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Traditionally, California, New York and Massachusetts have dominated the venture capital (VC) scene, comprising nearly 75% of all VC dollars in the United States. This has left VC firms and entrepreneurs throughout the rest of the country struggling to access or raise sufficient capital to grow their respective startup ecosystems in a meaningful way or to keep pace with the coastal VC markets.

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On March 11, 2021, Congress passed a $1.9 trillion federal stimulus package containing $10 billion for the State Small Business Credit Initiative (SSBCI), which will offer states and territories a once-in-a-generation opportunity to transform the capital landscape for entrepreneurs and VC firms. SSBCI was originally used from 2010 to 2017 to provide $1.5 billion to states to spur private investment. However, this new version is about seven times bigger, setting up major investment potential for states to exponentially grow their entrepreneurial ecosystems, stimulate job growth and develop new industries.

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The preliminary allocations for all states, territories and Washington, D.C. were released on May 7, 2021 by the Department of the Treasury, allocating hundreds of millions of dollars to several states, like Ohio, Pennsylvania, Michigan and Illinois. These amounts have the potential to transform America’s entrepreneurial capital landscape.

However, transformation is only possible if states structure the SSBCI capital in the right way. A crucial factor for success will be for the states to design programs that meet underlying market conditions and focus on capacity building for each of their respective ecosystems. If SSBCI is used to build long-term capital infrastructure, it could greatly expand the availability of venture capital for years to come, helping countless businesses grow, industries to innovate, and create jobs. As such, it is critical for states to begin building their allocation deployment strategies now to maximize the potential success of the program.

To maximize the potential for deployment and SSBCI success, states, territories and Washington, D.C. need to be savvy, willing to serve as the lead in fund formation and fund diverse investment professionals.

Use Capital to Grow More Capital.&nbsp;Rather than the typical model of government funding going directly to businesses (as seen with the Small Business Administration and other similar government funding projects), the states need to consider methods that will lead to multiplication of the available investment capital. One way to accomplish this goal is by creating investment funds charged with the specific goal of creating more investment funds, often known as “funds-of-funds,” which are pools of investment capital that help make more pools of capital. With the SSBCI influx of capital, each state could now develop its own. Only a few states created funds-of-funds with their last round of SSBCI money, and most of them put heavy constraints on them. Done well, these funds-of-funds can build entire capital markets to grow a multitude of startup and small businesses. In addition, the proceeds from these funds-of-funds can be recycled, so they become “evergreen” institutions. A coalition across multiple, traditionally underserved VC markets and traditionally well-funded markets alike, the Coalition of Development Finance Agencies (CDFA), has worked to formulate proposals that would allow state and local governments, through development finance agencies, to be immediate problem solvers that can help alleviate the extreme economic challenges facing small businesses and nascent startup communities.

Serve as the Lead, or Anchor, Investor.&nbsp;The lack of an anchor investor is one of the primary reasons new funds fail to launch. An anchor, or lead, investor often jumpstarts the activity of a fund and encourages other investors to participate by setting the material terms of the VC fund. While the government tends to be highly risk-averse, the SSBCI presents a once in a lifetime opportunity for state governments to lead the way to catalyze new VC fund formation – particularly early-stage venture funds, which are often difficult to raise. The difficulty in raising them results in funding gaps in the markets and deprives startups of much needed capital in their most critical of growth stages. Allowing the states to serve as the lead investor in VC funds could work to stimulate not only additional funds but could serve to fund and keep many startups in regions that they typically would have fled to look for coastal VC dollars to survive.

Prioritize Diverse Fund Managers. The SSBCI could also serve not only traditionally underserved geographies, but traditionally underrepresented fund managers as well. In venture capital, representation of women and/or racial/ethnic minorities among investment professionals remains abysmally low. According to the <a href="https://www2.deloitte.com/us/en/pages/audit/articles/diversity-venture-capital-human-capital-survey-dashboard.html" target="_blank" rel="noopener">VC Human Capital Survey</a> conducted by NVCA, Venture Forward and Deloitte:

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By focusing on diversification of general partners, as well as underserved geographic regions, the states can help accelerate gender and racial parity in VC.

In sum, the potential for the deployment of $10 billion of SSBCI money into underserved markets and to underrepresented general partners could result in a fundamental paradigm shift in the VC markets, spreading capital more evenly across the country, spurring innovation in regions that typically have lagged their coastal counterparts, and creating new jobs through the creation of new industries. However, successful outcomes in the various states, territories and Washington, D.C. will hinge on the states’ commitment to capital growth, willingness to take additional risk, and ability to service a more diverse investment population.

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Lindsay Karas Stencel 614.469.3222 <a href="mailto:Lindsay.Karas.Stencel@ThompsonHine.com">Lindsay.Karas.Stencel@ThompsonHine.com</a>

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Underserved Capital Markets to Receive Major Federal Boost