Investment strategies should fit economic development objectives

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Minnesotans, like most Americans, are looking for ways to pick up the pieces from this recession and are scrambling for ways to raise capital when traditional sources of venture capital have dried up or turned cautious.

Final part of an ongoing series. Click here to read part three.


Cautiousness was overdue. The choking of traditional flows of capital and credit, however, is the result of the severe financial crisis that has rocked the nation’s economy and spread worldwide and triggered unprecedented federal rescue efforts for banks.

Given this investment environment, this makes a perfect time for entrepreneurs, business, labor and community leaders, and economic development planners to step back and look at ethanol development in Minnesota.

Ethanol development was singled out in this four-part series because the renewable fuels industry is the most visible of new development in Minnesota. In part one, it was argued that the ethanol plants are a success for some farm investors but not for all investment bankers who partnered with the farmers. Part two included a research paper by Minnesota 2020 intern Aparna Bhasin that quantified the more than $1 billion in higher Minnesota farm income derived from these plants. And part three reviewed “agency theory” problems identified by Minneapolis native Michael Jensen and colleague, the late William Meckling, that show the clash of interests that occur among different classes of shareholders and stakeholders.

This final installment is a call for fresh thinking to build on Bhasin’s findings and to avoid the conflicting interests, or agency theory problems, identified by Jensen and Meckling. Let’s again return to ethanol:

Farm investments in local ethanol production companies are nearly identical to farm investments in cooperatives. While these plants are mostly limited liability companies with different investors, they operate like a co-op for the farmers in that they create a local market and add value to local crops.

Gert van Dijk, a Dutch economist currently serving as president of the farm cooperative council for the European Union at Brussels (COGECA), has identified the key difference between investing in cooperatives and in publicly traded stock corporations.

The co-op has two, or a dual bottom line objective for investor-members while the public stock company has one (see reference below). The co-op must be profitable in its own right to withstand competition, constantly modernize and adapt to changing market conditions. At the same time, he argues, the co-op must make its member-owners more profitable or more entrepreneurial in their own business or households. In contrast, passive stock investors are looking for returns on investment (ROIs) and grade management according to how well they provide those returns, regardless of the goods or services produced by the firm.

It needs to be stated that privately owned companies fall in between these extremes when a founder or family owners seek both profitability and sustainable business activity for good of community, employees and other stakeholders.

Looking at the ethanol example, the new industry has delivered on dual objectives for Minnesota farmers. But it is hard to imagine outside investors sitting around Wall Street and finding comfort in having helped raise Minnesota corn prices by $1.22 a bushel.

St. Paul native Michael Boland, an applied economist and co-op educator at Kansas State University, said the lesson from ethanol development should be the importance for community investment funds with clear, transparent objectives. Investors in a community investment fund are willing to receive lesser returns on their investment when they know it is for a common good, he said.

In the meantime, AgStar Financial Services at Mankato has assembled a group of financial institutions and creditors to buy six ethanol plants from VeraSun Energy Corp. of Sioux Falls, S.D., from a bankruptcy auction. Paul DeBriyn, president of AgStar, said the group’s intent is to sell these rescued plants back to farmers or farm cooperatives.

Several Minnesota ethanol plants, however, have Granite Falls and Sioux Falls design and build companies as investment partners. In these instances, the architects, engineers, contractors and plant operators are adding value as investors to their own skills and activities, and that gives them dual objectives along with their farm partners.

All this comes to mind as workers and civic groups in a number of stressed industries ponder ways to resuscitate business and industry hard hit by the recession and other factors.

For instance, the Minneapolis-based Star Tribune newspaper is in bankruptcy. As reported in the St. Paul Union Advocate newspaper (Moore), Minnesota Newspaper Guild and other union employees at the Star Tribune handed out “Save the Strib” bumper stickers and scorecards at the Minnesota Twins’ home opener on April 6 at the Metrodome.

Since newspapers are both capital intensive and labor intensive, communities have much at stake economically in keeping major media alive and operating. That is the dollars-and-cents bottom line even before a newspaper’s community service is considered.

Similar problems are facing industries and companies all across Minnesota. The spillover problems with employment and local economic activity back up on communities, their retailers, their service providers, and their local schools and governments.

How, then, should civic leaders and local investors structure investment pools to revive their local economies?

Community investment funds as suggested by Boland are one underutilized option. They could be structured to allow investors either interest payment returns on their investments or equity accumulation in the firm.

Minnesota’s 308B cooperative business model and the newer low-profit, limited liability companies (L3C) model that has spread from Vermont to several states are useful tools for helping communities and stakeholders to start or rescue companies. And examples of creative ways to use interest rate payment rewards for economic development purposes can be found close to home.

The McKnight Foundation and local housing groups announced April 28 that McKnight was contributing $10 million to loan funds to buy and renovate foreclosed housing in an effort to stabilize urban neighborhoods (Snowbeck). When the properties are resold, McKnight will be repaid.

Historically, McKnight has been a huge grant maker, not a lender. The new concept was referred to as “program-related investment.”

Another great example is the Community Reinvestment Fund, USA that is a national nonprofit organization conveniently headquartered in Minneapolis. It uses the secondary market to leverage capital from primary lenders and has made more than $1 billion in community development loans available to low-income and disadvantaged communities since its founding in 1988.

Valerie Hohman, who works with both clients and lenders on certain CRF programs, said her group holds second liens but doesn’t acquire equity in the homes or businesses that it helps. But by taking away some risks, it helps financial institutions to step in and make capital available that wouldn’t otherwise be accessible.

One of its programs is the CRF Individual Investor Program that allows individuals to make a social investment into the organization’s work.

Not surprising, CRF has also been supported by grants from the Otto Bremer Foundation, Minneapolis Foundation, Travelers Foundation and the Bush Foundation, along with social corporate responsibility arms of major banking firms from across the nation.

Models for reviving Minnesota’s economy are available, and growing. Expertise is close at hand. But any attempt to muster social investments must have transparent objectives for all stakeholders and shareholders.

Monetary returns on investments are easy to measure, whether as dividend payments, interest payments or return on equity (ROE). Returns from social investment are more difficult to gauge.

The latter brings up public investment and support. “Economists always ask, ‘Is it a public good or a private good,’ and it isn’t always clear,” said Mary Edwards, a regional economist and head of the Minnesota Economic Development Center at St. Cloud State University.

She isn’t sure that agency theory problems with different classes of shareholders and stakeholders can ever be avoided. But at the same time, Edwards added, evaluating public and private benefits of development would help shape investment strategies.

Jobs are probably the easiest benchmark for measuring investments. Local economic activity that reaches to suppliers and retailers is harder to weigh. But will a development effort lead to more taxpayers and tax revenue to supports schools and local services for the common, public good, is equally important.

Given the current economy, the time is right to ask the questions and use and adapt the tools that are available

References

CRF USA. “Community Reinvestment Fund USA Receives $110 Million New Markets Tax Credit Allocation to Stimulate Small Business Growth.” Oct. 22, 2008, a press release available at www.crfusa.com.

Moore, Michael. “Strib workers ask public to help save newspaper.” St. Paul Union Advocate. April 17, 2009.

Snowbeck, Chris. “Nonprofit loan fund to prop up housing.” St. Paul Pioneer Press. April 29, 2009.

Van Dijk, Gert and L.F.M. Klep. Als ‘de Markt’ faalt. Den Haag: Sdu Uitgevfeers bv. 2005.

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