Tips for Creating For-Profit Multibank CDCs
By Andrew Hamilton, Opportunity Alliance, LLC, Springfield, Illinois
Banks don’t have to be large to meet the needs of underserved populations in urban or rural communities. Increasingly, banks of varying sizes are joining forces and sharing knowledge under the auspices of multibank community development corporations (CDCs).
These corporate entities are rooted in the communities they serve and leverage local resources to create jobs, stimulate economic activity, and channel funds toward low- and moderate-income persons and neighborhoods.
Multibank CDCs offer a two-pronged advantage for providing credit to nontraditional borrowers: centralizing expertise and distributing specialized tasks among bank members. Working in this collaborative environment can save time and resources and give hope to struggling communities sooner than later.
While there is no single solution for forming a CDC from several investor banks or other organizations, a for-profit structure is sometimes preferable over a nonprofit one for the following reasons.
- Participating banks and stakeholders will likely see a return on investment.
- Money that banks pledge will not be drawn down until needed by specific borrowers.
- Establishing a for-profit entity is easier than setting up a nonprofit under the Internal Revenue Service Code. Forming a nonprofit CDC, however, could take as long as a year.
The following highlights several steps for investor banks and other organizations wanting to form a for-profit CDC:
1. Setting Up Pre-Organizational Meetings
The banks form a pre-organizational group and set up a meeting or series of meetings to discuss the community’s development and financing needs. The group vets the ideas with community leaders and draws up a list of high-priority needs into the CDC’s proposal for products and services.
2. Identifying Serious Investors
One way to separate serious bank investors from "tire kickers" is to include contingency language, such as "contingent upon adequate approval of the final CDC structure." This allows an individual bank to express interest in the initial idea but to withdraw if the final proposal is not to its liking.
Beside financial institutions, other potential investors include major corporations, units of government, development companies, utility companies, and other economic development stakeholders.
1. Articles of Incorporation
The group drafts articles of incorporation and submits them to the proper authorities with the agreed-upon structure.
By-laws should specify that shareholder voting rights are based on investment but allow for votes based on membership. Each investor generally receives a seat on the board of directors and has one vote each on the funding of loan requests. An investor may have cumulative voting when naming members to the board of directors. But, traditionally, once on the board, it’s one vote per board member. Avoid allowing veto powers or the ability for a member to decline a draw on a member’s subscription or weighted member voting. Such actions make for unequal representation and discourage smaller bank participation. With equal voting representation and decisions based on the strength of the majority, the members become team players.
3. Written Policy for Loan and Investment Decisions
Reach agreement on the types of investment products and services that the CDC plans to offer. These could be direct loans, subordinated loans, guaranteed loans, equity investments, or a combination of these financial assistance products. Then adopt a formal, written policy for the approval of loan and investment decisions.
Staffing and Operational Plans
The CDC may decide to think big and hire full-time staff or prefer to keep operational and administrative costs to a minimum. Alternatively, the board members may be hands-on and perform a number of operational duties for the corporation. No matter the approach, make sure to reach agreement on and document the startup plans as well as the short- or long-term operational plans.
Funding and Capitalization
Investors generally sign a one-page stock subscription agreement that establishes the maximum amount of allowable draw from each financial institution. When a project is approved, each investor allows a pro rata draw on his or her individual subscription on a shared basis.
The CDC could fund several projects with a minor draw on each subscription. Some investors may be under the impression that cash is expected up front to organize the CDC. This does not have to be the case. If bank investors sign a preorganizational subscription agreement, funds are earmarked and will be used only when a project is approved.
Signing a subscription initially has only a minimal effect on the bank’s income statement or balance sheet. The balance sheet change is booked only when the pro rata amount is drawn. Thus, a $1 subscription might have only 30¢ drawn in the first year or so. As a board member, the investor has a vote on whether the project is approved and, therefore, has control over the financial health of the portfolio.
CDCs often can close the gap between a borrower’s credit needs and the funding that is available from traditional lending sources. Banks investing in CDCs would carry their investment as an asset. See the Financial Accounting Standards Board’s "FAS 115" for a detailed explanation.
Operating Activities and Investment Guidelines
The CDC should formalize operating activities and investment guidelines. The guidelines should address the purpose or objectives of the CDC as well as:
- Eligible products and services.
- Investor eligibility and investment criteria.
- Rates and fees.
- Return on investment.
- Terms of loans and investments.
- Maximum and minimum amounts of investment or loan.
- Job creation.
- Resource leveraging.
- Application processes.
- Adequacy of collateral.
- Typical project structure.
- Project evaluation criteria.
- Financial analysis criteria.
- Servicing and collections.
After the CDC is formally organized, it must start marketing activities to generate new projects. The CDC can dictate the aggressiveness the marketing campaign. At the least, it should develop a fact sheet or brochure to summarize the CDC’s products and services.
Mass mailing — sending marketing materials to a directory listing of companies, major employers, and specific individual clients, for example — is a less costly but a more scattered, approach. A more time-consuming approach is setting up appointments with specific persons to solicit applications. The CDC should try a combination of these approaches.
Each board member should be able to provide relevant, potential contacts. Local entities, such as Economic Development Professionals, Chambers of Commerce, Small Business Development Centers, and the Senior Core of Retired Executives (SCORE), also are excellent resources.
Marketing the CDC is a collaborative effort for investors, city- and county-elected officials and administrators, and economic development professionals. When most — if not all — of the stakeholders are committed to achieving the CDC’s goals, the elements of success will be in place.
For more information, e-mail Andrew Hamilton at Opportunity Alliance, LLC
or visit his Web site