(co-authored with Ian O'Grady, Mary Jean Ryan, Ross Baird and Colin Higgins) 

In the six months since we launched the Innovative Finance project a central theme has emerged: delivering capital to where it’s needed most — namely, to millions of underserved entrepreneurs — is a central challenge for an inclusive economic recovery.

Somewhat unexpectedly, the large sums of federal and private capital currently available for investment have illustrated a more fundamental truth in our country’s small business finance system. Capital is not the problem, delivery is.

Many communities across the country are in need of pipelines through which capital can flow and reach a diversity of entrepreneurs. Capital delivery systems are remarkably uneven across the country. Coverage from CDFIs, community banks, and other lynchpins of small business lending varies significantly from community to community and in many places is unavailable altogether. Even the most innovative financial products are no good if there’s not the local delivery system to meet entrepreneurs where they are.

The good news is that solutions to these capital delivery issues exist. Significant ecosystem investments — in local capital providers and entrepreneurial support organizations— can help connect underserved entrepreneurs. And these investments need to happen alongside new capital products to truly tap our nation’s latent entrepreneurial potential.

The State Small Business Credit Initiative (SSBCI) presents an opportunity to address this delivery challenge. But states will need to act soon. The first installment of the program’s $10 billion is set to flow in the first few months of 2022, Treasury has set a deadline of February 11 for states to submit final applications. This means that over the next two months, states will need to establish programs that address this emerging delivery backlog.

SSBCI 2.0 is an ambitious renewal (and dramatic scaling) of an Obama-era small business program that poses unique opportunities and challenges to our nation’s capital delivery systems. The SSBCI program provides flexible capital to states to be allocated to programs that directly invest in entrepreneurs and small businesses across a full continuum — from individual sole proprietors to startups targeting explosive growth — a major opportunity for entrepreneurial growth in the United States. It also poses significant challenges that will test our nation’s local capital delivery systems (which did not pass the test posed by the Paycheck Protection Program):

• The size of the $10 billion in SSBCI cannot be emphasized enough. It represents an unusually large amount of money, dwarfing what almost all private (let alone public) funds could raise in a decade’s time. This is a tremendous opportunity for entrepreneurship.

• The ambition of the program matches its size. States are asked to simultaneously do three things in SSBCI 2.0: reach businesses that get a 10:1 ratio of private leverage, reach “Very Small Businesses” with fewer than 10 employees, and reach businesses owned by Socially and Economically Disadvantaged Individuals (SEDI), for which the program sets aside $1.5 billion.

The bad news is that taking advantage of the SSBCI’s historic opportunity requires states to think fast and plan early. Earlier this month the US Treasury Department released detailed guidance for how states may structure their SSBCI capital programs. Designing programs to take advantage of additional public funds and invest in ecosystems will require states to act strategically. State leadership will need to quickly convene a diversity of partners and ecosystem players to maximize the impact and meet the program guidelines.

Below we offer state leaders across sectors a framework of three strategies for deploying SSBCI 2.0 for maximum impact:

1. Strengthen and build capital delivery systems across geographies
2. Deliberately focus on reaching and scaling underserved entrepreneurs
3. Spur virtuous cycles of innovation through venture capital programs

Together, these three strategies address the SSBCI program’s at times competing objectives while hitting on two north stars of state and local economic development: growing the economic pie (innovation) and distributing it more equitably (inclusion). Likewise, these strategies focus on actions that Treasury can consider as they clarify and implement their final guidelines. Below we elaborate.

Strategy 1: Strengthen and build capital delivery systems across geographies

SSBCI presents an opportunity to invest in, and if needed to create anew, entrepreneurial support organizations and capital intermediaries that are community-focused and able to offer personalized small business support. As we wrote in July, SSBCI has potential to serve as a balance sheet expansion program for capital-strapped local CDFIs, credit unions, and community banks. These have historically served as key points of access to capital for local entrepreneurs. Investing SSBCI funds in them presents an opportunity to support and scale already-existing, quality technical assistance program and support networks. In the 2010 version of the program, the state of Georgia was exemplary — the state invested in a network of CDFIs and allowed them to keep loan repayments, infusing cash into community lenders whose balance sheets were hurt by the recession.

For the many communities across America that lack CDFIs — or even the most basic local lending capacity — SSBCI represents a potential opportunity to build a distribution pipeline. The current SSBCI program includes $500 million for technical assistance that can be put towards building the administrative support needed for businesses to become capital-ready. As of yet, however, it is unclear whether this money will be available before SSBCI capital investment dollars flow to states. According to the aforementioned Treasury’s guidance, applications for technical assistance grants are due in March, after states submit plans for SSBCI capital programs.

This banal point of program deadlines creates a very real time-crunch for states to build technical capacity — and by extent creates delivery risks for SSBCI. States will need delivery capacity to come online before they can fully meet the potential of SSBCI funds. It’s very possible that states will have SSBCI capital before they have been able to scale up with the staff necessary to underwrite and issue loans, slowing deployment. More fundamentally, these deadlines limit the ability of states to develop more holistic ecosystem-building investments — such as expanding the capacity of entrepreneurship support organizations, for example, or through novel program design such as alternative underwriting or revenue-based financing. The upshot is that, in the face of this time crunch, many states may fall back to traditional, less inclusive forms of capital when they submit their February 11 application, especially with Treasury’s requirement that state programs be of the executed SSBCI allocation agreement.

How to fix this issue and build a more capable system:

• As soon as possible, Treasury should allow states more flexibility in their February applications to elaborate on how they may adapt or innovate their SSBCI capital programs, so they have permission for future program adaptation.

• As soon as possible, States, hopefully with help from the Treasury, should work to get technical assistance money online ASAP. If they are unable, states should consider making ecosystem-building investments with State and Local Fiscal Recovery Funds from the American Rescue Plan (or using other private and civic sources).

Strategy 2: Deliberately focus on reaching and scaling underserved businesses

With investments in capital delivery systems elaborated in Strategy 1, states should focus on inclusion in reaching underserved entrepreneurs. This is often easier said than done. But it is especially difficult given the multiple goals SSBCI 2.0 is trying to achieve — a minimum 1:1 private-SSBCI capital match requirement, a targeted $10 of private investment for every $1 of SSBCI money across the program, and a large portion of funds reaching SEDI businesses.

The Nowak Metro Finance Lab has been collaborating with the National League of Cities Center on City Solutions on strategies for boosting inclusive entrepreneurship (look out for a forthcoming publication!). From this work, we’ve gleaned that can be helpful as states set up SSBCI programs. We suggest a few tactics states can deploy to deliberately focus on reaching and scaling underserved businesses:

Action: Assess the Ecosystem Baseline

By using available data to investigate the sectoral composition and size of businesses by race and ethnicity (with tools like our Small Business Equity Toolkit), state leaders can identify opportunities to implement capital products that better serve sectors with high representation of Black and Brown businesses. This is a key starting point for SEDI investment and building inclusive ecosystems generally. Through the Innovative Finance project, the authors have been able to pinpoint opportunities to implement new financial products that better serve entrepreneurs in different sectors — especially those in those with high representation of SEDI businesses.

Action: Convene capital behind the cause

After receiving SSBCI funds, state leaders are uniquely situated to convene organizations with capital behind funds and intermediaries serving specific regions, sectors, neighborhoods, and entrepreneurs. This is especially true for more risk-tolerant angel or civic-minded investors. Treasury still needs to clarify which funds can count towards private leverage. Meanwhile, Innovative Finance cohort members[1] are seeking clarification on sources such as EDA Revolving Loan Funds, Community Reinvestment Act-eligible private investment from large banks, and new federal money available to Minority Depository Institutions and CDFIs focused on financial services deserts. Moreover, private and philanthropic actors, coming off banner years in capital gains, are eager to invest in inclusion: targeting these investments to amplify SSBCI through ecosystems would be an impactful move.

Action: Customize capital to reach entrepreneurs across the continuum

Examining the national data shows firms are concentrated by race or ethnicity in different industries. Black- and Hispanic-owned firms are highly concentrated in construction industries. With funds incoming from the bipartisan infrastructure act, state authorities should ready financial products to support supplier diversity efforts. New York State, for example, used SSBCI 1.0 funds for a surety bond program to boost minority contracting. They were able to measurably increase Black- and Hispanic-owned business representation. Receivables financing in particular shows promise as a new way for scaling Black and Hispanic-owned businesses to fulfill large public contracts. Meanwhile, 95 percent of Black-owned businesses are non-employer firms. Revenue-based financing (RBF), typically with no collateral requirements and flexible payment structures, is another innovative product worth investigating for states that would help Black solopreneurs buy equipment, hire, and make other investments necessary to grow and create jobs — RBF loans that can be enhanced and de-risked by SSBCI loan loss reserves.

Action: Evaluate existing SBA programs with an equity lens (Pending Treasury Guidance)

Analysis also shows that a disproportionately large share of Black- and Brown-owned firms come up short in qualifying for 7(a) or 504 loans, the most common SBA tools for reaching small businesses. This is because they lack collateral or owner equity. With additional guidance, Treasury could (and in our view, should) encourage states to use SSBCI to fill these equity and collateral shortfalls, a potential boon for inclusive local lending. It is currently unclear from Treasury’s November guidance whether states can directly support SBA transactions with SSBCI funds. If allowed, this would unlock capital and the SBA’s workhorse programs, for a whole new range of transactions that benefit Black and Brown entrepreneurs (and helping states achieve SEDI investment goals). We encourage the Treasury to work closely with SBA on this and to grant permission for certain types of cross-program collaborations ahead of time.

Strategy 3: Spur Virtuous Cycles of Innovation with Venture Capital       

This third strategy focuses on growing the economic pie through innovation. This strategy should look most familiar to states and economic development practitioners: investing in high-growth-potential, early-stage start-ups. Though it’s less common for states to invest directly at this scale, a common strategy among states and cities looking to drive economic growth is to attract innovators and investors, harness the benefits of local unicorns, and, often, catch headlines for local success stories and venture investor attention.

With SSBCI, states have the ability to directly invest in professionally-managed Venture Capital (VC) funds and guide investment. This has the benefit of being better tailored to local cluster development and specific industry growth. With this newfound influence on directing VC investment, government officials can also infuse more equitable investing practices into the process through, for example, peer-based decision making and other investment policies that infuse democratic decision-making shown to improve both representation and returns.

Beyond supporting high-growth innovation economies, states can target high-leverage SSBCI venture capital investments to reach the 10:1 overall program target. Such targeting will allow them to balance against lower-leveraged products targeted at more main street entrepreneurs (though many states did successfully hit, or exceed, 10x leverage with more main street-oriented products). With SSBCI 2.0, states cannot afford to focus solely on VC ­while neglecting the other lower leverage capital products that are needed to reach the bulk of SEDI businesses.

At a higher level, states should focus on strategies that invest SSBCI funds alongside other federal investments. This could include: the EDA’s Build Back Better Regional Challenge grant funding, Small Business Innovation Research (SBIR), Small Business Technology Transfer (STTR), and Manufacturing Extension Partnership (MEP) programs. If used together, these programs put states in a stellar position to transform their economic fundamentals over the coming decade.

Two examples from SSBCI 1.0 show the potential impact of deploying SSBCI in concert with a regional innovation strategy:

• Benson Hill, Missouri’s billion-dollar regional play: Benson Hill, an Ag-Tech company based in St. Louis that is now a $2 billion unicorn that went public this past October. This firm was seeded through a combination of federal dollars and state programs, including the Missouri Tech Corporation’s IDEA Fund Co-Investment Program, launched with SSBCI 1.0 dollars. Beginning in 2013, the company received Phase I and 1b STTR funding along with a SBIR grant from the US Department of Agriculture. The Missouri Technology Corporation, created by the Missouri General Assembly to distribute public risk capital, participated in Benson Hill’s follow-on Series B round in 2017. An SSBCI-backed fund boosted the business while helping Missouri invest in its regional economic development and become home to a $2 billion unicorn.

• Baby Vend, Anchorage leveraging equity for underserved entrepreneurs: When the state of Alaska declined its SSBCI 1.0 funds, Anchorage stepped in and took the opportunity to invest locally and diversify its economy beyond oil and gas, mining, and seafood harvesting industries through SSBCI. As a result, the Municipality of Anchorage manages several funds through the 49th State Angel Fund (49SAF) that invest in new business opportunities 1:1 alongside private capital, with a dedicated focus on local and traditionally disadvantaged entrepreneurs, and only in equity deals (this is unusual among locally-focused funds outside of major markets and traditional tech hubs). Among its most impressive features, 49SAF funds have created a virtuous cycle: they were seeded by SSBCI 1.0, and successful investment returns now fund operations, future investments, and ecosystem and entrepreneurship support programming. One recent 49SAF direct investment is Baby Vend, a baby supply vending machine company started in Anchorage by Jasmine Smith. The company is expanding nationally to the lower 48 and on track to become the largest company in the industry. 49SAF demonstrates the potential for SSBCI funds to invest in promising industries and individuals, scale promising local companies, and reinvest its returns into new companies, programming, and other local ecosystem- and pipeline-building entrepreneur support.

Conclusion: the delivery race is on

Given its size and scale, SSBCI 2.0 represents a tremendous opportunity and challenge to modernize the nation’s capital distribution system, so it is more inclusive and dynamic. Doing so will test the system. We are optimistic. But it will take work and quick thinking. Whether this game-changing investment reaches its full potential in driving innovation and inclusion will be determined by actions taken now in communities and state capitols across the country and in the halls of the Treasury Department.

We have provided a framework that we hope guides conversations and decisions over the coming months. The potential for innovation and need for leadership could not be more pivotal as states face decisions that will shape the reach, scope, and success of SSBCI – and by extension the nation’s ability to deliver a continuum of capital to a continuum of entrepreneurs.