Undercapitalization is the chronic condition for most small business owners, especially manufacturers. It impedes their ability to buy needed equipment, hire new talent, invest in research and innovation, and access lines of credit to support daily operations. These challenges loom even larger for entrepreneurs of color who—as a result of inequitable and discriminatory practices in education, employment, and the financial system—experience a yawning wealth gap relative to white families, depriving them of capital to start or grow businesses.
Cohort member Inner City Advisors (ICA) recognized that small businesses can drive wealth-building opportunities for owners and their employees, especially for women and people of color. But ICA knows too many small business owners lack access to the growth capital—and the coaching and connections that help fuel growth and build wealth while creating good jobs in their communities. This is especially true for owners who are women or people of color, who are often turned down for financing because they have insufficient assets—a legacy of structural inequities resulting in a racial wealth gap.
To begin to address that gap in an innovative way in the San Francisco Bay Area, ICA is helping to deploy convertible debt as a way for undercapitalized entrepreneurs to attract investment to their growing companies. A convertible note is a flexible financing tool that is structured as debt—including terms and interest rates— but that can convert to equity at maturity. This is an especially attractive option for the owners of growing businesses who can decide either to repay the note with increasing revenues, or allow the notes to convert to investor equity knowing that the overall value of the company is increasing (and, therefore, not unduly diluting owner equity). Convertible debt is also relatively easy to put in place; agreements don’t require a company valuation, as stock agreements do and the legal agreements are typically much simpler. And, importantly, these funds show up on companies balance sheets as assets, which improves their ability to pursue loans from traditional lenders.
In addition to capital, ICA also offers a structured, four-month acceleration program that includes mentorship through a network of 60 pro bono professionals who ensure growing businesses have crystallized their growth strategy, including a plan for attracting and onboarding talent that will be aligned with the growth strategy, and preparing for additional rounds of investment. About 30 companies, approximately a third of whom are manufacturing businesses, have gone through ICA’s accelerator with five receiving investments, through convertible notes, totaling $2.5 million. ICA estimates that these companies have earned $30 million in revenue and support 350 jobs. In the past 5 years, the equity ICA has invested has grown by three times (though not all of it is yet liquid).
ICA’s focus is agnostic in terms of sector. Their primary focus is on businesses that are creating good jobs that are accessible at the entry, pay family-supporting wages, and have pathways to advancement.
ICA’s CEO, Allison Kelly, saw the opportunity to increase both the volume and velocity of their convertible debt investments in high-growth-potential entrepreneurs of color. She is currently raising a new $10 million fund and is working with ICA’s network of community-based partners to identify potential candidates for future investment and acceleration. “We have an impressive set of robust selection criteria,” Kelly says. “Our primary focus is on a business’ fundamentals—a sound business plan and growth strategy. But we also focus on metrics that support the impacts ICA is looking for, including employment opportunities with quality jobs and opportunities for wealth building. Applicants get extra points if they are people of color or women. We think it’s profitable to invest in businesses owned by people of color and women; we want to help them grow their firms into true assets that create wealth for them and their employees.”
This case study was co-authored by Mark Foggin and Johnny Magdaleno and published in 2020 as part of the Urban Manufacturing Alliance’s “Forging Fairness: How community-based lenders are centering both inclusion and manufacturing to promote equity [link to report].” This report highlights the work of practitioners in UMA’s Pathways to Patient Capital cohort and how these leaders are helping entrepreneurs of color – including makers and manufacturers – access to the capital and know-how they need to realize their business ideas and plans at scale.