the other areas on this checklist (e.g., veterans, low-income individuals, energy efficiency, etc.). Additionally, low-income housing tax credits may make certain affordable housing projects work that might not otherwise be economically viable.

● Brownfield Site / Environmental Contamination

The Environmental Protection Agency and state actors make cheap debt and grants available for environmental remediation. This includes everything from hard metals in soil to asbestos in walls. If an industry operated on a site before you acquired it, or if the building is old, there’s a good chance it could be a brownfield site. Best points of contact for these programs are typically EPA regional field offices and state departments of environmental protection.

● Old / Historic Buildings

Historic preservation grants and state and federal historic tax credits are some of the best sources of incentives for older buildings that are historic in character. Contact your state historic preservation office or find a historic tax credit consultant near you to explore the possibilities.