Open Capital Markets For Local Economies. William E. Scholz
Operators at these firms also do not have the personal and financial interest to see firms scale internationally, but to collect their paycheck, to think passively about growth, to not ruffle any feathers or make their boss upset. This is not how investment bankers operate!
Who serves the investment banking role for local economies?
The state of local economic development is fascinating for its byzantine structure and perceived inefficiency. Nobody seems happy besides the economic developers who receive great salaries without clearly having their performance measured by hard outcomes such as investment Dollars raised or jobs created.
The current licensure structure affords only financial brokers, intermediaries operating in financial capitals, to distribute investment banking licenses that allow investment banking professionals to solicit capital, compile investment prospectuses, and structure deals. A new intermediary is needed for cities outside of financial epicenters so that a new class of investment banking professionals can structure funds and deals that are appropriate for their specified region.
Many smaller to medium-size cities are currently exploring the creation of venture funds for startups and small businesses and additional funds related to real estate investing. These are equity funds that need the expertise of an investment banker to calculate, manage, and communicate risk on behalf of potential shareholders. There are currently no groups, public, private, or nonprofit, that fulfil this important function. Instead we have pockets of funds that are disconnected from one another, offer an inefficient and poor experience for shareholder investors, and cannot understand their rate of success in the context of other funds operating regionally.
As there is no individual investment banker function or firm, there is not enough data associated with deal flow to understand how we can mitigate risk for bold equity investors outside of major metros. This data must be made palatable for investors to better understand the internal rates of return that local funds can offer, again functions that are typically spearheaded by either an investment banking and advisory firm or ancillary data manufacturers that service the investment banking industry.
Consider a downtown economy that would like to revitalize its economy. This is an example we return to throughout this book, but it is a perfect example as to the complicated nature of financial relationships that are needed to coordinate investment capital within a region. If a region only focuses on one sector, such as real estate, but neglects sectors such as small business or existing manufacturers, the region will simply not generate enough juice to grow economically.
The missing Investment Banker and Investment Advisory Firm geared specifically to local economies is a gaping hole in the economies of smaller to medium-sized cities across the world. In addition to the sections outlined in this book, which take a comprehensive exploration of the nature of local finance, we hope to build awareness for this vital position.
Who Should Read This Book?
This book is not for the faint of heart. This book is for local policymakers to become better familiarized with the changes in the financial system that will come to their hometowns sooner or later. This book is also for management and economic professors who are seeking to better explore the nature of finance and entrepreneurship and small business ownership at the local level. Further, this book is for nonprofit groups who work on entrepreneurship as venture development or entrepreneur development organizations.
By reading this book, one can expect to take away a data-driven understanding about how financial capital works locally within the constellation of institutions, organizations, and firms of a geographic region. One can also expect to take away a much deeper understanding of new innovations related to financial capital such as equity crowdfunding and Blockchain, and their corresponding policy frameworks, that have still not been entirely finalized into United States Law.
Lastly, this book was written by its author, William Scholz, who is a passionate advocate for the importance of cities as the gravitational center for the economy in the 21st and 22nd Centuries. The secret ingredient to the economic growth of cities like New York City, London, France, and Los Angeles in the latter half of the 20th Century was an ability to leverage finance to increase the prosperity of all residents though admittedly unevenly distributed. We must inspire a much higher regard for all of our cities in the United States, especially small to medium-sized cities. We must aspire to creating cities that flourish in the 21st and 22nd Centuries as the major metropolises flourished in the latter half of the 20th Century.
Small Business And Capital In The 21st Century
Much like legislative efforts, the movement to increase resources for entrepreneurs represents a major positive development for the 21st century economy. This collective movement is known as entrepreneurial “ecosystem” building. In addition to more resources, academia has prioritized the study of entrepreneurship. Research efforts seek to understand what makes entrepreneurs succeed, what makes individuals capable of innovation and creativity, etc. The resulting research and know-how is packaged for local communities to benefit from in the form of ecosystem building.
All businesses start as small businesses. Some small businesses impact quality of life. Some small businesses scale rapidly as job creators. Many studies seek to determine the employment share of small businesses, which are defined as having less than 500 employees. One study suggests that large firms are net job destroyers because they lay off workers to improve efficiency during periods of economic stagnation [1]. By that logic, others argue that many small businesses lay off employees when they go out of business at higher rates than established firms.
The debate about job creation informs how much investment, low-interest rate loans, or grants are available for small business development. Resourcing small businesses or established corporates, for example through corporate tax cuts, are an important debate for the American economy. However, they may not be mutually exclusive from one another.
Practitioners and academics also debate what resources are helpful to entrepreneurs, a fundamental question for local economies across the world. How much resources should be available to support entrepreneurship, whether that is starting a new small business, a tech startup, or real estate development? After resources are invested, what is the return on investment for small businesses as a class?
Two different sets of resources and two different philosophies emerge to answer these questions. Resources are deployed either as entrepreneur development or venture development. Entrepreneur development seeks to train and prepare the entrepreneur for the road ahead. Entrepreneur Development Organizations support the entrepreneur with community, networks, and training independent of their venture.
Venture Development Organizations support companies, usually who have defensible Intellectual Property or market traction, with resources needed to quickly scale their operations. Resources might include grants, investment, or consulting services designed for startups.
Each of these resource providers will likely have a philosophy about how resources should be allocated. The first philosophy is the “tough love” approach. Entrepreneurship is brutal and hard. Resources should only go toward entrepreneurs who demonstrate ability typically by gaining customer traction without the need for resources. The convertible note is a good example of how investors seek to mitigate risk by requiring small businesses to have ongoing customer traction to access resources.
The second philosophy is the “market” approach. Resource providers see entrepreneurs acting within a capital market. The entrepreneur, perhaps based on previous success or the strength of their idea, can command pre-revenue investment for their startup. The investor views speed as the competitive advantage. If resources are deployed quickly, the entrepreneur has a better chance of success in a competitive global economy. Providing pre-seed grants to startups or pre-revenue equity investments are good examples of this philosophy. The SAFE investment contract is a good comparison to the convertible note.
Each set of resources or philosophies is not better or worse though many practitioners believe strongly in their chosen philosophy. However, the differences drive regional divergence and local economic development strategies. For example, some regions are heavily against a market approach to entrepreneurship.