In February 2021, UMA’s Pathways to Patient Capital Learning Session explored “Private Sector Guarantees and Guarantee Pools.” We focused on guarantees and guarantee pools as a risk mitigation strategy for CDFIs and other nonprofit lending institutions supporting small businesses, such as manufacturers. Serving as subject matter experts, Vickie Lakes-Battle, Executive Director of IFF Chicago, Cate Fox, Senior Program Officer-Chicago Commitment of the MacArthur Foundation, and Fran Lutz, Intermediary Specialist of Community Investment Guarantee Pool, shared their experiences working with guarantees and discussed how these tools opened the door for loan recipients to access technical assistance and stable funding. Allison Kelly, Chief Executive Officer of ICA, moderated our conversation, guiding the discussion how guarantees work and the ways they can be applied to funding institutions serving the manufacturing industry.

Private Sector Guarantees Defined: What Makes Them Useful for Funders
Similar to SBA loans and state level guarantee programs, private sector guarantees work as a form of credit enhancement for lenders. This is a form of insurance that enables CDFIs and other funding institutions to participate in funding business and community development opportunities that have a high perception of risk uncertainty. Private sector guarantees aim to create a structure around those opportunities to share the risk with lenders and help mitigate some of the lender’s losses. As these private programs are usually coming in with an institutional level of guarantee with $1 million dollars or more, this high level of backing helps make investors more comfortable adding capital to risky projects because guarantees lower the risk perception behind the project in question. This is particularly innovative for funders in the manufacturing and small business space considering that guarantees “basically, in the private sector, credit enhancement and insurance programs don’t really exist, especially on the small business side of things,” said Fran Lutz of the Community Investment Guarantee Pool.. The Community Investment Guarantee Pool is a pilot and test case. However, they are not alone in building a case for this innovation.

Vickie Lakes-Battle and Cate Fox are partners in the MacArthur Arts and Culture Loan Fund, with IFF and MacArthur providing a guarantee that enables local artists and small arts businesses to obtain financing. Although the MacArthur Loan Fund is centered around the arts, the nature of frequent cash flow transactions and working capital needs has strong connections to manufacturing start-ups. “[We are] incentivizing financial institutions to provide working capital lines of credit to artists and creatives. And these are not large loans. [Only] between $50,000 and $100,000, typically for a 1-year term, but they give organizations breathing space and to address difficulties for the cash flow purposes,” said Fox. For these same reasons, these financial products would also benefit small- and medium-sized manufacturers.

Guarantee Programs and Accompanying Tools Can Lead to Long-term Relationships and Understanding of Industries
For our panelists from the MacArthur Arts and Culture Loan Fund, their guarantee program shed light on deeper business needs and opportunities for continued collaboration and support. Reflecting on their early goals and actual outcomes, Fox shared, “I think in the beginning the philosophy behind the program was that it would provide that bridge for these arts organizations, temporarily… and it would be magical. What we found when we did a five-year look back was that wasn’t what was happening at all. Organizations were staying inside the program, in part because the structure of it was supportive and took their needs into account. They stayed inside the program, in part because it was just better financially for them to do it, and we got a lot of feedback from the organization saying this is what we think is working well.”

The guarantee program structure has also given funding recipients an opportunity to share their narrative which has then led to a better understanding of the core business model from their partners. Lakes-Battle re-emphasized the importance of lifting up these narratives in the arts and manufacturing space saying, “It has so much to do with the sharing of individual stories, connecting the dots, understanding inputs, outputs, the why behind the what, and I don’t think that there’s enough of that. So, when I think about it conventionally, manufacturing probably has less risk. But I will say, I can’t understate having deep knowledge in the sector.”

Achieving Equity Requires Us to Acknowledge the Structural Inequity in Capital Systems
Additionally, guarantee pools and programs can encourage deeper and ongoing conversations between lenders and the businesses they support, providing a bridge for shared language and communication particularly surrounding perceptions of risk. As we’ve highlighted in our past Learning Session on “Nontraditional Underwriting Standards,” the ways we conceptualize and quantify risk can create barriers to capital. Over the course of her career, Lakes-Battle has coined this as understanding “real risk versus perceived risk.” “I’ve come to understand risks as the things that we don’t understand and haven’t really invested the time to learn about. And therefore, it’s labeled as risky. And I entered this conversation with that framing, because the necessity for the guarantee is risk mitigation,” shared Lakes-Battle on her work with the Loan Fund and other IFF projects. Similar to manufacturing, the art sector presented the funders with a lot of assumptions and misunderstandings about the industry that the guarantees didn’t necessarily solve but made them “more comfortable with their lack of understanding.”

Kelly cited her own work at ICA noting how many of these investment opportunities “are not as risky as we expect them to be.” She prompted the panelists and attendees in further exploring this phenomenon detailing how these preconceptions and lack of understanding have implications for inequitable outcomes. The group reflected on how the world of banking and finance has traditionally defined risks as beyond our periphery of understanding i.e., outside of the box. Lakes-Battle expanded on insights from her years in the field, saying “Particularly, as community development financial institutions, we’re charged with taking organizational needs and interests that are outside of the box. Going back to my definition of risk as things that we don’t understand and haven’t invested the time to learn about, [we’re] trying to cram them into a box. Then, we’re trying to create solutions to make them conform…And so even as we bring this into manufacturing, yes, there are the challenges with manufacturing broadly. And then on top of it, when you look at the use and application of guarantees to de-risk the deal, you can’t ignore those challenges that are then further exacerbated among Black and brown operators in this space.”

“Perceived” Risk Mitigation Was the Core Theme Behind These Solutions
Citing Lakes-Battle’s strategic insights on structural barriers, racism, and perceived risks, Lutz’s commentary on the drive behind these private sector guarantees and guarantee pools highlight a recurring theme in our risk mitigation sessions: “we’re trying to prove through these models that using small business financing organizations that having a minimum credit score of 650 with no bankruptcies in your past history, no felonies in your bank history, or being able to finance 100% of the startup organizations capital with a little bit of thin equity is not a direct correlation to a successful business. So, these tools [that] have risk mitigations or these perceived risk mitigations, I am hopeful, will demonstrate over time that the credit scores, the collaterals, and the LTVs (loan-to-values) are not the most effective way of actually serving your market and deploying capital efficiently in our community.”