michigan small business lending study sm… · · 2008-08-26electronic or hard-copy transmission...

Michigan Small Business Lending Study Commissioned By: The Michigan Economic Development Corporation

STRATEGIC DEVELOPMENT SOLUTIONS11150 W. OLYMPIC BLVD. SUITE 910

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CONFIDENTIAL

This document and any electronic transmissions or correspondence accompanying this document contains confidential information belonging to the Michigan Economic Development Corporation. The information contained in this document is proprietary and legally privileged. The information is intended only for the use of the individual or entity to which Strategic Development Solutions, Economic Innovation International, Inc. and the Michigan Economic Development Corporation has forwarded it. If you are not the intended recipient, you are hereby notified that any disclosure, copying, distribution, or the taking of any action in reliance on or regarding the contents of this electronic or hard-copy transmission is strictly prohibited.

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Table of Contents

1.0 EXECUTIVE SUMMARY 5

2.0 PROJECT SUMMARY 12

3.0 THE STUDY TEAM 14

4.0 METHODOLOGY 15

4.1 Definition of Small Business for This Study 15

4.2 Definition of Small Business Loans for This Study 15

4.3 Bank Interview Methodology 16

4.4 Small Business Interview Methodology 19

5.0 CONCEPTUAL FRAMEWORK 23

5.1 Thinking About the Market for Small Business Lending 23

5.2 Understanding Barriers to Efficient Goods and Capital Markets 24

5.3 Financial Capital in the Market: Risk and Return Profiles 30

6.0 MEDC STUDY QUESTIONS 36

6.1 Aggressiveness of Bank Lending in Michigan and Comparison States 36

6.2 Aggressiveness of Bank Lending by Sector 48

6.3 Level of Bank Default and Loss Rates 49

6.4 Impact of Manufacturing Sector Decline on Lending 56

6.5 Differences in Lending to Growth vs. Traditional Businesses 63

6.6 Niche Banks and Industry-Specific Lending 73

6.7 Lending to Firms with Non-Traditional Assets 78

6.8 Lending Behavior of National Banks 79

6.9 Life Sciences Sector Growth and Lender Support 83

6.10 Community Banks and Small Business Lending 87

6.11 Composition of Community Banks in Comparison States 89

6.12 SBA Lending in Comparison States 93

6.13 Initiatives to Promote Community Bank Lending 99

6.14 Innovative Programs and Models for Lending 101

7.0 CONCLUSION 108

8.0 APPENDICES 109

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List of Figures Figure 4.1 Banks Interviewed by Assets, Small Business Loans Percentage, and Average Loan Size ............................. 19 Figure 5.1 Different Sources of Capital on the Risk-Reward Frontier ................................................................................ 25 Figure 6.1 Total Bank Assets in Michigan and Comparison States (2000–2006) ............................................................... 37 Figure 6.2 Average Number of Small Business Loans at an Institution in Michigan and Comparison States ............... 38 Figure 6.3 Total Number of Small Business Loans in Michigan and Comparison States (1998–2006) .......................... 39 Figure 6.4 Total Small Business Loans ($B) in Michigan and Comparison States (1998–2006) ..................................... 40 Figure 6.5 Average Small Business Loan Total ($) in Michigan and Comparison States (1998–006) ............................. 40 Figure 6.6 Average Small Business Loan Size ($) in Michigan and Comparison States (1998–2006) .............................. 41 Figure 6.7 Small Business Loans as a Percentage of Total Assets in Michigan and Comparison States (2001–2006) .. 42 Figure 6.8 Small Businesses Loans as Percentage of Total Business Loans in Michigan and Comparison States ......... 43 Figure 6.9 Number of Loan Originations in Select Counties in Michigan (1996, 2001, 2006) ......................................... 44 Figure 6.10 Amount of Loan Originations ($) in Select Counties in Michigan (1996, 2001, 2006) ................................... 45 Figure 6.11 Allowance for Losses on Loans and Leases to Gross Loans in Michigan and the Nation (1966–2006) ..... 51 Figure 6.12 Allowance for Losses on Loans and Leases to Gross Loans (10-year Weighted Average) in Michigan and

Comparison States (1967–2006) ............................................................................................................................. 52 Figure 6.13 Bank Allowance for Losses on Loans and Leases to Gross Loans of Total (%) Loans in Michigan and the

Comparison States (2000–2006) ............................................................................................................................. 53 Figure 6.14 Total Loans by Commercial Banks Headquartered in Each State in Michigan and Comparison States ... 53 Figure 6.15 Net Loan Losses of Total Loans in Michigan and Comparison States(2000–2006) ....................................... 54 Figure 6.16 Bank Allowance for Loan and Lease Losses of Noncurrent Loans in Michigan and Comparison States ... 55 Figure 6.17 Indexed Employment in Auto Parts Manufacturing (1992–2006) .................................................................... 57 Figure 6.18 Industrial Diversity in Michigan and Comparison States (2004) ........................................................................ 58 Figure 6.19 Number of Institutions Operating and Headquartered in MI and Comparison States (2007) ...................... 66 Figure 6.20 Number of Bank Branches by State (June 2007) .................................................................................................. 66 Figure 6.21 Venture Capital Investment Activity in MI and Comparison States (1995–2007) .......................................... 68 Figure 6.22 Venture Capital Investment Activity in MI and Comparison States (without CA and MA) (2001–2007) ... 69 Figure 6.23 Venture Capital Investments (Per Worker) in Michigan and Comparison States (2005) ............................... 70 Figure 6.24 Number of CDFIs in Michigan and Comparison States (2008) ........................................................................ 91 Figure 6.25 Percentage of Institutions Providing SBA Loans in Michigan and Comparison States .................................. 93 Figure 6.26 Total Number of SBA Loans in Michigan (Fiscal Years 2004–2007) ............................................................... 94 Figure 6.27 Total Dollar Value of SBA Loans in Michigan (2004–2007) .............................................................................. 94 Figure 6.28 Total Number of SBA 7(a) Loans in Michigan and Comparison States (2007) ............................................... 95 Figure 6.29 Total Value ($B) of SBA 7(a) Loans in Michigan and Comparison States (2007) ....................................... 95 Figure 6.30 Average Size of SBA 7(a) Loans ($K) in Michigan and Comparison States (2007) ..................................... 96 Figure 6.31 SBIC and SBIR Amounts (Per Worker) in Michigan and Comparison States (2006) ..................................... 97 Figure 8.1 Percent Change in Real GDP by State 2005–2006 ............................................................................................ 113 Figure 8.2 Growth in Real GDP by State 1997–2006 .......................................................................................................... 114 Figure 8.3 Unemployment Rate for Michigan and U.S. (1998–2008) ................................................................................ 115 Figure 8.4 Current Unemployment Rate in Michigan and Comparison States ................................................................. 115 Figure 8.5 Median Household Income of Michigan and Comparison States (2006) ....................................................... 116 Figure 8.6 Growth in Median Household Income for Michigan and Comparison States (2001–2006) .................... 116 Figure 8.7 Poverty Rate of Michigan and Comparison States (2006)................................................................................. 117 Figure 8.8 Estimated Population of Michigan 1900–2007 .................................................................................................. 118 Figure 8.9 Net Migration for Michigan 1960–2007 .............................................................................................................. 119 Figure 8.10 Job Creation by Start-Up Businesses (2002–2003) ............................................................................................ 121 Figure 8.12 Net Percentage of Banks Tightening Credit Standards for Commercial and Industrial (C&I) Loans ........ 129 Figure 8.13 Demand for Small Business Credit (1990–2007) ............................................................................................... 130 Figure 8.14 Michigan’s Business Vitality History (2002–2007) ............................................................................................. 131 Figure 8.15 Small Business Ownership in Comparison States (2005) .................................................................................. 132 Figure 8.16 Growth in Small and Large Firms in Michigan and Comparison States, 2000–2004 .................................... 133 Figure 8.17 Employment Growth among Michigan and Comparison States (2000–2004) .............................................. 133 Figure 8.18 Most Important Problems Facing Small Businesses Nationally (March 2008) ...................................... 134

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List of Tables Table 4.1 Banks Interviewed by Bank Type and Location ................................................................................................... 17 Table 4.2 Banks Interviewed by Bank Products .................................................................................................................... 18 Table 4.3 Businesses Interviewed by Business Type and Location ..................................................................................... 20 Table 6.1 Manufacturing in MI between 1992 and 2002 ...................................................................................................... 57 Table 6.2 Change in Banking Institutions and Deposits of FDIC-Insured Institutions Headquartered in Michigan . 67 Table 6.3 Percentage of Total Establishments in Manufacturing, Life Sciences, and Technology in Michigan and

Comparison States (2002) ........................................................................................................................................ 83 Table 8.1 Michigan and U.S. Employment by Sector 1996–2006 ..................................................................................... 120 Table 8.2 Number of Michigan Firms 1990–2004 .............................................................................................................. 132

June 27, 2008 Small Business Lending Report 1.0 Executive Summary

1.0 EXECUTIVE SUMMARY Project Summary

This report was commissioned by the Michigan Economic Development Corporation (MEDC) in order to determine whether small businesses in Michigan have more difficulty obtaining commercial bank financing than small businesses in California, Illinois, Indiana, Ohio, Massachusetts, Minnesota, New Jersey, and North Carolina (the “Comparison States”). MEDC presented the Study Team with 14 unique questions that are addressed in this report.

Study Team

MEDC contracted Strategic Development Solutions and Economic Innovation International, Inc. (the “Study Team”) to conduct this study. The two firms have over 60 years of economic development experience combined and have created numerous innovative financial vehicles across the U.S. and the globe.

Methodology

The Study Team conducted extensive primary and secondary research for this study in order to address MEDC’s study goals. In order to collect original data, the Study Team conducted over 25 interviews with banks, businesses, and leading life sciences organizations active in Michigan and across the U.S. Findings from all data sources are detailed throughout the study.

Conceptual Framework

Commercial banks, including national, regional, niche, and community banks, are market followers rather than market leaders. As such, they provide reliable, low-risk capital to enterprises with products, services, and assets they understand. Unlike venture capitalists who can take more risky positions and price up to that risk, commercial banks work within a more regulated environment that defines their world view and constrains their lending. Commercial banks’ ability to lend, particularly to emerging sector businesses, is often limited by their own lending criteria, experience, and limited risk appetite. Banks’ fundamental role in the economy and orientation toward risk is established and should not be expected to change. That said, commercial banks can become more adaptable and comfortable with lending opportunities given new financial mechanisms and education.

Within financial institutions generally, there are market imperfections that can impede lending and therefore, economic growth. These market imperfections include: (1) insufficient risk pricing, pooling, and spreading mechanisms, (2) high information and transaction costs, (3) market prejudice, (4) insufficient market competition, and (5) market-distorting government policies. In assessing these market imperfections as they apply to financial markets in Michigan, the Study Team employed techniques of analysis that its members have used in similar assessments over many decades.

Study Findings

The market imperfections noted above exist in every market, including Michigan. The Study Team identified three of these market imperfections as stand-outs in Michigan: (1) insufficient risk pricing, pooling, and spreading mechanisms, (2) high information and transaction costs, and (3) insufficient market competition. While the Study Team saw some market prejudice toward Michigan given the current state of the economy, it was limited. Overall, the Study Team found

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lenders’ consideration of the Michigan economy when making small businesses lending decisions to be appropriate and rational.

The Study Team addressed MEDC’s specific study questions, and the findings are as follows:

• Banks in Michigan have moderate-sized small business lending practices and appear to aggressively pursue and make loans to small businesses in the state, when compared to the Comparison States, based on Michigan banks’ high ratios of small business loans to total assets and small business loans to total business loans.

• Michigan has a solid showing in loan volume, dollar value of small business loans, and average number of small business loans per institution over time. This suggests that lenders are not shying away from lending in the state.

• Despite the data, many small businesses in Michigan are having difficulties securing financing. This difficulty appears to be more pronounced for companies in emerging sectors.

• Small business owners in Michigan, as well as across the country, tend not to understand lending practices at conventional banks. This leads to frustration with the lending process and can color business owners’ perception of problems with the banking industry.

• The current credit tightening occurring across the U.S. is impacting bank aggressiveness now and is expected to do so in the coming months. However, according to all lenders interviewed, there is and will be capital in the market for good credit-worthy small businesses.

• Forecast loan loss rates in Michigan have historically been under the national average and in keeping with the Comparison States, but recently, the actual performance of loans in Michigan (like that of many states in the study) deteriorated with an increase in net loan losses. In spite of this recent decline, the Study Team did not detect a drop-off in loans to small businesses in Michigan.

• Banks do not appear to use different credit standards when underwriting loans in Michigan. This is true across national, regional, niche, and community banks.

• The decline of manufacturing within Michigan has had a dramatic impact upon bank lending in the state given the impact micro and macroeconomic factors have upon business, and therefore, loan performance.

• Small business owners in Michigan that were interviewed feel that the business climate in the state is difficult for small businesses and tend to have a gloomy outlook.

• The Study Team found that while there may be isolated cases of market prejudice in Michigan due to the economy, there is no evidence of a lender pullback from the state. Overall, lenders in the state are interested in lending to small businesses located there, though they do so cautiously.

• Michigan’s current capital mix, which is heavily weighted in conventional commercial banks, is oriented toward traditional businesses that have more collateral and cash flow than those in emerging sectors. Michigan’s capital mix is sub-optimal for economic

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growth due to the low level of risk capital available to businesses in emerging sectors, including mezzanine debt and venture capital.

• Given that emerging sectors often require non-traditional underwriting standards and risk capital, Michigan’s current capital mix is sub-optimal for the growth in emerging sectors the state wishes to see. An increase in the number and variety of niche banks and risk capital institutions/tools in the state would likely help emerging sector small business growth in the state.

• Niche banks are active in Michigan and focus on specific industries (e.g., life sciences) and populations (e.g., Muslims), but the state could benefit from more niche banks in enter the market. Niche banks arise out of an unfilled market need. Therefore, to the extent new industries and opportunities grow in Michigan, the number and variety of niche banks will as well. For example, the number of niche banks in Michigan is expected to grow over time, especially as Michigan’s life sciences companies mature and qualify for conventional debt.

• Public policy initiatives within the state can (and do) attract and encourage the growth of niche banks to the extent these initiatives enhance business opportunities for firms that need niche bank products and services.

• Recent efforts by the state to expand life sciences activity have resulted in tremendous growth in the number of life sciences companies, but have not yet translated into a marked increase in conventional lending activity to the sector. This is because most of the life sciences companies in Michigan are in the emerging phase where it is more appropriate for angel investors or venture capital to invest given the level of risk.

• Michigan has a lower percentage of community banks than the national average, but ranks in the middle when compared to the Comparison States. Because community banks are more prevalent in rural areas that are under-banked, Michigan’s level of community banks is not surprising or necessarily problematic. However, Michigan has a low prevalence of CDFIs in the state which does set it apart from the Comparison States.

• Relative to the Comparison States, Michigan’s use of the SBA 7(a) program is moderate, whereas usage of more innovative SBIR and SBIC programs is mixed.

Policy Recommendations

In response to the above findings, the Study Team developed a set of policy recommendations for MEDC to consider. These recommendations are based upon the Study Team’s experience and innovative practices research. It should be noted that many of the recommendations below fall outside the “bank-only” scope of work for this study. Given that the Study Team found the level of lending activity and the attitudes of lenders toward conventional small business lending in Michigan to be appropriate, the Study Team looked at both banks and the broader capital mix in the state when making policy suggestions. Through its experience in other markets across the country, the Study Team has found that this more holistic approach to capital markets is useful in generating economic development activity.

The recommendations below are detailed in full in Sections 6.13 and 6.14 of this report, and are divided into three categories: 1) general banking, 2) community banking, and 3) SBA programs. To the extent possible, innovative practices are provided for each recommendation.

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General Banking Recommendations 1. Create strategic partnerships with banking and finance associations in the state.

MEDC may want to create partnerships with organizations such as the Michigan Bankers Association in order to facilitate the sharing of innovative bank lending programs across institutions in the state and the country. Partnerships could also be used to create programs that can educate bankers on emerging sectors or government programs that are available.

2. Consider using innovative partnerships to encourage creation of new finance mechanisms. MEDC could use partnerships with banking associations to encourage the creation of risk pricing, pooling, and spreading mechanisms. MEDC could bring in representatives from leading risk capital institutions to encourage local institutions to create these new tools.

• Innovative Practice: Massachusetts Bankers Association. The Massachusetts Bankers Association was actively engaged in the creation of Massachusetts Capital Resource Company, the Massachusetts Business Development Corporation (now The Business Development Company), and more recently, in the creation of the Massachusetts Housing Investment Corporation. All of these organizations provide risk capital within the state. On an ongoing basis, Massachusetts Bankers Association works with these entities to provide information and education to its members, who then promote their services to small business clients. In each instance, these risk capital institutions allow commercial bankers to grow their own clients while sharing the risk.

3. Implement bank education program for lenders not currently active in Michigan. MEDC could bring national, regional, or niche bankers that are not active in Michigan to the state in order to educate them about the opportunities that exist for bank lending activity in the state.

• Innovative Practice: Central City Association of Downtown Los Angeles. In the 1990s, the Central City Association of Downtown Los Angeles, in coordination with the City of Los Angeles, brought bankers from New York to downtown Los Angeles, took them on a tour of areas in need of investment, and presented opportunities for bank business activity. This effort was aimed at overcoming the investment prejudices held by large national banks against lending to real estate project in downtown Los Angeles. It broke down a market prejudice and a conceptual barrier for bankers and showed them that: (1) there were real estate investment opportunities in downtown Los Angeles, (2) opportunities were not as risky as originally viewed, and (3) these opportunities could be profitable to banks. Lending activity in the downtown area improved as a result.

4. Survey the small business and small business lending landscapes annually. MEDC may want to understand and track the outlook of lenders and small businesses within the state over time. If the state pursues this recommendation, it can partner with an organization, such as National Federation of Independent Business (NFIB), which conducts annual national small business surveys.

5. Enhance small business understanding of the banking process in order to increase small business satisfaction. This education could be done through organizing meetings

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between Michigan small business owners and banks, as well as the development of a comprehensive banking guide.

• Innovative Practice: “North Carolina’s Capital Opportunities for Small Businesses” report. This comprehensive guide provides an easy-to-understand overview of all the state and federal resources available to small businesses in North Carolina. The detailed guide is provided online.

6. Enhance ongoing public-private partnerships between business leaders, lenders, venture capital firms, community leaders, and government entities. Such partnerships could work with and advise the state on short and long term structural issues impacting business growth and health in the state. Michigan is currently supporting several public-private partnerships that are helping small business grow, including initiatives such as SmartZones. MEDC could also work to strengthen bonds between financial institutions already in the state as part of this effort.

• Innovative Practice: Enterprise Florida. Enterprise Florida is a public-private partnership responsible for leading Florida’s statewide economic development efforts. Enterprise Florida works collaboratively with a statewide network of regional and local economic development organizations to continually improve Florida’s business climate and ensure its global competitiveness.

• Innovative Practice: Bay Area Community Investment Network. BACIN is a network organized by the Bay Area Council and the Bay Area Family of Funds, linking the three funds in the Bay Area Family of Funds with CDFIs, community development venture funds, community loan funds, community credit unions, community development banks, and other community investment organizations. The network includes commercial bank CRA lenders, venture capitalists, angel investor networks, investment funds, insurance companies, federal, state, and regional government programs, and other sources of capital. The intent of BACIN is to provide prescreened, prequalified flow of real estate and business deals to appropriate BACIN participants, and exchange participant underwriting criteria to encourage mutual referrals of appropriate deals.

7. Consider initiatives to expand the capital mix in the state. Policymakers may wish to consider creating a system of risk institutions, including subordinated debt funds, mezzanine capital vehicles, a bond authority, industry specific investment funds, and an enhanced Capital Access Program. This would also include expanding existing programs such as the 21st Century Jobs Fund initiative.

• Innovative Practice (Mezzanine Debt): Mass Capital Resource Company. MCRC provides mezzanine (risk) capital to small manufacturing firms in the state. It provides financing to companies that it restructures to enhance performance and competitiveness. For almost 30 years, MCRC has achieved mid-teen returns. MCRC is owned by insurance companies.

• Innovative Practice (Subordinated Debt): Mass Business Development Corporation. MBDC provides subordinated debt (risk capital, which is less risky than mezzanine debt) to mature firms that are growing, but at a slower rate than those invested in by MCRC. MBDC was established in 1953 and has grown to become one of the leading business development corporations in the country. MBDC’s shareholders include

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virtually all of the commercial banks in Massachusetts as well as lending investors, corporations, and the Red Sox.

• Innovative Practice (Venture Capital Fund): Alliance Technology Ventures of Georgia. The Alliance is an early-stage venture capital firm investing in communications technology, Internet infrastructure, e-commerce, and life science startups. It was formed in 1995 as part of an initiative by the state of Georgia to increase the availability of private venture capital in the area. Co-investors include such companies as Georgia Power, BellSouth, UPS, Bank of America, Emory University, and Scientific Atlanta.

• Innovative Practice (Development Finance Authority): Massachusetts Development Finance Authority. This $15 billion organization is the preeminent state Development Finance Authority in the United States, undertaking more than $1 billion of new financing each year for a diverse range of projects.

• Innovative Practice (Industry-Specific Fund): St. Louis Vectis Life Sciences Fund. Established in 2004 to provide investors with an opportunity to participate in a strategic national life sciences investment vehicle based in St. Louis, Missouri, it has helped St. Louis develop into one of the leading life sciences research centers in the country.

Community Banking Recommendations 1. Create innovative partnerships with leading community banks in Michigan. MEDC

may want to explore potential partnerships with community banks in order to promote their small business lending products and expand their footprints.

2. Create partnerships with Michigan community banking associations. MEDC may want to create partnerships with organizations such as Michigan Association of Community Bankers in order to facilitate sharing of innovative community bank lending programs across institutions in the state and the country, as well as augment education programs for community bankers, and implement bank training programs.

3. Provide guidance and education on how to start community banks. This guidance could be directed to regional economic development organizations (including Community Development Corporations), Chambers of Commerce, community activists, trade associations, and other local parties likely to be interested in locally-focused financing.

4. Create a “CDFI business team” to encourage CDFI growth in Michigan. This team could travel the state promoting the creation of CDFIs to regional economic development organizations, Chambers of Commerce, technology networks, trade associations, and other organizations looking to utilize and expand innovative capital.

5. Partner with CDFI trade associations. The state may wish to partner with well-regarded CDFI trade organizations, such as the Opportunity Finance Network and the Community Venture Capital Alliance, in order to promote CDFI growth. The state may also want to encourage successful existing CDFIs to expand into Michigan.

6. Create financial incentives in order to encourage CDFI growth. The state may wish to create state-specific tax credits and grants accessible to CDFIs within Michigan. Michigan may also want to make Community Development Block Grant funds available to CDFIs as start-up capital.

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7. Examine best practices in community bank growth from other states. If the state is concerned with the level of community bank growth, it may wish to look at the practices and policies of banking commissioners in other states that have strong track records in this regard.

SBA Program Recommendations 1. Continue promoting SBIR grants and develop a formal strategy for using the

program. MEDC may want to work with the Michigan Small Business & Technology Development Center and other relevant entities to develop a formal statewide plan for using the SBIR program. Additionally, promotion of the grants should continue and could include annual awards and other press and media attention, which can increase awareness of the SBIR program and encourage SBIR program growth.

2. Continue matching SBIR grants with state funding. The continued growth of the Michigan Emerging Technologies Fund will be important to promoting usage of SBIR and other federal programs. Michigan may wish to assess the level of SBIR matching funds over time.

June 27, 2008 Small Business Lending Report 2.0 Project Summary

2.0 PROJECT SUMMARY This report was commissioned by the Michigan Economic Development Corporation (MEDC) in order to determine whether small businesses in Michigan have more difficulty obtaining commercial bank financing than small businesses in California, Illinois, Indiana, Ohio, Massachusetts, Minnesota, New Jersey, and North Carolina (the “Comparison States”).

MEDC contracted Strategic Development Solutions (SDS) and Economic Innovation International, Inc. (the “Study Team”) to assess the current small business lending industry in Michigan and identify and recommend innovative small business lending practices and actions that the state of Michigan could initiate to increase and expand commercial lending to small businesses.

MEDC presented the Study Team with 14 unique questions.

1) Compared to other states in the study, are Michigan banks becoming more aggressive in lending to small business? Does the data show whether more loans are being made and greater risk being accepted or that those getting the loans are getting them at better rates?

2) Are banks in identified comparison states more aggressive in small business lending than Michigan’s banks on a sector by sector basis? Over the past 10 years how has Michigan’s small business lending compared to other states in each of these sectors?

3) Are bank default and loss rates in Michigan higher or lower than default and loss rates in other key states on a sector by sector basis?

4) What is the impact of the decline in the manufacturing sector on lending practices in Michigan and other states? Does this decline have a more serious impact in Michigan due to the state’s reliance on manufacturing?

5) Is there a distinction between lending practices to emerging growth/technology companies and lending practices to more traditional small businesses? If so, what are those distinctions and how do the lending practices in Michigan compare to the comparison states in the areas that are unique to emerging growth/technology companies?

6) Are there banks in Michigan and other comparison states that focus on lending on specific industries? What are some examples of these niche banks and what is their market presence within the comparison states? Does the focus on these niche banks generally match the efforts put forth by the state? Do public policy initiatives influence the behavior and presence of these niche banks?

7) Michigan has put significant resources and effort into growing the life sciences sector. Is there evidence that banks have increased lending support in conjunction with the state’s objectives in this industry sector?

8) Are banks in other states funding creative ways to lend to firms with non-traditional assets and uses (e.g., intellectual property, software, R&D, prototyping) as opposed to firms with hard assets?

9) Do national banks exhibit more conservative lending behavior in Michigan than in other states?

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June 27, 2008 Small Business Lending Report 2.0 Project Summary

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10) Is there evidence that community banks are more favorably disposed to small business lending than regional banks or banks with a national presence?

11) Does the composition of community banks differ from state to state? For example, what percentage of banks in the comparison state are community banks; and do lending practices of community banks vary from state to state?

12) How does SBA lending in Michigan compare to other key states?

13) Are there initiatives the state could employ that would encourage or support community bank lending to small business?

14) What are other states doing to encourage and support small business lending? Are there specific “best practices” Michigan should be aware of? What models can be employed by state policymakers in Michigan to stimulate bank lending to small companies?

For each of the aforementioned questions, the Study Team will provide a general overview, data research findings, and interview findings when available.

June 27, 2008 Small Business Lending Report 3.0 The Study Team

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3.0 THE STUDY TEAM The Michigan Economic Development Corporation hired an experienced Study Team to assess small business lending in Michigan. Outlined below is information on the Study Team.

STRATEGIC DEVELOPMENT SOLUTIONS Deborah La Franchi is the founder and CEO of Strategic Development Solutions (SDS). SDS has been involved with the development of more than 13 different investment funds across the country and internationally. This work has included the development of the

Genesis Family of “Double Bottom Line” funds: six funds with more than $450 million of committed capital under management leveraged to more than $1.2 billion in development projects. The different funds designed and built by SDS range from private-equity venture/growth funds to real estate funds targeting specific areas such as commercial, industrial, retail, and workforce housing. Before forming SDS in 2002, Ms. La Franchi served as the founding President and CEO of Genesis LA. Before her work at Genesis LA, she served as Assistant Deputy Mayor for Economic Development under Mayor Richard Riordan. In this capacity she managed a number of economic policy initiatives, including: tax reform, business incentives, business attraction policies, and development reform.

ECONOMIC INNOVATION INTERNATIONAL, INC Belden Hull Daniels is the founder and CEO of Economic Innovation International,

Inc., a firm internationally recognized for building more than $100 billion of privately capitalized funds designed to accomplish civic and public purposes in 37 states and 21 nations of North America, Europe, and Asia since its founding in 1970. In building new development finance industries over the last 38 years, Economic Innovation has undertaken hundreds of market assessments that identify capital market failures and then implement instruments targeted to remove those barriers. Since 1997, Economic Innovation has been the leader, in partnership with Strategic Development Solutions (SDS), in creating a new Triple Bottom Line private equity industry, in which large institutional investors join with community stakeholders to invest nearly $20 billion of private capital in market-rate funds managed by world-class fund managers to rebuild poor neighborhoods. These Triple Bottom Line initiatives and private-equity funds invest in low-income neighborhoods to produce superior market returns for large institutional investors—major banks, insurance companies, pension funds, university endowments, corporations, and high-net-worth individuals—while simultaneously producing jobs, wealth, and community revitalization for low-income residents. Funds that Economic Innovation has helped to build are found from Boston, Massachusetts to San Diego, California and Puget Sound, Washington to Miami, Florida, as well as in such difficult overseas environments as Northern Ireland, Central Europe, Puerto Rico, and Palestine. Belden Hull Daniels, founder and CEO, is an attorney and former international banker in Asia who taught for many years at Harvard and MIT.

June 27, 2008 Small Business Lending Report 4.0 Methodology

4.0 METHODOLOGY The Study Team conducted extensive primary and secondary research in putting together this report.

First, the Study Team reviewed existing literature, studies, and data sets in order to document economic conditions, small business trends, and small business lending practices across the United States and in Michigan.

Data was collected from many sources, including:

• The Federal Reserve

• Census Bureau

• Small Business Administration

• U.S. Bureau of Economic Analysis

• Library of Michigan

• RealtyTrac

• Federal Deposit Insurance Corporation

• Bureau of Labor Statistics

• Corporation for Enterprise Development

• University of Michigan

• MoneyTree Report

• Federal Financial Institutions Examinations Council

Once this secondary data was collected, the Study Team conducted 20 interviews with banks and 12 interviews with small businesses, and two interviews with experts in the life sciences in order to further understand small business lending trends and perspectives. A description of the bank and business interview methodologies used is detailed below.

Once the primary and secondary research was complete, the Study Team developed its findings, as detailed in Section 6 of this report.

4.1 Definition of Small Business for This Study

The definition of a “small business” varies by industry and designating agency. According to the U.S. Small Business Administration (SBA), a small business is a firm or enterprise with fewer than 500 employees. This definition encompasses more than 99% of all businesses in the United States. However, the SBA has also developed industry-by-industry size standards to determine whether a business qualifies as a small business. For example, a construction company is designated as a small business based upon the value of sales, whereas a manufacturing company is designated based upon the number of employees.

For the purposes of this report, the Study Team uses the broad “less than 500 employees” definition, as available data typically uses this definition.

4.2 Definition of Small Business Loans for This Study

For the purposes of this report, small business loans are defined as those loans that are $1 million or under. Reporting agencies, and therefore available data, typically use this definition.

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4.3 Bank Interview Methodology

Overview

The Study Team conducted 20 phone interviews with banks that serve Michigan and the Comparison States in order to further understand small business lending practices and lender perspectives.

These interviews were conducted in order to:

1) Confirm and support the data research collected

2) Understand lender perspectives on small business lending in Michigan and the Comparison States

3) Provide qualitative information that further identifies small business lending trends

4) Identify underlying factors that may affect the small business lending environment in Michigan and the Comparison States

Specifically, the Study Team sought to address the following questions through its interviews:

1) What are general lender perspectives regarding Michigan?

2) Do banks’ perspectives on Michigan vary by size of bank, geographic reach, industry specialty, etc.?

3) Do lenders have a bias against Michigan or small business in Michigan?

4) How are Michigan small business owners regarded by lenders?

5) What lending services or products are available within Michigan?

6) What government or alternate programs are used in Michigan and across the country?

7) Which alternate programs work well and should be adopted/adapted for Michigan?

Bank Selection

In order to collect as much information as possible, the Study Team looked for banks that had strong small business lending practices and one or more of the following attributes:

1) Presence in Michigan

2) Presence in multiple states (for comparison purposes)

3) A focus on general/conventional lending

4) A unique lending niche

5) A specific focus on community lending

When determining which banks to interview, the Study Team consulted the following resources:

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• Report on Small and Micro Business Lending in the United States, for Data Years 2005-2006. This banking study, published annually by the SBA’s Office of Advocacy, provides rankings of depository institutions based upon small businesses loans (defined as loans of $1 million and less) by state. This information not only provided information on which institutions provide the most small business loans by state, but which banks are the most focused on small business lending. The Study Team used this report to determine which banks to interview.

• SBA lender rankings. The Study Team looked at national and state rankings of SBA lenders when determining which banks to interview.

• Website information. Internet research was important to locate niche banks and other community banks with specialized programs.

• Referrals. The Study Team also used referrals from the MEDC, SBA, and banks to identify banks for interviews.

By using these sources, the Study Team was able to identify and interview 20 banks in Michigan and the Comparison States.

Breakdown of Banks

A breakdown of the banks interviewed is provided below.

Table 4.1 Banks Interviewed by Bank Type and Location

Banks Interviewed Number of Banks Lending in Michigan

National 5 4 Regional 6 6 Community 6 4 Niche 3 2 TOTAL 20 16

For purposes of this report, financial institutions are categorized as follows:

• National Bank – A bank that operates in multiple regions of the United States. National banks in this study include: Bank of America, Citibank, Comerica, JP Morgan Chase, and Wells Fargo.

• Regional Bank – A bank with a footprint that covers several states in a single region. Regional banks in this study include: Fifth Third Bank, Huntington Bank, La Salle Bank, National City Bank, PNC Bank, and TCF Bank.

• Niche Bank – A bank that targets the needs of a certain industry segment or segments that is/are not well-served by conventional lenders. A niche bank may serve more than one geographic region and may have more than one specialty. Niche banks in this study include: Silicon Valley Bank (life science, technology, lending to venture capital firms), Bank of Ann Arbor (life science), and Square 1 Bank (lending to venture capital firms and their companies).

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• Community Bank – A bank that operates within a single state or a smaller geographic area of a particular state. For purposes of this report, community banks may be conventional lenders with a small geographic footprint or Community Development Financial Institutions (CDFIs). Community banks in this study include: Community Shores Bank (Michigan), Northern Initiatives (Michigan, CDFI), Macatawa Bank (Michigan), Capitol Bancorp - Oakland Commerce Bank (Michigan), National Commerce Bank (Ohio), and Self Help Credit Union (North Carolina, CDFI).

The banks interviewed had small business programs that ranged in size and scope. Some were well-established national and regional players with all-encompassing small business practices, while others were new niche players providing life science, technology, or micro loans. The range of bank specialties is detailed below.

Table 4.2 Banks Interviewed by Bank Products

Conventional Lenders

Life Sciences/Tech

Specific Microlending Lenders to VC

Firms* Total Banks

14 2 3 2 20

*Note: The four columns do not total to 20 because one bank provides financing to both life sciences/tech and VC firms and is therefore counted twice.

By looking at banks with this mix of size, geographic footprints, and specialties, the Study Team was able to understand similarities and differences regarding small business lending across the banking industry.

Figure 4.1 below provides a graphical representation of banks interviewed. The chart shows institution asset size, level of small business lending activity, and average small business loan size.

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Figure 4.1 Banks Interviewed by Assets, Small Business Loans Percentage, and Average Loan Size

Small Bank, High Small Business Lending (SBL)

Large Bank, High Small Business

Lending

Small Bank, Low SBL Large Bank,

Low SBL

Interview Questions

After banks were identified, the Study Team developed a set of interview questions to guide each interview and provide information on the state of small businesses and the small business lending landscape. The full list of interview questions is available in Appendix A. The questions were compiled by the Study Team with feedback from MEDC.

Interview Process

Each bank in the study was contacted via phone and email to schedule an interview. The Study Team then spent 30–45 minutes on the phone with each bank discussing the interview questions. Often interviews included multiple representatives from the same institution. The Study Team explicitly told banks that their answers would be unattributed (by institution and individual), in order to encourage candid and honest responses. While we sought to obtain answers to all of our formal interview questions, we allowed each person to deviate from the questions if the information was helpful.

4.4 Small Business Interview Methodology

Overview

The Study Team conducted 12 interviews with small businesses in Michigan and the Comparison States. Interviews were conducted in order to meet the following goals:

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1) Confirm and support the small business lending data with supporting anecdotal and qualitative information

2) Understand small business needs and perspectives on the small business lending environment

3) Identify factors impacting businesses in Michigan and the Comparison States

Business Selection

Businesses were identified through the following means:

• Recommendations. The Study Team used recommendations from MEDC and other businesses.

• Research. The Study Team located small businesses through research. Several businesses were identified through SBA’s small business award programs, the Michigan Small Business & Technology Development Center, and a general Internet search.

Breakdown of Businesses

The Study Team sought a cross-section of businesses in order to understand what similarities and differences existed across different geographies and sectors. The mix of businesses interviewed is as follows:

Table 4.3 Businesses Interviewed by Business Type and Location

Total Michigan California Massachusetts

Businesses Interviewed

12 8 2 2

In Manufacturing 4 2 1 1

In Life Science/Tech 7 5 1 1

In Service/Agriculture 1 1 0 0

At least two businesses were selected specifically because of their difficult experiences securing financing in Michigan. Others were selected because they had been recognized for small business accomplishments. In this way, the Study Team hoped to elicit positive as well as negative responses.

Additionally, two of the businesses interviewed were in the process of relocating—one from Michigan and one to Michigan.

Taken together, all of these businesses provided the team with points of comparison that allowed for the findings in this report.

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Brief Business Bios

Below is a brief description of the companies interviewed for this report. The Study Team promised interviewees that all responses would be anonymous, so none of the companies are named. Businesses in Michigan Agriculture Business – Located in Northern Michigan, this small business runs a winery, distillery, farm, and bed and breakfast. It employs 25 workers and additional seasonal workers. This is an established firm that is successful and growing.

Aluminum Business – This company is located in the Upper Peninsula of Michigan and employs 68 people in the aluminum business. The company is established and growing.

Engineering Business – This engineering firm is in Southeast Michigan and engineers products for manufacturing companies. The firm has 10 employees and is currently re-locating to North Carolina.

Life Sciences Business #1 – Located in Southeast Michigan, this firm conducts clinical trials and has been in operation for 11 years.

Manufacturing Business #1 – This business is located in Southeast Michigan and employees just under 50 workers. The company is almost 25 years old and is being impacted by the economic downturn in Michigan.

Tech Services Business #1 – Located in Southeast Michigan, this firm provides technology services to small and medium companies. This company employees 40 people and was started nine years ago. Is established and growing.

Tech Services Business #2 – Headquartered in Michigan, this technology services company was established in 1994 and serves the Midwest with 160 employees.

Tech Services Business #3 – This small business is located in Eastern Michigan and employs six people part time. The company is rapidly growing.

Businesses in California Life Sciences Business #2 – This biopharmaceutical business conducts research and development of oncology therapies. The firm currently has seven employees and is re-locating to Southwest Michigan from Northern California.

Manufacturing Business #2 – This California company manufactures advanced thermal processing equipment and employs 115 people.

Businesses in Massachusetts Life Sciences Business #3 – This biotechnology company is located in Massachusetts and is rapidly growing. It had 2 employees in 2006 and is expected to have over 80 employees in the next three years.

Manufacturing Business #3 – This tool and die and engineering company in Massachusetts works in plastics technologies. The firm has 45 employees and is established and growing.

Interview Questions

The Study Team developed a set of interview questions intended to collect as much information as possible about the type of business being interviewed, experiences securing

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small business loans in and outside of Michigan, and which aspects of small business lending can be improved. The full list of interview questions is available in Appendix B. The interview questions were compiled by the Study Team with feedback from MEDC.

Interview Process

The Study Team contacted each targeted business by email and phone to schedule interviews. We tried to interview the owner, CEO, or other top manager at each company whenever possible. Interviews lasted between 30–45 minutes and while we ensured that our questions were answered, we also allowed time for each business to talk more openly about their experiences.

June 27, 2008 Small Business Lending Report 5.0 Conceptual Framework

5.0 CONCEPTUAL FRAMEWORK In this section, the Study Team provides a framework that we have employed for many decades to analyze the availability of capital in the market. The conceptual framework first provides a way of understanding barriers confronting small enterprises in accessing financial markets, and then provides the framework for removing those barriers.

5.1 Thinking About the Market for Small Business Lending

As we begin this report about the availability of small business lending capital in Michigan, we start with an important truth: money is seldom the most important need for a small business (it may be an important “want”, but that is another story).

Contrary to a common belief of many small business advocates and economic development professionals, financial capital is not the most important factor of production—in fact, it is the least important.

Good money (prudent, available, and appropriately priced money) can never make up for the lack of markets, management, or the appropriate availability of labor, land, and other key supply factors. Markets must be accessible and owner-entrepreneur-managers must be able to produce goods or services for that market at a lower cost than sales generate. In 38 years of undertaking market assessments for potential funds, the Study Team has never yet seen a single case in which good money has ever made a bad deal good.

Good money can, however, cover up a bad deal. Too much finance can keep both an entrepreneur and a banker from addressing some underlying market and management problems in a small company until it is too late to correct the real problem.

Good money can definitely be instrumental in helping to bring a good product or service to market when all of the other factors of production have been assembled. Conversely, the absence of good money can stop an otherwise good firm from being born or growing. Thus, we see that money is a necessary, but an insufficient factor of production on its own.

The discrete role of conventional bank capital as a catalytic supply factor is the essential issue addressed in this study. But as we address this issue, we have to be sure that conventional bank capital is the necessary missing ingredient, rather than the easiest one for small business people and policymakers to focus upon. This is true in all economies and all states, and is as true in Michigan as in any other locale. Good conventional bank finance in any market cannot make up for the absence of a quality workforce at a competitive price, qualified management capable of providing goods and services that can be competitively sold from the local market, competitive technologies at an appropriate price, or the absence of appropriate risk capital to undertake risks and provide returns that are beyond the realm of conventional bank finance.

When Money is Needed, the Issue is Availability, Not Price

When good money is the essential missing ingredient for an otherwise sound venture, access to capital, rather than the cost of capital is usually the most important issue.

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Contrary to another common misunderstanding, the cost of capital is seldom the significant variable. Studies over the last 30 years make it abundantly clear that the cost of capital is only one-tenth as great as the cost of labor to an enterprise. Total annual capital costs seldom exceed 6%–10% of the total cost of sales. Regional differences in capital costs are even less significant.1

Worldwide, the cost of capital to small firms is invariably higher than the cost to larger firms because individual small loans are riskier and more expensive, unless there are special risk pooling and spreading mechanisms to average the cost and risk. Small businesses also seldom have available (for banks and financial partners) the same easily accessible free or inexpensive information about themselves that, in contrast, is widely and freely published and available on larger firms. Finally, small loans to small firms often cost as much to make as much larger loans to larger firms. All of these actual market imperfections are real barriers that make small business lending more expensive and risky for banks on a worldwide basis.

Further, as we shall see, a key issue in small business lending finance is the mix of capital sources in an area. Each type of small business financier has a unique view of risk and ability to price up to that risk, as discussed in Section 5.3.

5.2 Understanding Barriers to Efficient Goods and Capital Markets

As radical technological change rapidly removes barriers impeding a single 24/7/365 continuous global marketplace, all world markets are becoming increasingly more efficient by the moment.

• Human capital is the most important factor of production. Labor, on average, represents more than 10 times the cost of financial capital. Today, global firms can search global locations for the highest quality labor market at the lowest price, increasingly moving goods and services from one location to another electronically as well as physically.

• Land and infrastructure capital are equally available on a global basis.

• Financial capital is the most fluid capital of all, ceaselessly circling the globe on electrons and photons at the speed of light. Until recently, North American financial markets have been the most efficient in the world, constantly innovating new products and new services to remove imperfections in the marketplace. Just as the world is overtaking the efficiency of North American production in goods markets, global capital markets especially in Europe and Asia, and now the Gulf, are increasingly becoming more efficient than North American capital markets.

Despite great increases in the efficiency of all these global markets, all markets for land, labor, and financial capital are managed by people, and people are riddled with imperfect judgment. In spite of the fact that we are witnessing the most perfect goods and financial markets the world has ever seen, these markets continue to suffer from serious market

1 Cornia, G., Testa, W., and Stocker, F. “Local Fiscal incentives and Economic Development”. Academy for Contemporary Problems, June 1978


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imperfections. As Pogo noted, “we have met the enemy, and it is us.” Different judgments of risk make horse races and financial markets.

The imperfections in land, labor, and consumer markets, and the accompanying imperfections in the flow of capital to support the development of these markets, can be systematically analyzed as a set of identifiable market imperfections:

• Insufficient risk pricing, pooling and spreading mechanisms

• High information and transaction costs

• Market prejudice

• Insufficient market competition

• Market-distorting government policies

These market imperfections create powerful deterrents to private sector investment in the real goods markets of under-appreciated labor, land and consumer markets, as well as in the flow of financial capital to firms.

Because this study is concerned with whether or not there is sufficient supply of debt capital in Michigan, this analysis will focus on imperfections in financial markets. Nevertheless, before we shift our focus principally to imperfections in financial markets, we need to remind ourselves that financial capital is a necessary but insufficient factor of production. As we have noted, it cannot make up for inefficient and overpriced labor markets, or for lack of sufficient globally competitive entrepreneurs in new growth industries, or for any other essential missing factor of production. As bankers are fond of saying, “they can’t push string up a wall.”

We can state clearly what ideal financial markets are: financial markets operate at their best when capital flows from all available suppliers to all demanders at a cost and under terms that most completely reflect the relative risk of an investment. That is, there is a “risk-adjusted rate of return.” The most vivid way to graph an efficient market is by means of the following risk-return chart:

Figure 5.1 Different Sources of Capital on the Risk-Reward Frontier

FoolsRisk

Perfect

ly Effi

cient

Market

Monopolies

Return

R&D

Seed

Venture

ShortTermDebt

Long Term

DebtSubordinated

Debt

Mezzanine

Comm. Banks &Bond market

Individual investors& venture

capital companies

Retainedearnings& govt.grantsInvestment banks


Figure 5.1 graphically presents a picture of risk and return.

• A perfectly efficient market splits the middle between Risk and Return.

• The earlier the stage of development, the higher the risk. Research & Development (R&D) is generally riskier then Seed Capital; Seed Capital is riskier then Venture Capital; Venture Capital is riskier then Mezzanine (Expansion) Capital; all forms of risk capital are generally riskier than all forms of debt, including Subordinated Debt. The relative risk and return of each of these stages of finance is discussed in Section 5.3.

In assessing the supply side of the Supply-Demand Equation, it is relatively easy to measure the available supply of capital because it is finite at any given moment in time. The supply of capital is dependent upon the number of suppliers in the market, types of suppliers, and willingness to lend.

The demand side of the equation is a totally different matter altogether. At any given moment, demand is infinite in the eyes of demanders. However, there is a subtle yet fundamental distinction between the demand and the desire for capital. This reality absolutely affects the ability of any study to quantify the actual need for capital. As we assess the potential market demand for new capital mechanisms, our task is similar to looking into Plato’s Cave. Instead of seeing actual demand, we have to content ourselves with seeing the “shadows on the wall” (the projected or professed need of demanders) that Plato saw within his cave. As we have undertaken market assessments over the past 38 years to determine the need for properly capitalized and properly managed funds to meet the requirements of particular markets, we have developed a number of surrogate techniques for recognizing the patterns within the “shadows on the wall.”

We shall see that one of the most effective ways to address differences between need and desire, and better serve that need, is by creating a more competitive environment among suppliers. Suppliers include not only conventional banks, but community banks, CDFIs, and risk capital institutions. The number and range of these suppliers is vital to ensuring supply and appropriate capital pricing.

Before we propose intervening in financial markets to remove barriers, however, we need to understand the nature of those barriers, or financial market imperfections. The primary technique used in this report involves looking systematically at the five principal barriers to the flow of financial capital: (1) insufficient risk pricing, pooling and spreading mechanisms; (2) high information and transaction costs; (3) market prejudice; (4) insufficient market competition; and (5) market-distorting government policies.

An under-served market for financial capital may exist in Michigan if any one of the following factors interferes with the flow of resources between firms and resource suppliers.

Market Imperfections

1. Insufficient Risk Pricing, Risk Pooling and Risk Spreading Mechanisms The most serious barrier to appropriate capital access for otherwise viable, growing small enterprise in any market is the absence of financial intermediaries between suppliers and demanders which are capable of both pricing to risk and pooling and spreading risk.

Factors impacting capital availability are:

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• Risk Management - Risk management requires proper risk pricing and pooling and spreading. High risk requires high return.

• Risk Pricing - The risk of potential investments is evaluated. Based on this, a fund determines what return is necessary to fund the deal.

• Risk Pooling - Investments of varying degrees of risk are put together in a single portfolio to average out risk among investments.

• Risk Spreading - The risk associated with an investment or group of investments is spread among a number of individual investors to ensure that the risky investment(s) is only a small portion of each individual investor’s overall investment portfolios.

As we have noted, the supply of any form of financial capital can never make up for lack of markets, poor management, or the absence of other crucial supply factors such as adequate labor, land, and infrastructure.

In terms of risk pricing, it is important that small businesses understand that conventional commercial bank loans follow real goods demand created by businesses in real goods markets. Conventional commercial bank loans are supply-followers rather than supply leaders. As such, they provide reliable, lower risk capital to enterprises with products, services, and assets that they understand. Unlike venture capitalists who can take more risky positions and price up to that risk, commercial banks play within a regulated environment that defines their world view and constrains their lending.

Therefore, without these risk pricing mechanisms, commercial banks are structurally limited by the fact that they are regulated to use other people’s money to lend to less risky enterprises. They are themselves highly leveraged and highly regulated institutions that in turn lend other people’s money to leveraged firms. Thus, conventional commercial banks are constrained in their ability to price up to risk. The only response that a commercial bank has to a too young, too fast growing, too highly leveraged, too risky small firm—especially one in a dynamic, uncertain and rapidly changing field such as life sciences or information technology—is not to make the loan.

This is the opposite choice from that of the venture capitalist, or mezzanine or subordinated debt lender. The risk capitalist can look at the same facts as the commercial banker, and if the management, market, labor force and technology are there, the risk capitalist does not have to say “no”, but can simply price up to risk.

2. High Information and Transaction Costs High information and transaction costs are equally severe barriers to investment. These high information and transaction costs affect perceptions with regard to both real goods markets and financial markets. As we noted earlier, large firms provide large amounts of free information to financial markets, but it is much more costly to assemble for small firms; and small loans can be just as expensive to make as larger loans.

Time and again, specialized managements, capable of looking at highly specialized kinds of companies, have been able to lower the individual information and transaction costs necessary to identify, evaluate, approve and track investments in targeted areas and industries. All specialized risk capitalists do this, but this specialized capacity to reduce information and transaction costs is also a hallmark of niche and community banks, discussed in Sections 6.6, 6.10, and 6.11.

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For instance, community banks have several simple techniques for reducing information and transaction costs: they are physically close to their clients and specialize principally in new, expanding, and existing enterprises in the local economy. Similarly, niche banks reduce information costs by thoroughly understanding business fundamentals (especially of emerging sectors) and accepting non-conventional risk mitigants.

In summary, many small firms, young firms, firms in emerging sectors, firms in mature industries, and firms in certain geographies may be rationed out of many markets due to high information and transaction costs. Highly specialized community banking firms that have industry and locational comfort and knowledge may be able to reduce these costs.

Highly specialized seed and early stage venture capitalists, mezzanine capital funds and subordinated debt funds also, by definition, reduce information and transaction costs by virtue of their specialization in riskier, often contrarian decision-making based on specialized information in managing and taking risk.

3. Market Prejudice Market prejudice is a definable market barrier, as well as a social reality. Market prejudice is a pre-judgment by resource suppliers about particular industries, geographic areas or other key features of firm demanders, based on a short-hand assessment of a few key factors.

For example, many biotech investments currently do not produce a risk-adjusted rate of return in a timely period. Therefore, most biotech companies are prematurely judged to be a bad investment risk. The same shorthand is often applied to inner-city companies, mature industries, or emerging sector companies without lending institutions taking time to analyze the individual capacity of a particular company to outperform its class.

Such market pre-judgments avoid the high information cost of making individual resource allocation decisions by arbitrarily ruling out whole classes of potential demanders.

For instance, a large bank may take a more actuarial approach to lending in order to maintain control and reduce credit review costs. That is, the bank may structure its credit decision processes to rely predominantly upon quantifiable information, rather than a lending officer's individual judgment of management capacity. Similarly, a venture capitalist may rule out an entire area as being too remote or an entire sector as too risky to warrant the assessment of individual deals. Michigan itself faces a locational prejudice in which key financial suppliers outside the state prejudge investments within the state as too risky, without taking the time or expense to assess the individual risk of the venture.

4. Insufficient Competition Insufficient competition can lead to monopoly. Monopoly can lead to skimming because the few suppliers in the market can generate a high return while taking only low risk. When capital suppliers can price high risk for low return this, in turn, drives both higher risk and lower return investments out of the market.

Generally speaking, in market areas where there are limited current providers of conventional debt especially for emerging sector businesses, demander firms are forced to alter their enterprise plans, seek capital from outside the local market, and/or relocate or close down their business.

Thus, in geographic markets characterized by a scarcity of capital providers for local business needs, otherwise profitable and growing small-to-mid-size businesses may refrain from

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pursuing business opportunities that would add to local economic development and job creation.

Earlier we noted that the more that there is a competitive environment in which there are a wide variety of financial suppliers providing a wide range of financial instruments at a wide range of risk adjusted prices, the more likely it is that there will be a supplier who will bet on the need of the demander for capital, and be able to distinguish mere desire. Therefore, a solution to the market imperfections facing small business demanders in Michigan is to increase the number and variety of niche and community banks, and a host of insurance and risk capital mechanisms that give commercial bankers partners who will help them grow their own customers without taking risks inappropriate to the nature, structure, regulatory environment and culture of commercial banks.

5. Government Policies Government policies designed to accomplish essential public policy goals often indirectly and unintentionally increase market concentration, impose added information and transaction costs to investment decisions, or distort the negotiation of risk-adjusted rates of return between demanders and suppliers.

The Law of Unintended Consequences has special relevance to public intervention in financial markets. These operate at a large macro structural level (e.g., extremely low interest rates in the U.S. in the early 21st Century helped create an artificial housing boom that then led to extreme financial abuses). These also operate a lower level micro level (e.g., long-term historic regulation of commercial banks creates a lending environment more cautious than prudence may require).

Further, when public resources are available in financial markets either directly through grant mechanisms or indirectly through tax mechanisms, they often bring along rules and regulations that create a substantial reporting burden (increased transaction costs) for the investor or prohibit investments from flowing to where they are most needed. For example, a combination of federal and municipal regulations and “strings attached” to the Los Angeles Community Development Bank are judged to have contributed significantly to both the 32% loan default rate and the creation of only a tiny fraction of the jobs that were promised.2

Finally, federal, state and local government policies often constrain land from its highest and best use, and place artificial constraints on the cost and availability of labor.

Where market barriers between suppliers and demanders of financial capital exist, removal of these barriers offers the potential to free up a market of sound emerging and expanding investments.

These market barriers, as they exist in Michigan, will be highlighted further as the Study Team addresses MEDC’s study questions.

2 Sterngold, James. “A Grand Idea That Went Badly Awry”, New York Times, November 14, 1999.


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5.3 Financial Capital in the Market: Risk and Return Profiles

Financial Capital Markets: An Overview

Capital is critical to supporting and growing small businesses. Forms of financial capital essential to small enterprise growth and development include:

• Short-term debt*

• Intermediate & long-term debt*

• Insurance and guarantee mechanisms

• Long-term bond debt finance

• Revolving loan funds

• Subordinated debt

• Mezzanine capital

• Later stage venture capital

• Seed and early stage venture capital

* Small business lending is usually in the form of short-term, intermediate or long-term debt. Types and Levels of Financial Capital

Different types of financial institutions and capital suppliers have their own “world views” when it comes to assessing, accepting, and pricing risk. As a result, each plays a unique and important role in the capital structure that finances growing small businesses. Therefore, it is important to understand their perspectives and availability in Michigan before moving on.

The types of financial capital include: (1) Commercial Bank Finance, (2) Debt Mechanisms to Reduce Commercial Bank Risk, (3) Mezzanine Capital to Reduce Bank Risk, and (4) Seed Capital and Venture Capital Funds.

A brief discussion of these capital sources and their suppliers is below.

1. Commercial Bank Finance Commercial bank finance is the focus of this report. It involves short-, medium-, and long-term commercial loans. Small business loans fall within this type of finance capital. Banks are highly regulated institutions and are tasked with making investments that preserve capital. They are more conservative by nature and definition than other capital suppliers.

Regulated financial institutions, such as banks and credit unions, are among the largest sources of credit to small businesses. According to the 2003 Survey of Small Business Finances, of the 60.4% of small businesses that used traditional credit in 2003, 68% obtained credit from commercial banks.


a. Short-, Medium-, and Long-term Debt

Characteristics: Smaller, Slower Growing Firms Risk: Intermediate/Known Financial Returns: Low to market rates Economic Returns: Job Numbers Are Small But Stable (20–100)

Generally Low to Moderate Skills

The vast majority of small business loans from commercial banks are short term loans (by definition, those less than one year) that finance “working capital” or the credit necessary to finance the costs of production and the costs of goods being sold. This is what commercial bankers sometimes refer to as “Christmas tree” loans. These loans less than one year finance the cost of acquiring raw materials, converting these into saleable goods and services, and then financing the accounts receivable until the final payment is received from the purchaser. This is the bread and butter of commercial bank lending.

It is very important to understand that short-term debt is not development finance, as it does not grow the company. This is growing the “Christmas trees,” harvesting them, hauling them to market, selling them, and receiving payment—activities of the cost of production and accounts receivable that all happen within one year from December to December. Generally no new capacity for the small business is created through short term lending.

Intermediate-term bank loans (those generally from one to five years) often finance equipment purchases that can increase the capacity of a firm to produce more or more efficiently.

Longer term loans are generally land and real estate related, and can also increase capacity.

2. Debt Mechanisms to Reduce Bank Risk Debt mechanisms assume a portion of the loan risk on loans perceived to be riskier. This in turn, reduces the risk to commercial banks which originate the loans. These programs include (a) Capital Access Programs, (b) long-term bond debt finance, (c) revolving loan funds, and (d) subordinated debt finance.

a. Insurance and Guarantee Mechanisms, including Capital Access Programs Characteristics: Smaller, Slower Growing Firms Risk: Intermediate/Known Financial Returns: Low to market rates. Program is very

attractive to participating bankers, borrowers and local economic development organizations because the program is so lean, cost effective, fast and non-bureaucratic.

Economic Returns: Job Numbers are small but stable (20–100): Generally low to moderate skills.

The Capital Access Program (CAP), a form of a guarantee, allows participating banks to make larger loans to high-risk customers, without the use of federal SBA loans or similar state and local government operated programs. The Capital Access Program encourages

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banks and other financial institutions to lend to small enterprises that fall outside of the conventional underwriting standards of many banks. By participating in a CAP program, lenders have available to them a lean and quick mechanism to meet the capital needs of most local small enterprise.

The first CAP was developed in Michigan in 1986 as a method to increase the availability of credit to small businesses.

b. Long-Term Bond Debt Finance

Characteristics: Growing Firms with long-term needs for land, plant, and equipment

Risk: Intermediate/Known Financial Returns: Below-market tax exempt financing to market-

rates. Program provides states and their small businesses with access to global capital markets in a lean, cost effective, fast, and non-bureaucratic way.

Economic Returns: Program can have a significant impact on jobs because it imports capital from global capital markets to provide long-term finance to small, growing enterprises.

Long-term debt finance can be issued through publicly created, but independent development finance authorities that mobilize private capital from global bond markets to solve public infrastructure and development needs. These multipurpose state and municipal development banks undertake large scale development to build or rebuild whole neighborhoods, cities and regions; build new towns; redevelop abandoned military bases; create world class research centers for universities; build industrial and technology parks; do in-fill housing, affordable and mixed-income housing, and mixed-use development.

There are many development finance authorities around the country, such as Florida Development Finance Corporation (the newest model), and the classic model as exemplified by the Massachusetts Development Finance Authority, the Alaska Industrial Development and Export Authority, the Finance Authority of Maine, the Arkansas Development Finance Authority, the Nebraska Finance Authority, and many others. (See Appendix J for further information on development finance authorities.) However, there is no such entity in Michigan at the state level, only municipal mechanisms that have inherent limitations.

c. Revolving Loan Funds

Revolving loan funds are typically run by local economic development or community development organizations or state or local institutions. They may focus in on a particular group of borrowers. New loans are typically made through the repayment of earlier loans. These loans can be to expanding businesses that have been denied a loan by their local bank and are based on job creation potential.

In Michigan, several revolving loan funds exist at the county level, but there is not a statewide revolving loan fund. Good models exist in a variety of states around the country.

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d. Subordinated Debt

Characteristics: Smaller, Slower Growing Firms Risk: Intermediate/Known Financial Returns: Mid- to High-teens Economic Returns: Job Numbers Are Small But Stable (20 – 500)

Generally Low to Moderate Skills

Subordinated debt, as the name implies, plays a secondary role below traditional commercial bank debt. As such, the risk associated is somewhat greater than that of ordinary debt financing. This increased risk translates into higher financial returns which are typically in the mid- to high-teens. The federal SBA 504 Loan Program is a type of subordinated debt program.

The availability of SBA 504 loans in Michigan is discussed in Section 6.12.

Again, many states have created successful models, some of which are perceived by banks in their jurisdictions to be far more efficient than federal models. One of the paradigm subordinated debt mechanisms is The Business Development Company (formerly the Massachusetts Business Development Corporation). (See Appendices I and K for more information on the Massachusetts Business Development Corporation.)

3. Mezzanine Capital to Reduce Bank Risk Mezzanine capital mechanisms reduce risk by pooling and spreading risk on transactions that are considered too risky for traditional lenders. Classic market-oriented mezzanine capital funds are a type of mezzanine capital mechanism.

a. Classic Market-Oriented Mezzanine Capital Funds Characteristics: Proven Management and Market

Cash Flow Established & Growing Diverse, Often Mature Industries Investment $1–$5 million, averaging $2–$3 Million

Risk: Intermediate/Known Financial Returns: High Teens, Low 20% ROI for Expansion

Capital Economic Returns: Relatively Large Numbers of Jobs (20–500)

Generally Moderate Skills and reasonable wages

Mezzanine capital funds are perhaps the most important form of risk capital for purposes of job creation and economic development. Mezzanine capital finances the growth of companies that are growing too fast and are too risky for commercial bankers, but are not growing fast enough to support the high returns expected by venture capitalists and their investors. These companies are often far better job creators than seed and early stage venture capital companies, and they are generally creating jobs that offer reasonable wages, growth potential, and career ladders.

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Mezzanine capital is a high-risk and, consequently, a high-yielding finance mechanism. Typically, mezzanine financing will involve term debt convertible to equity. There are a few mezzanine funds in Michigan, but there are opportunities for others.

The paradigm mezzanine capital fund in the United States is the Massachusetts Resource Capital Corporation. (See Appendix I for more information.)

4. Seed Capital and Venture Capital Funds a. Seed and Early Stage Venture Capital

Characteristics: Unproven Management and Market Early Losses Lopsided Balance Sheets Investment $250,000 to $1–$3 Million

Risk: Extremely High/Unknown Financial Returns: Extremely High/Unknown

1000 Potential Deals Produce 10 Funded deals 1 of 10 Funded May Produce 50%–100% Returns on Investment (ROI)

Economic Returns: Job Numbers Are Small in Early Stages

Seed capital targets entrepreneurs with great business ideas. Typically, there is not yet a company to finance. Therefore the capital is financing an individual or team of individuals with a promising business model. Seed capital investment managers work with the entrepreneur(s) to develop a business plan, product line, and distribution network.

Early stage venture capital targets existing companies which have moved from the idea stage to the product stage. Early stage venture capital is still very risky, however it is not as risky as seed capital, because the company already exists and often a product has been developed.

While there are a few small seed and venture capital funds in Michigan, the state has a low amount of angel investor and venture capital activity currently. This is discussed further in Section 6.5.

b. Later Stage Venture Capital Characteristics: Proven Management and Market

Cash Flow Established & Growing Diverse, Often Mature Industries Investment $250,000 to $2–$3 Million

Risk: Intermediate/Known Financial Returns: High Teens – Low 20% ROI for Expansion

Capital 25%–50% for Later Stage Venture Capital

Economic Returns: Relatively Large Numbers of Jobs (20–200) Generally Moderate to High Skills

Later stage venture capital targets established companies that have a successfully developed product line and market niche. Because later stage venture capital finances established companies with an established management, market, and products, the amount of risk is not

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as high as seed and early stage venture capital. Later stage venture capital is usually a straight equity infusion into a growing company.

June 27, 2008 Small Business Lending Report 6.0 Study Questions

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6.0 MEDC STUDY QUESTIONS In this section, the Study Team will address the 14 questions put forth by the MEDC.

6.1 Aggressiveness of Bank Lending in Michigan and Comparison States

Study Question: Compared to other states in the study, are Michigan banks becoming more aggressive in lending to small business? Does the data show whether more loans are being made and greater risk being accepted or that those getting the loans are getting them at better rates?

Overview of Findings

Banks in Michigan have moderate-sized small business lending practices and appear to aggressively pursue and make loans to small businesses in the state (when compared to the Comparison States). Michigan’s small business lending practice is especially strong when compared to the Great Lakes states. Michigan has a high ratio of small business loans to total bank assets, a high ratio of small business loans to total business loans, and a high average of small business loans per lending institution. All of these are indicators of substantial small business lending activity in the state. While some Comparison States have seen dramatic fluctuations in loan volume and other aggressiveness metrics, Michigan has experienced slow but steady growth over time. Michigan’s solid showing in loan volume, small business loan amounts, and other metrics suggest that lenders are not shying away from lending in the state.

Data Research Findings

There are multiple metrics that denote bank lending aggressiveness, though many of them are not collected or reported. Bank lenders the Study Team spoke with identified three specific metrics that provide insight into aggressiveness: (1) price of loans, (2) time to originate loans, and (3) policy exceptions. However, banks do not report such information and therefore, no data exists on these metrics.

In order to identify another metric to assess aggressiveness the Study Team looked to existing literature. Dallas Federal Reserve used value of loans as a measure of aggressiveness in a 1995 report.3 The Review of Business, a business journal, cited loans to total bank assets as an indicator of aggressiveness. Therefore, the Study Team evaluated these metrics and others, as listed below.

• Total Bank Assets ($)

• Number of Small Business Loans by State

• Value of Small Business Loans ($) by State

• Ratio of Small Business Loans to Total Assets

• Ratio of Small Business Loans to Total Business Loans

3 Federal Reserve Bank of Dallas, “Houston Business: A Perspective on the Houston Economy,” (December 1995).


The Study Team also looked at loan originations by county in order to assess aggressiveness within the state of Michigan. Based upon this information, the Study Team found Michigan to have a relatively healthy and active small business lending environment, as detailed in the charts on the following pages of this section. Note: It is important to note that most of the data in this section is from Federal Reserve Call Reports. These reports provide data by state, but only for banks that are headquartered in the state. This means that the lending and asset data for Michigan is only reported for banks that have headquarters in Michigan. Thus, metrics for some states (such as North Carolina, where Wachovia and Bank of America have their headquarters) are skewed to the higher end. For example, North Carolina’s numbers will be overstated because Wachovia’s loan activity is reported within North Carolina, though much of its activity occurs elsewhere. At the same time, numbers may be understated for a state where lending activities come from banks headquartered elsewhere. This is the case with Michigan. The Study Team has provided explanations below where these factors may impact the findings.

Bank Assets Before evaluating small business loan activity, the Study Team begins by looking at the amount of bank assets in Michigan and the Comparison States. This is important because the level of assets affects the volume of loans that can be provided. According to Figure 6.1, Michigan is in the middle of the Comparison States in terms of total bank assets. Assets in Michigan remained steady with incremental growth from 2000 to 2006.

Figure 6.1 Total Bank Assets in Michigan and Comparison States (2000–2006)

North Carolina and Ohio have the largest level of assets. In North Carolina, this is primarily because of the headquarters of Bank of America and Wachovia. In Ohio it is due to the headquarters of US Bank, JP Morgan Chase, Key Bank, Huntington Bank, and several other larger banks. Minnesota and Indiana have the lowest level of assets. This does not necessarily mean that these states are under-banked. In fact, Minnesota has a large number

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of institutions headquartered in the state (over 450 in 2006), but most of them are small community banks that have a lower level of assets.

Number of Small Business Loans

When we look at small business loan activity, we see that Michigan has a relatively high level of activity. A valuable metric for evaluating small business loans activity is the average number of small business loans per institution in each state. This figure shows the level of lending activity and aggressiveness in each state.

As we see in Figure 6.2, institutions in Michigan have made steady through increasing numbers of loans over time. In fact, in 2006, banks in Michigan made more loans per institution than any other Comparison State.

Figure 6.2 Average Number of Small Business Loans at an Institution in Michigan and Comparison States (1998–2006)

When we look at small business loan activity per state (without normalizing for banks in the state), we see that Michigan is in the middle of the Comparison States. This is shown in Figure 6.3.

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Figure 6.3 Total Number of Small Business Loans in Michigan and Comparison States (1998–2006)

This metric, while showing the total number of small business loan activity by state, is somewhat misleading given the disparity in the number and types of banks headquartered in each state (especially North Carolina and Ohio). Therefore, the Study Team feels that the average number of small business loans by institution (Figure 6.2) better reflects small business lending in Michigan.

Value ($) of Small Business Loans by State The Study Team evaluated the dollar value of loans made in Michigan and the Comparison States over time to further assess lending activity. When looking at the dollar amount of total small business loans by state from 1998–2006, Michigan in the middle with a sizable value of small business loans.

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Figure 6.4 Total Small Business Loans ($B) in Michigan and Comparison States (1998–2006)

However, when we normalize the data, as shown in Figure 6.5, we see that as of 2006, Michigan has a higher average value of small business loan than every other Comparison State (except for North Carolina and Ohio).

Michigan’s average value of small business loans has also grown steadily from 1998–2006, whereas several other states have experienced declines. This is an indicator that over time Michigan’s aggressiveness is not fluctuating significantly and the state is staying competitive comparatively.

Figure 6.5 Average Small Business Loan Total ($) in Michigan and Comparison States (1998–2006)


Small Business Loan Size Michigan is also relatively strong when it comes to average small business loan size ($) to small businesses. Figure 6.6 shows that Michigan is in the middle of the Comparison States and that its average small business loan size has increased steadily between 1998 and 2006.

Figure 6.6 Average Small Business Loan Size ($) in Michigan and Comparison States (1998–2006)

Michigan has the highest average small business loan size among all the Great Lakes states, with states outside the region having larger average loan sizes. In looking at this graph together with the average number of small business loans from an institution in each state (Figure 6.2), Michigan provides a high average number of small business loans at a sizeable dollar amount.

Ratio of Small Business Loans to Total Assets As noted in the Review of Business, the ratio of bank loans to assets is one metric for measuring lending aggressiveness. This metric has been used in previous studies that examine bank aggressiveness, and provides insight into how much of a bank’s assets is going to small businesses. The Study Team adapted this metric to measure banking aggressiveness in small business lending by looking at the ratio of small business loans to total bank assets. A low percentage indicates that a bank is not very aggressive in lending to small businesses, while a higher percentage indicates that a bank is active and aggressive in lending to small businesses.

When evaluating this metric, we see that Michigan has the highest ratio of small business loans to total assets in the most recent reporting year (2006) and was first or second among Comparison States from 2001–2006. This is depicted in Figure 6.7 below. This is a strong indicator of Michigan’s relative aggressiveness in providing small business loans.

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Figure 6.7 Small Business Loans as a Percentage of Total Assets in Michigan and Comparison States (2001–2006)

It should also be noted that Michigan’s level remained steady between 2001 and 2006, while most of the other states (except Minnesota) experienced declines in the ratio. States in the Great Lakes region experienced less drastic declines than North Carolina, Massachusetts, California, and New Jersey. Ratio of Small Business Loans to Total Business Loans Another metric for assessing small business lending aggressiveness is the ratio of small business loans to total business loans. This metric shows what percentage of a bank’s loan portfolio goes to small businesses within the state. Michigan banks provide a high percentage of small business loans to total business loans, as shown in Figure 6.8 below. This is important because it shows how aggressive banks are in targeting small businesses as part of their total business loan activities. Michigan has consistently ranked second or third in the category since 2001, providing further evidence that banks in the state are aggressive in providing small business loans relative to the Comparison States.

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Figure 6.8 Small Businesses Loans as Percentage of Total Business Loans in Michigan and Comparison States (2001–2006)

While Michigan has decreased its ratio from 2001 to 2006 by 7.2 percentage points, every other state has also experienced a decrease, with several at a much greater level of change. Generally the Great Lakes states provide a high proportion of small business loans to total business loans, while the non-Great Lakes states provide a lower proportion.

Lending Aggressiveness across Counties in Michigan In addition to examining aggressiveness among the Comparison States, the Study Team looked at the differences between markets within Michigan in order to assess aggressiveness. From the data collected, the Study Team found that small business loan activity has grown in all surveyed markets over the last 10 years. The Study Team found this growth to be an indicator of aggressiveness within the state. The rate of growth varies by county, suggesting the relative competitiveness of each market. The Study Team selected Ingham, Kalamazoo, Kent, Oakland, Washtenaw, and Wayne counties for evaluation, as they are located in various parts of the state, and have high levels of population concentration.

The data provided is from Community Reinvestment Act (CRA) reports, which show lending activity by all banks active in a state (not just those headquartered in the state). From these CRA reports, the Study Team was able to find small business loan origination and dollar value figures for each of the counties.

According to Figure 6.9 below, loan originations are increasing in all of the counties examined, with Oakland and Wayne counties having the most significant increases and Kalamazoo and Ingham counties having the lowest number of loan originations over the 10-year time period.

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Figure 6.9 Number of Loan Originations in Select Counties in Michigan (1996, 2001, 2006)

Interestingly, multiple lenders interviewed for this study cited Ann Arbor (Washtenaw County) as a hot bed of lending activity. That is not shown in this chart, though the Study Team does believe it to be true.

When we look at the dollar amount of loan originations in Figure 6.10, we again see strong performance overall. Similar to the number of loan originations, Oakland and Wayne counties saw the highest levels of total loan dollars originated. Again, the level of activity taking place in Ann Arbor and the surrounding cities appears to be low given lender interviews. It is possible that firms in this area are using alternate sources of capital, but it is unclear from the data.

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Figure 6.10 Amount of Loan Originations ($) in Select Counties in Michigan (1996, 2001, 2006)

As seen in Figures 6.9 and 6.10, although loan origination levels vary among counties, all are growing, indicating that lending is not decreasing in Michigan.

The Current Credit Market and its Impact on Aggressiveness The current national economic and credit markets are in a state of flux, which is directly impacting credit availability and lender aggressiveness nationwide. According to the lenders interviewed and the “Report to the Congress on the Availability of Credit to Small Businesses” from October 2007, current lending in Michigan and the nation is less “aggressive” overall than it was 6–12 months ago with the price of credit rising and increased underwriting scrutiny. It should be noted, however, that this is not true uniformly across all geographies and sectors.

The credit tightening nationwide will color “aggressiveness” statistics for Michigan and Comparison States now and into the next 12–36 months. Information about the current credit tightening is provided in Appendix F.

Bank Interview Findings

1. Some Markets in Michigan Are More Active with Small Business Lending than Others Of all banks interviewed, 65% commented that there is intense bank competition for small business loans in Michigan and across the country. Of the banks that lend in Michigan, 68.8% believed that bank competition for small business loans is strong.

Within Michigan, specific areas, such as Ann Arbor and Kalamazoo, are seeing strong lender activity, according to lenders. In fact, one lender described business loan activity in Ann Arbor as a “feeding frenzy of piranhas.” These areas are not experiencing the downturn like the rest of the state and are at the forefront of life sciences and technology activity in

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Michigan. As one national bank noted, banks want to be in “areas of the future.” According to the same lender, that is why Ann Arbor’s bank activity is busy while Detroit’s is “lax” and “not as fierce.”

Though the data provided in this section seems to contradict these statements about Ann Arbor and Kalamazoo, the Study Team believes that business finance activity (whether it be through conventional or risk capital lending) to be high in these areas.

2. Credit is Tightening Nationwide and That is Impacting Small Businesses Across the U.S. and in Michigan

Of all the banks we interviewed, 76.2% talked about the tightening of credit across the country. The current subprime crisis has had ripple effects throughout the banking industry, including in small business lending. With banks experiencing defaults in mortgages and investment losses, liquidity is an issue. As a result, banks everywhere are becoming more conservative with underwriting criteria and pricing. As one banker with a national institution noted, the current “liquidity crisis” banks are experiencing “filters down” to small business owners. One large regional bank commented further that “it is no longer a borrowers market” for small business owners or others looking for credit. The Study Team expects that such a trickle-down will impact bank aggressiveness metrics (discussed in this section) over the next 12–36 months.

This credit situation is not unique to any specific area of the country. As one national bank noted, “Michigan shouldn’t feel alone” with the downturn of the economy and the credit situation. A small community bank noted that all banks are still trying to understand how the credit crisis will impact their business lines.

Several banks noted that the credit tightening affects small businesses in particular. One national bank noted that it is getting harder to finance small businesses now given the “defensive posture” of banks in the current market. Another banker noted that banks are in “tightening down mode” at this point.

This credit tightening is clearly impacting Michigan small business owners, according to the bankers interviewed, with 61.9% of banks that operate in Michigan commenting that small businesses in Michigan are having trouble obtaining credit.

3. There is Still Capital in the Market for the Right Borrowers Without any prompting, 68.8% of bank interviewees commented that there is credit in the market for good borrowers, in spite of the current credit crisis. Additionally, not a single bank that was interviewed said that credit was unavailable for quality borrowers. As one national bank commented, there is a universal refrain in small business banking: businesses say there is not enough capital and banks say there are not enough good businesses to lend to. This suggests that strong businesses and concepts that meet bank credit standards will be able to receive capital and grow even in the current market, which is becoming less aggressive nationally.

As discussed in Section 5.2, demand is infinite in the eyes of demanders; therefore it is difficult to assess actual need for capital, as opposed to the actual desire for capital. However, the more that there are a wide variety of financial suppliers providing a wide range of financial instruments at a wide range of risk adjusted prices, the more likely that market imperfections will be reduced.

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Business Interview Findings

1. Small Businesses’ Experience with Lending Challenges the Aggressiveness Data Presented At least nine (75%) of the businesses interviewed were currently or had recently had difficulty securing financing needed. Of the businesses in Michigan, 88% said that obtaining financing is a problem. This was true across all business sectors surveyed for this report. Most businesses interviewed spoke of lending experiences post-2006. However, data post-2006 is not currently available. This may be a reason for the disparity and suggests that though Michigan appears to be relatively aggressive with small business lending, it may have become slightly less so in recent years. However, because of economic conditions nationally after 2006, it is likely that banks are becoming less aggressive everywhere.

2. Loans are Getting Harder to Obtain Nationally and in Michigan As discussed, the credit market is tightening; thereby, making it harder for small businesses to get loans. The businesses interviewed concurred, with 42% of business owners mentioning that the general credit tightening in the market is a problem for small businesses. As one small business in Michigan noted, there is “a lot of less money available than in the past” and that for the smallest businesses, “you’re going to need help from something other than a bank.”

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6.2 Aggressiveness of Bank Lending by Sector Study Question: Are banks in identified comparison states more aggressive in small business lending than Michigan’s banks on a sector by sector basis? Over the past 10 years how has Michigan’s small business lending compared to other states in each of these sectors?


Data is not available for lender aggressiveness on a sector by sector basis. A thorough discussion of lending aggressiveness in Michigan and the Comparison States over at least the last 5–10 years is provided in Section 6.1. Further, a discussion of lending activities targeting companies in emerging sectors can be found in Sections 6.5, 6.6, and 6.9.

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6.3 Level of Bank Default and Loss Rates Study Question: Are bank default and loss rates in Michigan higher or lower than default and loss rates in other key states on a sector by sector basis? Overview of Findings

Forecast loan loss (which is partially derived from active historical loan loss) in Michigan has historically been under the national average and in keeping with the Comparison States in this study. However, the actual performance of loans in Michigan (like that of many states in the study) has deteriorated with an increase in net loan losses. In fact, Michigan’s loan loss performance as of 2006 was the worst of the Comparison States. Further, in 2006 Michigan’s actual loan losses exceeded the loan loss reserves set aside for anticipated loan failures. Given the current level of loan loss in the state, it would not be surprising if banks increased their loan loss reserves and possibly tightened underwriting criteria in the near future. Such a move should be viewed by Michigan policymakers as practical and prudent rather than market discrimination. Note: Loan loss data does not exist on a sector by sector basis.


Actual loan loss rates and allowances for loan loss are important indicators of the riskiness of a bank’s portfolio. The Study Team evaluated a number of loan loss metrics in order to assess loan loss rates in Michigan over time. These metrics are defined below.

Metrics 1) Allowance for Losses on Loans and Leases (ALLL) to Gross Loans

ALLL is defined as the percentage of gross loans an institution expects to “go bad.” In this section, it is also referred to as “loan reserves,” “allowance for future loan losses,” and “allowances for loan loss.” ALLL to Gross Loans gives insight into the ratio of total loans a bank expects to lose, shedding light on the relative riskiness of a bank’s portfolio.

The Study Team interviewed a finance person at a national bank in order to understand how ALLL is derived. Banks determine this number by assessing their loan portfolios quarterly. Banks consider quantitative and qualitative factors when determining ALLL. Factors considered in the analysis are: risk of clients, industry concentration and performance, geographic concentration and performance, weighting of long-term versus short-term debt, and type of loan collateral/security. Banks determine ALLL for each business division and then aggregate those figures in a single ALLL figure. The reported ALLL aggregates all loan loss allocations derived at a bank. A high ALLL is considered bad.

Calculating ALLL to Gross Loans: The median ratio of the allowance for loan and lease losses on a consolidated basis divided by total loans for FDIC-insured institutions headquartered in the state.

2) ALLL to Noncurrent Loans

This ratio shows whether an institution is losing more of its loans than it has projected to lose. If the ratio falls below 1.0, this means that a bank is losing more than it has set aside to lose. When this happens, it suggests that a bank’s portfolio is riskier than

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anticipated. As of 2006, Michigan was the only state in the study to have a ratio less than 1.0.

Calculating ALLL to Noncurrent Loans: The median ratio of the allowance for loan and lease losses on a consolidated basis divided by loans and leases ninety days or more past due and loans and leases in nonaccrual status for FDIC-insured institutions headquartered in the state.

3) Net Loan Losses of Total Loans

This ratio gives an indication of the percentage of loans actually being lost. A higher value suggests that a bank is losing more of its loans. This data is only available from 2000 on. As a result, the Study Team looks largely to the previous two metrics in this section.

Calculating Net Loan Losses of Total Loans: The median ratio of net loan losses divided by an average total loans for FDIC-insured institutions headquartered in the state. Net loan losses are total loans and leases charged off (removed from the balance sheet because of uncollectability), less amounts recovered on loans and leases previously charged off.

Loan Loss in Michigan Historically A bank’s projected loan loss reserve is generally viewed as a bank’s best estimate of how much money it expects to lose from its loans.4 In essence, it shows how risky banks believe their portfolios to be. Banks are willing to lose a certain percentage of their loan portfolio because the nature of the business requires that they take a certain level of risk in order to capture business. If banks only invested in sure bets, they would have very few clients.

The level of bank loan loss in Michigan, as suggested by ALLL to Gross Loans, is lower than the national average and in the mix when compared to the Comparison States. Further, the ALLL to Gross Loan ratio of banks in Michigan has been relatively steady over time, unlike many of the Comparison States, suggesting steady loan performance over time.

In Figure 6.11 below, we see that compared to the national average, Michigan’s ALLL to Gross Loans ratio has been lower and steadier over the last 20 years. It is only recently that Michigan’s ALLL exceeds that of the nation.

4 U.S. House of Representatives, Subcommittee on Financial Institutions & Consumer Credit, Committee on Banking and Financial Services, (June 16, 1999), http://commdocs.house.gov/committees/bank/hba57680.000/hba57680_0.htm


Figure 6.11 Allowance for Losses on Loans and Leases to Gross Loans in Michigan and the Nation (1966–2006)

Figure 6.12 demonstrates the relative riskiness of loan portfolios across Comparison States from 1967–2006. This shows that over the last 40 years, Michigan’s ALLL to Gross Loans has been on par with that of the Comparison States and has been relatively steady over time compared to the other states. Over all periods, Michigan remains under the “healthy” ALLL level of 2% (as cited in numerous articles), whereas that is not true of all other Comparison States.

Loan loss rates and loan reserves are generally higher when the economy is bad. Typically more loans “go bad” when the economy is weak. As a result, banks have to build up their loan loss reserves to account for the bad loans they expect. This is evident in Figure 6.12 below where loan reserves spike during periods of economy distress (e.g., the late 1980s and early 2000s).

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Figure 6.12 Allowance for Losses on Loans and Leases to Gross Loans (10-year Weighted Average) in Michigan and Comparison States (1967–2006)

Looking more closely, Michigan’s percentage of ALLL to Gross Loans has been slightly lower than that of most Comparison States, except for the period between 1997 and 2006, when it was among the highest. This could be due to the recent economic malaise in Michigan, which could be leading to a higher number of distressed loans and risk.

Historically, Michigan’s percentage has been relatively steady compared to the Comparison States, whereas California, Massachusetts, New Jersey, and Illinois have been more volatile.

It is important to note that the ALLL to Gross Loans statistic factors in all loans made by banks, not just small business loans. Thus, a reason for the spike experienced in California, Massachusetts, and New Jersey from 1987 to 1996 was likely related to the real estate tumble and bank failures in the late 1980s and early 1990s rather than a dip in small business loan performance. That said, overall portfolio performance impacts a bank’s ability to lend to all borrowers, including small businesses. Note: The nation’s current real estate and mortgage crisis is not reflected in the data yet.

As shown above, loan loss allowances vary over time as portfolio risk changes. Figure 6.13 below shows how ALLL to Gross Loans ratios have changed in Michigan and the Comparison States in recent years. Again, we see that Michigan is toward the higher end of the spectrum, suggesting the relative risk of loans in the state are high.

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Figure 6.13 Bank Allowance for Losses on Loans and Leases to Gross Loans of Total (%) Loans in Michigan and the Comparison States (2000–2006)

It is important to understand the context for these loan loss allocation statistics. In order to do that, the Study Team examined total loan volume (including all types of loans) in Michigan and the Comparison States. The Study Team wanted to ensure that steady ALLL to Gross Loans figures were as a result of steady performance rather than declining loan volume.

In fact, as depicted in Figure 6.14 below, the Study Team found that loan volume in Michigan has been growing over time and that its growth is moderate relative to the Comparison States. This indicates that Michigan’s relatively steady ALLL to Gross Loans rate occurs in an environment of historically low small business lending growth.

Figure 6.14 Total Loans by Commercial Banks Headquartered in Each State in Michigan and Comparison States (1966–2006)

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Recent Loan Loss in Michigan In looking at Michigan’s recent loan loss data, we see performance of all loans in the state has weakened, with rising net loan loss rates outstripping loan loss reserves (ALLL).

According to Figure 6.15, while Michigan has not had the highest net loan losses over the period from 2000 to 2006, beginning in 2005, Michigan net loan losses began to increase and as of 2006, Michigan had the highest net loan loss rate of the Comparison States. However, its recent loan performance is not dramatically different from that of the Comparison States.

Figure 6.15 Net Loan Losses of Total Loans in Michigan and Comparison States (2000–2006)

Michigan’s net loan loss rate is on par with that of the Great Lakes states, which are notably higher than those of California, Massachusetts, and New Jersey. Note: Again it is important to note that this data is not specific to small business loans, but is an indication of general loan risk in the Comparison States. We also see changes in loan portfolio risk by comparing loan loss reserves (ALLL) to actual losses (noncurrent loans). This shows whether the banks are able to correctly assess their own loan risk. As depicted in Figure 6.16 below, Michigan's ratio of bank ALLL to Noncurrent Loans has hovered between 1.0 and 2.0 during 2000–2006. As discussed previously, any number above 1.0 shows that a bank is able to cover its loan losses with reserves, while any number below 1.0 means that a portfolio has exceeded its anticipated risk. Since 2004, Michigan’s ratio has dipped dramatically. This suggests that loans in Michigan are performing more poorly than anticipated and may be more risky than those in other states. As of 2006, Michigan was the only state in the study under 1.0.

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Figure 6.16 Bank Allowance for Loan and Lease Losses of Noncurrent Loans in Michigan and Comparison States (2000–2006)

Though Michigan’s ratio of loan loss reserves to actual loan losses has fallen, Michigan’s loan volume has not decreased (as shown in Figure 6.14 and Section 6.1). Rather it has increased, suggesting that there has not been pullback from Michigan, despite the state’s economic woes and changing loan profile.

Additionally, the decline of the ALLL to Noncurrent Loans ratio suggests that banks in Michigan will be raising their loan loss allocations. When and if this happens, MEDC and others in the state should recognize this as “rational” and “prudent” given the data presented.


There are no bank interview findings that address this topic.


There are no business interview findings that address this topic.

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6.4 Impact of Manufacturing Sector Decline on Lending Study Question: What is the impact of the decline in the manufacturing sector on lending practices in Michigan and other states? Does this decline have a more serious impact in Michigan due to the state’s reliance on manufacturing?


The decline of manufacturing within Michigan has had a dramatic impact upon bank lending in the state, as the resulting distress prevalent in much of Michigan’s economy colors bankers’ risk assessment of loans in the state. Conventional banks are, by nature, conservative institutions. When evaluating loans in any state, banks take into account the micro and macroeconomic factors that are likely to impact business success. Michigan’s reliance on manufacturing has made it weaker than other states in the study given the current market’s move towards globalization and the “knowledge economy.” Given the difficulty of Michigan’s current economy, the question becomes: “Is there market prejudice against Michigan and small business owners in the state?” The Study Team found that while there may be isolated cases of market prejudice, overall lenders in the state are interested in lending to small businesses located there, though they do so cautiously. In short, the Study Team found that there is no wholesale lender pullback from Michigan and that lenders regard Michigan’s small business owners as they do others from across the United States.


Of the banks interviewed, over 70% mentioned that the macroeconomic conditions of a state or region impact the underwriting of loans. Therefore, a discussion of Michigan’s economy is important to this report.

In researching the economy in Michigan and the Comparison States, the Study Team identified two main trends, neither of which will be a surprise to MEDC:

1) Michigan’s economy is in a state of substantial economic turmoil, and

2) Michigan’s economy is becoming increasingly diverse.

A full discussion of economic data is provided in Appendix C.

Michigan has historically relied heavily on the manufacturing industry, with the sector accounting for the largest share of jobs in the state. Table 6.1 shows the change in number of manufacturing establishments, sales, employees, and payroll from 1992 to 2002. Despite positive growth in manufacturing sales, the number of manufacturing establishments, employees, and payroll has declined. This decline has been caused by foreign competition, domestic relocation, and automation.

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Table 6.1 Manufacturing in MI between 1992 and 2002

Total Manufacturing 1992 1997 % Change 2002 % Change

Establishments 15,996 16,045 0.30% 15,193 -5.30%

Sales 159,324,094 214,900,655 34.90% 221,433,262 3.00%

Paid employees 783,384 833,429 6.40% 736,259 -11.70%

Annual payroll 27,265,829 34,418,934 26.20% 33,171,232 -3.60%

Source: US Economic Census 1992, 1997, 2002

Within manufacturing in Michigan, auto and auto parts manufacturing are by far the largest sectors. Between 1992 and 2006 the auto parts manufacturing industry in the Midwest lost 12.7% of its employment, with Michigan losing the most jobs (nearly 31,000). Since 2000, auto manufacturing has been hit hard across the U.S. However, as Figure 6.17 shows below, the Midwest has been hurt disproportionately.

Figure 6.17 Indexed Employment in Auto Parts Manufacturing (1992–2006)

The decline of the manufacturing sector has been especially difficult in Michigan because the state lacks industrial diversity. According to the 2007 Development Report Card for the States, published annually by the Corporation for Enterprise Development, Michigan ranks third worst (among the 50 states) in industrial diversity with a score of 0.115 (the higher the score,

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the lower the diversity). With its score of 0.115, Michigan has a less diversified economy than almost every other state in the U.S., including all Comparison States.5 Using this scoring system, among the Comparison States, Illinois has the most diversified economy, as shown in Figure 6.18 below.

Figure 6.18 Industrial Diversity in Michigan and Comparison States (2004)

Losses in the manufacturing sector have sent shockwaves through other areas of Michigan’s economy. As manufacturing jobs have declined and the economy has deteriorated, mortgage foreclosures have increased dramatically. The current housing market in Michigan, which is distressed and has been for some time, directly impacts home lending and small business lending in the state. As one bank interviewee commented, lenders cannot ignore the ripple effect that a declining housing market has on businesses. This banker remarked that it would be hard to lend money to a small business—such as a local tourism outfit serving Michigan residents—if area residents were losing the equity in their homes and, as a result, had less money to spend.


Most lenders interviewed spoke synonymously about the decline of manufacturing and the decline of the economy in Michigan. Therefore, though the findings below reference the Michigan economy, they also speak to the state of manufacturing in Michigan.

5 Score based on the Herfindahl Index, indicating the degree of diversity among industries within the state's traded sector, 2003. A "0" score indicates perfect diversification; a score of "1" indicates that all the traded sector activity is in just one industry.


1. Michigan’s Economy Clearly Complicates Lending in the State Of the bankers interviewed, 71% stated that the micro and macroeconomic situation in an area impacts ability to lend. This sentiment was true across national, regional, community, and niche banks. Of the banks that lend in Michigan, 62.5% said that the economy is a driving factor in making loan decisions and 81.3% said that the state economy is not good. At least 10% of the lenders interviewed used the word “recession” to describe Michigan’s economy without any prompting. One bank in particular noted that “economic conditions [in Michigan] are the biggest challenge right now [to small business lending].”

From the banks’ perspective, the nature of lending requires that banks pay attention to these trends and what it means for their clients’ new or existing businesses. The economy affects company sales, the quality of employees that companies can retain, and ultimately, the cash flow that is available to repay loans. Therefore, banks carefully watch these conditions and make credit decisions accordingly. As one national banker noted, for any area where there is a downturn, bankers “scrutinize those deals because they can’t ignore the larger picture.”

One niche bank indicated that banks’ perception of the Michigan economy is the same as that of the public: Michigan is in distress. Another national lender was more direct about the impacts on lending, saying the “economy in Michigan is not so hot” which is “a driving factor” impacting lending and small business growth.

2. Loans in Michigan Receive Additional Scrutiny Due to the Economy Because of the current economic conditions in Michigan, loans in the state are subject to additional scrutiny. Of the banks lending in Michigan, 25% commented that loans from Michigan should receive additional scrutiny given the economy. This point was summarized clearly by one national banker (who is also a credit officer): If I saw a small business loan in Michigan, I would “look long and hard” given the overall economy. The credit officer went on to say that layoffs and the subprime market make it harder for consumers to spend in Michigan and that, in turn, can impact small business revenue.

Of the lenders who do not lend in Michigan, 20% believe that loans in the state should receive additional scrutiny. This suggests that lenders within Michigan may be more biased against businesses in their own state than the overall market. The reasons for such a bias may be based on market experience, market perception, or other factors.

Given the real impact that the economy has on small business performance, the Study Team feels that such scrutiny in Michigan is pragmatic and rational rather than market prejudice.

3. State of Economy Impacts Perception of Small Business Strength The state of the economy also impacts banks’ perception of small business strength. During our interviews, 70% of banks noted that Michigan is not a good place for small businesses currently. Responses were most negative from community banks in Michigan, but were also negative from national and regional institutions active in the state. Niche banks were most positive regarding the opportunities in the state, perhaps because of their unique focus on growth industries. This negative overall perception can impact loan underwriting.

Though the majority of lenders mentioned the poor state of the Michigan economy, a few made sure to note that other areas of the country have overcome the situation that Michigan is in now. Specifically, these lenders cited Seattle in the 1980s and Los Angeles (with the

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civil unrest and loss of the aerospace industry) in the 1990s. According to these lenders, banks reacted and lent to those economies differently than they do today.

4. There Is No Wholesale Lending Pullback from Michigan or Small Businesses in Michigan … But There May Be Some Bias

When the Study Team spoke with lenders, we initially asked each whether its underwriting criteria varied from state to state. The answer was a resounding, “No.” (While the consistency of the answer was impressive, it should be noted that a “yes” answer would have constituted redlining.) However, in our business interviews, we heard from one business owner that he had been told by a particular bank that the institution was “clamping down on lending in Michigan and especially in service [businesses in Michigan].”

In order to test the prevalence of such a bias, we began to ask bank interviewees a new question: “What is the feeling in the banking industry—not your institution in particular—about lending in Michigan?” Even with this question, we yielded much the same response—that banks are not averse to lending in Michigan, but that they do consider the economy an important factor when making credit decisions.

Of all the banks interviewed, only two mentioned that there may be an industry-wide bias against Michigan. One of these institutions was a community bank in Michigan while the other was a community bank outside of Michigan. The lender from outside of Michigan noted that she had heard of a banking pullback in Michigan but was not sure if that was actually occurring or just her general feeling about industry perceptions.

All other respondents were adamant that there was no wholesale bias against Michigan businesses. The quotes below show those responses:

• “Come on! If you have a customer base in Michigan, you have to support the businesses there.” – National Lender, active in Michigan

• “There is no mandate against Michigan.” – National Lender (credit officer), active in Michigan

• “Banks aren’t skipping Michigan.” – National Lender, active in Michigan

• “If banks are saying that [they won’t lend in Michigan], they probably are not doing business in Michigan. I can’t imagine our competitors saying that.” – National Lender, active in Michigan

• “Our lending decisions are ‘just business.’ They are not about like or dislike of a state or region.” – National Lender, not active in Michigan

• “We will never not do business in an area, but you have to recognize the impact of an industry downturn.” – National Lender, active in Michigan

Though banks were nearly uniform in their support of lending in Michigan, we did hear from a few lenders that banks:

1) Do not want to go to Michigan if they are not already there.

2) Scrutinize loan requests in Michigan more stringently given the state of the Michigan economy.

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3) Do not want to be headquartered in Michigan due to Wall Street’s bias against the state currently.

These sentiments were not universal, but should be taken into account.

5. There is No Bias Against Small Business Owners in Michigan Of the banks interviewed, not a single institution thought that Michigan business owners were any more or less adept than other small business owners across the U.S. This is important because it shows that negative views of the Michigan economy do not color banks’ perceptions of the inherent credit worthiness of state residents. They did, however, believe that businesses in Michigan face more challenges given the state of the Michigan economy.

With regard to borrower sophistication, multiple lenders noted that business owners across the country run the gamut from very savvy to not savvy at all. As one national lender noted, borrower sophistication is not specific to states.

When asked if borrowers were becoming more sophisticated generally, banks split evenly with half saying yes and half saying no. Community lenders tended to say they have the least sophisticated clients.

While lenders did not have negative opinions about business owners themselves, one lender did note that the caliber of new businesses in Michigan may be changing in a negative way because of out-migration. Another spoke of the general mentality in Michigan as an impediment to scalable entrepreneurial growth. These sentiments were neither widespread nor isolated.


1. The Business Climate in Michigan is Difficult for Small Businesses Small businesses in the study have mixed feelings about the business climate in Michigan. Of the businesses in Michigan that were interviewed, 50% commented without prompting that the business climate needs improvement. This sentiment was shared by companies across all sectors.

When asked to expand upon what made business difficult in Michigan, these were the responses:

• Most businesses discussed the overall economy in Michigan to some extent.

• One business in Michigan summed up the economic troubles by pointing out that the state has always been dependent on a workforce of skilled laborers, and is now “experiencing culture shock” from the large cuts in that workforce.

• Two businesses noted that the union culture in Michigan created problems for small businesses.

• Four businesses singled out taxes (in particular recent tax changes) as a problem.

As one business noted, Michigan is an “unfriendly business atmosphere.” None of the small businesses in Michigan thought that the state’s business climate was good. In fact, one small business owner was so frustrated with his experience and the roadblocks he encountered that he stated, “If if had to do it again I don’t think I would invest in Michigan.”

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2. Small Businesses Feel Gloomy and Frustrated Given the Economy Of the businesses in Michigan that were interviewed, 37.5% stated that Michigan is a bad place for small businesses currently. The Study Team judged that the negativity among Michigan businesses was far deeper than that of businesses in other parts of the country. This may be related to the overarching economic situation in the state and the ripple effect that it is having on small businesses.

Such gloominess is not isolated to Michigan. In April 2008, the NFIB reported on “The Index of Small Business Optimism,” which fell 3.3 points in March 2008. This fall resulted in the lowest monthly reading since the monthly surveys began in 1986. 6 This outlook was attributed to recession fears and rising inflation.

Negativity about the economy and small business overall is problematic for a number of reasons. First, when businesses are less optimistic, they are less likely to expand. We see this when we look at the NFIB’s 2008 report, which shows that 53% of small business owners believe that it is not a good time to expand due to economic conditions. Second, a business owner’s outlook may impact his or her view of what is possible for the company. Therefore, a business owner that is overly negative may not see or not push for new opportunities because all he or she sees are roadblocks. Finally, a business owner with a negative view of the market may have a more difficult time obtaining business loans if he or she cannot project confidence to a loan officer.

It should be noted that of all the businesses interviewed, the majority had a positive outlook about their ability to grow and prosper. However, most felt negative about their previous experiences with lenders and gloomy about their ability to secure financing from conventional lenders in the future. Negativity was prevalent across all sectors.

3. There is Anecdotal Evidence of Discrimination Against Businesses in Michigan As mentioned previously, none of banks with which the Study Team spoke acknowledged any bias or market prejudice against Michigan, although most cited the Michigan economy and the downturn of the auto industry as a factor when considering loan requests. However, one technology services business owner interviewed spoke about having his line of credit reduced because he was located in Michigan. According to the business owner, the company approached the bank for an increase in its line of credit given its business needs. Instead of increasing the line of credit, the bank reduced the amount. The business owner recalled that the banker said that the reason for the decrease was Michigan’s economy and that, as a result, the bank was “clamping down on lending in Michigan” especially in the services sector.

It should be noted that no other small business interviewed had a similar experience. Given this, the Study Team does not believe that this is a widespread phenomenon in Michigan. However, the Study Team does not necessarily believe that this was an isolated incident, either.

6 National Federation of Independent Business, “Small Business Economic Trends,” (April 2008), http://www.nfib.com/object/IO_36841.html


6.5 Differences in Lending to Growth vs. Traditional Businesses

Study Question: Is there a distinction between lending practices to emerging growth/technology companies and lending practices to more traditional small businesses? If so, what are those distinctions and how do the lending practices in Michigan compare to the comparison states in the areas that are unique to emerging growth/technology companies?


There is a difference between small business lending to traditional firms and growth/emerging sector firms within Michigan and nationally. Traditional firms have collateral, cash flow, and business fundamentals that conventional bankers understand. Businesses in emerging sectors are often less understood by bankers and have assets that are harder to underwrite. Therefore, conventional banks view these loans as more risky. As a result, businesses in growth sectors are often served by niche banks that specialize in certain industries, rather than conventional banks. Niche banks are able to reduce information costs, transaction costs, and market prejudice as a result of their specialization. Lending practices to traditional and growing sector companies do not vary from state to state. What does vary, however, are the number and types of niche banks and other sources of capital (such as mezzanine debt and venture capital) available in each state. Michigan’s current capital mix is sub-optimal for the growth the state wishes to see in emerging sectors.


The information provided in this section is divided into two categories: (1) distinctions between lending to traditional companies versus growth sector companies, and (2) the mix of capital in Michigan. Note: Throughout this section, the Study Team focuses on life sciences and technology when discussing emerging sectors. While these are only two of the emerging sectors within Michigan, this focus is a direct response to MEDC’s study questions.

1. Distinctions between Lending to Traditional Companies and Businesses in Growth Sectors

The Study Team found that lending practices to businesses in growth sectors do vary from those to traditional companies. This distinction is due to banks’ historical experience with traditional companies and the unique nature and needs of emerging industries such as life sciences and technology.

Traditional Lending Traditional lending has been the dominant form of lending in the United States for over 100 years. Traditional lending is based upon the 5 Cs of credit: (1) capacity to repay the loan (cash flow), (2) capital, (3) collateral, (4) conditions, and (5) character of the borrower. Of the 5 Cs, banks rely most heavily upon collateral and cash flow, which emerging sector businesses often have a difficult time providing. Businesses that fit the conventional mold (e.g., manufacturing companies) have an easier time securing loans, especially from conventional lenders. In Michigan, most banks have been focused on traditional businesses, many of which are in manufacturing. Therefore, it is not surprising that lending in Michigan is geared more towards those traditional businesses than emerging sector businesses.

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Growth Sector Lending Businesses in emerging sectors have different fundamentals (products, business practices, assets, etc.) that make traditional lending difficult. However, there are banks that understand how to underwrite assets specific to life sciences and technology industries. As a result, these banks are able to make loans that others cannot. Banks that serve these growth sector companies include conventional banks with specialty arms (e.g., a life sciences division within Bank of America and entertainment and energy divisions within Union Bank of California) and niche banks (e.g., Silicon Valley Bank and Bank of Ann Arbor). A discussion of niche banks is included in Section 6.6.

Banks that cater to these industries may underwrite assets, such as intellectual property, research and development, software, and hardware. They are also willing to underwrite based on the strength of the company’s management team.

The uniqueness and challenges associated with lending to emerging life sciences and technology companies (just two of the growth sectors in Michigan) are summarized in two articles that focus on a niche lender to the life sciences and technology fields, Silicon Valley Bank (Silicon Valley Bank is discussed in detail in Section 6.6). Excerpted below are highlights from the articles which discuss the high information costs and market prejudice associated with lending to these sectors.

Life Sciences Lending (San Francisco Business Times, April 11, 2003)7

• “In reality, banking biotechnology companies is not attractive to most commercial banks and requires a specialized understanding of the industry.”

• “‘Most of the [life science] companies have pretty substantial losses for a long period of time, so most traditional banks shudder when they see that,’ said Scott Morrison, director of life sciences for Ernst & Young. ‘Boutique, unique players that understand the industry are important. There a just a handful of players and Silicon Valley Bank is very dominant. They just get it. They understand the industry. They understand what is unique about it, what the risks are and what their clients’ needs are.’’

Technology Lending (Innovation, December 2005/January 2006)8

• “‘Technology-related companies are investing for a fairly long period, losing money and requiring a lot of capital,’ says Greg Becker, chief operating officer of Silicon Valley Bank’s commercial banking practice. ‘The venture capitalists finance them. Our bank built up a unique knowledge of how that model works. We work with a significant number of companies that are pre-profit or in some cases pre-revenue. ’’

• “Banks typically lend based on cash flow, but many tech companies don’t have cash flow. The company will make loans based on the pedigrees and connections of the founders of a company. Silicon Valley Bank will do equipment financing, working capital loans, loans based on intellectual property. It issues asset-based lines of credit or receivable-based lines of credit, with little regard to financial condition. The terms

7 Daniel Levine, “Silicon valley bank fortifies life sciences focus,” (April 11, 2003), San Francisco Business Times, http://sanfrancisco.bizjournals.com/sanfrancisco/stories/2003/04/14/story7.html 8 Dean Takahashi, “Technology’s banker,” (December 2005/January 2006), Innovation: America’s Journal of technology Commercialization, http://www.innovation-america.org/archive.php?articleID=18

http://sanfrancisco.bizjournals.com/sanfrancisco/stories/2003/04/14/story7.html

http://www.innovation-america.org/archive.php?articleID=18


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are better for startups with good prospects. For those struggling, the loans are tied to assets so that the bank’s exposure isn’t as bad in case the company goes belly-up. The startup with the good prospects would have fewer restrictions on funding, while the one that is struggling would have to meet certain financial milestones.”

These excerpts demonstrate the need for specialists and industry experts to play a role in lending to these companies. Such experts bring with them information that reduces the assessment of risk by the lenders. Not surprisingly, many industry-specific niche banks do bring industry experts to their staff. For example, in 2003 Silicon Valley Bank appointed a senior relationship manager in technology to head its life sciences team and serve as a liaison to the healthcare venture capital community.

Additionally, bankers lending to emerging sectors often think and act outside of the traditional lending “box” in terms of business development and sector leadership. For example, Silicon Valley Bank created a venture capitalist advisory board “to meet with life sciences industry leaders quarterly to discuss industry trends and provide feedback on the bank’s products and services.”9 Similarly, the Bank of Ann Arbor has a Technology Industry Group (loosely modeled after Silicon Valley Bank) and the Ann Arbor Angels. Both venture capitalist groups work collaboratively with these conventional lenders and cater to startups in the technology and life sciences industries.

2. Capital Diversity is Critical for Small Business Growth and is Suboptimal in Michigan

Practices in traditional lending and lending to growth sector companies do not vary from state to state. However, the mix of capital in each state does vary. The mix of capital is important because different types of lenders play different roles in funding small businesses, as discussed in Section 5.3. Below is a general overview of capital sources discussed in this report:

1) Conventional Lenders: Broad-based, general business lenders often focused on traditional lending opportunities. Conventional lenders may or may not have specialty lending arms. (For the intent of this report, those specialty lending arms would fall under the “niche lenders” designation below.)

2) Niche Lenders: Focused on specific industries, ethnic groups, and loan types to capitalize on underserved market opportunities.

3) Community Banks: A type of niche bank focused on local community lending and which is more likely to make microloans.

4) Risk Capital: Mezzanine debt, angel investments, and venture capital that provide high risk/high reward investment capital to unproven businesses with high growth potential.

The availability of each type of capital in Michigan is described below.

Conventional Lenders There are a moderate number of commercial banks that operate and are headquartered within the state. As is shown in Figure 6.19 below, Michigan has a low number of banks

9 San Francisco Business Times, “Silicon valley bank fortifies life sciences focus,” (April 11, 2003), http://sanfrancisco.bizjournals.com/sanfrancisco/stories/2003/04/14/story.7.html


headquartered in and operating in Michigan, as compared with the Comparison States. The data shows that banks headquartered in the state account for 71.5% to 93% of all conventional banking institutions in that state.

Figure 6.19 Number of Institutions Operating and Headquartered in MI and Comparison States (2007)

However, it is important to note that the number of bank branches is a more useful metric to determine how well-banked each state is. For example, California is third among the Comparison States according to institutions operating in the state, but first in terms of bank branches. Michigan moves up among the Comparison States when looking at the number of bank branches, with 3,137. Only New Jersey, Ohio, Illinois, and California have more branches.

Figure 6.20 Number of Bank Branches by State (June 2007)

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The number of banks headquartered in Michigan has fluctuated in the last three years, as Table 6.2 shows. From the fourth quarter of 2006 to the fourth quarter of 2007, Michigan lost seven institutions headquartered in the state and $65.65 billion in assets. However, as of the end of the fourth quarter in 2007, there were nine new FDIC-insured institutions headquartered within Michigan during the past three years. The drop in assets between the third and fourth quarters is most likely due to Comerica’s move from Michigan to Texas.

Table 6.2 Change in Banking Institutions and Deposits of FDIC-Insured Institutions Headquartered in Michigan

BANKING TRENDS IN MICHIGAN General Information Q4-07 Q3-07 Q4-06 2006 2005 Institutions (#) 164 166 171 171 174 Total Assets (in millions) $165,832 $220,220 $231,479 $231,479 $212,186New Institutions (# < 3 years old) 9 8 8 8 6

Source: FDIC State Profile Q4-07

The drop in number of institutions in Michigan follows a national trend, in which the number of commercial banks has dropped over the past 17 years, from 12,343 commercial banks in 1990 to 7,282 commercial banks in 2007. This drop is mainly due to mergers.10

Niche Lenders There are industry-specific (life sciences and technology) and population-specific (Muslim) niche banks in Michigan. The number of niche lenders in each state is unknown as data on this metric is unavailable. Niche lenders are discussed in more detail in Section 6.6.

Community Banks Michigan has a lower percentage of community banks than the national average, but is in the middle relative to the Comparison States. A more in-depth assessment of community banks in Michigan can be found in Sections 6.10 and 6.11.

Risk Capital Michigan has a low level of risk capital available to small businesses and companies in growth sectors relative to the Comparison States. Currently, Michigan is virtually without mezzanine debt capital and has limited venture capital activity. However, it should be noted that several new state initiatives seek to address this issue, including the 21st Century Jobs Fund and the Venture Michigan Fund. We will address the need for aggressive, innovative capital in Michigan by looking at venture capital availability in the state.

The presence of nationally recognized private equity and venture capital fund managers is a major indication of the vitality of the local and regional economies. It is important to understand that venture capital is only able to finance 2% of the young, rapidly growing firms that have the growth capacity to generate the high multiple returns required of seed and early stage venture capital and later stage private equity. The presence of a wide range of subordinated debt and mezzanine capital mechanisms is generally much more important to the growth and development of a healthy and vital small business sector. However, we will

10 Federal Deposit Insurance Corporation, “Statistics At A Glance,” http://www.fdic.gov/bank/statistical/stats/2007dec/FDIC.pdf


use venture capital as a proxy for the level of innovative risk capital in the state given Michigan’s lack of mezzanine capital mechanisms.

Venture capital, which is equity provided during the start-up and growth phases of companies, is usually geared towards technology and life sciences companies. This type of start-up equity is offered by angel investors and venture capital firms.

Venture capitalists play a role that conventional banks cannot—that of pioneering risk takers. Unlike venture capitalists, banks provide financing once a company is established, has a track record, and/or has stable cash flows or collateral. As one banker interviewed noted, “We hear goofy ideas all day long… that’s what VCs are for.”

Because venture capital helps potentially high-growth businesses get off the ground, the lack of this capital source can have multiple negative impacts for lenders and the state. First, the state may miss out on business growth opportunities. Second, many businesses that receive venture capital financing will eventually need conventional financing. If those businesses requiring venture capital do not exist in or are lured from Michigan, that means less bank business overall in the state over the long term. Third, as small companies grow they hire more employees whose deposits grow. Again, this can mean a missed opportunity for Michigan banks to grow their new deposits business, which then impacts banks’ abilities to lend to small businesses.

When looking at venture capital activity across Michigan and the Comparison States, as shown in Figure 6.21, one notices that activity is highest in California and Massachusetts.

Figure 6.21 Venture Capital Investment Activity in MI and Comparison States (1995–2007)

Once we take out California and Massachusetts and focus more specifically on years 2001 to 2007, it is easier to see the level of venture capital investment in other states, including

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Michigan. Of the remaining states, New Jersey, Illinois, North Carolina, and Minnesota have the highest level of venture capital investment, with Indiana, Ohio, and Michigan at the low end.

Figure 6.22 Venture Capital Investment Activity in MI and Comparison States (without CA and MA) (2001–2007)

Another way to assess venture capital activity is to compare venture capital investments per worker, as shown in Figure 6.23 below. By this measure, Michigan has the lowest venture capital investment per worker of all Comparison States, and is ranked 38 out of the 50 states.

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Figure 6.23 Venture Capital Investments (Per Worker) in Michigan and Comparison States (2005)

Again, while venture capital is not the all-important source of capital, its availability does impact that state’s prospects for small business growth and long term economic vitality.


1. Traditional Underwriting Standards Favor Manufacturing Firms Over Firms in Emerging Industries Regardless of geography served, lending institutions favor businesses that meet the 5 Cs of credit, as previously mentioned. These firm characteristics are reviewed rigorously by all banks when considering loan requests. In fact, at least 70% of lenders interviewed used the terms “5 Cs,” “collateral,” or “cash flow” when talking about evaluating business creditworthiness.

As the hallmark of bank underwriting, the 5 Cs cause banks to favor more traditional firms, such as manufacturing businesses, that have hard assets to collateralize. Firms in emerging industries, such as technology, generally do not have the hard assets that banks are accustomed to seeing, which makes lending to these firms more difficult. One-third of the banks interviewed said, or strongly implied, that bank underwriting standards favor manufacturing firms. Further, 40% of lenders noted that under-collateralized firms had a harder time securing financing than those with collateral.

The focus on underwriting standards which favor manufacturing firms may be more pronounced in Michigan given its economic history. Many of the businesses the Study Team interviewed mentioned that conventional banks would not provide loans without traditional collateral, and furthermore, did not understand non-manufacturing businesses overall. As one niche lender noted, lending in Michigan has not changed over time—underwriting criteria has not changed and neither has lenders’ approach to reviewing businesses.

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2. Banks Realize that Having an Array of Financial Institutions is Important for Small Business Growth

The banks interviewed by the Study Team were realistic about their place in the capital structure and saw themselves playing an important but limited role in business growth. Multiple lenders commented that “bankers are by nature conservative” and that their role in the economy is to lend capital to stable, cash flow positive companies. As one national lender commented, “We don’t have crystal balls” and we don’t lend as though we do.

One national banker noted that small business lending is a “low profit, low risk” business. As a result, a single bad investment can eliminate profits from a whole portfolio of loans. It is not surprising, therefore, that banks adhere closely to the 5 Cs of credit and underwriting.

Recognizing the limitations on conventional financing, many of the lenders interviewed work with micro-lenders, business incubators, and venture capital firms in their markets. In fact, 35% of the banks interviewed actively refer businesses that they cannot fund to business incubation and business plan writing programs. Additionally, at least 25% of banks interviewed mentioned venture capital as an important source of financing that fills a gap banks cannot.

Together, capital institutions—conventional lenders, community banks, niche banks, venture capital firms, and business incubation centers—are able to provide the capital that each alone cannot.

3. Niche Banks Can and Do Underwrite Emerging Sectors The niche banks interviewed spoke of their unique underwriting standards that focus less on collateral and more on industry-specific risk mitigants. As a result, these niche banks are able to provide loans more readily to businesses in emerging sectors, such as life sciences and technology. As one niche banker focused on life sciences noted, “lending to such firms in not risky, but it can be for those who do not understand it.”


1. Businesses Feel that Banks are Too Reliant on Manufacturing and Collateral When asked, 50% of small businesses in Michigan, as well as 50% of the businesses outside of Michigan noted that banks do not understand their business and that this complicates lending. This sentiment is even more pronounced when we look at the responses from businesses in emerging sectors (agriculture/service, life sciences, technology). Of the six Michigan companies in emerging sectors, five noted that banks in Michigan do not understand them and therefore do not lend to them. Neither of the two emerging companies outside of Michigan noted this as a problem.

One reason cited for this disconnect is bank unfamiliarity with non-manufacturing businesses. One Michigan business noted that banks “have trouble making the switch from asset-heavy environments to knowledge based economy.” Two small technology businesses in Michigan commented that “banks weren’t really familiar with tech businesses” and “banks just don’t seem to get a tech services business.” One of these business owners noted that he has friends in Silicon Valley and the East Coast and that “bankers there get it.”

General frustration with bank standards that do not fit small businesses was commonly cited by businesses interviewed. One business commented on the lack of products available for emerging sectors in Michigan and that “too much attention [is] paid on chasing yesterday’s

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businesses, which is basic manufacturing.” The frustration around this was clear in a statement from a business owner in Michigan: “Commissioned loan officers don’t want to find things that aren’t fast boilerplate loans.”

Not only do small businesses in emerging sectors believe that banks do not understand their businesses, but small businesses overall also noted that banks are overly interested in collateral. Of all businesses interviewed, 42% mentioned collateral as an issue when obtaining financing. This makes securing financing difficult for small businesses, especially those in emerging sectors that do not have traditional forms of collateral.

The issue of collateral is not unique to Michigan. One California manufacturing business interviewed commented that it has had trouble obtaining financing because its equipment is too specialized and customized for a bank to collateralize.

2. Businesses Cite the lack of Venture Capital in Michigan as an Issue Given the difficulty obtaining credit in Michigan, it is not surprising that several businesses commented that Michigan has a sub-optimal mix of capital. Overall, businesses noted that conventional lending is focused on the traditional manufacturing sector and that government programs and equity sources should be used to help get capital to businesses in all sectors.

Venture capital availability is of concern to business owners in emerging sectors in Michigan. Twenty-five percent of all Michigan businesses interviewed noted the lack of venture capital as a problem. These businesses pointed out that the lack of venture capital in Michigan makes it unattractive for recruiting business and talent. They noted that as a result, many companies choose to locate along the coasts in order to secure venture capital. One of these business owners commented that funds like the Southwest Michigan First Life Science Fund are attractive, but are slow and make it difficult for companies that are re-locating to Michigan to use.

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6.6 Niche Banks and Industry-Specific Lending Study Question: Are there banks in Michigan and other comparison states that focus on lending to specific industries? What are some examples of these niche banks and what is their market presence within the comparison states? Does the focus on these niche banks generally match the efforts put forth by the state? Do public policy initiatives influence the behavior and presence of these niche banks?


There are banks within Michigan and the Comparison States that focus on specific industries and populations. These banks are known as niche banks. Unlike larger conventional banks with a broad focus, these niche banks focus on specific industries and populations. The niche banks’ level of industry knowledge allows them to make loans that others in the market do not understand. For example, niche banks have been very active in life sciences and technology where conventional banks have had difficulty quantifying loan risk and asset collateralization. Within Michigan, there are industry-focused (life sciences, technology) and ethnically-focused (Muslim banks) niche banks. Over the last 10 years, the prevalence of such institutions has fluctuated as the various industries and ethnic groups have changed. These changes have happened for a number of reasons: population changes, economic changes, and government policy initiatives. Niche banks emerge and adapt as a result of changing opportunities rather than government initiatives. However, to the extent policy initiatives grow business opportunities they will encourage the growth of niche banks.


Niche banks emerge in response to underserved market opportunities. Niche banks specialize in loan products, underwriting standards, and customer services that benefit specific industries or populations. Because of their intense focus, these banks are able to lower information and transaction costs, overcome market prejudice, and make loans that others cannot.

Niche banks typically fall into two categories:

1) Industry-Specific: Provide loans to life sciences, technology, import-export businesses, etc. These banks understand the challenges and rewards of these businesses and underwrite accordingly.

2) Population-Specific: Provide loans and services to local and ethnic populations. This may include Muslim banks, Hispanic banks, and general community banks.

Currently, there is no data available on the number of niche banks by state. A New York Times article noted that “though no one keeps records indicating whether the number of niche banks is rising or waning, experts in the banking field see growth in three particular areas: Hispanic banking, environmentally responsible banking, and banking aimed at observant Muslims.”11 Though not mentioned in this article, industry-specific banks are also an important part of the lending landscape.

11 The New York Times, “Banks springing up to serve the underserved,” (March 8, 2008), http://www.nytimes.com/2008/03/08/business/yourmoney/08money.html?_r=2&scp=2&sq=niche+business&st=nyt&oref=slogin&oref=slogin

http://www.nytimes.com/2008/03/08/business/yourmoney/08money.html?_r=2&scp=2&sq=niche+business&st=nyt&oref=slogin&oref=slogin

http://www.nytimes.com/2008/03/08/business/yourmoney/08money.html?_r=2&scp=2&sq=niche+business&st=nyt&oref=slogin&oref=slogin


The mix of niche banks within each state depends on the needs and opportunities available in each state. Within Michigan and the Comparison States, niche banks that focus on specific industries exist and have emerged and exploited underserved market opportunities.

In Michigan, niche banks have focused most on catering to the life sciences and technology sectors, as well as the state’s growing Muslim population. Similarly, niche banks in Comparison States have emerged to support their emerging industries and large ethnic populations. Examples of niche banks across the nation are below:

• Indiana has niche community banks that serve small towns. There are also several niche banks that target very specialized businesses like private aircraft lending.

• A bank in Boston, Massachusetts has made a reputation as a socially responsible bank that invests in community development and progressive nonprofit organizations.

• In California, niche banks have been created to support strong and emerging industries and large ethnic populations. In San Francisco there is a bank that targets green construction. In Los Angeles, there are banks that focus on health care, apparel, entertainment, and international trade. Even larger banks have created specialty divisions that serve a niche market. Union Bank of California, for example, has niche lending divisions that operate in the entertainment and energy industries. Asian-owned banks and those that target Hispanics are also prominent.

• New York has seen a rise in niche banks that caters to the Hispanic population.

Profiles of Prominent Niche Banks Below are profiles of several prominent niche banks in Michigan and the Comparison States. Several of these institutions were interviewed for this study. These profiles highlight the unique qualities of each institution and the value (financial and otherwise) that they bring to the markets in which they are active.

Industry-Specific Niche Banks

• Bank of Ann Arbor (Life Sciences and Technology, Michigan) is a fast-growing niche bank that serves Ann Arbor and Southeast Michigan. In 2001, just five years after its inception, the bank had more than $180 million in managed assets. The bank has been an important capital resource to the state’s emerging technology and life sciences sectors. It has also been active with angel investors and venture capital firms. It has succeeded by combining leading-edge technology with a customer-focused approach, regularly meeting with emerging industry leaders to address their unique needs.

In 2002, the bank launched the Technology Industry Group to focus on the unique needs of the region’s growing technology business community. In 2004, the bank created the Ann Arbor Angels, a group of venture capitalists that seek to finance and advise start-ups in the industry. The Bank of Ann Arbor, along with Pfizer, the University of Michigan, Eastern Michigan University, and several other private and public firms also founded Ann Arbor SPARK to increase the number of technology companies in Washtenaw County. In a conversation with Ann Arbor SPARK, Bank of Ann Arbor was cited as one of the top life sciences niche lenders in Michigan.

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• Silicon Valley Bank (Life Sciences and Technology, California) was founded in 1982. It has a dominant presence in the life sciences sector and specializes in a number of niches within the technology and life sciences industries. The company also provides services to venture capitalists, high-net-worth individuals, and global businesses. As of 2003, Silicon Valley Bank had more than half of all life sciences companies nationally as its clients, and had worked with more than 30,000 companies. It played an important role in lending capital in the early stages of what are now big firms (e.g., Cisco, Intuit, Veritas). The company seeks out opportunities across the country, including Michigan. Commercial banking accounts for about 70% of the banks business. Within that, about 60% is focused on technology, 25% on life sciences, and 15% on wine. Silicon Valley Bank also lends to venture capital firms.

Part of Silicon Valley Bank’s success has been in its strategies to: follow technology innovators; take risks by lending to entrepreneurs and companies that are not profitable and may not be for some time; and partner with venture capitalists. Since its inception, the bank has filled a critical need lending to startup companies. Today, the bank is recognized for its innovative lending approaches and impressive returns.

• Square One Bank (Life Sciences and Technology, North Carolina) was founded in 2005. Headquartered in Durham, North Carolina, Square One Bank is now national with a market presence in multiple states, including California, Washington, Colorado, and New York. It banks venture capital firms and the companies in which the venture capitalists invest. It has served more than 270 startup technology and life sciences companies and venture capital firms to date. Square One Bank has sought out venture capital clients in Michigan, but has not found opportunities to date.

When it was founded, Square One Bank became one of three major banks that cater to venture capitalists. At that time, North Carolina was ripe for this type of bank because it had a strong base in the Research Triangle Park. By June 2006, the bank had $79 million in loans, up almost 800% from 2005.

• GBC International Bank (International Trade, California) was established in 1976 as the Guaranty Bank of California. It has a presence in Los Angeles, San Francisco, and Houston. The bank specializes in domestic and international trade finance services with an emphasis on export financing. It has narrowly defined its niche by concentrating on funding ventures in the Pacific Rim region. In 2002, the bank was the number one provider of export-import bank guaranteed working capital loans in California and in 2003 was the fifth most active provider of this financing nationwide.

Population-Specific Niche Banks

• University Bank in Ann Arbor (Muslim, Michigan) primarily serves the cities of Ann Arbor and Ypsilanti of Washtenaw County. The bank focuses on three main niches: credit unions, Islamic banking, and community banking. Its credit union business line was created in response to credit unions gaining financial market share in Michigan and nationally. Its Midwest Loan Services subsidiary grew 32% per year on average for the past eight years in the value of mortgage loans subserviced to over

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$4.0 billion. It provides services to about 2.7% of all credit unions in the United States, including three of the top 25 credit unions. In 2005, the bank had a 66.3% return on equity and was the second most profitable bank in the nation, based on that metric.

The University Bank also recently formed the University Islamic Financial Corporation to capture the opportunities present with the growing Muslim community. This subsidiary creates specialized products and services for Muslims that fall within the tenets of Islamic law, or Sharia. Currently, it has $5.5 million in Islamic-compliant deposits. Approximately 36% of the bank’s business is Sharia financing, including residential and commercial lending, while 28% of the bank’s deposits are Islamic-focused.12

Niche Banks and Public Policy Initiatives The Study Team’s research suggests that public policy initiatives can attract and encourage the growth of niche banks to the extent that the initiatives enhance business opportunities. However, policy initiatives that call for more niche banks without creating new opportunities will fail. Below are two examples of ways in which opportunities can be created for niche banks to grow.

Example 1: Government Encouraging Niche Bank Activity

The efforts of New Jersey Economic Development Authority (NJEDA) exemplify how a government program can pull together niche banks and focus niche bank activities to support a particular industry. It also shows how niche banks make government policies more credible.

In 1998, NJEDA created the Technology Funding Program to focus financial and business development resources on emerging high technology companies. The Technology Funding Program is a financing partnership between the NJEDA and leading banks in the state, including Commerce Bank and Summit Bank, which provides a loan guarantee program. The NJEDA lends its share of Technology Funding Program loans at below-market rates to technology businesses seeking to develop innovative products, expand, and invest in new facilities and equipment, while partnering banks lend their portion of the loans at their normal lending rates.

The Technology Fund Program allows the NJEDA to share risk with banks through its loans and/or guarantees. The program allows banks to make loans to businesses without a proven product or proven cash flow. Businesses that are targeted by this program are those that often possess promising products, but do not have the available capital and the financial profile to secure bank loans.

Under the program, qualified businesses can borrow from $100,000 to $3 million. Of the total amount borrowed, the NJEDA may provide up to $500,000 for fixed assets like buildings and equipment and up to $250,000 for working capital. The remainder of the loan is made by the bank. NJEDA also may provide up to a 50% guarantee of the bank loan. The borrower gets the benefit of an overall below-market interest rate because the NJEDA portion of the financing is made at a reduced interest rate although the bank loan is at its regular commercial rate.

12 http://www.university-bank.com

http://www.university-bank.com/


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In 1999, recognizing the opportunity available to spur entrepreneurial activity, Silicon Valley Bank became the eighth bank to join this program (prior to participating in this program, Silicon Valley Bank was active in New Jersey, but did not have an office there). Prior to joining NJEDA, Silicon Valley Bank was respected for its innovative life sciences and technology practices. Because of this reputation, Silicon Valley Bank’s participation lent additional credibility to New Jersey’s efforts and ultimately increased the supply of capital to the state’s high technology businesses.

Thus, we see that government activity can draw capital to an area and that bank support of government activity can augment results.

Example 2: Nongovernmental Entities Complementing Government Initiatives

In some instances, niche banks or other nongovernmental entities act outside of government to promote business growth through methods that complement policy initiatives. Bank of Ann Arbor’s participation in Ann Arbor SPARK is an example of such a case.

In 2004, the University of Michigan’s Technology Transfer National Advisory Board declared that the Ann Arbor region needed to become a more fertile ground for innovation and business creation if the university’s technology transfer efforts were to reach their full potential. This was the impetus for the creation of the Ann Arbor SPARK in 2005, a partnership designed to advance innovation-based economic development in Ann Arbor. The Bank of Ann Arbor, along with Pfizer, the University of Michigan, and Eastern Michigan University, were among its founding members. In 2006, Ann Arbor SPARK and the Washtenaw Development Council, an economic development agency, merged.

In this instance, public universities and the private sector recognized and pursued an opportunity that happened to advance the state’s life sciences and technology initiatives, but it was not initiated by government policies. The participants in this effort, including a niche bank, created a non-government initiative that will allow innovative small businesses to grow. This, in turn, will likely create opportunities for the growth of additional niche banks in Ann Arbor. Thus, we see that bank activity can arise without government and also parallel government policies.

Taken together, the NJEDA-Silicon Valley Bank partnership and Ann Arbor SPARK collaboration illustrate that the key to attracting and growing niche banks is creating business opportunities. Policy initiatives alone are not sufficient to promoting the growth of niche banks, though they can help if targeted appropriately.


1. Niche Banks are Vital to Emerging Sectors As mentioned in this section and Sections 6.5 and 6.6, niche banks exist to provide financing to businesses with risk profiles that conventional lenders cannot underwrite. As one niche banker in Michigan stated, “New companies are coming along that are exciting but can't find the funding to keep talent in the state.” Michigan has seen the emergence of several niche lenders (especially in the Ann Arbor area) in order to address this trend, fill the financing gap, and provide the capital necessary to grow these new companies.




6.7 Lending to Firms with Non-Traditional Assets Study Team: Are banks in other states finding creative ways to lend to firms with non-traditional assets and uses (e.g. intellectual property, software, R&D, prototyping) as opposed to firms with hard assets?


Banks in and outside of Michigan are finding creative ways to lend to companies with non-traditional assets. It is the mix of capital institutions that allows for a sufficient amount of such creativity. As previously discussed in Section 6.5, the mix of institutions in Michigan is sub-optimal. While the state is well banked by conventional bank lenders, it is underserved by niche banks and risk capital institutions. As a result, there are fewer institutions in Michigan that are able to think outside of the “credit box” than in other states with a healthier capital mix. The discussions of capital institutions (Section 6.5) and niche banks (Section 6.6) address this question in more detail.

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6.8 Lending Behavior of National Banks Study Question: Do national banks exhibit more conservative lending behavior in Michigan than in other states?


National banks do not exhibit more conservative lending behavior in Michigan than in other states. Bankers review the same general set of criteria when determining loan risk. As noted in Section 6.4, micro and macroeconomic conditions do factor into this evaluation. The current state of the Michigan economy makes it harder to lend in the state, as certain businesses (such as those in the tourism and service sectors) rely upon economic health and disposable income in order to succeed. This type of economic evaluation is true across national, regional, niche, and community banks and is not unique to Michigan.

Research Data Findings

As discussed in Section 6.5, conventional lenders tend to have traditional underwriting standards that make it difficult to lend to emerging sectors. The national banks the Study Team researched and interviewed are conventional lenders, although some have specialty arms that function more as niche banks. As conventional lenders, these national banks are more conservative in the types of companies to which they will lend. However, this is also true of regional and community banks, as they also tend to focus on conventional lending. Therefore, the inclination to serve traditional industries is not specific or unique to national banks.

There is no data available that measures national bank lending practices, differences in underwriting criteria, or behaviors across states. Therefore, the Study Team used interview findings to derive the conclusion above.


As previously discussed, the Study Team interviewed five national banks, four of which lend in Michigan. Six regional banks, six community banks, and three niche banks were also interviewed for this study.

When looking at lending behavior among national banks, the Study Team identified factors from the interview data that are likely to impact lending. These factors, which are detailed below, are:

• View of the Michigan economy

• Bias against Michigan

• Bank pullback from Michigan

• View of small business owners in Michigan

• Capital availability for strong businesses

1. Bankers of All Types Cite the Economy as Problem that Affects Lending in Michigan The national banks the Study Team spoke with were very pragmatic in terms of small business lending. Four of the five banks are active in Michigan but indicated that the

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national and regional economies impact lending to all sorts of borrowers, especially small business owners.

As noted previously, conventional banks tend to be conservative in their approach to underwriting and risk assessment. A national bank confirmed this by saying that small business lending is a “low profit, low risk” business for the bank. The national lender went on to say that if the bank loses one business loan in a portfolio, it can wipe out profits for all of the other loans.

When asked how the economy factors into loan decisions, 80% of national banks indicated that the economy is a driving factor when making loan decisions.

This is similar to the responses of the other groups of banks:

• 75% of regional banks said that the economy is a factor

• 100% of niche banks said that economy is a factor

• 100% of community banks said at economy is a factor Note: The sample size for each group is small so even one response can greatly affect the percentages.

Because the economy plays such a large role in lending, it is no surprise that many of the national banks noted Michigan’s economic problems. Of the national banks that spoke about Michigan’s economy, 100% said the economy is not doing well. This statistic is the same for all of the other bank groups. One national bank that does not currently lend in Michigan noted that Michigan is “always a tough state” for lending and small business because it is too tied into auto and machinery.

Though national bankers cited problems with the economy as a concern, they were mixed on whether loans from Michigan in particular should receive additional scrutiny.

• One national bank said loans in Michigan should not receive additional scrutiny.

• Two national banks said loans in Michigan should receive additional scrutiny.

This variation in responses suggests that national banking institutions (and the individual lenders at national banking institutions) do not view underwriting factors uniformly.

Most of the regional, community, and niche banks did not touch on this issue of additional scrutiny. However, one regional bank that serves Michigan and one community bank that lends outside of Michigan, both agreed that loans from Michigan small businesses should be assessed more carefully because of the economy. This suggests that, to the extent conservative lending exists among national banks, it is not unique to them.

2. National Lenders Do Not Appear to be Biased in Their Lending and Underwriting in Michigan While the economy impacts small business lending in Michigan and other states with distressed economies, national and regional banks noted that there is no bias against small businesses in Michigan and that underwriting criteria does not change for loans to businesses in the state. In fact, of all interviewees, two of the national bankers interviewed were among the most emphatic and earnest about their desire to lend in Michigan.

No national, regional, niche, or community banks indicated they would discriminate against a business because of its geography. One national bank noted that “we care about industry,

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not geography.” Others seconded this notion that lending decisions are “just business” and that “nobody cares” about whether a small business in Michigan. Another national lender commented that if a business is making money, the business can get a loan regardless of location.

A credit officer at another large national bank echoed this, saying her institution will never not do business in an area, but cautioned that one must “recognize the impact of industry downturn” when assessing loan risk. She also noted that “Michigan shouldn’t feel alone” with the downturn of the economy and the credit situation.

3. National Banks Say They Know of No Lending Pulling Back in Michigan During interviews, the Study Team spoke with national banks about any perceived pullback from Michigan by banks. Of those banks that answered, 100% said they have not heard of any pullback from Michigan in the market from national lenders.

One of these national banks explicitly noted that “people [banks] aren’t skipping Michigan.” Another national banker was indignant when the Study Team asked about general biases toward Michigan, saying “Come on!”

Comparatively, one regional bank and one community bank lending outside of Michigan said that they had heard of pullback from Michigan, but they were not specific on whether they felt this was actual, perceived, or unique to any type of banking group.

4. National Bankers Do Not View Small Business Owners in Michigan Differently National banks did not indicate that the caliber of small business applicants differs between Michigan and other states. Of the national banks that discussed this topic, 100% said there were no differences with Michigan small business owners. One national bank specifically noted that borrower sophistication is not specific to states. Similarly, no regional, community, or niche banks indicated that Michigan small business owners were any different than others across the nation.

5. National Bankers Note that There is Money in the Market for Strong Small Businesses Two national banks noted that there is intense competition for small business loans across markets. Both of these lenders spoke of their practices in Ann Arbor when discussing competition. Several regional, community, and niche banks also noted the availability of capital for strong businesses.

One national banker spoke of growing opportunities for small businesses in Michigan. According to this lender, with the decline of large industries in Michigan, there are and will be new and different opportunities for small business owners in the state.


1. Businesses Do Not Cite National Banks as Uniquely Conservative None of the small businesses the Study Team interviewed reported that national banks exhibit different behavior toward businesses in Michigan. That said, many of the small businesses in Michigan interviewed use regional or community lenders.

While no small businesses reported a bias against Michigan from national banks, there were isolated reports of conservative activity among local and regional banks. One small manufacturing business in Michigan noted that the local banks in Michigan are “very

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conservative.” Additionally, a small technology business in Michigan reported that it was told by a large regional bank that the banks is “clamping down on lending in Michigan.”

Overall, this suggests that there is no wholesale bias or overly conservative lending behavior among national banks.

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6.9 Life Sciences Sector Growth and Lender Support Study Question: Michigan has put significant resources and effort into growing the life sciences sector. Is there evidence that banks have increased lending support in conjunction with the state’s objectives in this industry sector?


Recent efforts by the state to expand life sciences activity have resulted in tremendous growth in the number of life sciences companies, but have not yet translated into a marked increase in conventional lending activity to the sector. This is because most of the life sciences companies in Michigan are in the emerging phase where it is too risky for bank investment. Typically, venture capital firms finance these types of early state companies given their risk profile. While there are some life sciences niche banks currently active in Michigan, that number is expected to grow over time as Michigan’s life sciences companies mature and qualify for conventional bank lending.

Research Data Findings

Growing Life Sciences Sector in Michigan As of 2002, Michigan was doing relatively well in the life sciences area as compared to the nation overall, with 0.3% of its total establishments falling into this sector. However, all of the Comparison States were doing as well or better than Michigan in this regard.

Table 6.3 Percentage of Total Establishments in Manufacturing, Life Sciences, and Technology in Michigan and Comparison States (2002)

ManufacturingLife

Sciences Technology0.6% 10.0%

Illinois 0.3% 8.7%Indiana 0.3%Massachusetts 0.8% 11.2%Michigan 6.7% 0.3% 7.1%Minnesota 0.4% 8.9%New Jersey 0.5% 12.2%North Carolina 0.4% 7.3%Ohio 6.7% 0.3%United States 9.6%*Values in red are those that are lower than MichiganSource: 2002 Economic Census Data

Percentage of Total Establishments by Sector

California 6.1%5.7%6.6% 5.9%5.3%

5.9%4.7%5.5%

6.7%6.0% 0.2%

More recent data on the life sciences sector in Michigan indicates that this will likely increase substantially when the next Economic Census data is published in 2009 and 2010.

According to the MEDC, Michigan’s life sciences sector currently generates $4.8 billion in sales annually and is comprised of 542 companies that employ nearly 32,000 employees, making it the fourth largest high technology workforce in the nation. The growth of


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Michigan’s life sciences industry has exceeded sector growth nationally, expanding 27% in employment, 32% in the number of companies, and 165% in sales. Since 2000, approximately 125 new life sciences companies were created in the state and more than $500 million invested in the industry, making it the fastest growing in the nation.13 Much of this growth is occurring in the Ann Arbor, Kalamazoo, and Grand Rapids regions.

This dramatic growth was also cited by Ann Arbor SPARK in an interview conducted by the Study Team. Ann Arbor SPARK noted that Ann Arbor had only a handful of life sciences firms 10 years ago, but today has more than 100 life sciences firms in a diverse set of fields ranging from pharmaceuticals to bioinformatics.

The Study Team found that Michigan’s efforts to advance the life sciences industry have been key to this growth. Below is a brief description of several state initiatives that have contributed to expanding the life sciences sector in Michigan.

• Michigan Life Sciences Corridor – Established in 1999 to foster growth in the life sciences industry by investing in biotechnology research at four Michigan institutions: the University of Michigan in Ann Arbor, Michigan State University in East Lansing, Wayne State University in Detroit, and the Van Andel Institute in Grand Rapids. A representative from Ann Arbor SPARK highlighted this initiative as the most impactful program in Michigan and in Ann Arbor because it provides needed funding and branded Michigan as a viable life sciences location.

• MichBio – A nonprofit life sciences trade association, founded in 1993, to promote the growth of the industry in Michigan. It provides a wide array of services to meet the needs of individual businesses and the Michigan life sciences industry in general.

• 21st Century Jobs Fund – A 10-year initiative created in 2005 to allocate up to $1 billion to strengthen and diversify Michigan’s economic base by focusing resources in three programs: 1) Commercial Lending Program – uses commercial enhancement programs to stimulate additional lending by financial institutions across the state; 2) Capital Investment Program – makes investments in private equity, mezzanine, and venture capital funds; and 3) Competitive Edge Commercialization Program – invests in basic and applied research and the commercialization of products and services. These programs focus on four strategic sectors in Michigan: life sciences; alternative energy; advanced automotive, manufacturing and materials; and homeland security and defense.

The Study Team found life sciences to be a real area of opportunity for the state given the level of support from government, and the related industry growth experience in recent years.

State Policies Have Grown the Life Sciences Sector in Michigan, But Not Necessarily Lending to Life Sciences Firms The Study Team interviewed both Ann Arbor SPARK and a leading national niche bank serving the life sciences and technology sectors in order to understand life sciences sector growth and lending in Michigan. Both entities, which are active in Michigan, cited the following:

13 Western Michigan Business Review, “Build better identity, life sciences urged,” (March 20, 2008).


1) The life sciences sector is growing.

As discussed, the life sciences sector has grown tremendously in Michigan in the last 10 years due to decisive and concerted public-private actions.

Both entities commented that growth can be seen in the both the number of life sciences institutions and size of the overall life sciences market in Michigan. The majority of these life sciences firms are new or early-stage in terms of their development.

2) Venture capital, rather than conventional lending, is the leading financial tool for life sciences firms in Michigan.

Given that most life sciences firms in Michigan are new or early stage, they are not appropriate for conventional lending, even from niche banks, as these institutions require cash flow or profits to support debt. As the niche banker commented, “By nature commercial lending to life sciences businesses is difficult. The banks need to be extremely specialized. Otherwise they will lose their shirts. Even if [niche banks] are specialized, bank regulators might not let the banks lend to typical emerging life sciences firms.” For these reasons, the niche banker cited venture capital as critical to these companies. These lender and regulator considerations are not unique to Michigan.

Ann Arbor SPARK commented that venture capital is also vital for companies with products moving from concept to market (prior to product launch), as conventional funding is not available prior to that point.

According to the niche banker, commercial and niche banks will be present in markets where there are opportunities for debt. While there are only a handful of such niche banks serving life sciences firms now, more are expected to enter the Michigan market once the state’s emerging life sciences firms grow and earn profits. Note: Though the report calls out a low volume of venture capital activity in Michigan, clearly it is a vital and active source of capital in Ann Arbor.

3) Banks lending to life sciences companies are becoming more educated, not necessarily more “aggressive.”

Once life sciences companies are off the ground and have grown in scale, niche banks are able to finance their activities. Ann Arbor SPARK recounted that 10 years ago there were no banks in the area focused on life sciences because there were so few life sciences companies. Now there are multiple institutions serving this need in the state.

While the number of life sciences firms that have formed in the past several years can be tracked, no such data exists to track the number of banks that focus on life sciences. Though there is no full accounting of banks with life sciences practices in Michigan, Ann Arbor SPARK did highlight the Bank of Ann Arbor as Michigan’s most active bank in the sector.

When asked whether banks in Michigan have been more “aggressive” in terms of lending to life sciences firms over the past 10 years, Ann Arbor SPARK responded:

I don’t believe ‘aggressive’ is the proper word. The banks have been open to learning about the life sciences industry and lending to successful firms.

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Ann Arbor SPARK went on to say that banks have been supportive of successful life sciences firms that meet lending criteria. This suggests that while banks cannot finance new life sciences companies, they are supportive of established life sciences firms.


1. Michigan’s Life Sciences Efforts Have Not Gone Unnoticed The government’s concerted effort to grow the life sciences industry has piqued the interest of niche lenders in and outside of Michigan. At least one niche lender who is out of state commented that there is “a lot to chew on in Ann Arbor” with tech transfer happening and initiatives like Ann Arbor SPARK.

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6.10 Community Banks and Small Business Lending Study Question: Is there evidence that community banks are more favorably disposed to small business lending than regional banks or banks with a national presence?


Community banks play a unique and important role in the economy and in supporting small businesses. Community banks’ extensive knowledge of the local landscape lowers information costs and allows them to serve small businesses differently than regional or national banks. Community banks generally have more flexibility in terms of their underwriting criteria and business products. As a result, they are often able to provide loans that larger institutions cannot. Regional and national banks provide the majority of small business loans nationally and are committed to small businesses. However, community banks provide a tremendous number of small business loans given their relative size. In short, community banks are a vital part of the small business lending continuum, though they are not the only engine for small business lending activity.


Community banks play an important role in the economy and in supporting small businesses. Community banks are typically smaller banks whose niche is in knowing and serving the needs of their local area and having lending products that are tailored to the community. These institutions are defined by their local leadership, local decision making, and civic involvement in the local community, not necessarily by their size. As Doug Campbell of The Business Journal said, “It’s usually the very mission of community banks to make credit available to local small businesses.”14

Community banks focus on “relationship banking,” basing decisions on a keen understanding of business conditions in the communities they serve and personal knowledge of customers’ creditworthiness. Research suggests that knowledge of the local market provides community banks with informational advantages, allowing them to overcome information costs and market prejudice, and make “better choices” in lending. In fact, according to FDIC, community banks tend to have loan loss reserves equal to other types of banks, but their actual loan losses are far lower.

Nationally, small businesses do have an ally in small banks and local lenders. According to the October 2007 “Report to the Congress on the Availability of Credit to Small Businesses,” “Although larger banks supply the majority of bank loans to small businesses, they tend to be proportionately less committed than smaller banks to small business lending.” Of all banking organizations, 73.1% are small banks (assets of $250 million or less). While these small banks hold only 5.4% of all banking assets nationally, they originate 16% of small business loans and 21.3% of microloans ($100,000 or less).15 On a dollar-for-dollar basis, community banks make nearly three times as many small business loans as the typical large banking company.16

14 The Business Journal Serving the Greater Triad Area, “Small banks beef up loan-loss reserves,” (November 2001), http://www.bizjournals.com/triad/stories/2001/12/03/story4.html?page=2 15 Board of Governors of the Federal Reserve System, “Report to the Congress on the Availability of Credit to Small Businesses,” (October 2007). 16 Federal Reserve Bank of Chicago, “2004 Annual Report: Community Banks At Their Best: Serving Local Financial Needs,” (2004).


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1. Community Bankers Understand and Enjoy Their Unique Role in the Market Community banks recognize the unique role that they play in the capital landscape. One community banker remarked that “community banks understand the local marketplace better than large chain banks and [are] unique in that [they] know the competitive landscape and have a full range of business products to help owners navigate business challenges and take advantage opportunities.”

Several of the community banks with which the Study Team spoke offer micro-loan programs, SBA backed loans, and other innovative sources of capital to new businesses that are considered “un-bankable” by conventional lenders. As one community banker noted, “We do things that conventional banks can’t, won’t, and shouldn’t do.” At least one of the community banks interviewed mentioned that her organization’s goal is to graduate businesses from their institution (a CDFI) to conventional banks.

The value of community banks was summarized by one community bank representative who said that community banks are “an eclectic group of lenders serving different needs of different people.”


1. Personal Relationships Assist in Lending Process Businesses interviewed saw a bright spot when it came to their relationships with local lenders. Without being prompted, 50% of small businesses noted that personal relationships were important to the lending process. Though the value of local lenders is not unique to community banks, the fact that community lenders are on the ground helps them win trust and business from small business owners, and also overcome market barriers that might impede lending to local small businesses.

Businesses both in and outside of Michigan reported that they were more successful obtaining loans from institutions with which they had relationships. As one business outside of Michigan stated, “All banking is relationship based.” Businesses were quick to note that relationships are not a guarantee of receiving loans, but that they often helped.


6.11 Composition of Community Banks in Comparison States

Study Question: Does the composition of community banks differ from state to state? For example, what percentage of banks in the comparison state are community banks; and do lending practices of community banks vary from state to state?


The composition of community banks does vary from state to state. As a type of niche bank, community banks serve local needs and markets. Therefore, the composition of community banks changes by geography and economic need. Generally, community banks are more prevalent in rural or smaller metropolitan areas that are underserved by other banking institutions. Michigan, like most of the Comparison States, is largely industrial and well-banked by national and regional players (as discussed in Section 6.5). As a result, Michigan has a lower percentage of community banks than the national average, but ranks in the middle when compared to the Comparison States. However, the growing presence of credit unions and the low prevalence of CDFIs in Michigan set it apart from the Comparison States in the study. Though the composition of community banks varies from state to state, general lending practices at these institutions do not vary by geography.


Nationally, community banks account for about one-third of all bank branches and hold approximately 20% of all deposits. Generally, states that are largely rural and are served less by national and regional banks have higher percentages of community banks.

In 2002, there were in excess of 23,500 community bank branches throughout the United States, 568 (2.4%) of which were located in Michigan. As shown in the table below, Michigan and most of the Comparison States have a lower percentage of community banks and deposits than the national average. As a whole, the Comparison States are more industrialized and have larger metro areas. Only Minnesota, Illinois, and Indiana have a higher percentage of community banks and control a higher percentage of deposits when compared to the nation. Therefore, these findings are not surprising.

Table 6.4 Presence of Community Banks in Michigan and Comparison States (2002) State Number of

Community Bank Branches

Percent of All Bank Branches

Percent of Deposits at All Bank Branches

California 871 19.9 9.9 Illinois 1543 45.7 27.7 Indiana 553 30.0 23.2 Massachusetts 147 16.8 6.5 Michigan 568 22.0 14.4 Minnesota 923 62.7 36.9 New Jersey 318 14.8 8.7 North Carolina 521 23.0 11.6 Ohio 738 23.0 12.6 United States 23,565 34.1 19.8

Values in red are those that are lower than the national figures Source: Federal Reserve Bank of Kansas City, 2002

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The composition of community banks is always in flux due to multiple factors in the economy. Over the last 20 years, the number of community banks has decreased, largely due to mergers and competition. Despite this decline, Ben Bernanke, Federal Reserve System Chairman, expects community banks to continue to play an important role in the economy, citing that slightly more than 700 community banks were formed between 2000 through 2005.17 Even in Michigan’s tough operating environment, 20 to 25 new community banks were established during the last 10 years.18

Credit Unions One type of community bank that is growing in Michigan is credit unions. A March 2008 article in the Ann Arbor Business Review points to the growth in credit union business lending in Michigan, even while many conventional banks are having difficulty making loans. The article notes that in Michigan, there are 4.4 million credit union members, which means that 42% of the population belongs to a credit union. This is “one of the highest state penetration ratios” in the nation.19 With more members, credit unions have more money to lend to small business owners in their localities. As an example, one credit union based in Troy, Michigan has increased its business lending by 200% over the past few years.20

The credit unions are beginning to market themselves as small business lenders, and many small businesses are approaching them for loans. The Ann Arbor Business Review article notes, “The shift is in part because select credit unions are marketing themselves as commercial lenders—and also because these nonprofit, member-owned banking alternatives are attractive to many small-business owners.”21

Many credit unions in Michigan are succeeding by forming alliances and partnerships to utilize each other’s expertise and pool risk. For example, nine credit unions participate in the Commercial Alliance credit union service organization, which provides member banks with ongoing training on regulations and standards, underwriting services, and monitoring services. The Alliance also facilitates loan processing for loans that are shared by multiple credit unions.

Credit unions have a limit on small business lending activity by law and cannot lend over 12.25% of their total assets. However, proposed federal legislation would raise the cap to 20%, giving credit unions further opportunity to become active in small business lending in the state and nationally.

Community Development Financial Institutions (CDFIs) While credit unions are seeing growth, Community Development Financial Institutions (CDFIs) in Michigan are not. CDFIs provide low-income people and communities with highly innovative affordable financial products and services. While not conventional banks, CDFIs provide an important complement to traditional bank products and can help small businesses become stable enough to secure bank financing eventually. CDFIs form an important piece of the capital mix in all states.

17 Ben Bernanke, Speech at the Independent Community Bankers of America National Convention and Techworld, Las Vegas, Nevada (March 8, 2006), http://www.federalreserve.gov/newsevents/speech/Bernanke20060308a.htm 18 Detroit Free Press, “State leads U.S. in problem banks,” (April 4, 2008), http://www.freep.com/apps/pbcs.dll/article?AID=/20080404/BUSINESS06/804040310/ 19 Ann Arbor Business Review, “Credit unions prosper as business loans rise,” (March 13, 2008), http://blog.mlive.com/ann_arbor_business_review/2008/03/credit_unions_prosper_as_busin.html#more 20 Ibid. 21 Ibid.


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Looking at Michigan and the Comparison States, Michigan has a low number of CDFIs. Nationally, there are 803 CDFIs, 10 (or 1.25%) of which are located in Michigan. Indiana is the only Comparison State that has a lower number, while California, Illinois, and Minnesota have the highest number of CDFIs, as shown in Figure 6.24. It should be noted that some states, such as Massachusetts, have many community finance institutions (like CDFIs) that pre-date the creation of the CDFI program by decades.

Figure 6.24 Number of CDFIs in Michigan and Comparison States (2008)

With a low number of CDFIs, Michigan is less able to get non-traditional capital out to the small business owners and areas that need it to grow.

No Significant Differences in Community Bank Lending Practices Across States Though the Study Team did find different mixes of community lending institutions across states, our research did not find significant differences in lending practices among community banks based upon geography. Community banks in different states vary in the ways they specialize, but they share similar general lending approaches. Through these approaches, community banks focus locally, emphasize “relationship banking,” and provide a high percentage of small business loans relative to larger banks.

Thomas Payne, a professor of finance at the University of Tennessee-Martin, notes that successful community banks employ several common strategies, shown below.22

1) Knowledge of the customer – Community banks actively serve their communities to gain extensive knowledge of their customers and local business conditions.

2) Personal approach and regular communication – Successful community banks invest in building relationships and regular communication to ensure that they are responsive to their customers’ needs. For example, a community bank in New Jersey assigns a local business development officer in each bank to partner with local

22 Thomas Payne, “Successful community banks make commitment to relationship banking,” Memphis Business Journal (August 10, 2007), http://memphis.bizjournals.com/memphis/stories/2007/08/13/focus4.html.


businesses to ensure that banking programs are understood and appropriate to their unique needs.

3) Strategic deployment of technology – Successful community banks understand that the strategic implementation of technology can improve customer service and the bottom line.

4) Continuous improvement through training and education – Successful community banks invest in continuing education to build their employees’ knowledge and skill base.


There are no bank interview findings that address this topic.



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6.12 SBA Lending in Comparison States Study Question: How does SBA lending in Michigan compare to other key states?


SBA usage in Michigan is average compared to the Comparison States. Relative to the Comparison States, Michigan’s use of the 7(a) program is moderate, whereas usage of more innovative SBIR and SBIC programs is mixed. Michigan’s SBA usage (number of loans and dollar value) grew from 2004 to 2006, but fell in 2007 and 2008. SBA usage fell nationally over the 2007–2008 period, though the drop may be more pronounced in Michigan than elsewhere.


Data shows that the vast majority of lenders in Michigan and the Comparison States use SBA programs in order to serve small businesses. In Michigan, 91.5% of lenders in the state actively use SBA programs. As shown in Figure 6.25 below, Michigan is in the middle to high end of the range when compared to the Comparison States.

Figure 6.25 Percentage of Institutions Providing SBA Loans in Michigan and Comparison States

SBA loans have been used increasingly in Michigan in recent years though this trend is unstable. In fiscal year 2006, the state guaranteed 3,702 SBA loans for a total of $548.9 million, the state’s highest usage of the program to date. In fiscal year 2007, the state had 10% fewer SBA guaranteed loans. However, this level of SBA usage in Michigan is still considered high relative to Michigan’s historical usage of the program. Figures 6.26 and 6.27 below show the number and dollar value of SBA loans in Michigan from 2004 to 2007.

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Figure 6.26 Total Number of SBA Loans in Michigan (Fiscal Years 2004–2007)

Figure 6.27 Total Dollar Value of SBA Loans in Michigan (2004–2007)

The trend of increased usage is unstable. According to the Michigan District Office of the SBA in April 2008, nationwide SBA loans are down 18% in number of loans compared to the same period in 2007. However, Michigan is down 38% compared to 2007, suggesting that far fewer SBA loans are being provided to small businesses in the state. This may be a result of decreasing demand or lender unwillingness to use the SBA loan programs.

SBA 7(a) Loans While Michigan is trending upward in the number and dollar amounts of SBA loans it provides, it is useful to see how its usage compares to the Comparison States. Figures 6.28

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and 6.29 below show the total number and dollar amount of SBA 7(a) loans across Michigan and the Comparison States.

When reviewing these numbers, we see that Michigan falls in the middle with 3,103 7(a) loans provided for a total of $380.1 million. It is behind California, Illinois, Ohio, and New Jersey. The high level of loans in California is not surprising due to its size.

Figure 6.28 Total Number of SBA 7(a) Loans in Michigan and Comparison States (2007)

Figure 6.29 Total Value ($B) of SBA 7(a) Loans in Michigan and Comparison States (2007)


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Figure 6.30 below shows the average 7(a) loan size for each state. When comparing Figure 6.28 with Figure 6.30, one can see several interesting trends. For example, Illinois has the smallest average SBA 7(a) loan size ($103,012), but provides a high number of loans. California provides the highest number 7(a) loans at the largest average amount ($165,356). In both of these metrics, Michigan is in the middle, providing a moderate number of loans with a fair average size. While Michigan is not at the bottom in usage or amount, these graphs show that there is room for SBA usage to grow in the state.

Figure 6.30 Average Size of SBA 7(a) Loans ($K) in Michigan and Comparison States (2007)

It should be noted that states with easy-to-use, well-regarded alternate types of loans, such as Massachusetts, tend to have lower SBA usage than other states.

SBIC and SBIR Loans In addition to SBA 7(a) loans, the Small Business Administration offers two programs that are intended to spur innovation in new companies: the Small Business Investment Company (SBIC) and Small Business Innovation Research (SBIR) programs.

As shown in Figure 6.31 below, Michigan ranks low in its use of the SBIC program when looking at dollar per worker. Of the Comparison States, Michigan and Ohio use the program least, with small businesses receiving only $8 of investments from SBICs per worker (October 2004–September 2005). Massachusetts, which has aggressively promoted the program in the state, has the highest level of SBIC use with $62 received per worker. Looking at overall dollar amount, however, Michigan fares well, receiving nearly $50 million in SBIC dollars in 2006, which places it 10th in the nation.23 This seemingly contradictory data suggests that there is room for improvement in the use of this program statewide.

Michigan fares slightly better in its use of the SBIR program using the dollar per worker metric, ranking 29th in the country. Michigan’s level of $6.91 per worker is higher than

23 http://tech-net.sba.gov/tech-net/public/dsp_search.cfm


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Illinois, Indiana, and North Carolina. Massachusetts also leads in SBIR use, with $82 per worker, signaling the state has a high level of technological sophistication. However, when looking at the total dollar amount for the SBIR program, in 2006 Michigan received a total of $4,520,874, putting it at 15th in the nation.24 Again, this data suggests that there is room for improvement in SBIR usage in Michigan.

Figure 6.31 SBIC and SBIR Amounts (Per Worker) in Michigan and Comparison States (2006)

6.9

12.1

4.0 4.27.5

23.7

6.213.8

81.8

7.6 8.1 9.5

22.3 22.6

27.5

10.7

26.2

61.7

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

SBIC Financing and SBIR Grants ($/Worker)

SBIR Grants SBIC Financing

$

Source: U.S. SBA, Investment Division, Office of Technology, 2006


1. Use of SBA and Alternate Sources of Capital is Common among All Types of Lending Institutions Regardless of Size or Geography

Approximately 76% of the banks interviewed use SBA loans to extend credit to companies that would have difficulty under traditional lending standards. Additionally, 70% of the banks interviewed use other sources of capital, such as the Capital Access Fund, when making loans to small businesses. One national bank noted that it was looking for more ways to say yes to small businesses and that the SBA programs allow it to do that.

Despite the high use of the SBA program by banks interviewed, several bankers noted that the SBA program is “not the great deal it used to be” because fees have gone up for lenders and borrowers. Overall, approximately 25% of banks surveyed mentioned some issue with SBA loans that discouraged them from increasing their use of the program. A small community bank in Michigan stated that the program has a “very steep learning curve and [is] cumbersome.” He went on to say that “Anything [the government] could do to streamline the process would be a lot of help.” Another community bank not active in

24 http://tech-net.sba.gov/tech-net/public/dsp_search.cfm


Michigan indicated that many programs are not used by bankers because lenders do not know about them or do not know how to use them.

Though there is some hesitation to use the SBA and alternative programs, they clearly remain important tools in small business lending.


1. Small Business Owners Want to See More SBA Usage in Michigan Within the realm of conventional lending, small business owners wished to see banks use SBA financing more readily. Though SBA program usage increased in Michigan in recent years, two businesses in Michigan noted that they had trouble obtaining SBA loans, even when they specifically asked their lenders for SBA loans. In one case, a small business owner was told that the bank used SBA products, but in his case they “were not willing to do it.”

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6.13 Initiatives to Promote Community Bank Lending Study Question: Are there initiatives the state could employ that would encourage or support community bank lending to small business?

Findings and Recommendations

Community banks arise because of opportunities from an underserved market need. In short, community banks are born because bigger banks are not sufficiently serving local community needs. Often the need for small business lending is a key driver of community bank creation.

Because community banks arise out of an organic process, the state’s role in creating community banks is limited to (1) facilitating new charters to community banks and (2) augmenting communications and education to encourage the creation of new community banks, as well as communication and education between community banks. Given that, the Study Team has the following recommendations for encouraging and supporting community bank lending to small businesses:

1. Provide Guidance on How to Start Community Banks

Michigan can hold training and information sessions on establishing community banks. Likely attendees and targets would include regional economic development organizations, Chambers of Commerce, community organizations and activists, trade associations, and other local parties likely to be interested in locally-focused financing.

2. Partner with Leading Community Banking Associations, such as Michigan Association of Community Bankers

Banking associations are trade associations that provide members with business development and education opportunities. By partnering with such associations in Michigan, MEDC can facilitate sharing of innovative community banking lending programs across institutions in the state.

3. Hold Forums with Innovative Community Bankers. MEDC can also promote education by bringing innovative community banking lenders from across the nation to community banking association meetings for member education.

4. Create Innovative Partnerships with Leading Community Banks

MEDC may want to explore potential partnerships with community banks in order to promote their small business lending products and expand their footprints.

5. Examine Practices/Policies of Banking Commissioners in Other States

If the state is concerned with the level of community bank growth, it may wish to look at the practices and policies of banking commissioners in other states that have strong track records in this regard. It is important to note that the Study Team has no data indicating that there is or is not a problem with the current charter practice for new community banks in Michigan (this is outside of the scope of this report). This suggestion is provided in case MEDC judges that the charter practice in the state could use revision.

The state can also take aggressive steps if it wishes to encourage the creation of CDFIs and the usage of the SBIR in Michigan. As discussed, the number of CDFI organizations is low

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(Section 6.11) and the SBIR program has room for improvement given the SBIR dollars per worker when compared to other states in the study (Section 6.12).

To increase the number of CDFIs, the state can:

6. Create a “CDFI Business Team” to Encourage CDFI Growth

MEDC may consider creating a CDFI business team that travels the state promoting the creation of CDFIs. Presentations could be made to regional economic development organizations (including community development corporations), Chambers of Commerce, technology networks, trade associations, and other regional and community organizations looking to utilize and expand innovative capital.

7. Partner with CDFI Trade Associations to Encourage CDFI Growth

There are national trade organizations serving CDFIs that the state may wish to reach out to if it pursues such an effort:

• Opportunity Finance Network: A trade association of opportunity finance organizations and CDFIs including community development banks, community development credit unions, community development venture funds, loan funds, and micro loan funds.

• Community Development Venture Capital Alliance (CDVCA): A trade association of CDFI venture funds. Similar to the Opportunity Finance Network, CDVCA works on multiple fronts to build the venture capital field.

If the state pursues this suggestion, it may wish to bring these CDFI trade organizations together with associations of community development credit unions, community development banks, and micro lending groups in the state for such outreach, in addition to the regional economic development organizations (including Community Development Corporations), Chambers of Commerce, community activists, and others. The state may also want to encourage successful existing CDFIs to expand into Michigan.

8. Create Financial Incentives to Encourage CDFI Growth

The state may encourage CDFI growth by creating state-specific tax credits and grants accessible to CDFIs within Michigan. Training in such incentives would be required if they were created by the state. Trainees would include current CDFIs and the entities identified as targets in the “CDFI business team” recommendation above.

To increase usage of the SBIR program, the state can:

9. Continue Promoting SBIR grants and Develop a Formal Strategy for Using the Program.

MEDC may want to work with the Michigan Small Business & Technology Development Center and other relevant entities to develop a formal statewide plan for using the SBIR program.

10. Continue Matching SBIR Funds with State Money

The continued growth of the Michigan Emerging Technologies Fund will be important in promoting the SBIR and STTR federal programs. Over time, Michigan may wish to assess whether the level of matching dollars available should be increased.

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6.14 Innovative Programs and Models for Lending Study Question: What are other states doing to encourage and support small business lending? Are there specific “best practices” Michigan should be aware of? What models can be employed by state policymakers in Michigan to stimulate bank lending to small companies?

Findings and Recommendations

Before we begin a discussion on what policymakers can do in order to improve financing to small businesses in Michigan, we must begin with a word about what policymakers cannot do: state policies cannot and should not make banks into what they are not.

As we have discussed, banks play an important role in small business finance, but they are not overt risk takers by definition, structure, regulation and culture. This study finds that banks within Michigan are active and prudent in the market given market opportunities, as well as risks inherent in the state’s current economy. Therefore, the recommendations below are meant to augment the current lending going on in the state, rather than as a criticism of the banks.

Unlike the federal government, states cannot print money or put up tariff barriers. Therefore, they have no fiscal and monetary power to affect short term business cycles. What they do have is the power to affect and address those structural problems that exist in the state which impede the key supply factors essential to a successful business climate in today’s global knowledge-based economy: the quality of the environment for innovation; the education and training of a highly qualified and properly priced labor force; the economic, social and cultural environment that attracts and sustains innovative, risk-taking and visionary entrepreneurs and management; and other factors of production, including a wide range of kinds and price points of financial capital capable of supporting and partnering with commercial banks in birthing and growing innovative enterprise.

Therefore, to improve the environment for small business growth and lending, state policymakers should consider the following actions (for each recommendation, the Study Team has provided innovative practices from other states):

1. Create Innovative Finance Partnerships with Associations in Michigan

Banking associations are trade associations that are also business development and education organizations. MEDC could create a joint venture with the Michigan Bankers Association to help augment its education programs for bankers in the emerging life sciences and technology industries, as well as other industries targeted by the state. MEDC’s educational efforts could also include local economic development incentives and general government programs.

2. Consider using innovative partnerships to encourage creation of new finance mechanisms.

MEDC could use partnerships to encourage the creation of risk pricing, pooling, and spreading mechanisms. An example from Massachusetts depicts the impact such a partnership could have. The Massachusetts Bankers Association was actively engaged in the creation of Massachusetts Capital Resource Company (MCRC) and Massachusetts Business Development Corporation (MBDC, now The Business Development Company) and more recently, in the creation of the Massachusetts Housing Investment Corporation (MHIC). On an ongoing basis, Massachusetts Bankers Association works

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with these entities to provide information and education to its members, who then promote their services to small business clients. In each instance, these risk capital institutions allow commercial bankers to grow their own clients while sharing the risk. A similar partnership could be created in Michigan.

3. Consider Innovative Finance Partnerships Outside the State to Encourage the Creation of New Financing Mechanisms

MEDC could also work to bring in leaders in the lending field from across the country to assist with education and trainings, and the creation of new innovative financing tools. MEDC might bring in representatives from Mass Capital and the Business Development Company, the nation’s premier subordinated debt lender, to encourage local institutions to create these new tools.

4. Implement Bank Education Program for Lenders Not Active in Michigan

In the 1990s, the Central City Association of Downtown Los Angeles, in coordination with the City of Los Angeles, brought bankers from New York to downtown Los Angeles, took them on a tour of areas in need of investment, and presented opportunities for bank business activity. This effort was aimed at overcoming the investment prejudices held by large national banks against lending to real estate project in downtown Los Angeles. This effort broke down a market prejudice and a conceptual barrier for bankers and showed them that: (1) there were real estate investment opportunities in downtown Los Angeles, (2) opportunities were not as risky as originally viewed, and (3) they could be profitable to banks. Lending activity in the downtown area improved as a result.

5. Enhance Small Business Understanding of the Banking Process

MEDC can do this through creation of additional resources, as detailed below, or by convening meetings between bankers and business owners in the state. Through our interviews, we saw that there is a large disconnect between banks and business owners.

Of the banks that responded, 45.5% noted that small business owners do not understand the bank’s business or point of view. This is a practical consequence of the difference between “need” and “want” discussed earlier. As a result, small business owners often become frustrated with the time, documentation, and back-and-forth that is required to obtain a loan. As one community banker noted, she often has to explain to people (1) the bank’s perspective, (2) what is risky about their business, and (3) that she will not collateralize their house if she thinks she might have to take it from them someday. Multiple banks also noted that small businesses want immediate responses on loans, which most banks cannot do. As a result, many bankers had to educate potential borrowers on time horizons for lending.

A simple business banking guide posted to the MEDC website could be a great tool to help small businesses understand the loan process at commercial banks and what to expect when they apply. This would alleviate much of the business and lender frustration that was voiced to the Study Team during interviews. We know that MEDC currently has a lot of good information on its site, however, a single business banking guide would be useful. The Study Team was particularly impressed by the following best practice.

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• North Carolina’s Small Business Lending Guide – North Carolina’s Small Business and Technology Development Center publishes Capital Opportunities for Small Businesses, A Guide to Financial Resources for Small Business in North Carolina. This comprehensive guide provides an easy to understand overview of all the state and federal resources available to small businesses in North Carolina. A copy of this guide can be found at http://www.sbtdc.org/publications/cap_opps.asp.

6. Consider Initiatives to Expand the State’s Capital Mix

As discussed in this report, Michigan needs additional risk mitigation and risk capital mechanisms in order to increase lending and economic development activity in the state. In our 38 years of economic development experience, the Study Team has always engaged banking institutions and their trade associations when considering and then building risk capital institutions. These institutions will create substantial opportunities for banks in the long-term and they, therefore, have a stake in the effort.

When building risk capital institutions, it is insufficient to build one alone. Instead, there should be a system of institutions that support and build upon each other. While the Study Team acknowledges that new programs exist in Michigan, such as the 21st Century Job Fund initiative and the Venture Michigan Fund, additional institutions may help expand the capital mix and therefore increase the amount of financing available to small businesses in the state.

The following initiatives (which are detailed in the Appendices) are those that the Study Team believes the state of Michigan could consider.

• Subordinated Debt Funds Models (described in detail in Appendix I)

Indiana Community Business Credit Corporation (1985) - The Indiana Community Business Credit Corporation (Credit Corp) is a privately owned company created by the banking industry that manages a pool of risk capital provided by Indiana banks (currently 34). One of the 34 banks must be a primary lender with at least a 50% exposure. The Credit Corp takes a subordinate collateral position. The Credit Corp participates in projects that need at least $200,000 in new financing. The project funding can be used for any legitimate business purpose, including working capital. When it was originally created, the Indiana Community Business Credit Corporation was very successful and was used as a national model. It is now a part of a larger network of risk capital mechanisms that provide a range of risk capital, including venture, mezzanine and assorted subordinated debt mechanisms. In that regard, Indiana CBCC is much like Mass Business and Arkansas Capital. In recent years, activity by this organization may have waned. However, its activity when it first began is of note. (See Appendices I and K for details.)

Massachusetts Business Development Corporation (now The Business Development Company) (1977) - A private company restructured by its member banks in 1977 that provides financial assistance with loans, mezzanine, and equity investments, guarantees, and financial services to businesses for its member banks. Funds are sourced from member banks and enable banks to make

http://www.sbtdc.org/publications/cap_opps.asp


loans they might otherwise be unable to make. (See Appendices I and J for details.)

• Mezzanine Capital Fund Models (described in detail in Appendix I)

Massachusetts Capital Resource Company (1977) - Massachusetts Capital Resource Company is the pioneer geographically targeted growth capital fund upon which all other models have been designed. MCRC was founded by the Massachusetts Life Insurance Industry in 1977 in response to an identified need by the Massachusetts’ Task Force on Economic Development for long term growth capital to expand small and medium size businesses. Financing ranges from $250,000 to $5 million, averaging less than $2 million per company. Fifty percent of these companies have under $10 million in sales at the time of financing, and 50% have above $10 million sales. (See Appendix I for details.)

Arkansas Capital Corporation (1985) - Offers alternative financing for small businesses. This broad based risk capital institution was restructured in partnership with the Arkansas Banking Association in 1985 based on the then best current models nationally, beginning with that of Mass Business. Like Mass Business and Indiana, Arkansas Capital has gone on the create a range of affiliates covering the spectrum of risk capital from early stage to mezzanine finance, always adapting from the best current national models. (http://arcapital.com/)

Kansas Venture Capital, Inc. (1986) - Provides equity and mezzanine capital primarily to small and middle market Midwestern companies. (http://www.kvci.com/)

• Venture Capital Models (described in detail in Appendix H) Alliance Technology Ventures of Georgia (1995) - Focuses its capital on young start-ups in the fields of life sciences and information technology. (See Appendix H for more information)

NorthEast Pennsylvania Venture Fund (1984) – Now Mid-Atlantic Venture Funds of Pennsylvania is a seed venture capital fund that focuses on technology companies. (See Appendix H for more information)

Oklahoma Capital Investment Board (1993) - OCIB looks to operate a balanced portfolio made up of venture capital funds which are actively investing within the State of Oklahoma. OCIB seeks to have seed and early stage venture capital funds, alongside mezzanine and later-stage funds. (See Appendix H for more information)

• Statewide Development Finance Authorities or Corporations Information on the development of such state development banks, authorities/corporations is provided in Appendix J.

Massachusetts Development Finance Authority (1977) – This $15 billion organization is the preeminent state Development Finance Authority in the United States, undertaking more than $1 billion of new financing each year for a diverse range of projects. (See Appendix J and K for more information)

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Florida Development Finance Corporation (1994) - Was created by special state statute as an issuer of bonds, both taxable and tax-exempt, to provide low cost capital to Florida manufacturers. FDFC’s Board of Directors is appointed by the governor, and its day-to-day operations are administered by executives provided by Enterprise Florida Inc. (see below)

• Industry Specific Funds St. Louis Vectis Life Sciences Fund (2004) - A private equity fund that invests in seed and very early stage life sciences companies in greater St. Louis. (See Appendix K)

• Enhanced Capital Access Program Michigan could assess its current Capital Access Program and look for ways to enhance its ability to provide credit to small business. Capital Access Programs (CAPs), originated in Michigan in 1986, are now widely adopted state-wide self-insured loan programs that allow participating banks in twenty-one states to make larger loans to high-risk customers, without the government bureaucracy of federal SBA loans or similar state and local government operated programs.

The Capital Access Program encourages banks and other financial institutions to lend to small enterprises that fall outside of the conventional underwriting standards of many banks. CAPs provide a form of loan portfolio insurance that can provide up to 100% coverage on certain loan defaults. By participating in a CAP, lenders have available to them a proven financing mechanism to meet the capital needs of most local small enterprise.

CAPs are lending programs in which participating states and municipalities make contributions to lenders' loan loss reserve pools, allowing lenders to make slightly more challenging small business loans than they would using conventional underwriting. According to a report issued by the U.S. Treasury in January 2001, nationwide cumulative CAP lending totaled over $1.5 billion by June 2000. In addition to the 21 states with thriving programs, Akron, Ohio has a regional program, which could be a model for similar regional CAPs in Michigan.

According to the report, the 14-year track record of state-run CAPs suggests that these programs encourage small business lending in a cost-efficient and simple way. Under CAPs, the bank and the borrower pay an up-front insurance premium, typically between 3% and 7% of the loan amount at the bank’s discretion, which goes into a reserve fund held at the originating bank. The state (or participating community/region) matches the combined bank and borrower contribution with a deposit into the same reserve fund. The CAP reserve fund allows a lending bank to make slightly higher risk loans than conventional underwriting, with the protection of the reserve fund for its entire pool of CAP loans.

CAPs allow banks to use their own underwriting standards for eligible loans, without governmental approval on the loan-making decision. Compared to other credit enhancement programs, CAPs have minimal administrative costs to banks, borrowers or the government. In most states the majority of small businesses are eligible for the program, although some states put a limit on the size of the loan and eligible industries. A state’s up-front payment of 3%–7% of the loan amount into a

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bank’s CAP reserve fund supports a bank loan that is 14 to 33 times larger than that amount.

The strongest argument for an enhanced Michigan CAP is the widely held judgment of commercial banks, borrowers, and economic development organizations now participating in the 21 current state programs that they vastly prefer the lean, quick, non-bureaucratic decision-making of CAPs to similar programs offered by the SBA or most other local or state government programs. Some states have taken the further step to privatize the administration of the CAP program to a bank member institution, such as Mass Business. This creates even more confidence in participating bankers and is perceived to increase efficiency.

Other Credit Insurance and Guarantee Models are found in Appendix K Other Innovative Financing Models.

7. Survey the Small Business and Small Business Lending Landscapes Annually

MEDC may want to help the state better understand general sentiments, as well as the impact of various efforts over time. In order to conserve resources, it may make sense for the state to partner with an organization, such as National Federation of Independent Business (NFIB) which conducts annual national small business surveys, in such an effort.

8. Create Public-Private Partnerships Between Business Leaders, Lenders, Venture Capital Firms, Community Leaders, and Government Entities

From the time the Michigan Strategic Fund was created in the 1980s through the current version of the MEDC, Michigan has always been at the forefront of thinking about public-private partnerships. Michigan is currently supporting several public-private partnerships that are helping small business grow, including initiatives such as SmartZones. However, there is national experience worth looking at from an evolutionary best practices perspective. Within this recommendation are two suggestions: (1) MEDC could convene a general council of players within the state and (2) MEDC could strengthen the relationships between existing financial organizations within the state.

• Enterprise Florida (General Partnership) - Enterprise Florida, Inc. (EFI) is the public-private partnership responsible for leading Florida’s statewide economic development efforts. EFI was formed in July 1996, when Florida became one of the few states in the nation to replace its Commerce Department with a public-private organization that is responsible for economic development, international trade, and statewide business marketing.

Enterprise Florida’s mission is to diversify Florida’s economy and create better paying jobs for its citizens by supporting, attracting, and helping to create businesses in innovative, high-growth industries. Enterprise Florida focuses on high-value sectors such as: international commerce, information technology, life sciences, aviation/aerospace, homeland security/defense, modeling/simulation/training (part of IT), and financial/professional services.

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Enterprise Florida also works collaboratively with a statewide network of regional and local economic development organizations ("Partners") to continually improve Florida’s business climate and ensure its global competitiveness.

A Board of Directors—including leaders from Florida's business, economic development, educational and government communities—provides broad based policy direction. The Governor of Florida serves as the chair of the Board.25

• Bay Area Community Investment Network (Financial Partnership) - BACIN is a network organized by the Bay Area Council and the Bay Area Family of Funds, linking the three funds in the Bay Area Family of Funds with CDFIs, community development venture funds, community loan funds, community credit unions, community development banks, and other community investment organizations. The network includes commercial bank CRA lending programs, venture capitalists, angel investor networks, investment funds, insurance companies, federal, state, and regional government programs, and other sources of capital. The intent of BACIN is to provide prescreened, prequalified flow of real estate and business deals to appropriate BACIN participants, and exchange participant underwriting criteria to encourage mutual referrals of appropriate deals.

9. Review Other Innovative Financial Vehicles Across the Country

MEDC may also wish to review a number of other innovative financial tools across the country in order to determine if they might be useful to Michigan’s effort to bring more capital to small businesses. These innovative programs are listed in Appendix K.

25 http://www.eflorida.com

June 27, 2008 Small Business Lending Report 7.0 Conclusion

7.0 CONCLUSION The Study Team detailed its research and findings on small business lending in this report, focusing on the current state of lending in Michigan, the impact of the decline in manufacturing on lending in Michigan, lending practices to emerging sectors, the level and mix of capital availability in Michigan, and policies the state of Michigan may wish to consider for small business financing improvement.

Through this research, Study Team found that there are issues with small business lending in Michigan, although they are not issues caused by a market prejudice by banks. Instead, the problems stem from a lack of innovative risk reduction mechanisms for debt financing and a sub-optimal mix of financial institutions in the state. These issues, which are not unique to Michigan, have been faced and overcome by other states across the nation that have employed innovative programs.

The Study Team encourages the MEDC to consider the findings and recommendations in this report when deciding upon a course of action going forward.

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June 27, 2008 Small Business Lending Report 8.0 Appendices

8.0 APPENDICES

Appendix A: Bank Interview Questions

Sample Questions for Interviews with Banks

1. How would you characterize the small business landscape in your state?

a. How has small business changed over time in your state?

b. IF MICHIGAN: Over the last 5 years, has it been easier, harder, about the same to get a small business loan in Michigan? Why?

c. What are the main industries within small business?

d. Which sectors are growing? What are the factors leading to that growth?

2. How would you characterize small business banking at your institution?

a. Is small business a focus of your bank?

b. Who are your clients? Why do clients choose you?

c. What is the main purpose of the small business loan requests you receive? Growth, working capital, start-up costs?

d. Of the products you offer, are any unique to the market? Which are most popular?

e. Are certain sectors more comfortable for your institution? Why?

f. Which sectors are more attractive? How often do you change target sectors? What products/services do you offer to attract that sector?

g. Do you offer a line of credit or bridge loan product to small to medium size manufacturing companies? What is the product called? Who should we contact about that product?

3. Describe the capacity/sophistication/preparation of the small business applicants you see.

a. How does capacity vary from state to state? Industry to industry?

b. Are there impressions of Michigan small businesses and business owners in the banking industry?

4. How does your bank view small business risk?

a. What are your typical underwriting criteria for small businesses?

b. Does underwriting criteria vary from state to state? Why and how?

c. Does underwriting criteria vary from industry to industry? Why and how?

5. What are your impediments to making loans to small businesses?

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a. How do you get around those impediments?

b. If you can’t get around them currently, what would you propose be done to get around them?

c. Are there products you would like to see that don’t currently exist?

d. Are the problems you see more prevalent in certain states and/or industries?

6. How much do you focus on SBA-backed loans?

a. Are your clients knowledgeable about these programs?

b. What are your criteria for directing a client towards an SBA loan instead of a conventional loan?

c. Do you favor 7(a) loans vs. 504 loans? Why? In which situations?

7. Do you use any other government or non-government programs or incentives to aid in loan approvals (national, state, or local)?

8. Can you give me examples:

a. Of a difficult deal that you made work – What is the business, what was the problem, how did you get around it, outcome, did the bank change its criteria, etc.

b. Of small business best practices you’ve heard

9. Is there anything else you would like to share or that you think we should know?


Appendix B: Business Interview Questions

Sample Questions for Interviews with Businesses

1. How would you describe the type of business you have?

a. What is the name of your business?

b. What does this business do?

c. How long have you been in business?

d. How large is the business?

Number of employees

Annual revenue/Sales

e. How would you describe your company’s stage of growth? Start-up? Established and growing? Stable operating? Etc.

2. What is your experience with small business loans?

a. When was the last time you requested a bank loan for your business?

b. What kind of loan was it? Was it an SBA-backed loan?

c. What was the purpose of the loan?

Growth/investment

Working capital

Startup

Other

d. To which bank(s) did you apply for a loan?

e. How would you describe the loan process?

f. What was the hardest part of the loan application process?

g. Have you worked with other banks for small business loans? Describe how the experience differed from bank to bank, if at all.

h. Have you ever sought other kinds of small business financing apart from bank loans?

If so, which kind and why?

Do you think this is a good financing product for small businesses in general?

3. How do banks in Michigan compare to banks in other states?

a. How would you rate small business lending conditions in Michigan?

Too stringent

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Adequate

Too relaxed

b. Does your business operate in a state other than Michigan?

c. Have you ever requested a bank loan from a bank outside of Michigan?

If so, which state?

Describe how the experience differed from state to state, if at all.

d. Did you find lending conditions to be more stringent, more relaxed or roughly the same among different states?

e. Over the last 10 years, do you feel it has gotten harder to obtain a small business loan in Michigan? In the other states in which you do business?

If so, why do you think this is?

4. How do you feel financial services for small businesses could be improved?

a. What is the biggest challenge facing your business today?

b. What is the biggest obstacle for growth in your business today?

c. Are there any small business lending products that you feel are particularly well suited for small businesses’ needs? Do the banks you use provide those products?

d. Are there any changes you would make to the current small business lending process?

e. Are there any changes you would like to see in non-bank sources of financing?

f. Do you believe you will require additional financing over the next 5 years?

If so, which type of financing are you most likely to seek? Why?

5. If you could tell banks and/or the Michigan government anything about the state of small business lending in Michigan what would you say?

6. If you could tell banks and/or the Michigan government how they could help your business personally, what would you say?

7. Is there anyone else you think we should speak to?

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Appendix C: Michigan Economic Data

Overall, Michigan’s economy is troubled, with GDP falling, a population migrating from the state, a high unemployment rate, a low level of business creation, and low industrial diversity.

Falling GDP: An Indicator of an Economy in Distress

Michigan’s economy shrank by 0.5%26 (from $339,507,000 to $337,885,000) between 2005 and 2006. Michigan was the only state to have a negative GDP, 27 thus suggesting the relative economic situation in the state. Figure 8.1 below shows GDP growth across the nation.

Figure 8.1 Percent Change in Real GDP by State 2005–2006

As Figures 8.1 and 8.2 (below) show, many states in the Great Lakes region are experiencing lower growth than those in other parts of the country. Figure 8.2 below further demonstrates the region’s economic strength relative to that of other regions of the U.S. This lower growth is largely attributed to the region’s lack of diversification and the current shift away from manufacturing.

26 U.S. Bureau of Economic Analysis, “Real GDP by State, 2003-2006,” http://www.bea.gov/newsreleases/regional/gdp_state/2007/xls/gsp0607.xls. 27 GDP by state is the state counterpart of the Nation's gross domestic product (GDP), the Bureau's featured and most comprehensive measure of U.S. economic activity. GDP by state is derived as the sum of the GDP originating in all the industries in the state.


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Figure 8.2 Growth in Real GDP by State 1997–2006

Unemployment in Michigan: Highest in the Nation

Given the seismic shift from auto and manufacturing occurring in Michigan, it is not surprising that the state has the highest unemployment rate in the nation. In January of 2008, Michigan unemployment was reported at 7.1%, nearly 45% higher than the national average of 4.9%.28

The impact of the shift from manufacturing and decline of the automobile industry on Michigan over time can be seen in Figure 8.3 below. In this chart, we see that, from 1998 to 2000 Michigan’s unemployment rate was under the national average and from 2000 to 2002 unemployment basically tracked the national average. However, beginning in 2002, Michigan’s unemployment rate far outstripped the national average.

28 Bureau of Labor Statistics, http://www.bls.gov/lau/home.htm


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Figure 8.3 Unemployment Rate for Michigan and U.S. (1998–2008)

In Figure 8.4 below, Michigan’s unemployment rate (January 2008) is contrasted with that of the Comparison States. Readers will note that Michigan’s unemployment is 1.2% higher than that of the second highest Comparison State (California at 5.9%).

Figure 8.4 Current Unemployment Rate in Michigan and Comparison States

The employment picture is similarly bleak when one reviews the 2007 Development Report Card for the States29, which finds the following:

• Michigan ranks 48 out of the 50 states in long-term employment growth (percent change in annual average employment, by place of residence, from 1995–2005).

• Michigan has the third worst record when it comes to private sector layoffs. Private sector layoffs are defined as extended mass layoff events (private, non-farm businesses). In 2004, 11.4 of every 10,000 companies in Michigan had mass layoffs.

29 Corporation for Enterprise Development, 2007 Development Report Card for the States, http://www.cfed.org/focus.m?parentid=5&siteid=2346&id=2346


Income Level and Growth

Economic conditions in Michigan are impacting the growth of state residents’ household income. According to U.S. Census 2006 American Community Survey, Michigan’s median household income of $47,182 was lower than the national average. In comparing this with the Comparison States, Michigan was in the middle, with North Carolina, Ohio, and Indiana having lower median incomes.

Figure 8.5 Median Household Income of Michigan and Comparison States (2006)

However, Michigan’s median household income from 2001 to 2006 had the slowest growth of all Comparison States, as shown in Figure 8.6 below.

Figure 8.6 Growth in Median Household Income for Michigan and Comparison States (2001–2006)

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Poverty

According to Census data, 13.5% of Michigan’s population is below the poverty line, which is just slightly above the national average of 13.3%. Michigan has the 20th highest poverty rate among all the U.S. states, and the second highest among the Comparison States, as shown in Figure 8.7 below.

Figure 8.7 Poverty Rate of Michigan and Comparison States (2006)

It is worth noting that Michigan’s poverty rate grew 2.4% between 2000 and 2004. This growth rate was the 7th highest in the nation and 2nd highest among Comparison States (behind Indiana’s 3.2%).

Housing

According to 2007 Census data, 76.4% of Michigan households own their own home, the third highest homeownership rate in the country, just behind Delaware (76.8%) and West Virginia (77.6%).30

However, Michigan’s housing market has one of the highest foreclosure rates in the country. According to RealtyTrac, in March 2008, Michigan had the eighth highest foreclosure rate in the country with foreclosure filings reported on one in 475 households, and is 1.13 times the national average. 31 The situation was even worse in Detroit where the foreclosure rate hit 4.9% in 2007 (or 4.8 times the national average) making the city the highest metropolitan area for foreclosures.32

Michigan has been in the midst of the foreclosure crisis for longer than much of the country, as demonstrated by the data and the Study Team’s conversations with lenders. According to

30 U.S. Census Bureau, “Homeownership Rates by State: 1984 to 2007,” http://www.census.gov/hhes/www/housing/hvs/annual07/ann07t13.html 31 RealtyTrac®, “March 2008 U.S. Foreclosure Market Report™,” http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=4450 32 Associated Press, “Detroit Had Top Foreclosure Rate in '07,” (February, 13, 2008), http://biz.yahoo.com/ap/080213/foreclosure_rates.html

http://biz.yahoo.com/ap/080213/foreclosure_rates.html


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Reuters, Michigan’s foreclosure rate in 2007 was 68% higher than in 2006.33 However, Michigan’s foreclosure rate has dropped in the beginning of 2008. Between February 2008 and March 2008, Michigan’s foreclosures dropped by 13.35%.34 This may suggest that Michigan’s housing crisis is beginning to stabilize.

Michigan’s Falling Population

Given the economic and housing distress discussed, it is not surprising that Michigan’s population has fallen in recent years. In 2006, Michigan had a total population of 10.1 million. That number fell by 30,500 from 2006 to 2007. In fact, Michigan had the third highest level of net domestic out-migration of all the states in 2007, with only New York and Rhode Island having higher levels. Additionally, since the 2000 Census, Michigan has had the nation’s seventh-highest rate of out-migration.

In spite of the falling population, Michigan remains the nation's eighth-largest state with a population of 10,071,822 in 2008.

Figure 8.8 below depicts Michigan’s population growth over the last 107 years, as well as its most recent slowing and decline.

Figure 8.8 Estimated Population of Michigan 1900–2007

Source: Library of Michigan

Michigan has seen its net out-migration rise over the past 10 years. However, the recent level of out-migration remains lower than the early 1980s. Figure 8.9 below demonstrates out-migration trends over the last 47 years.

33 Reuters, “Foreclosure rate almost doubled in 2007: report,” (January 29, 2008), http://www.reuters.com/article/hotStocksNews/idUSN2849823320080129 34 RealtyTrac®, “March 2008 U.S. Foreclosure Market Report™,” http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=4450

http://www.reuters.com/article/hotStocksNews/idUSN2849823320080129


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Figure 8.9 Net Migration for Michigan 1960–2007

Source: Library of Michigan

Human Capital

As Michigan looks to diversify into the new economy, it will need non-industrial workers with higher levels of education and/or a draw to technical and scientific innovation. Currently, education trends in Michigan do not support the need for such a workforce.

As of 2006, only 24.5% of Michigan residents age 25 and over have a bachelor’s degree or higher, giving the state a ranking of 35 out of the 50 states and the District of Columbia.35 Further, more students are leaving the state than are entering to attend college, further exacerbating the human capital issues for the state.

Michigan also had the highest rate nationally of recent college graduates moving out of the state, indicating that the state is losing much of its human capital, which can impact the quality of employees that small businesses are able to attract.36

Recent Growth in Economic Diversity

Though Michigan’s economy is clearly in a state of distress, there is a bright spot when one looks at the growing economic diversity, particularly in emerging sectors.

Despite Michigan’s historical reliance on the manufacturing sector, the Michigan economy has seen a recent increase in diversity, as shown in Table 8.1, with growth in the Education and Health Services, Leisure and Hospitality, Professional and Business Services, Financial Activities, Other Services, Government, and Construction sectors. While these sectors grew in Michigan, they did not grow at the level seen nationally.

35 U.S. Census Bureau, 2006 American Community Survey, http://factfinder.census.gov/servlet/GRTSelectServlet?ds_name=ACS_2006_EST_G00_&_lang=en_sse=on 36 The Michigan Journal, “Michigan graduates leaving state in record numbers,” (April 24, 2007), http://media.www.themichiganjournal.com/media/storage/paper255/news/2007/04/24/News/Michigan.Graduates.Leaving.State.In.Record.Numbers-2875140.shtml


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Table 8.1 Michigan and U.S. Employment by Sector 1996–2006

Sector

Percentage of MI

Employment

MI Employment in Thousands

Percentage of MI

EmploymentMI Employment in Thousands

% Change in MI

Employment

% Change in U.S.

EmploymentEducational and Health Services 11.13% 489.4 13.66% 590.7 20.69% 30.28%Leisure and Hospitality 8.60% 378.1 9.42% 407.6 7.80% 22.68%Professional and Business Services 12.60% 554 13.72% 593.3 7.09% 28.97%

Other Services 3.85% 169.2 4.14% 179.2 5.91% 14.88%

Financial Activities 4.62% 203.1 4.97% 215.1 5.91% 19.65%

Government 14.76% 649.1 15.36% 664.2 2.32% 12.99%

Construction 3.97% 174.6 4.07% 176.2 1.00% 35.40%Trade, Transport, Utilities 19.01% 835.6 18.34% 793.3 -5.06%

-5.63%

-19.39%

-26.85% -18.25%

-1.64%

7.62%

Information 1.61% 71 1.55% 67 2.50%Nat. Resources/Mining 0.22% 9.8 0.18% 7.9 10.33%

Manufacturing 19.62% 862.5 14.59% 630.9

TOTAL 100% 4396.4 100% 4324.4 13.36%

1996 2006 1996-2006

Source: “Michigan’s Economic Transition: Toward a Knowledge Economy” 2007

Growth in Michigan’s Economic Diversity

The Michigan economy is becoming more diverse. Data from the 2007 report, “Michigan’s Economic Transition: Toward a Knowledge Economy” shows that small business creation in Michigan is growing in every sector except manufacturing. Sectors experiencing small business growth include finance and insurance; professional, scientific, and tech services; educational services; arts, entertainment, and recreation; information; and management of companies. This trend is important for Michigan’s long-term economic outlook and paints a picture different from the state’s “all auto and manufacturing” connotation.

Small business creation is particularly important in Michigan because they are powerful engines for job creation. Michigan is the number one state nationally in job creation by start-up businesses. For every new establishment in Michigan with fewer than 500 employees created between 2002 and 2003, 6.55 new jobs were created. This is a promising statistic about how robust Michigan’s new businesses are, as well as the impact new business creation has on the state’s economy overall.


Figure 8.10 Job Creation by Start-Up Businesses (2002–2003)

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Appendix D: Government Small Business Lending Programs

Government Programs

According to a 2007 Federal Reserve survey, larger firms use more credit products more frequently than younger firms. This may be due to a greater need for credit at larger firms, because lenders are more willing to lend to larger firms, or a combination of both.37

In order to encourage lending to small businesses, the federal and state governments have created loan guarantee, credit insurance, and various capital access programs. These programs help banks to minimize their risk on small business loans that do not meet standard lending criteria. Federal government programs include, among others:

• Small Business Administration (SBA) 7(a) Loan Guarantee Program

• SBA 504 Program

• Small Business Investment Companies (SBIC) Program

• Small Business Innovation Research (SBIR) Program

• USDA Rural Economic Development Loan and Grant Program

• Community Development Financial Institutions (CDFI) Program

In addition to these federal programs, most states have a wide range of small business financing mechanisms available, many of which are perceived as faster, more flexible, and more efficient than their federal counterparts.

1) Small Business Administration (SBA)

The SBA was created to aid, assist, and protect the interests of small businesses. The SBA assists small business owners to start and expand their businesses by providing them with loans or by helping them get loans and venture capital through banks, intermediaries, and other financial institutions.

The SBA administers a variety of programs targeted to small businesses. They include:

• The Basic Section 7(a) Loan Guaranty Program:

The Basic Section 7(a) Loan Guaranty Program is the SBA's primary business loan program. The program helps qualified small businesses obtain financing when the business might not be eligible for business loans through normal lending channels. Loans under the 7(a) Program are provided and administered by lenders who participate with the SBA in this program. Most banks in the U.S. participate in this program, although not all lenders do. Loans under the 7(a) Program are available only on a guaranty basis, which means the loans are provided by lenders who have decided to structure their own loans according to the SBA's requirements, and who apply to and receive from the SBA a guaranty on a portion of the loan. Under this concept of guaranty lending, commercial lenders make and administer the loans, and the business applies to a lender, not the Government, for the loan.

37 Board of Governors of the Federal Reserve System, “Report to the Congress on the Availability of Credit to Small Businesses,” (October 2007).


Loans through this program can be used for working capital, equipment, furniture, land and building, and debt refinancing. Loan maturity varies depending on its intended use.

• The Section 504 Certified Development Company (CDC) Program:

The 504 loan program provides long-term, fixed-rate financing to small businesses. This product is mainly for small businesses acquiring real estate or equipment for expansion or modernization. This program involves a collaboration between a private sector lender, such as a bank, and a certified development company (CDC). Interest rates on 504 loans are pegged to U.S. Treasury issues

• The MicroLoan, a Section 7(m) Loan Program:

The SBA’s Microloan Program provides short-term and smaller loans (up to $35,000) than the loans offered by its Basic Section 7(a) Loan Program to small businesses. These loans can be used for working capital or the purchase of inventory, supplies, furniture, fixtures, and equipment. The SBA makes or guarantees a loan to an intermediary, who in turn, makes the microloan to the applicant. These organizations also provide management and technical assistance. The loans are not guaranteed by the SBA. SBA Microloans are generally designed to target low- and moderate-income entrepreneurs, particularly those that have little or no access to other primary funding sources.

• Loan Prequalification:

This program allows small businesses to have their loan applications analyzed by the SBA before they are submitted to lenders. An intermediary designated by the SBA will also assist the owner in strengthening the loan application. This program is offered to small businesses with loan applications for $250,000 or less.

• Disaster Assistance Loans:

The SBA’s Disaster Assistance Loans are targeted to small businesses that have suffered substantial economic injury from a physical disaster. This program provides economic injury loans and physical disaster loans to businesses of up to $1.5 million. It also provides disaster assistance to individuals.

• Small Business Investment Company (SBIC):

SBICs put venture capital, in the form of small business loans and equity financing, into small businesses for growth, modernization, and expansion. SBICs are privately organized and managed investment companies licensed and regulated by the Small Business Administration.

• Small Business Development Centers:

Each state has a Small Business Development Center (SBDC) to provide management assistance to current and prospective small business owners. SBDCs offer one-stop assistance to individuals and small businesses by providing a wide variety of information and guidance in central and easily accessible branch locations. The program is a cooperative effort of the private sector; the educational community, and federal, state, and local governments.

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• Small Business Innovation Research (SBIR) Program:

Under the SBIR program, 10 federal agencies having annual external research and development requirements of more than $100 million must reserve 2.5% of these funds for award to small businesses.

• Small Business Technology Transfer (STTR) Program:

Under the STTR program, five agencies with annual external research and development budgets of more than $1 billion must reserve .15% of these funds for award to collaborative efforts between small businesses and non-profit research institutions.

2) United States Department of Agriculture (USDA)

The USDA works with private sector and community-based organizations to provide financial assistance and other technical resources to businesses in rural areas. The USDA’s business programs include:

• Business and Industry Guaranteed Loans:

The Business and Industry (B&I) Guaranteed Loan Program helps create jobs and stimulates rural economies by providing financial backing for rural businesses. This program provides guarantees up to 80% of a loan made by a commercial lender. Loan proceeds may be used for working capital, machinery and equipment, buildings and real estate, and certain types of debt refinancing.

• Intermediary Re-Lending Program (IRP):

The IRP program finances business facilities and community development projects in rural areas. The program makes loans to intermediaries, who then re-lend the funds to businesses. These loans may be used for the establishment of new businesses or the creation of employment opportunities.

• Rural Business Enterprise Grants:

Through its Rural Business Enterprise Grant Program, the USDA makes grants to public agencies, nonprofit organizations, and other groups to finance the development of small businesses and private enterprises in rural areas.

• Farm Operating Loans:

These loans are provided by the USDA’s Farm Service Agency and can be used to pay for livestock, equipment, or other items needed for farm operations. Terms on these loans range from one to seven years.

3) Economic Development Administration (EDA)

The EDA has a Revolving Loan Fund Program, which provide gap financing loans for fixed assets and working capital. The program supports small business start-ups and expansion, business and job retention, and growing industries.

4) Minority Business Development Agency (MBDA)

The MBDA is the only federal agency created specifically to foster the establishment and growth of minority-owned businesses. MBDA provides funding for a network of Minority

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Business Development Centers (MBDCs), Native American Business Development Centers (NABDCs), and Business Resource Centers (BRCs) located throughout the country. The centers provide minority entrepreneurs with personalized assistance in writing business plans, marketing, management and technical assistance, and financial planning to secure adequate financing for business ventures.

5) Industrial Development Revenue Bond Programs (IDRB)

IDRB’s are for financing business and industrial expansions for firms with strong credit. IDRBs can provide low-interest loans for large projects. Bond proceeds from this program can only be used to acquire land, building, and equipment. These bonds are issued by county or state agencies and purchased by private parties.

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Appendix E: Bridge Loan Information

The Study Team asked each of the banks it interviewed if the institution offered bridge loans for manufacturing businesses. Most banks responded that they offered lines of credit that served to meet this “bridge” need and noted that they could be accessed through local branches.

One bank did note that the SBA increased the maximum loan amount (from $2 million to $4 million) to small manufacturing businesses recently to meet this very need.

The Export-Import Bank also provides financing products that small businesses can use to purchase inventory, but only applies to exporters.38

Lastly, in looking at the Comparison States, Illinois does have a state-sponsored revolving line of credit program that small businesses can tap into. This program fills a gap not covered by conventional banks and might be an interesting model for Michigan. See Appendix K for additional information on Illinois’ revolving loan program.

38 More information at http://www.exim.gov/smallbiz/work_cap.html


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Appendix F: Small Business Trends

National Small Business Trends

According to the SBA, businesses with less than 500 employees (1) account for half of the U.S. nonfarm private gross domestic product and (2) employ half of the U.S. private workforce. More importantly, over the past decade, small firms have provided 60% to 80% of the net new jobs in the economy.

The 2003 Survey of Small Business Finances (the most recent data available) evaluated trends in small businesses across the country. 39 The information collected pertains to the more than 6.3 million nonfarm, nonfinancial businesses with fewer than 500 workers in the U.S.

Key findings include:

• Over 91% of small businesses have fewer than 20 employees

• 60% of businesses have fewer than five employees

• The geographic distribution of small businesses is relatively even with 19.8% in the Northeast, 21.1% in the Midwest, 24.4% in the West, and 34.7% in the South.

• The most common industries for small businesses in 2003 were business services (25%), professional services (20.7%), retail trade (18.4%), construction and mining (11.8%), insurance and real estate (7.2%), manufacturing (7.1%), wholesale trade (5.9%), and transportation (3.8%).

When looking at the data, it becomes clear that small businesses do have a more difficult time accessing capital than larger companies in both good and difficult markets.

The October 2007 “Report to the Congress on the Availability of Credit to Small Businesses” notes that “lending to small businesses is generally considered riskier and more costly than lending to larger firms.” The report goes on to state that small businesses are more affected by swings in the economy, have a higher failure rate than larger firms, and have a more difficult time proving creditworthiness. The report notes that lenders have more difficulty evaluating applications because “the heterogeneity across small firms, together with widely varying uses of borrowed funds, has impeded the development of general standards for assessing applications for small business loans and has made evaluating such loans relatively expensive.”

It also notes that small business loans have a higher cost to lenders because of additional monitoring needed, and because the loans amounts are usually smaller, they are less attractive.

The report also shows that between 2000 and 2003, larger small businesses (100–499 employees) applied for and received loans more frequently than very small firms (fewer than two employees). Younger firms had more difficulty securing credit. The report cites data that confirms its conclusions: “credit score data collected from Dun and Bradstreet show that smaller and younger firms have lower credit scores, and therefore are deemed more risky.”

39 Federal Reserve, “Financial Services Used by Small Businesses: Evidence from the 2003 Survey of Small Business Finances,” (October 2007), http://www.federalreserve.gov/pubs/bulletin/2006/smallbusiness/smallbusiness.pdf


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Credit Conditions Are Tightening Nationally, Impacting Small Business Lending

From 2002 through June 2007, credit conditions were favorable for small and large firms. During this period, there were no significant barriers for creditworthy borrowers and businesses. As shown in Figure 8.11 below, between 2002 and June 2007 total debt grew by 49.9% and the number of loans grew by 36% nationally. Commercial small business bank loans (those less than or equal to $1 million) showed modest but steady growth from 2003 through 2006.40 Total small business debt, estimated as the total debt of partnerships and proprietorships, reached $3.1 trillion in the first quarter of 2007.

Figure 8.11 Total Debt of Partnerships and Proprietorships (2002–2007)

Source: Federal Reserve Report to Congress on the Availability of Credit to Small Businesses (Oct 2007)

Beginning in mid-2007 with the emergence of the sub-prime mortgage issue in much of the country, new trends began to emerge. These trends, which are listed below, continue to plague the capital markets and small businesses seeking loans today.

Internal Confidence at Banks is Falling The “January 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices” indicates that banks are expecting their commercial and industrial loan portfolios to deteriorate during 2008. Between 75% and 85% of domestic and foreign banks surveyed expect this deterioration in quality of loans, suggesting that bank credit standards were not as sound as thought in the last up-market.

Credit Standards are Tightening Credit conditions appear to be tightening, with data showing that one-third of domestic banks tightened credit standards at the end of 2007 to businesses of all sizes.41 In fact, of the

40 Board of Governors of the Federal Reserve System, “Report to the Congress on the Availability of Credit to Small Businesses,” (October 2007). 41 Federal Reserve, “The January 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices,” (January 2008), http://www.federalreserve.gov/boarddocs/snloansurvey/200801/default.htm


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banks the Study Team interviewed that lend in Michigan, 76.2% noted that credit standards are becoming more stringent in the current market.

Figure 8.12 below shows the net percentage of banks that have tightened credit standards over a 16-year period. The figure show that credit standards have recently started to rise for both small and large firms, although standards have risen more sharply for small firms. Note: In the figure, “large firms” are those with annual sales above $50 million.

Figure 8.11 Net Percentage of Banks Tightening Credit Standards for Commercial and Industrial (C&I) Loans (1991–2007)

Source: Federal Reserve Report to Congress on the Availability of Credit to Small Businesses (Jan 2008)

Credit is Becoming More Expensive Getting a small business loan has also become more expensive over the last three months, with the “January 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices” showing that 40.0% of banks have increased the cost of credit lines, 43.7% have widened the spread over their own cost of funds, and 43.7% have increased the premium they charge on riskier loans.

Bank Liquidity is Affecting Lending As the market for loan syndication dries up, banks’ ability to make new loans declines. Several of the lenders interviewed cited illiquidity as a current or future issue for bank lending.

Inflation is Affecting Lending During the next six months, it is expected that slow growth will occur in the economy, with uncomfortably high inflation and surprisingly low unemployment rates. Given the current environment’s low interest rates and rising costs, banks are reluctant to make longer-term loans, which will negatively impact borrowing.42

42 National Federation of Independent Business, “Small Business Economic Trends,” (April 2008), http://www.nfib.com/object/IO_36841.html


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Current Demand for Small Business Loans is Lower At the same time that credit standards were tightening in late 2007, about one-fourth of all domestic banks experienced lower demand for commercial and industrial loans from small firms.43

Interestingly, although the data above shows that credit standards were easing between 2000 and 2003, the Federal Reserve’s Survey of Small Business Finances (last published in 2003) indicates that 18% of the respondents had not applied for credit during this time period when they needed it because they expected to be turned down. Figure 8.13 below also shows that demand for credit was lower during this time period. Demand picked up in 2004 and 2005, and then dropped to low levels in 2006 and 2007.

Figure 8.12 Demand for Small Business Credit (1990–2007)

Source: Federal Reserve Report to Congress on the Availability of Credit to Small Businesses (Oct 2007)

The Study Team has surveyed various data sources in order to assess Michigan’s small business sector and activity. As discussed below, Michigan’s small business sector is weak relative to the overall U.S. economy and the Comparison States.

The findings from this research are detailed below.

Michigan’s Small Business Vitality Graded ‘C’

The Corporation for Enterprise Development’s 2007 Development Report Card for the States graded each state in the U.S. based upon its business vitality, which is defined as how dynamic a state’s large and small businesses are.

Although this metric rates both small and large businesses, it is still useful in assessing the health of the overall business climate. For 2007, Michigan and the Comparison States were graded and ranked as follows (1 is the best in the nation):

43 Federal Reserve, “The January 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices,” (January 2008), http://www.federalreserve.gov/boarddocs/snloansurvey/200801/default.htm


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• Massachusetts = A (ranked 2)

• California = A (ranked 4)

• Illinois = A (ranked 5)

• New Jersey = B (ranked 17)

• Minnesota = B (ranked 19)

• North Carolina = B (ranked 20, tied)

• Ohio = B (ranked 20, tied)

• Michigan = C (ranked 27)

• Indiana = C (ranked 32)

As the chart below shows, Michigan’s overall business vitality has improved since 2002, but declined between 2006 and 2007.

Figure 8.13 Michigan’s Business Vitality History (2002–2007)

Source: CFED 2007 Development Report Card for the States

Michigan’s most recent drop in grade from ‘A’ in 2006 to ‘C’ in 2007 can be explained as follows:

• Dramatic increase in business closings. In 2006, Michigan ranked 15th in the country in terms of business closings, as 11.7% of businesses closed between 2003 and 2004. In 2007 the state dropped to 25th place, with 12.66% of businesses closing between 2004 and 2005.

• Decline in the growth of new companies. Between 2003 and 2004, Michigan had an 11.82% increase in new business, bringing its rank in new business growth to 8th in the nation in 2006. This ranking dropped to 35th in 2007, as the number of new companies formed in Michigan between 2004 and 2005 increased by only .07%.

Small Business Ownership in Michigan is Low

According to the 2007 Development Report Card for the States, 44 Michigan ranks 46 out of the 51 states and D.C. in small business ownership (with 1 being the best), with only 13.8 small businesses existing per every 100 workers. Of the Comparison States, Indiana and Ohio are the lowest, with California having the highest level of small business ownership, as shown in Figure 8.15.

44 Corporation for Enterprise Development, 2007 Development Report Card for the States, http://www.cfed.org/focus.m?parentid=5&siteid=2346&id=2346


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Figure 8.14 Small Business Ownership in Comparison States (2005)

Michigan’s Small Business Growth is Flat Overall and Employment Growth in Small Businesses is Negative

According to the SBA, small businesses across sectors in Michigan grew between 1990 and 2000, but then remained relatively flat between 2000 and 2004. Large firms experienced negative growth within Michigan between 2000 and 2004. The table below shows how the number of Michigan’s small and large businesses changed over a 14-year period.

Table 8.2 Number of Michigan Firms 1990–2004

1990 1995 2000 2001 2002 2003 2004 90-04 00-04Michigan firms 175,884 188,149 193,861 192,712 192,284 192,310 193,690 0.70% 0.00%<500 employees 173,446 185,317 190,738 189,624 189,259 189,311 190,718 0.70% 0.00%>500 employees 2,438 2,832 3,123 3,088 3,025 2,999 2,972 1.40% -1.20%Source: U.S. Small Business Administration, Office of Advocacy, based on data provided by the U.S. Census Bureau.

When compared to the Comparison States, the growth in the number of small and large firms in Michigan was poor over the 2000–2004 period. As shown in Figure 8.16, Michigan’s growth rate of 0.0% for small businesses during this period ranks above only Ohio and Massachusetts.


Figure 8.15 Growth in Small and Large Firms in Michigan and Comparison States, 2000–2004

Over this same time period, Michigan also fared poorly in its small business employment growth. Michigan had -0.5% growth in employment in small businesses, but again Ohio and Massachusetts had even more employment loss.

Figure 8.16 Employment Growth among Michigan and Comparison States (2000–2004)

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Appendix G: Additional Small Business Interview Findings

Financing is a Concern for Small Businesses, But Not the Number One Concern

Research shows that lending is not the biggest constraint on small businesses nationally. Although this report by the Study Team is focused on small business lending, it is important to note that businesses face a number of challenges that impact their ability to grow and become successful. The National Federation of Independent Business’ (NFIB) “Small Business Economic Trends” report published in April 2008 surveyed small business owners across the country in order to learn more about these challenges. The resulting data shows that while lending is a concern for small businesses, only 2% of small business owners report cost and availability of credit as their number one business problem. Instead, business owners cited taxes, poor sales, and inflation (see Figure 8.18 below). According to the report, “The number of owners citing inflation as their number one business problem is at its highest level since 1982.”

Figure 8.17 Most Important Problems Facing Small Businesses Nationally (March 2008)

Source: NFIB Small Business Economic Trends (April 2008)

A similar small business survey was conducted in Michigan by National Federation of Independent Business (NFIB) in December 2005. While somewhat dated, the data shows similarities with the national data above. At that time, only 2.6% of Michigan small business owners cited credit availability as the most important issue facing their business. In that report, weak sales ranked the highest (19.7%), followed by inflation and rising prices (17.7%), big business competition (14.2%), insurance (12.5%), taxes (8.3%), employee quality or costs (7.7%), and regulations (5.1%).

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While obtaining credit was not the most pressing problem for most business owners in Michigan, 10% of the respondents did say their credit needs were not satisfied.45

The Study Team’s interviews with small businesses in Michigan, California, and Massachusetts found similar findings. Of all businesses interviewed, two-thirds said that obtaining financing was not their biggest barrier currently. Of the Michigan businesses, 75% said financing was not their biggest problem. Interestingly, in our small sample, businesses outside of Michigan felt that financing was more of a concern than those in the state.

While the interview results differ from the NFIB data, which cites capital as a top concern for only 2% of small business owners, it does support the assertion that small businesses in Michigan and elsewhere are grappling with a number of challenges besides financing. The Michigan businesses interviewed indicated that taxes, the general economy, government regulations, and globalization were among their top concerns. These results indicate that in order to further assist and grow small businesses in Michigan, comprehensive assistance beyond financing is needed.

Businesses in Michigan Are Unhappy with Government Action and Inaction

Of the businesses interviewed by the Study Team, 50% of the businesses in Michigan indicated that the government is failing to help small businesses in the state. Three businesses stated that the government needed to do more, such as help small businesses find and attract financing, reduce the regulatory burden, and provide tax rebates or incentives. One of these businesses commented, “My sense is that medium- to small-sized businesses don’t get much attention in Michigan.” Another stated that instead of becoming more involved, “government needs to get out of the way.”

Stories of Small Business Coming to and Leaving Michigan

The Study Team spoke to one business that is re-locating to Michigan, and one that is re-locating out of Michigan. Both firms provided insight into what they believe to be the pros and cons of operating in Michigan as opposed to other states. The Study Team believes that both stories provide insight that the MEDC would find useful. The California firm re-locating to Michigan looked at a number of places when considering re-location. These locations included Michigan, New Jersey, and India. It settled on Michigan because the firm has a number of business partners and collaborators in the state. The business owner then explored several areas, including Kalamazoo, Ann Arbor, Detroit, and Grand Rapids. Through one of its partners, the business owner found the Southwest Michigan Innovation Center and the incentives it offered. As a result, the firm is locating in Kalamazoo. While this firm has received funding from the Southwest Michigan First Life Science Fund and is excited about the move, the business owner did have some ideas for improvement that would be helpful for the state. First, the company found that programs offered by the state are geared too much toward businesses in the state already rather than at businesses moving to the state, thereby making re-location difficult. The business owner noted that it would “difficult to attract” more companies like his into Michigan “because of all the hoops.” He did not see this in other states. The owner also commented that the lack of venture capital in Michigan would make the state less attractive to companies like his, whether they are currently in the state or considering a move there.

45 National Federation of Independent Business, “Michigan Small-Business Conditions, December 2005,” http://www.nfib.com/object/IO_25616.html


The firm that is leaving Michigan for North Carolina is doing so largely for the weather. However, the business owner did point out a number of ways in which North Carolina has proved to be a welcoming environment for small businesses. North Carolina seems to have aligned government agencies, banks, and business development entities in order to attract and keep small businesses in the state. There, everyone seems to be working together including the banks, the relocation people, the Chambers of Commerce, and the real estate people. The business owner noted that by aggregating the resources, the transition from Michigan to North Carolina has been seamless. The business owner also noted that they market the Research Triangle in North Carolina very well. The business owner made sure to note that even though they have not moved yet, banks in North Carolina have already contacted them to begin a relationship. The business owner has not experienced anything like this in Michigan. Her sense is that small- and medium-sized businesses do not get much attention in Michigan.

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Appendix H: Venture Capital Models

Alliance Technology Ventures of Georgia

Origin, Sponsorship, Mission and Goals The Georgia Research Alliance, a coalition of Georgia’s top six research institutions, the local business community, and the state government, was founded in 1990 with the charge of fostering economic development within Georgia by leveraging the research which existed within the universities. Its technology commercialization goals are very similar to those of the Biomedical Research Foundation of Northwest Louisiana. The Alliance developed the idea to create an early stage focused venture capital fund in the fall of 1992 under the leadership of Bill Dahlberg, CEO of Georgia Power Co. As business recruiting changed from 1970s “smokestack chasing” to 1990s technology commercialization and information industries, Georgia business leadership realized the state needed to market its increasingly research-oriented university system to high tech companies. This technology orientation was needed both to (1) recruit high tech firms to relocate to Georgia, as well as to (2) grow companies already located in the state. The Alliance was particularly interested in ensuring that a source of capital existed to finance emerging opportunities in two areas of technological strength in Georgia: the life sciences and information sciences (especially biotechnology, communications and computer software). Although the state already had a number of venture capital partnerships, none focused on early stage, technology-based investment opportunities. Alliance Technology Ventures would not be restricted to investing exclusively in seed stage financings, but could also do follow-on investments in early and expansion stage companies. Bill Dahlberg, as CEO of Georgia Power, is one of the most highly regarded CEOs in the State of Georgia. Many of the most successful state-sponsored seed and venture capital funds have had such a champion to rally other investors to a first time fund. In the absence of a proven 10 year track record of high performance, or special tax or other investment incentive, such leadership is often essential to attract investors. Alliance Technology Ventures (ATV) was created in 1995. Although strong civic and corporate leadership, such as the CEO of the largest utility, can be very helpful in gaining the interest of other corporate leaders to consider investing, management matters most. After recruiting a highly respected venture capitalist, Michael Henos, as its General Partner, ATV was able to close the fund with $35 million at the end of December 1995. The quality of management insured the successful closing of the fund. In all, close to 20 investors committed funds to the Partnership, the largest of which are: Georgia Power, NationsBank, BellSouth, the United Parcel Service Retirement Plan, and First Financial Management from the private sector, as well as Georgia Technical Institute and Emory University. All investors committed funds on equal terms with no subsidy offered to any investor. (Georgia Power did have to invest funds in a separate side-by-side legal structure to ensure that its capital was used only for Georgia based companies.) Market Analysis and Investment Criteria Alliance Technology Ventures focuses its capital on young start-ups in the fields of life sciences and information technology. In choosing these two fields, ATV was looking to build its future success in the areas which the universities of Georgia had a competitive advantage. Though ATV is not limited to investing in seed and early stage companies, it

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favors early stage investments as the greatest opportunity to leverage the value its general partners can add to companies. Alliance Technology Ventures pools risk across a broad range of technology from Georgia universities. Its focus, however, is mainly on biotechnology & life sciences and communications & software. Investment size is between $250,000 and $2 million dollars. Like most of the funds in this study, Alliance Technology Ventures is not restricted to investments in Georgia. Rather, the Fund is encouraged to make investments that strengthen Georgia’s position within biotechnology and telecommunications nationally, and ensure profitable returns to the partnership. ATV will often act as the local lead investor for venture capital firms outside of the region. In this way it is acting as a catalyst for the continued development of the venture capital industry within Georgia. In contrast, when investing out of the region, ATV will co-invest in a promising enterprise, but usually not as the lead investor. Of the investments which ATV has made, 70% have been in the State of Georgia and 30% outside the state. The 30% represents four deals; three in the southeastern US and one in California. Management Team, Compensation and Management Oversight The Georgia Research Alliance as sponsor developed the basic details of Alliance Technology Ventures, pre-marketed the Fund to investors, and then recruited an experienced venture capitalist to manage the Fund through an aggressive search process. Proven management talent, as we have noted, is the key to any venture fund’s success. Both Managing Directors have significant experience in their respective fields. Michael Henos has over 20 years experience in the area of Life Sciences. Mr. Henos had previously founded and co-managed Aspen Ventures in California. 3i/Aspen Ventures is a $150 million venture capital fund with offices in California and New England. His successful track record with 3i/Aspen Ventures made Mr. Henos the keystone around which the Georgia Research Alliance could build ATV in 1995. Mr. Henos is still a partner in 3i/Aspen Ventures but his commitment is winding down as the fund matures. Mr. Henos is with ATV full time. Mr. Henos is responsible for all aspects of investment in life sciences companies. Stephen Fleming brings with him an extremely successful track record in the field of Information Technology. Mr. Fleming, a native Georgian and Honors graduate of Georgia Tech, has held senior positions with some of the giants of the industry including, AT&T Bell Laboratories and Northern Telecom. Mr. Fleming was brought in as a Managing Director of ATV in 1995. Mr. Fleming is responsible for all aspects of investment in information technology companies. Both Mr. Henos and Mr. Fleming are active participants in stimulating demand for venture capital within Georgia and the Southeastern United States. This is achieved through their own efforts and in partnership with the Georgia Research Alliance. For example, they have jointly organized highly targeted investor conferences designed to help ensure co-investments by the national venture capital industry in Georgia-based venture-backed companies. Both Mr. Henos and Mr. Fleming are widely published and often speak on the topic of entrepreneurism at regional conferences. Alliance Technology Ventures operates under the standard 80-20% split. ATV has a 2.5% management fee.

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As a classic venture capital partnership, Alliance Technology Ventures has an Advisory Committee which is written into the partnership agreement. This committee is made up of six members who represent corporations among ATV’s limited partners. Financial Structure Alliance Technology Ventures had its first closing at $32 million in late 1993, and a final closing in December 1995 at $35 million. The first closing was particularly noteworthy as 1993 was a year in which few first time funds succeeded in raising capital nationally. As we noted, 20 of the most important corporate investors in Georgia participated as a result of the Fund’s leadership and management. A $35 million fund is an ideal size for a newly formed partnership and does not constrain Alliance Technology Ventures in its choice of investments. $30 million is today generally considered to be the threshold in the United States today for a seed and early stage venture capital fund to be successful. Anything fund below that is hindered by high information and transaction costs. Smaller funds can only succeed with a subsidy from a sponsoring parent. Funds larger than $30 million are faced with additional pressures to make larger deals. The transaction costs for a large deal will be the same as a small one, so it is in the fund’s interest to do more larger deals and increase returns. This may be good for investors, but inconsistent with the reason the fund was created in the first place. Alliance Technology Ventures recently announced plans to market their second fund. The General Partner anticipates that the close working relationship they have enjoyed with both Emory University and Georgia Tech will continue with significant investments in the new fund. There are no angel investors in Alliance Technology Ventures. ATV does however often syndicate with angel investors. There is no formal network of angels in the Atlanta area. It is estimated that between 35% - 50% of the time ATV will introduce an angel for follow-on investments in its portfolio companies. Legal Structure Alliance Technology Ventures is a Side-by-Side Limited Partnership. This structure was created to meet the needs of one of the major investors in the Fund; Georgia Power. The Side-by-Side Limited Partnership allowed the Fund to restrict the use of Georgia Power money to within the State of Georgia while capital received from other limited partners can be invested either in Georgia or elsewhere, generally in the Southeastern United States. These latter funds could also be used to enter into syndications with other venture capitalists in other regions of the United States. Operations Alliance Technology Ventures benefits greatly from its origins with the Georgia Research Alliance. Occasionally, the Georgia Research Alliance will recommend a company for ATV to evaluate. However, ATV spends more time directly making the rounds to the universities making up the Alliance. An ATV representative estimates that 70% of its portfolio is made up of situations where ATV developed a company around a technology originating in a university. The other 30% of the portfolio is made up of investments in existing companies. Additionally, both Mr. Henos and Mr. Fleming are quite active with both the local community and the national venture capital community. Like most of the funds presented in this report, Alliance Technology Ventures has a fairly standard due diligence routine. The general partners will evaluate the risk with respect to

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four areas: (1) technology and market potential, (2) financing needs and projections, (3) patents or proprietary ownership of technology, and most importantly (4) management of the potential investment. Should Alliance Technology Ventures go forward with an investment, it always takes a seat on the Board of its portfolio company to ensure that it has some influence on the strategic decisions of the company. The exit strategies which Alliance Technology Ventures are also fairly standard. Two out of eleven investments have gone public with the remaining exits made through acquisitions. To date, none of ATV’s exits have been through a management or employee buyback of equity. Accountability and Oversight Alliance Technology Ventures has no public money invested in its first fund and the one currently being raised. Georgia State Law prohibits the state pension funds from investing any portion of its portfolio in alternative investments such as venture capital. An ATV representative noted that this is something that the Fund would like to discuss with the new Governor. ATV does compile annual and quarterly reports for it investors on the performance of the portfolio as a whole and each individual company. Unlike many of the state sponsored and funded investment funds, ATV does not have a board of directors. ATV does have an Advisory Committee made up of representatives of Fund investors. As a 100% privately capitalized fund, the issue of conflict of interest is not major, however, the Fund does have a standard conflict of interest policy which ensures that all conflicts or potential conflicts are disclosed in advance so that they may be addressed.

Heartland Capital Fund, Ltd. of Nebraska

Origin, Sponsorship, Mission and Goals Heartland Capital Fund of Nebraska (1992) is a successful, privately capitalized seed and early stage venture capital fund which has emerged Phoenix-like from a failed state capitalized technology commercialization institution, the Nebraska Research and Development Authority (NRDA). After NRDA had lost two-thirds of its value (or $6 million) in 18 months, the Governor and the Department of Economic Development a management initiated restructuring which attracted such major private sector investors as Mutual of Omaha, First Commerce Bankshares, leading local regional investment banks and high net worth individuals. Working in the difficult investment environment of Nebraska, Heartland has produced an incremental IRR of 30%, and is now raising a new fund. Market Analysis and Investment Criteria

Heartland invests $500,000 to $2 million in early stage companies with a focus on telecommunications, information technology and electronic components. No more than 10% of capital may be invested in a single company without approval of the Advisory Committee. Heartland is not restricted to investment within the State of Nebraska as NRDA was in the past. It is currently raising a new fund capitalized in the area of $100 million. This fund, raised in conjunction with the Sunwestern Investment Group of Dallas, will have a regional focus which will encompass more of the Central and Southwestern United States. The new fund will focus on transition stage financings.

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Management Team and Structure As Heartland was being put together from the remains of the NRDA board, Brad Edwards emerged as the new president of NRDA to take charge of the transitional operations. Edwards asked Pat Rivelli, a general partner of Sunwestern Investment Group in Dallas, to join him as a general partner in the Heartland Capital Fund. The additional experience of a second investment manager ensured investor confidence in the new fund. The Heartland management team includes the two managing partners, Edwards and Rivelli. They receive a 2.5% management fee, and the partnership is structured with the standard 80/20% split on the carried interest beginning after return of committed capital to investors. A third investment professional, John Gustafson, was brought into Heartland’s operations as its portfolio grew. Brad Edwards has been the driving force behind Heartland Capital Fund. Mr. Edwards played a vital role in the creation of Heartland Capital from the Nebraska Research and Development Authority. Before the creation of Heartland, Mr. Edwards served as the president of NRDA and was a principal of Performance Criterion Corp, a venture-oriented subsidiary of a regional health care organization. Patrick Rivelli was an experienced venture capitalist with the Sunwestern Investment Group out of Dallas when he joined Mr. Edwards in the capitalization and management of Heartland Capital. Mr. Rivelli has over 30 years of experience in the computer and electronics industries. He demonstrated his entrepreneurial nature in 1969 when he founded National Micronetics, Inc., a manufacturer of technical ceramics. John Gustafson is the third member of the Heartland’s investment management team. Mr. Gustafson joined Heartland Capital in 1994 upon completion of his studies at the University of Nebraska. Mr. Gustafson is a Level III Chartered Financial Analyst (CFA) candidate. Financial Structure In 1991, Governor Nelson vetoed funding for the Nebraska Research and Development Authority (NRDA) because the Governor had concluded that the agency took an unsuccessful public sector “grants” approach to technology commercialization seed capital investment. Until that time, the State of Nebraska had invested $9.5 million in NRDA over a five year period, but, by June 30, 1991 the portfolio of NRDA was valued at just $3.5 million including $2 million in cash.

The changes undertaken had three specific goals: 1) To shift management to performance-based compensation; 2) To establish an organizational structure familiar to the venture capital industry; and 3) To leverage state funds with investments from other investors.

The result was the Heartland Capital Fund, Nebraska’s first formal venture capital partnership. To bring it into formation, NRDA created a corporate general partner capitalized with $200,000 from NRDA. The management of NRDA was significantly reduced, and remaining staff moved to Heartland. Heartland Capital Fund then acquired the NRDA portfolio consisting of 8 companies. By the end of 1995 Heartland had closed on $11 million, including $4.32 million contributed by NRDA as well as funds from additional private sector investors. These investors included Mutual of Omaha, Security Mutual Insurance, First Commerce Bancshares, United Nebraska Financial Co, World Investments, Inc., and some high net worth individuals.

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Legal Structure Heartland is now a conventional 10 year Limited Partnership with an Advisory Committee composed of four representatives of the limited partners. All investments are reviewed by the general partners before an investment decision is made. Operations Heartland continues to play an active role in its local community. The Fund has good relationships with both the University of Nebraska and the University of Nebraska Medical Center. Heartland will often do presentations to the emerging pool of entrepreneurs at the University of Nebraska’s Center for Entrepreneurship. Heartland will also review business plans coming out of both the university and the medical center. Heartland reviews between 200 and 300 business plans a year, and will typically invest in one to three of these. Heartland notes that the majority of the deals they have entered into are referred to them through a cultivated network of attorneys, business professionals and other venture funds. Heartland operates under an extensive due diligence practice that includes analysis of the business, management team, market, financial plan and compensation. Heartland prepares its own weighted average projections to determine the appropriate terms, structure and pricing for each deal. In addition to conventional venture capital due diligence and valuation techniques, Heartland has developed a proprietary software to value its portfolio at any moment in time, and to run alternative scenarios for exiting investments. Other state-sponsored funds have found this particularly useful software to adapt to their purposes. Due to its limited capital base, Heartland nearly always syndicates with other investment funds or angel investors. The new fund is being formed with sufficient capital to avoid this situation going forward. Heartland will typically take a seat on the Board of its portfolio companies and work with the company to complete its professional management team. Heartland has exited from one of its investment through a successful acquisition. A second of Heartland’s investments had a successful IPO at the beginning of this year. Heartland will continue to be a shareholder until it is appropriate to exit the investment. Accountability and Oversight Heartland’s policies on confidentiality and conflict of interest reflect the strict venture capital industry standards. Heartland will not violate the confidentiality between itself and its portfolio companies or potential portfolio companies. The Heartland Capital partnership agreement states that all business plans and anything considered to be trade secrets will be held in complete confidentiality. Heartland’s conflict of interest policy is similarly strict. Any conflict or potential conflict which any of the staff or managing directors have must be disclosed in advance to the Fund’s Advisory Committee. Additionally, that person would then recuse him/herself from the investment decision making process.

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Mid-Atlantic Venture Funds of Pennsylvania

Origin, Sponsorship, Mission and Goals The Pennsylvania Ben Franklin Partnership, a private public partnership created in the early 1980s to shift Pennsylvania from a “rustbelt state” to a technology-driven economy, is a state technology development and commercialization private-public partnership very similar to KTEC. The Ben Franklin Partnership sponsored legislation in 1984 to establish five seed venture capital funds to help commercialize technology stimulated by the Partnership. Each seed fund was affiliated with one of four regional Advanced Technology Centers established by the Ben Franklin Partnership. Each center was in turn sponsored by a leading research university. The Advanced Technology Centers are independently operated by a local industry/university board, hire their own staff, and are subjected to performance-based competition with the other three centers for state funding. Through these four Advanced Technology Centers, the Partnership administers: (1) the Challenge Grant Program for Technological Innovation (95% of the Partnership budget); (2) US Small Business Investment Research(SBIR) seed grants; (3) PENNTAP, a technology assistance service; (4) PrepNet, a telecommunications initiative; (5) JobLink; (6) Small Business Incubators; and (8) the Engineering School Equipment Grant Program. Because of constitutional limitations on the state’s ability to place state revenues directly in a private, for-profit seed capital fund, each of the five seed venture funds created by the Ben Franklin Partnership was affiliated with one of the technology centers. The ownership rights created by the state’s investment were then given to the respective Center. Thus, the Centers serve as limited partners to each fund, but assume no operational responsibility for their respective funds other than making potential investment opportunities known to the fund manager. The NEPA Venture Fund was created in 1984. NEPA (NorthEast PA), as the name implies, services the Northeast corner of Pennsylvania (PA); an area known more for its coal mines, cement plants, and heavy industry than for cutting edge technology. From the beginning NEPA was associated with The Ben Franklin Technology Center at Lehigh University. The founding CEO of NEPA’s general partner, Fred Beste, developed a close relationship with the university but did not limit the Fund to investments only in the local area. Mr. Beste, an experienced venture capitalist and realist, sought out the best deals throughout Pennsylvania. It was this strategy which enabled him to succeed where the other Ben Franklin Funds failed. The most important reason for the failure of the other funds, however, was that none of the other fund managers had any prior venture capital experience. As a result, the NEPA Fund is the only one of the five original seed capital funds sponsored by the Pennsylvania Ben Franklin Partnership and the state’s leading universities to have achieved long term investment success. This is particularly noteworthy in light of the high visibility and apparent success of the Pennsylvania Ben Franklin Partnership. NEPA Venture Funds became Mid-Atlantic Venture Funds in 1997 as it began marketing its third and largest Fund. The new name reflects the reality that the number of viable deals in Pennsylvania is still limited, and Mid-Atlantic needs a broader area to seek out profitable investment opportunities. With the opening of Mid-Atlantic’s Virginia Office, the fund managers have the ability to look at young companies from New York south to Virginia. This will enable Mid-Atlantic to continue to make the returns which have kept its investors coming back.

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Oklahoma Capital Investment Board

Origin, Sponsorship, Mission and Goals The Oklahoma Capital Investment Board (OCIB,) was designed to be part of a broad effort to move the Oklahoma economy from low wage jobs dependent on natural resources, to high value-added jobs created by the application of technology to those resources. Oklahoma developed a tax credit in 1987 with the goal of developing a venture capital industry within the state. However, the legislation necessary to begin operations of OCIB was not passed until July 1994. At that time, the state implemented a $50 million tax credit which was transferred to the control of OCIB. OCIB has used these tax credits as an insurance authority to access commercial bank loans. Originally, OCIB was to use the $50 million to back a bond issue; however, the management of OCIB decided that it was more practical for the new organization to limit the amount of cash on which it was paying interest. OCIB decided it was more efficient to use the $50 million as a guarantee to lines of credit at commercial banks. The money borrowed from the commercial banks is then invested in venture capital companies. OCIB had originally issued a Request for Proposal (RFP) to venture capital companies wishing to apply for investment by OCIB. However, this proved inefficient as it was hard to match the fund raising cycles of the venture capital industry. OCIB now has an open RFP which potential portfolio partnerships may respond to at any time. Though not named, OCIB acts basically as a Fund of Funds. It is similar to the Grupo Guayacàn Fund of Funds which invests in various venture capital partnerships in the US and UK. OCIB adds one condition. Any fund receiving investment from OCIB must invest 55% of its capitalization in Oklahoma Business Ventures. By the end of 1996, OCIB had attracted five nationally regarded venture capital companies to invest in capital-poor Oklahoma, and has begun to build a resident venture capital industry. A $14 million investment by OCIB in these five partnerships has leveraged $125 million of venture capital in Oklahoma. Market Analysis and Investment Criteria OCIB looks to operate a balanced portfolio made up of venture capital funds which are actively investing within the State of Oklahoma. OCIB seeks to have seed and early stage venture capital funds, alongside mezzanine and later-stage funds. The allocations were slated to be 20% seed & early stage, 33% later stage, and 47% mezzanine. With the assistance of its investment advisor, Sovereign, OCIB selects which funds in which it will make an investment. OCIB has closed on seven funds to date. The investments in a partnership range from $2-4 million dollars; averaging closer to four million. Management Team, Compensation and Management Oversight Michael Tharpe has been with OCIB since its formation. Mr. Tharpe became president in 1994 when the founding president, Robert Heard, left OCIB to begin his own company. The members of the management team of OCIB are considered state employees and have a set salary capped by state legislation. OCIB operates with a small incentive bonus which the president allocates to his staff annually. The president does not share in this bonus. All of the funds which OCIB invests in as a limited partner are traditional 10 year venture capital partnerships. They operate on an 80-20% split, and have a management fee that is

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set forth in the partnership agreement. Typically, this would be in the area of 2-3% for a $30 million fund. OCIB is allowed to charge each of the funds in which it invests a fee. This fee, however, comes out of the final returns for the fund. The OCIB Board of Directors consists of five members who are appointed by the Governor. The members of the Board of Directors all come from a financial background. Financial Structure: Uses and Sources of Capital OCIB is backed by a pool of $50 million in tax credits which the state authorized in 1991. As noted earlier, OCIB uses these funds as a guarantee for lines of credit which it uses to make investments in new venture capital partnerships. OCIB has invested in: Ventures Medical II ($2 million), Richland Ventures ($4 million), Intersouth Partners III ($4 million), Davis Venture Partners II ($4 million), and Chisholm Private Capital Partners ($2 million). Legal Structure OCIB is a trust of the State with a Board of Directors appointed by the Governor. Operations OCIB has a standing RFP to any venture capital partnership which wants to apply for review. OCIB works closely with its investment advisor, Sovereign. Together they review approximately 100 partnerships a year and invest in maybe one or two. Each of the funds of which OCIB invests is responsible for exiting their individual portfolio companies. As a fund of funds, OCIB does not have exit strategies. OCIB will get disbursements as the funds exit their portfolio companies. Accountability and Oversight OCIB works from a strict policy of confidentiality. OCIB’s governing legislation states, “Any information submitted to or compiled by the Oklahoma Capital Investment Board with respect to the marketing plans, financial statements, trade secrets, research concepts, methods or products, or any other proprietary information of persons, firms, associations, partnerships, agencies, corporations or other entities shall be confidential, except to the extent that the person or entity that provided such information or that is the subject of such information consents to disclosure.” OCIB’s legislation also goes on to spell out its strict conflict of interest policy. If a director, officer or agent has a conflict or potential conflict of interest he or she must fully and publicly disclose it and “he or she shall refrain from any further official involvement in regard to such contract or agreement, from voting on any matter pertaining to such contract or agreement, and from communicating with other Board members, officers, agents or employees concerning said contract or agreement.” Failure to disclose such a conflict of interest will result in termination. Through the use of the most innovative tax credit thus far devised by a state, OCIB has attracted more than 11 nationally regarded venture capital companies to invest in capital-poor Oklahoma, and has begun to build a resident venture capital industry that has generated more than $660 million in capital under management.

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Appendix I: Mezzanine Capital and Subordinated Debt Models

Massachusetts Capital Resource Company

Origin, Sponsorship, Mission and Goals Massachusetts Capital Resource Company (MCRC, 1977) is, as we have noted, the pioneer geographically targeted growth capital fund upon which all other models have been designed. MCRC was initiated by the Commonwealth of Massachusetts, and is capitalized, owned and managed by the four largest Massachusetts life insurance companies. When MCRC was created in 1977, the insurance industry was deeply concerned that this was a high risk investment with little prospect of return. They were induced to consider the investment in exchange for a five year tax credit. At the end of five years, if they were unhappy with the investment and its returns, they could close down the Fund and receive back their principal. At the end of five years, in 1981, they were so pleased with their investment that they opted to continue the Fund for a full 25-year partnership term. That commitment has now been rolled over five times, and now extends to 2023. MCRC’s superior returns in the high teens - low twenties has led the insurance industry to continually reinvest their initial $100 million principal for a total investment of nearly one half billion dollars. For more than 20 years, MCRC has financed nearly $500 million of small business expansion capital and generated more than 14,000 jobs in Massachusetts. Finally, the success of MCRC has led the Massachusetts Insurance Industry to invest an estimated $3 billion in the creation of a number of risk capital funds based on the Mass Capital model. Because of these successful operations, MCRC has become the principal model for the design of small business expansion capital funds throughout the US. The life insurance industry and the property and casualty insurance industry have recently concluded negotiations with the Commonwealth to invest another $100 million each in a second fund which will target investments in the inner city areas of the state. MCRC has been selected to manage this fund as well. Market Analysis and Investment Criteria MCRC was founded in 1977 by the Massachusetts Life Insurance Industry in response to an identified need by the Massachusetts’ Task Force on Economic Development for long term growth capital for expanding small and medium size businesses. Although the economic conditions and available sources of capital have varied greatly during this 20 year period, the essential need for risk capital for small expanding companies throughout the state has remained constant and high. Not only has MCRC invested more than $400 million in more than 220 companies in 98 cities and towns across the state over 20 years, but half of this total has been invested in state-designated economic target areas. Most importantly, from a policy standpoint, the Massachusetts Capital Resource Company has profitably financed the technological restructuring of more than 100 century-old shoe, leather, textile, paper, jewelry and fish processing firms into innovative, high-growth

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Intelligence Age firms capable of competing in global markets. More than half of all firms invested in by MCRC are manufacturing companies – most in older, more traditional industries. The principal instrument for financing their growing or restructuring small and medium sized companies is with mezzanine capital – fixed rate subordinated expansion capital loans from five to 10 years, with some form of equity component. These flexible instruments may involve warrants, coupon rates, exercise price, and other means of convertibility. Financings range from $250,000 to $5 million, averaging less than $2 million per company. Fifty percent of these companies have under $10 million in sales at the time of financing, and 50% have above $10 million sales. A company must have less than a Baa rating from Moody’s to be considered for financing. Financings range from helping a young, rapidly growing company to increase its growth, to helping a mature company restructure itself to grow again. Although MCRC’s unique niche is in providing subordinated debt and mezzanine capital to help small firms expand and grow, MCRC will provide senior debt and later stage venture capital where appropriate. Management Team, Compensation and Management Oversight William (Bill) Torpey, President of MCRC, has been a part of senior management since MCRC was closed as a Fund more than 20 years ago. He has served as President since 1982. Prior to the creation of MCRC, Mr. Torpey was a senior investment professional from the life insurance industry. Mr. Torpey’s investment management team all has a history as bank lending officers. One of the strengths of MCRC is the continuity of the management team over their 20 years. The combined management experience of MCRC’s management team today exceeds 125 years. Of that, 64% or a combined 80 years the management team has been together. Unlike a typical venture capital partnership, MCRC does not operate under a standard 80/20 split between the small limited partner life insurance companies and the four large general partner companies. There is no standard allocation to management. Instead, MCRC resembles an investment subsidiary for each of the companies involved. Profits are distributed annually to partners, and have been since the first year. 100% of profits are distributed each year based on the percentage each partner originally put into the partnership. Principal is retained for future investments. MCRC has recycled its capital over four times since the original investments were made. Because the Managers are salaried, there is really no standard “Management Fee”. Operations are paid for through the annual bonus which MCRC puts together and submits for approval to its Executive Committee, which is made up of the four largest partners. Managers receive an incentive in the form of an annual bonus. Each year after closing the books the Executive Committee, made up of the General Partners, decide on the bonus to be awarded to the managers of the fund. The bonus involves net IRR as well as a variety of economic external measures including geographic coverage and job creation. Not only has MCRC exceeded its risk adjusted rate of return to its partners, but it has had broad economic and job creation impact within the state.

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Financial Structure: Uses and Sources of Capital The life insurance companies invested $100 million over five years beginning in 1977, in exchange for a permanent tax reform. MCRC’s superior returns, estimated to be in the high teens - low twenties, have led the insurance industry to continue the Fund and reinvest its earnings. The life insurance industry and the property and casualty insurance industry have recently concluded negotiations with the Commonwealth to invest another $100 million each in a second fund which will target investments in the inner-city areas of the state. MCRC has been selected to manage this fund as well. Legal Structure MCRC is structured as a 25 year Limited Partnership in which the four largest life insurance companies in the state are General Partners, and the smaller life insurance companies are Limited Partners. The CEOs of the four General Partner insurance companies form the four person Executive Committee of the partnership. The four senior investment officers from the General Partner insurance companies, plus one highly respected outside member appointed by the Governor, and the President of MCRC, Bill Torpey, form the six person Investment Committee. Operations In its 20 years of continuously meeting both internal and economic return goals under dramatically different economic and financial market conditions, MCRC has become a paradigm for maintaining a long term, high quality, consistent management team, sound due diligence practices, monitoring and exit strategies, and the capability to adapt its forms of non-traditional finance to rapidly changing conventional financing practices. As a result, the need for MCRC capital continues to grow with changing market conditions. MCRC operates on due diligence practices which are standard for all investment funds including venture capital. It requires all potential portfolio companies to present a detailed business plan, five years of historical financial data (if available), and five years of financial projects. Based on this information and its own research, MCRC will determine whether or not to make an investment. MCRC has financed 220 companies, of which about two-thirds, or 150, have had some equity potential. MCRC has exited from 25% of these companies through IPOs; 40% through an acquisition by another company; and 10-15% had the warrants repurchased by the portfolio company. Because of these successful operations, MCRC has become the principal model for the design of small business expansion capital funds throughout the US. Accountability and Oversight MCRC, like all of the other companies presented in this report, has a strict confidentiality policy. In no way will MCRC violate the bond of trust between itself and its portfolio clients. MCRC prepares an annual report and audited financial statements of its portfolio for its partners and the State of Massachusetts. In addition, there are certain reports that it must

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make to state regulators, however these reports do not disclose any proprietary data or trade secrets of its portfolio clients. MCRC’s policy on conflict of interest is simple. No member of MCRC’s investment team or staff may have any personal involvement with any company in which MCRC makes an investment. This is to avoid even the appearance of a conflict of interest. Perhaps most important, in June, 1998 MCRC teamed with Massachusetts Business Development Corporation (MBDC) in establishing a small business Mezzanine Capital Fund to provide higher-risk, equity-type capital to local businesses that are unable to access Mezzanine Capital from MCRC due to size considerations. MBDC was established in 1953 and has grown to become one of the leading business development corporations in the country. MBDC’s shareholders include virtually all of the commercial banks in Massachusetts as well as lending investors, corporations and the Red Sox. MBDC provides the sourcing, due diligence, and monitoring of the portfolio investments which range between $100,000 and $500,000. MCRC participates with the Mezzanine Capital Fund in the form of a one third participation. MCRC reviews and approves each investment to insure credit worthiness and compliance with MCRC’s “qualified investment” requirement. As part of the “teaming arrangement” all prospective investments greater than $500,000 would be referred directly to MCRC. A six million-dollar fund was established consisting of $2mm from MCRC, $1mm from MBDC and $3mm from 5 local banks (Bank Boston, Fleet, State Street, Citizens and US Trust). MCRC’s investments direct investments on a participation basis.

See Appendix K for additional information on the Massachusetts Business Development Corporation.

Indiana Community Business Credit Corporation

Origin, Sponsorship, Mission and Goals The Indiana Community Business Credit Corporation (ICBCC, 1986) is a result of a comprehensive capital markets analysis undertaken for the Governor in the mid 1980s. This analysis led to inter- and intra-state banking legislation reform in Indiana, and the creation of the ICBCC, a Small Cap Mezzanine Fund managed by Cambridge Capital Management Corporation. In the mid-1980s, Indiana banks had a powerful incentive to invest in ICBCC. New Indiana intra-state banking legislation encouraged commercial banks to become investors in ICBCC in order to win the right to do business outside of their own county. As a result, 33 Indiana financial institutions initially invested in ICBCC to finance the capital needs of small and medium-size Indiana companies which otherwise would be unable to obtain financing from these same banks. ICBCC’s capitalization of $19 million allows it considerable flexibility, risk pooling and spreading with respect to the companies it makes loans and investments. Market Analysis and Investment Criteria In the mid 1980s the State of Indiana underwent an in-depth review of its economic development alternatives. At that time, there was a clear need for established Indiana companies to access expansion capital. These companies were not growing fast enough to produce venture capital returns, and yet were too risky to qualify for loans from conventional lenders.

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Management Team and Structure The Indiana Community Business Credit Corporation is managed by Cambridge Capital Management Corporation. The latter is a well established financial management corporation which manages a spectrum of financial institutions that offer various products from US Federal SBA 504 loans, and mezzanine capital, through to venture capital. Financing Structure The Indiana Community Business Credit Corporation was created to fill this need. It offers mezzanine financing for working capital or fixed assets to any company located in the State of Indiana. The Indiana Community Business Credit Corporation markets its tailored financial products throughout the state by way of a network of seventy participating lenders. These lenders will typically introduce a potential portfolio company to the ICBCC and be willing to cover 50% of the total capital needed by the applicant. The firms which receive financing from the Indiana Community Business Credit Corporation are generally small. The Fund’s guidelines are similar to those it operates for its US Federal Small Business Association (SBA) loan operations. Companies applying for financing must have a net worth of less than $6 million and a net profit of less than $2 million. All firms must be geographically within the State of Indiana. Legal Structure Indiana Community Business Credit Corporation’s headquarters are in Cambridge Capital’s offices in Indianapolis. However, its network of 47 member financial institutions encompasses the entire State of Indiana. As ICBCC has a sixteen-year track record of success, the number of member institutions has increased, as has its reputation. Operations ICBCC’s due diligence practices are extensive. Along with its application for financing, a company must present a signed letter of commitment for 50% of the financing from a member bank; a history detailing the past three years of operations; financial projections for the next two years; description of its accounts receivable, accounts payable, and inventories; and the personal financial statements of the owners and principals. Indiana Community Business Credit Corporation closely monitors all its portfolio companies. ICBCC, as a convertible debt financier like Mass Capital, does not usually take a seat on the portfolio company’s Board of Directors. This is so that it does not compromise its position as a creditor of the company. Instead, portfolio companies must submit financial documents on a monthly basis and be open to unannounced visits by the ICBCC investment team. These documents are closely monitored for any signs that the portfolio company is having financial difficulty. Indiana Community Business Credit Corporation uses two basic means of exit depending on how the financing has been structured. For those funds that are structured as a debt instrument, the investment is exited as the debt is paid off. The near-equity mezzanine products are structured with warrants, which ICBCC typically refers to as exit fees. These exit fees provide the equivalent of a mezzanine return in the high teens-low twenties.

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Appendix J: Long Term Development Finance Corporation Models

Development Finance Corporations/Authorities are a well-established 30 year old state development bank models that uses tax-exempt and taxable bonding mechanisms to generate from global capital markets the very large scale capital necessary to assemble, acquire and hold large properties, develop a plan for rebuilding them, and then implement the rebuilding plan over an extended period of time that can be decades. They have the benefit of being able to undertake both tax exempt and taxable financing, but are managed by flexible not-for-profit institutions that are either (1) quasi-public agencies that are “of-but-not-in” government, or (2) in the newest models, operate through private-public partnerships.

The new model Development Finance Corporations build on the best Authority models [Massachusetts, Maine, Alaska, Arkansas and others] with their highly professional quasi-public, non-civil service, performance-driven managements rewarded for success, The new model then goes the next step: to create the Development Finance Corporation within a private-public partnership model with a mixed private-public board that sets the public policy values to be carried out by the Corporation, then hires a competitive private sector management through a national search, pays market rates and rewards success and penalizes failure for meeting both bottom lines—the return expectations of bond holders and the public values established by the private-public partnership.

These multipurpose development banks undertake large scale development to build or rebuild whole neighborhoods, cities and regions; redevelop abandoned military bases into new towns; clean up and redevelop large, often polluted former industrial sites; create world class research centers for universities; build industrial and technology parks; do in-fill housing, affordable and mixed-income housing, and mixed-use development, and redevelop whole inner city neighborhoods that have experienced devastation and distress.

The $15 billion Massachusetts Development Finance Authority is the preeminent state Development Finance Authority in the United States, undertaking more than $1 billion of new financing each year for a very diverse range of projects. See Appendix K for additional information on the Massachusetts Development Finance Authority. The Florida Development Finance Corporation is the paradigm of the new model with a DBL management that understands the value framework, is rewarded for success and hired by an overall private-public, market-driven partnership that oversees and directs development in the state.

These development banks, including the Massachusetts and Florida models, have generated well over $50 billion in public purpose development in their states, and our now part of a national industry.

Michigan has no such state wide development bank, but does authorize local bond authorities. Experience in other localities and states shows that these local bond authorities are often controlled by local bond counsel and investment banks for their own benefit rather than for the benefit of the communities they serve. In contrast, these state-wide development finance institutions are structured with strong professional managements to manage the process for public benefit and put the bond counsel and investment bankers in a

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rigorous competitive environment. These Development Finance Authorities/Corporations thus not only reduce the cost and increase the efficiency of local access to global capital markets, but ensure that these resources are used for the public good.


Appendix K: Other Innovative Financing Models

Credit Insurance, Guarantees, including Capital Access Programs Program: California State Small Business Loan Guarantee Program (California)

Offered Through:

Financial Development Corporations (FDCs) within CA, in partnership with the State of California

Inception: 1999

Description: Provides guarantees up to 90% of a commercial loan or line of credit.

Industry Served:

None specified

Types of Companies:

Small businesses

Targeted Geography:

California

Amount of Capital:

Up to $500,000

Innovative Features:

Provides a lender with additional security for a credit request in the form of a guarantee, which serves as an incentive for the lender to approve a commercial credit request it might not normally consider. The Guarantee is issued on behalf of the State of California by 11 non-profit Financial Development Corporations located throughout California.

Track Record:

Has made over $200 million in loans Created and retained 51,700 jobs Generates an estimated $2 in California tax revenue for every $1 of program

costs

Contact Information & Website:

Glenn Stober (916) 324-9538 www.calbusiness.ca.gov

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Program: New Jersey Business Growth Fund (New Jersey)

Offered Through:

PNC Bank and the New Jersey Economic Development Authority

Inception:

2004

Description: A $100 million fund that provides below-market loans for business growth and expansion and job creation.

Industry Served:

Manufacturing, business/personal services, technology drivers, transportation, and wholesale trade

Types of Companies:

Small- and medium-sized companies

Targeted Geography:

New Jersey

Amount of Capital:

$100,000 - $ 2 million


A public-private partnership between PNC Bank and the New Jersey Economic Development Authority, which will provide up to a 50% guarantee on any single loan.

Track Record:

Information was not available.


New Jersey Economic Development Authority 36 West State Street Trenton, NJ 08625 (609) 292-1800 www.njeda.com

http://www.njeda.com/


Long-Term Bond Debt Finance

Program: Massachusetts Development Finance Authority

Offered Through:

Massachusetts Development Finance Authority, a $15 billion state development finance authority

Inception: 1977

Description: Provides states and their small businesses with access to global capital markets to provide long-term finance to small, growing enterprises for land, plan, and equipment.

Industry Served:

All

Types of Companies:

Small and growing businesses

Targeted Geography:

Massachusetts

Amount of Capital:

Up to $2.5 million


Provides access to global capital markets in a lean, cost effective, fast, and non-bureaucratic way

Utilizes a wide range of financing tools, such as development funds, tax-exempt bonds and a variety of loan and guarantee programs

Can have a powerful impact on jobs Can finance an enormously diverse range of entrepreneurial products, including

the building of an entire new town on a former semi-rural military base

Track Record:

Financed or managed 211 projects representing an investment of more than $2 billion in the Massachusetts economy

Supported the creation of more than 1,280 housing units and 11,000 permanent and construction-related jobs


MassDevelopment 160 Federal St. Boston, MA 02110 800-445-8030 www.massdevelopment.com

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http://www.massdevelopment.com/



Program: Emerging Technology Fund (Massachusetts)

Offered Through:

Massachusetts Development Finance Authority (see above)

Inception: 2004

Description: Provides loans and guarantees for buying equipment, renovating leased space, or purchasing and expanding facilities.

Industry Served:

Technology-based manufacturing

Types of Companies:

None specified

Targeted Geography:

Massachusetts

Amount of Capital:

Up to $2.5 million


The ETF was created to help technology-based businesses locate and expand in Massachusetts. The fund targets companies that are ready to transition from research and development to production.

Track Record:

Has supported more than seven projects totaling more than $8.9 million


MassDevelopment 160 Federal St. Boston, MA 02110 800-445-8030 www.massdevelopment.com

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Program: TradePort Export Finance Online (California)

Offered Through:

TEFO is an international trade financial services provider. It is a managed financial network of banks, lenders, and brokers

Inception: 2004

Description: Provides California-based companies, their buyers, suppliers, and partners worldwide with much-needed pre-export capital, and trade finance consulting services.

Industry Served:

Import/export

Types of Companies:

Small and Mid-sized Businesses

Targeted Geography:

California and international

Amount of Capital:

$10,000 to $10 million


Brings together California's trade promotion community, private sector banks and lenders, the U.S. Commercial Service, the U.S. Export-Import Bank (EXIM) and the Small Business Administration (SBA) for the benefit of SME international trade development.

Track Record:

Information was not available


www.tefo.org

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http://www.export.gov/

http://www.exim.gov/

http://www.sba.gov/financing/loanprog/tradeloans.html


Revolving Loan Funds Program: Revolving Line of Credit Program (Illinois)

Offered Through:

Illinois Department of Commerce and Economic Opportunity

Inception: Information was not available.

Description: Provides subordinated lines of credit to small businesses having seasonal or variable working capital demands.

Industry Served:

None specified

Types of Companies:

Small businesses

Targeted Geography:

Illinois

Amount of Capital:

$10,000 to $750,000


Allows a business to borrow, repay, and re-borrow according its needs, without applying for a new loan.

Track Record:



Illinois Department of Commerce and Economic Opportunity Business Finance Division 620 East Adams Springfield, Illinois 62701 217-782-3891 www.illinoisbiz.biz

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Program: Small Business Environmental Loan Program (Minnesota)

Offered Through:

Minnesota Pollution Control Agency

Inception:

1995

Description: Provides low-interest loans to small businesses that financing environmental projects such as equipment or process upgrades and costs associated with the investigation and clean-up of hazardous materials.

Industry Served:

Transportation

Types of Companies:

Small businesses

Targeted Geography:

Minnesota

Amount of Capital:

$1,000 to $50,000


Helps small businesses reduce its pollutants to air, ground, or water.

Track Record:

Has issued over 50 loans for over $1.7 Million.


Small Business Ombudsman MPCA 520 Lafayette Road St. Paul, MN 55155 (651) 297-8615 www.pca.state.mn.us

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Program: Self-Help Ventures Fund (North Carolina)

Offered Through:

Self-Help Ventures Fund, a nonprofit Certified Community Development Financial Institution (CDFI), and an affiliate of Self-Help Credit Union

Inception:

1984

Description: Provides higher-risk, unconventional, and high-impact business loans to small businesses and nonprofits

Industry Served:

None

Types of Companies:

Small businesses and nonprofits

Targeted Geography:

National

Amount of Capital:

$1,000 to large multi−million dollar loans


Utilizes New Markets Tax Credits to originate loans and purchase loans to ensure liquidity

Targets businesses in low-income communities

Track Record:

Provided more than $5 billion in financing to 55,000 small businesses, non−profits, and first time homebuyers


301 W. Main Street Durham, NC 27701 (919)956−4400 www.self−help.org

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Program: Innovation Ohio Loan Fund (Ohio)

Offered Through:

State of Ohio Department of Development

Inception:

2004

Description: A $50 million fund that provides loans to finance the acquisition, construction, and related costs of technology, facilities, and equipment.

Industry Served:

Manufacturing; Advanced materials; Instruments, controls, and electronics; Power and propulsion; Biosciences; and Information Technology

Types of Companies:

Small- and mid-sized companies

Targeted Geography:

Ohio

Amount of Capital:

$500,000 - $3 million


Provides capital to Ohio companies having difficulty securing funds from conventional sources due to technical and commercial risk factors associated with the development of a new product or service.

Track Record:

Seeks to provide $19 million in loans in 2008, expecting to retain 238 positions and create 324 jobs

Will eventually be a $100 million revolving loan fund


Ohio Department of Development 77 S. High St. PO Box 1001 Columbus, OH 43216 (614) 466-5420 www.odod.state.oh.us

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Program: Pioneer Rural Loan (Ohio)

Offered Through:


Inception: 1997

Description: Provides direct loans for the acquisition of land and buildings, new construction, renovation and expansion of existing buildings, and acquisition of machinery and equipment.

Industry Served:

None specified

Types of Companies:

Businesses locating or expanding in Ohio’s rural areas

Targeted Geography:

Ohio

Amount of Capital:

Up to $750,000


Creates jobs in rural areas.

Track Record:



Ohio Department of Development 77 S. High St. PO Box 1001 Columbus, OH 43216 (614) 466-5420 www.odod.state.oh.us

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Subordinated Debt

Program: Participation Loan Program (Illinois)

Offered Through:

Illinois Department of Commerce and Economic Opportunity

Inception: Information was not available.

Description: Provides loans for the purchase and installation of machinery and equipment, working capital, purchase of land, construction, or renovation of buildings.

Industry Served:

None specified

Types of Companies:

Any small business

Targeted Geography:

Illinois

Amount of Capital:

$10,000 - $750,000


Designed to work through banks and other conventional lending institutions to provide subordinated financial assistance.

Track Record:

In 2000, the program has facilitated more than $34 million in investments, resulting in the creation of almost 446 jobs and retention of nearly 224 jobs.


Illinois Department of Commerce & Economic Opportunity Business Finance Division 620 E. Adams Springfield IL, 62701 217-782-3891 www.illinoisbiz.biz

163


Program: Minnesota Community Capital Fund (Minnesota)

Offered Through:

MCCF, a nonprofit bank participation loan fund

Inception:

2003

Description: Provides gap-financing capital, including subordinated long-term debt financing, for businesses located in rural communities

Industry Served:

None specified

Types of Companies:

None specified

Targeted Geography:

Minnesota

Amount of Capital:

$50,000 to $2.5 million


Leverages millions of dollars in underutilized local revolving loan fund (RLF) capital

Has the capability of offering much larger loans and it provides borrowers with greater lending flexibility

Track Record:

Has approved more 98 loans totaling more than $33 million


Minnesota Community Capital Fund 13911 Ridgedale Dr, Suite 260 Minneapolis, MN 55305 (952) 546-9049 www.mncommunitycapitalfund.org

164


Program: SoCal CDFI (California)

Offered Through:

SoCal CDFI, a multi-bank lending consortium comprised of 45 member banks. It is a for profit corporation and a certified Community Development Financial Institution (CDFI).

Inception: 2005

Description: Provides commercial loans and pre- and post-loan technical assistance to small businesses, particularly those owned by minorities and women and located in low- to moderate-income communities.

Industry Served:

None specified

Types of Companies:

Small businesses

Targeted Geography:

Southern California

Amount of Capital:

Up to $200,000


Loan pool funds are from a consortium of financial institutions Make loans available for small businesses who do not qualify for SBA or

conventional bank financing Seek to improve the condition of small businesses, particularly those owned by

minorities, women, and persons in low- to moderate-income census tracts

Track Record:



Stacey Sanchez, Executive Director 2390 E. Orangewood Ave. Anaheim, CA 92806 (714) 918-0886 www.socalcdfi.com

165


Program: Massachusetts Business Development Corporation (Massachusetts)

Offered Through:

Mass Business Development Corporation, a private company in which many financial institutions have pooled their money.

Inception: 1953

Description: Provides financial assistance with loans, mezzanine and equity investments, guarantees and financial services to businesses. Includes direct loans, Capital Access Program, SBA 504 loans, mezzanine capital, and private equity.

Industry Served:

None specified

Types of Companies:

All

Targeted Geography:

Massachusetts

Amount of Capital:

$50,000 - $ 5 million


Financial institutions in the New England region have pooled their money to share the risks if helping growing companies.

Funds are sourced from member banks and enable banks to make loans they might otherwise be unable to make.

Track Record:

Has invested over $1 billion in more than 3,000 companies in New England.


500 Edgewater Drive, Suite 555 Wakefield, MA 01880 (781) 928-1100 www.mass-business.com

166


Seed Capital

Program: Research and Development Loan Fund Program (Ohio)

Offered Through:


Inception: 2004

Description: Provides low-interest loans, partnered with a tax credit, to businesses that create jobs.

Industry Served:

None specified

Types of Companies:

Companies involved in research and development projects

Targeted Geography:

Ohio

Amount of Capital:

$1 million - $25 million


Promotes economic development, business expansion, and job creation by encouraging private-sector R&D investments.

Track Record:



Ohio Department of Development Economic Development Division 77 S. High St. PO Box 1001 Columbus, OH 43216 (614) 466-4551 www.odod.state.oh.us

167


Program: Indiana Seed Fund (Indiana)

Offered Through:

A $6 million investment fund managed by BioCrossroads, a public-private collaboration.

Inception: 2005

Description: Provides pre-venture investment capital for emerging Indiana life sciences companies

Industry Served:

Life sciences

Types of Companies:

Seed-stage companies

Targeted Geography:

Indiana

Amount of Capital:

$50,000 - $500,000


Formed to help narrow the gap between discovery and third-party funding in Indiana and to prepare companies for venture investments.

Track Record:



300 N. Meridian St. Suite 950 Indianapolis, IN 46204 (317) 238-2450 www.biocrossroads.com

168


Early Stage Venture Capital Program: St. Louis Vectis Life Sciences Fund (Missouri)

Offered Through:

An $81 million life sciences fund of funds capitalized with investments made by foundations, university endowments and large institutional investors. The initiative was organized by the St. Louis Regional Chamber and Growth Association and the St. Louis Plant and Life Sciences Coalition and is managed by Brooke Private Equity Advisors.

Inception: 2004

Description: A private equity fund that invests in seed and very early stage life sciences companies in greater St. Louis.

Industry Served:

Life sciences

Types of Companies:

Seed and early stage companies

Targeted Geography:

St. Louis, Missouri

Amount of Capital:

$7.5 million to $10 million


Designed to create St. Louis as a Biotech hothouse by transforming health and life sciences research into life sciences enterprises.

Track Record:

Has invested over $55 million in 11 life sciences funds in Missouri and across the nation

Has directly invested over $2 million in five companies


4041 Forest Park Avenue, Suite 230 St. Louis, MO 63108 Tel: (314) 633-1860 www.brookepea.com/vectis-life-sciences/

169


Program: Indiana Future Fund (Indiana)

Offered Through:

A $73 million capital pool of investments made by institutional investors. The fund was organized by BioCrossroads, a public-private collaboration, and is managed by Credit Suisse First Boston.

Inception: 2003

Description: Fund-of-funds that make investments in venture capital funds, which then invest directly into companies.

Industry Served:

Life sciences

Types of Companies:

Early-stage or seed-stage companies

Targeted Geography:

Indiana

Amount of Capital:

None specified


Creates public and private partnerships to support and capitalize on Indiana’s strong foundation in the life sciences industry.

Track Record:

Has invested in six local and national funds which have begun making direct investments into Indiana life sciences businesses.


Indiana Future Fund I, LLC c/o Credit Suisse Customized Fund Investment Group Eleven Madison Avenue New York, New York 10010-3629 (212) 325-2000 www.indianafuturefund.com

170


Program: Edison Innovation Fund (New Jersey)

Offered Through:

A $150 million fund created by the New Jersey Economic Development Authority, in partnership with the New Jersey Commission on Science and Technology and New Jersey Commission on Higher Education.

Inception: 2006

Description: Provides different forms of financing, access to venture capital, and an incubator network for businesses in the stages of discovery development and commercialization.

Industry Served:

Technology and life sciences

Types of Companies:

None specified

Targeted Geography:

New Jersey

Amount of Capital:

None specified


• Public/private partnership between New Jersey EDA and the New Jersey Commission on Science and Technology

• Launched alongside the Governor’s Economic Growth Strategy • Builds the capacity of the state’s research in strategic areas that complement

economic development within the state • Increases access to early stage capital • Provides specialized assistance to existing businesses

Track Record:

Has made over $20 million in venture fund commitments.


New Jersey Economic Development Authority PO Box 990 Trenton, NJ 08625 (609) 777-4898 www.edisoninnovationfund.com

171


Other Innovative Resources

Program: Capital Opportunities for Small Businesses (North Carolina)

Offered Through:

North Carolina Small Business and Technology Development Center (SBTDC), a business and technology extension service of The University of North Carolina. SBTDC is administered by North Carolina State University and is operated in partnership with the U.S. Small Business Administration (SBA).

Published:

2008

Description: A published guide that provides information about the various financial resources, tools, and programs available to small businesses in North Carolina. Includes a description, along with a list of contacts, offices, and locations for each program listed.

Industry Served:

All

Types of Companies:

Small businesses

Targeted Geography:

North Carolina


A comprehensive source that educates and supports the state’s small business community


Small Business and Technology Development Center 5 West Hargett Street, Suite 600 Raleigh, NC 27601-1348 ( 919) 715-7272 www.sbtdc.org

172


Program: New Jersey Manufacturing Extension Program (New Jersey)

Offered Through:

New Jersey Institute of Technology (NJIT), New Jersey Commission on Science & Technology, and the U.S. Department of Commerce

Inception:

1996

Description: Offers technical and management solutions to the changing manufacturing sector in New Jersey.

Industry Served:

Manufacturing

Types of Companies:

Small- and medium-sized businesses Early-stage companies awarded Technology Fellowships or SBIR Bridge Grants

Targeted Geography:

New Jersey

Amount of Capital:

None


Program targets the needs and issues of the manufacturing sector and is supported by a federal and state partnership.

Track Record:

Completed more than 2,000 projects, benefiting more than 1,200 manufacturers.


520 Speedwell Avenue Morris Plains, NJ 07950 (973) 998-9801 www.njmep.org

173


174

Appendix L: Related Articles and Reports

ECONOMIC INDICATORS (Change from year ago, unless noted)

20052006Q4-06Q3-07Q4-07Employment Growth Rates

-0.2%-1.4%-1.9%-1.2%-1.5%Total Nonfarm (share of trailing four quarter employment in parentheses)-2.9%-4.3%-5.8%-4.5%-5.7% Manufacturing (14%)-1.0%-5.8%-7.8%-5.6%-5.4% Other (non-manufacturing) Goods-Producing (4%)0.7%-0.5%-0.7%-0.3%-0.4% Private Service-Producing (66%)

-0.8%-1.3%-1.5%-0.7%-1.2% Government (15%)6.9%6.9%7.1%7.2%7.4%Unemployment Rate (% of labor force)20052006Q4-06Q3-07Q4-07Other Indicators

-8.8%-35.2%-40.0%-27.3%-36.4%Single-Family Home Permits-16.4%-23.5%-46.9%-35.8%-56.3%Multifamily Building Permits

3.9%-0.2%-0.8%-3.7%-4.3%Home Price Index8.753.283.744.59N/ANonbusiness Bankruptcy Filings per 1000 people (quarterly annualized level)

BANKING TRENDS

20052006Q4-06Q3-07Q4-07General Information

174171171166164Institutions (#)212,186231,479231,479220,220165,832Total Assets (in millions)

68889New Institutions (# < 3 years)1215151616Subchapter S Institutions

20052006Q4-06Q3-07Q4-07Asset Quality

1.812.642.643.363.58Past-Due and Nonaccrual Loans / Total Loans (median %)1.201.211.211.241.25ALLL/Total Loans (median %)1.570.990.990.870.67ALLL/Noncurrent Loans (median multiple)0.110.130.150.120.48Net Loan Losses / Total Loans (median %)

20052006Q4-06Q3-07Q4-07Capital / Earnings

9.609.709.709.639.25Tier 1 Leverage (median %)1.020.950.810.750.49Return on Assets (median %)1.381.281.101.000.58Pretax Return on Assets (median %)4.194.144.083.983.84Net Interest Margin (median %)6.296.967.177.227.04Yield on Earning Assets (median %)2.052.813.073.253.19Cost of Funding Earning Assets (median %)0.150.140.150.170.38Provisions to Avg. Assets (median %)0.700.650.600.610.63Noninterest Income to Avg. Assets (median %)3.013.093.103.093.15Overhead to Avg. Assets (median %)

20052006Q4-06Q3-07Q4-07Liquidity / Sensitivity

77.277.177.177.178.3Loans to Assets (median %)23.024.424.423.224.2Noncore Funding to Assets (median %)11.312.012.012.913.5Long-term Assets to Assets (median %, call filers)

8489898280Brokered Deposits (number of institutions)9.18.98.97.98.3 Brokered Deposits to Assets (median % for those above)

20052006Q4-06Q3-07Q4-07Loan Concentrations (median % of Tier 1 Capital)

92.888.788.786.697.0Commercial and Industrial263.5267.3267.3272.5285.9Commercial Real Estate55.156.356.355.158.0 Construction & Development6.55.75.77.38.5 Multifamily Residential Real Estate

187.4208.6208.6218.0226.9 Nonresidential Real Estate270.8249.7249.7240.7250.5Residential Real Estate31.026.826.823.823.8Consumer2.62.62.63.33.5Agriculture

BANKING PROFILE

Institutions

Asset

Distribution

Deposits

($ millions)

Institutions in

MarketLargest Deposit Markets (from 2007 Summary of Deposits)

110 (67.1% )< $250 million88,29260Detroit-Warren-Livonia, MI43 (26.2% )$250 million to $1 billion11,96631Grand Rapids-Wyoming, MI

7 (4.3% )$1 billion to $10 billion5,77518Ann Arbor, MI4 (2.4% )> $10 billion4,77024Lansing-East Lansing, MI

4,19616Flint, MI

Michigan

Fourth Quarter 2007

C PerformanceEmployment Growth: Long Term 48Employment Growth: Short Term 40Unemployment Rate 46Private Sector Layoffs 47Average Annual Pay 11Average Annual Pay Growth 49Employer-provided Health Insurance 11Working Poor 18Involuntary Part-Time Employment 45Poverty Rate 32Income Distribution 29Income Distribution Change 38Disparity between Rural and Urban Areas 39Net Migration 44Infant Mortality 44Uninsured Low-Income Children 7Teen Pregnancy 16Heart Disease 40Homeownership Rate 5Charitable Giving 23Voting Rate 15Crime Rate 20Per Capita Energy Consumption 18Use of Alternative Energy 31Toxic Release Inventory 17Vehicle Miles Traveled 20Rate of Recycled Waste 33Greenhouse Gas Emissions 21

Change in Unemployment 47Change in Average Annual Pay 45Change in Poverty Rate 43Change in Uninsured Low Income Children 29Change in Homeownership Rate 34Change in Toxic Release Inventory 26

C

Performance History

State Rankings: Michigan2007 Development Report Card for the States

Resource Efficiency

Equity

Performance Trends

Six measures were selected to track the change over time.These trend indicators do not contribute to the index or subindex grades.

EmploymentF

C

D

B

Earnings &Job Quality

Quality of Life

2002 2003 2004 2006 2007

ABCDF

50th 40th 30th 20th 10th 1st


www.cfed.org 202.408.9788 2007 Development Report Card for the States

C Business VitalityStrength of Traded Sector 5Business Closings 25Manufacturing Investment 25Industrial Diversity 48New Companies 39Change in New Companies 35Job Creation by Start-up Businesses 1Technology Industry Employment 22Initial Public Offerings 25

Change in Business Closings 19Five Year Change in New Companies 13

C EntrepreneurialEnergy

Business Vitality History

Two measures were selected to track the change over time.These trend indicators do not contribute to the index or subindex grades.

Business Vitality Trends

Competitiveness of Existing Businesses

C


2002 2003 2004 2006 2007

ABCDF




C Development CapacityBasic Educational Skills Proficiency-Reading 27Basic Educational Skills Proficiency-Math 24Average Teacher Salary 1K-12 Education Expenditures 19High School Completion Rate 25High School Attainment 20College Attainment 33Income from Dividends, Interest and Rent 30Venture Capital Investments 38SBIC Financing 39Loans to Small Business 9Highway Performance 40Bridge Deficiency 30Urban Mass Transit 26Electronic Public Services 5Energy Costs 27Affordable Urban Housing 18Health Professional Shortage Areas 26Conversion of Cropland to Other Uses 32Air Pollution 39Ph.D. Scientists & Engineers 27Graduate Students in Science & Engineering 22Broadband Access 23Academic Research & Development 25Federal Research & Development 30Private Research & Development 4SBIR Grants 29Royalties and Licenses 9Patents Issued 11Business Created via University R&D 33

Change in Math Proficiency 25Change in High School Attainment 13Change in Venture Capital Investments 24Change in Dividends, Interest and Rent 35Change in Health Professional Shortage Areas 24Change in Energy Costs 6Change in Private Research & Development 41

Financial Resources

B

Amenity Resources& Natural Capital

Innovation Assets

InfrastructureResources

B

Seven measures were selected to track the change over time.These trend indicators do not contribute to the index or subindex grades.

Human Resources

Development Capacity TrendsDevelopment Capacity History

C

C

C


2002 2003 2004 2006 2007

ABCDF




Number 9 • Summer 2007

This report examines evidence of Michigan’s continuing economic transition and considers the state’s capacity to reinvent itself by replacing its 20th century industrial economy with a 21st century knowledge economy.

There is no question that Michigan’s economy today is suffering, due largely to the loss of market share among the Big 3 U.S. automotive companies and the ripple effects of that downturn, as well as the loss of manufacturing jobs in general. There has been a full and nearly constant supply of bad economic news in Michigan since 2001, fi lling newspaper headlines and leading to a public sense of economic devasta-tion. A recent report on similar problems in the wider Great Lakes region argues that “attitudes infl uence success” and that “for too long, this Great Lakes Region has accepted and even amplifi ed its own down-at-the-heels image. Short-term economic stories of chaos, loss, and grim statistics have been given pride-of-place in the media, in divisive political squabbles, and in antagonisms between labor and management. So often repeated is the pessimism that it is taken for granted as the ‘real’ story ...” (Plante & Moran 2007, p2). The report notes that “voices attempting to point out real advantages to the region have been swallowed up and muffl ed beneath drum beats of doom” (Plante & Moran 2007, p2).

Whereas the overwhelmingly negative portrayal of Michigan’s economy over the last half-decade has resulted in a public sense of gloom and self-doubt, this report presents evidence of numerous positive developments occurring in the state economy, and argues that Michigan has signifi cant capacity to continue making positive steps toward establishing a knowledge economy. While there are certainly long term struggles yet to come, there are also signs that Michigan is navigating a historic transformation be-tween economic models, as its former industrial foundation gives way to the nascent growth of a post-industrial knowledge economy.

Many promising policy recommendations designed to foster economic growth and the transition to a knowledge economy have been proposed recently by others (Michigan Future, Inc. 2006; Hollins et. al. 2006; Bartik et al. 2006; Drake 2006). Rather than repeating those recommendations, the intent of this report is to promote a better understanding of the economic transition underway in Michigan, by examing the positive outcomes occurring now, as well as the state’s capacity to continue the transition toward a knowledge economy. The recent one-sided focus on only the negative aspects of the state’s economy has been counterproductive. It is time now to look not just at the state’s job losses, but also at its areas of growth.

Center for Local, State, and Urban PolicyU N I V E R S I T Y O F M I C H I G A N

Summary

Policy Report

Michigan’s Economic Transition:Toward a Knowledge Economy

By Thomas Ivacko, University of Michigan

Note: This 2nd version of the report uses Census Bureau fi rm and establishment data through 2002 rather than 2004, as in the original version


2

IntroductionMichigan is in a period of historic

economic transformation. Once a world economic leader based on a manufactur-ing and industrial foundation, Michigan is now being ravaged by its own legacy costs, globalization and increased com-petition. Where manufacturing once drove the state’s economic expansion and growing prosperity through much of the 20th century, it has since become a brake on the state’s economy, with mas-sive job losses beginning around June 2000. Due primarily to the loss of market share among the Big 3 domestic auto-makers (Bartik et al. 2006; Drake 2006; Johnson 2006) and other manufacturing losses, hundreds of thousands of low-skill high-paying factory jobs have since been shed, leaving a sense of economic collapse which has been highlighted repeatedly across the state’s media outlets.

Years of bad economic news – a slow-motion economic train wreck unfolding before the citizens’ eyes - have dominated the headlines and framed the political and policy debates surrounding ques-tions of economic development strategy. Although previous recessions (especially that of the early 1980’s) hit the state hard, for much of the last century Michigan had been an economic power, bringing a sense of economic might and supremacy. Michigan’s recent economic troubles have replaced that view in many quar-ters with a self-image of Michigan as a rust-belt economic wasteland. Terms like “economic meltdown” (Schmid 2006) have highlighted the media coverage and reinforced the widespread sense of gloom.

Meanwhile, two new points of consen-sus have emerged among leading analysts: fi rst, Michigan’s 20th century economic model is no longer viable and the only hope for a prosperous future is one based on a knowledge economy in place of

yesterday’s industrial economy; and sec-ond, a critical component in establishing a sustainable and successful knowledge economy is human capital, a critical mass of individual talent based in a cultural context that promotes education and life-long learning, entrepreneurialism, innovation, risk-taking, and commit-ment to diversity (Hollins III et. al. 2006; Michigan Future, Inc. 2006).

Unfortunately, many analysts argue that Michigan’s previously functional economic culture has long since evolved into a dysfunctional entitlement mental-ity, where workers expect to have high-paying secure jobs without the need for higher education. Michigan’s battered economic culture appears at fi rst ill-suited for success in a 21st century knowledge economy, which requires a motivated and educated workforce suffused with a spirit of entrepreneurialism, a sense of personal responsibility for one’s own economic future, a penchant for risk-taking, a love of life-long learning, and an openness to other cultures. The culture required for the new economy is one of optimism and hope. Unfortunately Michigan seems mired in a counterproductive culture of negativism, driven on by a constant focus on the forces of economic destruction in the manufacturing sector.

The question now is whether the state can move forward given today’s environ-ment of gloom. Are there only forces of economic destruction at work in Michi-gan, or is a new economy already begin-ning to grow? Are there signs for hope in Michigan’s future? Are there successes upon which to build? And does Michi-gan have the capacity to reinvent itself for success in a knowledge economy?

Despite the still unfolding train wreck that must be part of the transition away from the industrial economy of the past, there is in fact evidence of a new economy slowly taking root in the state, as presented below.

Growth Amidst Destruction

Like a forest that regenerates itself fi rst with ground cover and saplings after a fi re, the state economy is slowly, and somewhat haltingly, showing signs of emergent new growth amidst the losses in the manufacturing sector. Looking back to a period covering the last ten years, employment fi gures from the U.S. Bureau of Labor Statistics (BLS) show evidence of growth in the new economy sectors (generally identifi ed as those re-quiring higher than average levels of edu-cation and offering higher levels of pay, such as the sectors of fi nancial services and insurance, professional, scientifi c and technical services, educational and health services, and business support services). The BLS data presented below and summarized in Table 7 show Michigan employment growth in areas such as fi -nancial services, professional and business services, educational and health services, religious, grantmaking, civic, professional and similar organizations, as well as in other sectors. While Table 7 shows that this employment growth has lagged that of the nation at-large, nonetheless these fi gures show growth in new economy sectors during this period of manufactur-ing decline. In addition, using data from the U.S. Census Bureau’s County Busi-ness Patterns survey, there is similar evi-dence of growth in the number of fi rms and establishments in Michigan between 1998 and 2002 across a number of these new economy sectors.

EMPLOYMENT FIGURES

MANUFACTURING

Job losses in the manufacturing sector provide the main story, and the head-line fodder, in the drama of Michigan’s economic transition. Since its recent


3

employment peak in July 1999, the man-ufacturing sector has shed over 274,000 high paying jobs, many of which required little or no higher education. Dominating the headlines, these losses have overshad-owed other economic news and helped drive the sense of economic despair in the state. These losses have occurred in almost all of the industries classifi ed in the manufacturing sector, especially in Michigan’s bedrock automotive indus-tries as shown in Table 1.

As described by Dana Johnson, Chief Economist at Comerica Bank, direct job losses in the automotive industry also result in signifi cant indirect job losses through a “multiplier” effect. According to Johnson: “Not only have the auto companies reduced their purchases of all sorts of goods and services throughout their extensive supply chains, but also autoworkers who have lost their jobs or seen their incomes slashed have had to reduce their spending. In this manner, the cutbacks in autos have rippled throughout the state economy” (Johnson 2006, p.1). Johnson uses a conservative multiplier effect of 3, meaning that for each auto

industry job lost an additional 3 other jobs would also be lost in other sectors (other manufacturing, retail, restaurants, construction, etc.). And inversely, it could be expected that absent these enormous manufacturing job losses, the state’s other sectors would be growing at a faster clip than they have been. According to Johnson, if “… employment in the auto sector had held steady over the past 12 months, employment in Michigan would have risen by 66,000 instead of fallen by 27,000. That would have resulted in a 1.5 percent increase in Michigan payrolls, which would have matched the national rate of increase …” (Johnson 2006, p. 1).

FINANCIAL ACTIVITIES

Meanwhile, against that massive tide of manufacturing job losses BLS employ-ment fi gures show long-term positive job growth in a number of the new economy sectors (although usually at rates below the national average, due at least in part to the negative manufacturing losses multiplier effect outlined above). For instance, Michigan’s Financial Activities sector has had employment growth in 7

of the last 10 years (see Table 2), resulting in approximately 12,000 new jobs (Table 7). Although the 10-year cumulative employment growth rate in this sector is only 5.9 percent (compared to 19.6 per-cent for the nation at-large, as shown in Table 7) it is nonetheless positive growth in an important new economy sector.

When looking in more detail at in-dustries classifi ed within the Financial Activities sector, a similar pattern is found for the Finance and Insurance industry subset of the Financial Activities sector: employment gains in 8 of the last 10 years with overall growth of 7.2 percent between December 1996 and December 2006. Drilling down further into the data, similar patterns of uneven, yet overall growth, are found in the industry sub-classifi cations of Credit Intermediation and Related Activities (gains in 4 of the last 5 years, overall growth of 3.9 percent), and Insurance Carriers and Related Ac-tivities (gains in 5 of the last 10 years with overall growth of 5.5 percent).

While the uneven nature of this growth is evident, with gains followed by losses and then more gains, the data still

Sector and Industry DescriptionsOverall

% change 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Financial Activities Sector* 5.91% 1.08 1.56 -1.10 2.18 0.76 1.98 0.51 0.18 -0.28 -1.06

Finance & Insurance 7.25% 1.06 1.91 -1.94 1.97 1.29 2.68 0.12 0.43 0.06 -0.49Insurance Carriers & Related 5.54% 1.90 4.41 -2.76 -0.84 4.55 2.10 -1.42 -1.92 -0.98 0.66

Credit Intermediation & Related 3.89% - - - - - 3.28 1.18 0.70 0.58 -1.84

Table 2. Employment Percentage Changes in Michigan’s Financial Activities Sector

Source: U.S. Bureau of Labor Statistics, Current Employment Statistics series. Figures represent the percentage change in employment for the period from December of the previous year to December of the given year. Green fi gures indicate year-over-year growth, red fi gures indicate year-over-year decline, dashes indicate unavail-able data. * indicates seasonally adjusted data, otherwise data is not seasonally adjusted.


% change 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Manufacturing* -26.85% 2.55 1.03 -0.34 -1.22 -11.37 -4.27 -5.88 -1.74 -3.29 -5.50

Motor Vehicle Manufacturing -32.93% 15.86 -1.25 -5.71 9.43 -10.87 -4.83 -7.13 -6.64 -7.81 -16.19Motor Vehicle Parts Manufacturing -33.89% -0.70 4.01 2.42 -2.15 -11.73 -2.79 -7.46 -5.98 -4.62 -10.31

Table 1. Employment Percentage Changes in Michigan’s Manufacturing Sector

Source: U.S. Bureau of Labor Statistics, Current Employment Statistics series. Figures represent the percentage change in employment for the period from December of the previous year to December of the given year. Green fi gures indicate year-over-year growth, red fi gures indicate year-over-year decline. * indicates seasonally adjusted data, otherwise data is not seasonally adjusted.


4

job gains of 7 percent over the decade, resulting in approximately 39,300 ad-ditional jobs (Table 7). When looking in more detail, the industry of Accounting, Tax Preparation, Bookkeeping and Pay-roll Services has experienced job gains in 6 of the last 10 years, with overall gains of 5.7 percent since December 1996. Man-agement, Scientifi c and Technical Con-sulting Services has shown employment increases in 5 of the last 10 years (plus 1 year of neither gains nor losses), with overall growth of 27.3 percent between December 1996 and December 2006. And the industry classifi ed as Scientifi c Research and Development Services has had substantial growth in 2 of the last 5 years, with overall employment levels up

3.8 percent in the last half-decade. Other industries with long-term growth pat-terns include Other Professional, Scien-tifi c and Technical Services (growth in 4 of the last 5 years and overall gains of 8.7 percent), Administrative and Support and Waste Management and Remediation Services (growth in 7 of the last 10 years; overall gains of 19.1 percent), Employ-ment Services (growth in 5 of the last 10 years; overall gains of 17.3 percent), and Business Support Services (growth in 4 of the last 5 years; overall gains of 43.4 percent).

EDUCATIONAL AND HEALTH SERVICES

Employment has increased in the last 8 straight years in the sector of Educa-

point to overall patterns of modest job growth in this new economy sector over the last 10 years. The fact that these gains are happening at all during this period of enormous contraction in the state’s bed-rock automotive manufacturing sector is noteworthy.

PROFESSIONAL AND BUSINESS SERVICES

Looking at other new economy sec-tors, employment fi gures for the Pro-fessional and Business Services sector show job gains in 7 of the last 10 years, including 3 straight years of gains since December 2003 (see Table 3). Although employment in this sector was lower at the end of 2006 than in 2000, the 10 year period ending in 2006 still shows overall


% change 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Professional & Business Services Sector* 7.09% 3.68 6.28 3.46 -0.43 -6.58 1.96 -3.09 1.22 0.75 0.22

Accounting, Tax Prep., Bookkeeping & Payroll 5.75% 1.08 -2.14 16.36 0.31 -2.80 6.09 -12.08 -0.34 1.03 0.34Management, Scientifi c & Technical Consulting 27.27% 6.49 20.12 15.74 10.96 -4.35 -6.61 -17.26 0.00 5.88 -1.01

Admin. & Support & Waste Mgmt. Services 19.14% 9.89 8.96 2.28 -1.68 -9.92 6.79 -2.40 3.65 1.65 0.04Employment Services 17.28% 14.88 13.54 3.23 -4.46 -16.53 11.62 -4.58 5.45 -0.37 -2.38

Scientifi c Research & Development Services 3.79% - - - - - 5.06 -0.40 -3.63 -0.42 3.36Other Prof., Scientifi c, & Technical Services 8.72% - - - - - 3.36 0.00 2.60 0.63 1.89

Business Support Services 43.38% - - - - - 19.12 10.49 7.26 2.60 -1.02

Table 3. Employment Percentage Changes in Michigan’s Professional and Business Services Sector

Source: U.S. Bureau of Labor Statistics, Current Employment Statistics series. Figures represent the percentage change in employment for the period from December of the previous year to December of the given year. Green fi gures indicate year-over-year growth, red fi gures indicate year-over-year decline, dashes indicate unavailable data. * indicates seasonally adjusted data, otherwise data is not seasonally adjusted.


% change 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Education and Health Services Sector* 20.69% 0.20 -0.47 1.48 2.40 3.12 3.27 2.04 2.30 3.17 1.55

Educational Services 64.76% 7.13 0.00 3.04 3.14 11.09 9.66 7.05 6.72 1.67 2.28Elementary and Secondary Schools 45.26% 0.53 6.81 4.41 -17.84 12.57 5.58 12.02 7.73 6.37 3.37

Colleges, Universities and Professional Schools 71.50% 7.25 -0.90 -0.91 33.49 -1.72 17.83 1.78 5.83 -1.65 -0.56Health Care and Social Assistance 16.15% -0.99 -0.50 1.35 2.42 2.27 2.59 1.49 1.84 3.52 1.18

Offi ces of Dentists 13.12% 1.77 2.09 1.02 2.36 1.32 2.61 0.32 0.63 0.63 -0.31Ambulatory Health Care Services 15.86% - - - - - 3.83 2.23 2.93 3.63 2.34

Offi ces of Physicians 18.39% - - - - - 3.34 4.37 2.64 4.83 2.02Offi ces of Other Health Practitioners 19.64% - - - - - 7.74 4.42 2.12 2.59 1.52

Home Health Care Services 26.60% - - - - - 6.88 1.29 5.93 2.40 7.81Hospitals 7.29% - - - - - 3.30 1.06 -0.17 2.61 0.32

Outpatient Care Centers 9.16% - - - - - - - 3.05 2.96 2.88

Table 4. Employment Percentage Changes in Michigan’s Educational and Health Services Sector



5

tional and Health Services (see Table 4). The overall growth of 20.7 percent since December 1996 has resulted in approxi-mately 101,300 new jobs (Table 7). Given the central role of education in growing a knowledge economy, this seems a par-ticularly good sign. And when looking at this sector’s sub-classifi cations by industry, the Educational Services industry overall has had job growth in 9 of the last 10 years, with 64.8 percent overall growth since December 1996. Drilling down fur-ther, Elementary and Secondary Schools have experienced growth in 9 of the last 10 years, with an overall increase of 45.3 percent, while Colleges, Universities and Professional Schools have had growth in 5 of the last 10 years, with an impressive overall growth rate of 71.5 percent in that period.

In the industry classifi ed as Health Care and Social Assistance, overall employment has increased in 8 of the last 10 years, with cumulative growth of 16.1 percent since December 1996. Again drilling further down into the data, the follow-ing industry sub-classifi cations have also experienced growth: Ambulatory Health Care Services (5 straight years of growth; overall 15.9 percent increase since De-cember 2001); Offi ces of Physicians (5 straight years of growth; 18.4 percent in-crease since December 2001); Offi ces of Dentists (growth in 9 of the last 10 years; 13.1 percent increase since December 1996); Offi ces of Other Health Practitio-ners (5 straight years of job gains; 19.6

percent increase since December 2001); Outpatient Care Centers (3 straight years of growth; overall increase of 9.1 percent since December 2003); Home Health Care Services (5 straight years of gains; 26.6 percent increase since December 2001), and Hospitals (growth in 4 of the last 5 years; overall increase of 7.3 percent since December 2001).

LEISURE AND HOSPITALITY

The Leisure and Hospitality sector, with 29,500 new jobs since 1996 (see Table 7), has experienced employment gains in 7 of the last 10 years, with overall growth of 7.8 percent since December 1996 (Table 5). Although some of the jobs within this sector may not be con-sidered new economy jobs in terms of skills required and wages paid, nonethe-less services provided by this sector such as dining, entertainment and recreation can be important factors in creating the context required to attract the talent for a knowledge economy labor force. Qual-ity of life, including entertainment and recreation opportunities, is critical to attracting a highly educated workforce. Industries experiencing growth in this sector include Arts, Entertainment, and Recreation (job gains in 7 of the last 10 years; overall growth of 27.9 percent); Other Amusement and Recreation In-dustries (growth in 6 of the last 10 years; overall gains of 14.5 percent); Accommo-dation (gains in 4 of the last 5 years; 9.1 percent overall growth); and Full-Service

Restaurants (10 straight years of growth providing job gains of 25.7 percent).

OTHER MISCELLANEOUS INDUSTRIES AND SECTORS

As shown in Table 6, the industry clas-sifi ed as Religious, Grantmaking, Civic, Professional, and Similar Organizations has experienced job growth in each of the last 10 years, with overall growth of 21.2 percent between December 1996 and December 2006. Approximately 17,300 new jobs were created in this industry. Meanwhile, in the Government sector, industries with long term growth include State Government Educational Services (employment growth in 8 of the last 10 years; overall gains of 9.7 percent); Local Government Junior Colleges (gains in 7 of the last 10 years; overall growth of 11.8 percent), and Government Hospitals (job growth in 7 of the last 10 years; overall gains of 21.2 percent). For the Govern-ment sector as a whole, approximately 15,100 new jobs were created between 1996 and 2006 (see Table 7).

INFORMATION SECTOR DECLINE

In the midst of these numerous cat-egories of growth, one particular new economy industry stands out for its cu-mulative job losses over the last 10 years: the Information sector (see Table 6). At the national level, Information sector em-ployment peaked in 2000 and fell each subsequent year until beginning to recover in 2006. This group of industries (includ-


% change 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Leisure and Hospitality Sector* 7.80% 0.29 -0.95 5.09 1.70 -2.17 1.81 0.53 -0.07 0.77 0.72

Arts, Entertainment and Recreation 27.94% 5.54 3.94 10.53 12.38 -9.66 4.13 1.26 -3.20 2.02 -0.18Other Amusement and Recreation 14.48% 1.72 5.08 3.55 1.25 -0.31 5.86 -0.58 -2.64 4.82 -4.60

Full-service Restaurants 25.76% 1.14 3.01 5.66 2.68 2.27 1.73 3.64 0.78 1.01 1.38Accomodation 9.12% - - - - - 4.89 0.62 1.23 0.00 2.13

Table 5. Employment Percentage Changes in Michigan’s Leisure and Hospitality Sector



6

ing publishing, telecommunications and wired telecommunications carriers) grew overall only 2.5% nationally between 1996 and 2006, while the experience in Michigan included job losses in 5 of the last 10 years, with an overall employment decline of 5.6 percent, resulting in about 4,000 fewer jobs (Table 7).

A MORE BALANCED EMPLOYMENT BASEDeclines in manufacturing employ-

ment accompanied by increases in the new economy sectors have resulted in a more balanced and diversifi ed employ-ment base for the state, as shown in Table 7. According to the BLS data, in 1996 manufacturing employment accounted for 19.6 percent of Michigan’s total

nonfarm employment base. By 2006 that portion had fallen to only 14.6 percent, a decline of more than 25.6 percent from the 1996 fi gure. Other sectors experi-encing relative declines in their portions of the total nonfarm employment base include: Natural Resources and Mining (down 18.1 percent), Trade, Transporta-tion and Utilities (down 3.5 percent), and Information as noted above (down 4.1 percent). Meanwhile, sectors whose shares of the employment base increased over the last ten years include: Financial Activities (up by 7.6 percent from 1996), Professional and Business Services (up 8.8 percent), Educational and health services (up 22.6 percent), Leisure and Hospitality (up 9.6 percent), Other Services (up 7.6

percent), Government (up 4 percent), and Construction (up 2.6 percent).

Overall, the number of nonfarm jobs in Michigan fell by about 71,000 over the period from December 1996 to December 2006 (see last 3 columns of Table 7). Gains in the growing sectors (about 209,000 new jobs) didn’t quite offset the losses in manufacturing, natural resources and mining, trade, transporta-tion and utilities, and information (losses of about 280,000 jobs). By the end of 2006, although resulting from a period of overall employment decline, Michigan’s employment base was signifi cantly less reliant on the old economy sector of manufacturing.

FIRMS AND ESTABLISHMENTSAnother view of Michigan’s eco-

nomic transformation considers changes in the number of fi rms and establish-ments over time, to round out the data on employment presented above. Firm and establishment data come from the U.S. Census Bureau.

Using data from the Bureau’s Statis-tics of U.S. Businesses series (from 1998, the oldest comparable data available, to 2002, the most recent comparable data available), there are encouraging signs of new growth in the number of Michigan fi rms and establishments for several of the new economy sectors, as described below and shown in Table 8. In the fol-lowing sections, an establishment is de-fi ned by the Census Bureau as a single

Percentage of Mi. Employment Mi. Employment in Thousands Total U.S.Sector 1996 2006 % change 1996 2006 % change % change

Manufacturing 19.62% 14.59% -25.65% 862.5 630.9 -26.85% -18.25%Natural Resources and Mining 0.22% 0.18% -18.06% 9.8 7.9 -19.39% 10.33%

Information 1.61% 1.55% -4.08% 71.0 67.0 -5.63% 2.50%Trade, Transportation and Utilities 19.01% 18.34% -3.50% 835.6 793.3 -5.06% 7.62%

Construction 3.97% 4.07% 2.57% 174.6 176.2 1.00% 35.40%Government 14.76% 15.36% 4.01% 649.1 664.2 2.32% 12.99%

Other Services 3.85% 4.14% 7.65% 169.2 179.2 5.91% 14.88%Financial Activities 4.62% 4.97% 7.65% 203.1 215.1 5.91% 19.65%

Professional and Business Services 12.60% 13.72% 8.85% 554.0 593.3 7.09% 28.97%Leisure and Hospitality 8.60% 9.42% 9.57% 378.1 407.6 7.80% 22.68%

Educational and Health Services 11.13% 13.66% 22.68% 489.4 590.7 20.69% 30.28%Total 100.0% 100.0% 4,396.4 4,324.4 -1.64% 13.36%

Table 7. Michigan and U.S. Nonfarm Employment by Sector, 1996 - 2006

Source: U.S. Bureau of Labor Statistics, Current Employment Statistics series. Figures in 1st and 2nd data columns represent each sector’s share of the total Michigan nonfarm employment in December of the given year, while fi gures in 3rd data col-umn represent the percentage change from 1996 to 2006 for each sector. Figures in 4th and 5th data columns represent actual Michigan employment in thousands by sector for December of the given year, while fi gures in the 6th data column represent the percentage change from 1996 to 2006 for employment in each sector. Figures in the fi nal column represent the change from 1996 to 2006 in total U.S. employment by sector. Green fi gures indicate growth, red fi gures indicate decline. All data are seasonally adjusted.


% change 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Religious, Grantmaking, Civic, Professional 21.27% 3.94 1.78 1.16 2.87 2.46 1.85 0.86 0.74 2.95 0.92

State Government Educational Services 9.73% 3.31 0.90 -0.30 1.69 1.57 2.80 -4.97 2.86 0.19 1.53Local Government Junior Colleges 11.82% 1.97 0.97 0.96 1.42 -1.40 7.11 -0.88 -3.13 3.23 1.34

Government Hospitals 21.25% 2.36 -0.77 3.10 -6.77 9.68 0.00 0.74 5.11 1.39 5.48Information Sector Overall* -5.63% 1.55 3.47 0.00 2.28 -1.18 -4.91 -3.63 -1.30 -2.64 0.90

Table 6. Employment Percentage Changes in Miscellaneous Other Sectors in Michigan

Source: U.S. Bureau of Labor Statistics, Current Employment Statistics series. Figures represent the percentage change in employment for the period from December of the previous year to December of the given year. Green fi gures indicate year-over-year growth, red fi gures indicate year-over-year decline. * indicates seasonally adjusted data, otherwise data is not seasonally adjusted.


7

FINANCE AND INSURANCE

Positive growth is evident in the number of Finance and Insurance sector fi rms and establishments across all but the largest of the enterprise size categories described in the Census data. Towards the lower end of the spectrum, for enterprises employing 1 to 4 workers, there was growth of just over 7 percent in the number of fi rms and establishments between 1998 and 2002. For enterprises with 5 to 9 workers, there was 13.26 percent growth in the number of both fi rms and establishments between 1998 and 2002. And even at the upper end of the spectrum, there was 9.8 per-cent growth in the number of fi rms and 11.4 percent growth in establishments for companies employing 20 to 99 workers, 16.4 percent growth in fi rms employing 100 to 499 workers, and 12.5 percent growth in establishments for companies employing more than 500 workers. The only categories in this sector that shrank over time were the number of fi rms em-ploying more than 500 workers, which fell by 8.9 percent, and the number of establishments in the 100-499 category, which fell by 3.6 percent.

business location, while a fi rm can consist of one or more locations for a single busi-ness. Firms and establishments are catego-rized here by the number of employees for the overall enterprise (not necessarily the specifi c location/establishment) as follows: 0 employees (that is, 0 employees reported during the offi cial mid-March counting period, but some employees at other times of the year); 1-4 employees; 5-9; 10-19; 20-99; 100-499; and 500 or more employees. Excluded from the more detailed descriptions below are reports of units with 0 employees, al-though the Census data do show growth in this category of fi rms and establish-ments across the sectors of Finance and Insurance (9.58 percent growth in these fi rms from 1998 to 2002), Professional, Scientifi c and Technical Services (5.28 percent growth), Educational Services (6.48 percent growth), Management of Companies (5.05 percent growth), and Arts, Entertainment and Recreation (3.13 percent growth).

The Census data show encouraging signs for small enterprise creation across several of the new economy sectors, pro-viding a glimpse of entrepreneurial activ-

ity in the state, as well as a hint of possible job growth in the future.

Michigan may be witnessing aspects of “creative destruction” as described by economist Joseph Schumpeter, in which older established fi rms eventually lose their competitive advantages to newer innovative fi rms (Schumpeter 1975). This evolution in the marketplace is marked by churning of jobs and fi rms with the simultaneous destruction of older estab-lished fi rms and creation of new small and often innovative fi rms. Entrepreneurs bring new energy, ideas, technologies and processes that help convert startups into growing fi rms with additional job growth (Barth et al. 2006). As a sign of hope for the future, according to a recent Milken Institute report, “over the last decade, small fi rms [i.e., fi rms with fewer than 500 employees] have provided 60 percent to 80 percent of the net new jobs in the economy ....” (Barth et al., p.1, 2006). In this light, the new fi rms entering the Michigan marketplace not only point the way for additional entrepreneurs to join their ranks, but also hold the hope for signifi cant future job growth.

Organization Category

Overall% change

Number of Employees in the Enterprise Overall

Sector 0 1-4 5 - 9 10 - 19 20 - 99 100 - 499 500+

Finance and Insurance Firms 9.58% 32.87 7.18 13.26 1.63 9.80 16.44 -8.90Establishments 10.14% 33.05 7.10 13.26 0.91 11.41 -3.65 12.55

Prof., Scientifi c, & Tech. Svcs Firms 5.28% 12.16 1.61 5.85 8.22 9.38 25.25 12.00Establishments 7.33% 12.16 1.58 5.50 8.06 11.04 17.27 58.98

Educational Services Firms 6.48% -2.30 4.06 14.01 -1.43 12.46 19.70 15.79Establishments 7.80% -2.30 4.24 14.01 -3.21 5.40 21.05 61.11

Arts, Entertainment, & Rec. Firms 3.13% 15.03 3.47 2.30 -7.67 -8.51 24.53 6.06Establishments 3.44% 15.03 3.47 2.71 -8.31 -8.23 23.29 14.43

Information Firms 2.84% -5.66 12.77 -2.31 -2.44 -10.38 2.20 10.18Establishments 11.72% -5.66 12.77 -3.26 -3.49 0.00 -0.94 25.03

Management of Companies Firms 5.05% 3.70 18.64 40.00 55.17 -0.01 10.90 -2.41Establishments 10.70% 3.70 18.64 40.00 62.07 0.00 11.54 10.62

Manufacturing Firms --7.56% -10.44 2.44 -4.69 -10.25 -16.42 -14.52 -7.56Establishments -7.06% -10.12 2.46 -4.39 -9.86 -15.73 -12.75 -4.14

Table 8. Percentage Changes in Mi. Firms and Establishments, 1998 to 2002, by Employment Size of Enterprise

Source: U.S. Census Bureau, Statistics of U.S. Businesses series. Figures represent the percentage change in fi rms and establishments by size of enterprise, be-tween 1998 and 2002. Green fi gures indicate growth, red fi gures indicate decline.


8

PROFESSIONAL, SCIENTIFIC AND TECHNICAL SERVICES

Although growth in the Professional, Scientifi c and Technical Services sector was generally not as signifi cant at the lower end of the spectrum as was the case in the Finance and Insurance sector, there were large increases at the upper end. For enterprises employing 100 to 499 workers, the number of fi rms grew by 25.2 percent while the number of estab-lishments grew by 17.3 percent between 1998 and 2002. And for those companies with more than 500 workers, the number of fi rms increased by 12 percent while the number of establishments increased by 59 percent.

EDUCATIONAL SERVICES

For the Educational Services sector, growth was found in all segments except for companies employing 0 workers in the March reporting period, and those employing 10 to 19 workers. For compa-nies employing 5 to 9 workers, fi rms and establishments increased by 14 percent between 1998 and 2002. At the same time, the number of fi rms employing 20 to 99 workers grew 12.5 percent while establishments grew by 5.4 percent. And at the top of the spectrum, for those com-panies employing more than 500 workers, the number of fi rms grew by 15.8 percent while establishments grew by 61 percent.

ARTS, ENTERTAINMENT, AND RECREATION

The number of fi rms and establish-ments in the Arts, Entertainment and Recreation sector showed growth across all size categories except for companies employing from 10 to 19 workers and those employing from 20 to 99 workers. Otherwise growth was widespread. For companies employing 1 to 4 workers, the number of fi rms and establishments both grew by 3.5 percent between 1998 and 2002. For companies employing 100 to 499 workers, the number of fi rms

increased by 24.5 percent while establish-ments increased by 23.3 percent. And for those organizations employing more than 500 workers, fi rms increased by 6.1 per-cent while establishments grew by 14.4 percent. Again, while this sector may not provide core knowledge economy em-ployment, entertainment, recreational and cultural attractions are important factors in providing the quality of life desired by highly educated knowledge workers.

MANAGEMENT OF COMPANIES

The number of fi rms employing more than 500 workers fell by 2.4 percent be-tween 1998 and 2002 for enterprises in the Management of Companies sector. Otherwise, growth was robust for enter-prises employing from 1 to 4 workers, with 18.6 percent growth in fi rms and establishments, and for those employing from 5 to 9 workers, where fi rms and establishments both grew by 40 percent. Growth was largest in this sector for enterprises employing 10 to 19 workers, where fi rms increased by 55 percent and establishments increased by 62 percent.

DECLINING SECTORS

Losses in fi rms and establishments be-tween 1998 and 2002 were more wide-spread across the Information sector and were especially widespread in Manufac-turing. Similar to the drop in employment fi gures described above in the Information sector, there were decreases in the number of fi rms and establishments across most of the Information sector size categories, although there were a few bright spots. For instance, for companies employing 1 to 4 workers, the number of fi rms and establishments increased by 12.7 percent between 1998 and 2002. In addition, for companies employing more than 500 workers, the number of fi rms grew by 10.2 percent while establishments increased by 25 percent.

Finally, almost all portions of the Manu-facturing sector suffered cumulative losses,

as shown by the red fi gures in the bottom two rows of Table 8.

SUMMARY OF EMPLOYMENT, FIRMS AND ESTABLISHMENTS FINDINGS

The fi ndings presented above paint a general picture of nascent economic growth in terms of both employment and businesses in the sectors generally described as part of the new economy, even during a period of overall economic decline driven by massive losses in Michigan’s previously dominant manufacturing sector. Although the new economy growth at times has been anemic and halting, with increases followed sometimes by declines, there has been relatively widespread overall growth during the last 10 years.

This picture of growth in new economy sectors despite the huge manufacturing losses should provide a sense of hope and spur confi dence that Michigan is not in a state of total economic meltdown or implosion. Rather, Michigan appears to be in the midst of a wrenching economic transformation, moving from an industrial model, in which great and sustained suc-cess led eventually to bloated bureaucra-cies and expectations, toward a new model of a knowledge economy that requires signifi cantly different foundations and support structures.

Michigan’s Capacity to Reinvent Itself for a 21st Century Economy and Culture

Given the evidence above that Michi-gan’s economy is transforming and diver-sifying itself, we turn next to the question of Michigan’s capacity to continue this transformation and to establish a successful new 21st century knowledge economy.

There is no question that Michigan lags the rest of the country in economic


9

growth. Countless statistics, reports and media articles have described Michigan in a “one state recession” (despite the growth in the new economy sectors). Here the relevant question is whether Michigan has the capacity to pick itself up by its bootstraps and reestablish robust and sus-tainable economic growth based on the requirements for success in a knowledge economy.

Leading analysts have concluded that a primary resource required to successfully create a sustainable knowledge economy is a well educated workforce, or human capital, summed up with the word “tal-ent.” According to Michigan Future, Inc.’s report A New Agenda for a New Michigan, talent is defi ned as “a combination of knowledge, creativity, and entrepreneur-ship” (Michigan Future, Inc., p. iii). Ac-cording to this increasingly dominant line of economic thought, locations “without concentrations of talent will have great diffi culty retaining or attracting knowl-edge-based enterprises, nor are they likely to be the place where new knowledge-based enterprises are created” (Michigan Future, Inc., p. iii).

How does Michigan fare on this front? Is there cause for hope? Although Michi-gan clearly suffers in some areas, there is indeed reason for hope and optimism

about Michigan’s capacity to reinvent it-self economically, as described below.

HUMAN CAPITALWith its history of readily available low-

skill manufacturing employment and a below-average rate of adults with college degrees, Michigan certainly has defi cits in human capital. Compared to the 27 per-cent of the U.S. adult population aged 25 or older with at least a bachelor’s degree in 2004, only 24.6 percent of Michigan-ians aged 25 or more had graduated from college (Michigan Future, Inc. 2006, p. 13). And at least some analysts have argued that Michiganians don’t value education enough, citing the 2005 public opinion survey “Culture of Education” conducted by EPIC-MRA, in which only 54 percent of Michiganians surveyed agreed with the statement “everybody should get a college education” while only 63 percent agreed that “people who have a college educa-tion are usually better off than people who don’t” (EPIC-MRA Your Child Survey 2005).

On the other hand, it seems possible that those respondents do value education in general, while the responses quoted above might reveal beliefs that not all people will succeed in college, or that some people would rather not pursue

higher education because they are simply better suited to low skill/low pay jobs. There is evidence in the same survey to support this view. For instance, 71 percent of Michiganians disagreed with the state-ment that “you can make a decent living with just a high school education.” And 80 percent of respondents disagreed with the statement that “education is useful up to a point, but it’s possible to have too much” (EPIC-MRA Your Child Survey 2005). Furthermore, the EPIC-MRA study was repeated in 2007, at which time 59 percent of parents agreed that everyone should get a college education, up from 54 percent in 2005 (Mrozowksi and Wilkinson 2007). In addition, the most recent U.S. Census data show that more Michiganians are graduating from high school and college than in the past. By 2006, 89.7 percent of Michiganians aged 25 or older had gradu-ated from high school, compared to 88.6 percent a year earlier, while 26.1 percent had graduated from college, compared to 24.6 percent in the previous year (Gon-gwer Michigan Report, March 16, 2007). These statistics seem to belie the argument that Michiganians do not value education, and at a minimum, the data show that Michiganians are moving in the right direction.

Beyond that mixed evidence, Michigan shows strengths in a number of labor force areas, including its science and engineer-ing sector which is a critical component in helping establish high-paying high-tech industries that can form the core of a knowledge economy (see Table 9). Ac-cording to the National Science Founda-tion (NSF) report Science and Engineering Indicators 2006, Michigan ranked 10th in the nation in the number of engineers as a percentage of the state workforce in 2003 (NSF 2006). In terms of individuals in science and engineering occupations as a percentage of the workforce, Michigan ranked 13th in 2003. And the performance levels of these workers was impressive:

Indicator Description RankEmployment in high-tech establishments as a share of total state employment 2

Advanced science and engineering (S&E) degrees as a share of all S&E degrees conferred 8Patents awarded per 1000 individuals in S&E occupations 9

Number of engineers as a share of the state workforce 10Academic patents awarded per 1000 S&E doctorate holders in academia 11

8th grade science profi ciency 118th grade science performance 11

4th grade science profi ciency 11Number of S&E employees as a share of the state workforce 13

Number of bachelor’s degree s in S&E conferred per 1000 18-24 year olds 15Number of S&E graduate students per 1000 24-34 year olds 16

4th grade science performance 17

Table 9. Michigan’s National Rankings

on NSF Science & Engineering Indicators

Source: National Science Foundation, “Science and Engineering Indicators, 2006.”


10

Michigan ranked 11th in academic patents awarded per 1000 science and engineer-ing doctorate holders in academia, and 9th in patents awarded per 1000 individuals in science and engineering occupations. These impressive patent statistics point to a workforce that performs well on in-novation activities, a key component of a knowledge economy.

On another dimension, Michigan ranked 2nd in the nation in terms of employment in high-tech establishments as a percent-age of total state employment. High-tech industries were defi ned as: “those in which the proportion of employees both in research and development and in all technology occupations is at least twice the average proportion for all industries” (NSF 2006, p. 8-83). That NSF report argues that states with a high proportion of high-tech employment “ … are prob-ably well positioned to take advantage of new technological developments because they have a relatively larger pool of expe-rienced high-technology workers” (NSF 2006, p. 8-82). Thus, Michigan appears well positioned to be able to take advan-tage of future technological developments in a high-tech knowledge economy.

As for future generations of employees, it must be noted that the U.S. overall is falling dangerously behind other nations in producing scientists, engineers and mathematicians (Friedman 2005). Still, there are promising signs regarding Mich-igan’s capacity to produce high-skill em-ployees, compared to the nation at large. According to the NSF report, Michigan performs well compared to other states on the following measures: the number of advanced science and engineering (S&E) degrees as a share of all S&E degrees con-ferred in 2003 (Michigan ranks 8th on this measure); the number of bachelor’s degrees in natural sciences and engineer-ing conferred per 1,000 individuals 18-24 years old (Michigan ranks 15th); and the number of S&E graduate students per

1,000 25-34 year olds (Michigan ranks 16th).

Michigan’s current primary students also demonstrate strengths compared to the nation at large, according to the NSF statistics which show that Michigan ranks 11th of the 38 states assessed on both 8th grade science profi ciency (measuring the ability to undertake high school science) and 8th grade science performance (the level of knowledge of the subject mat-ter) using data from 2000. In addition, Michigan’s 4th graders ranked 11th on science profi ciency and 17th on science performance. Other metrics on which Michigan performed above the national average include 4th grade mathematics profi ciency and performance, the share of public high school students taking advanced placement exams, the share of public high school students scoring 3 or higher on at least one advanced place-ment exam, and the number of bachelor’s degrees conferred per 1,000 18 – 24 year olds (NSF 2006).

Although Michigan does not lead the nation in any of these rankings, these data provide reason to believe in the capacity of Michigan’s youth compared to their counterparts around the country. Em-ployers looking at these data would see a base of math, science and engineering tal-ent that compares favorably to other states around the nation.

INNOVATION, RESEARCH AND DEVELOPMENT

Beyond looking at tomorrow’s work-ers, there are also positive signs based on the current status of innovation, research and development activity in the state. Michigan today has a strong foundation of research and development (R&D) activity, a promising indicator of the state’s capac-ity to reinvent itself and move toward a knowledge economy. For instance, even as the state’s manufacturing capacity has withered, at the same time Michigan has

become the “world center of automotive research and design” (Drake 2006, p. 11).

The Corporation for Enterprise Devel-opment (CFED) produces an annual re-port entitled the Development Report Card for the States, assessing business perfor-mance, business vitality, and development capacity (the capacity for future economic development). According to the CFED report, Michigan ranks 18th in terms of “innovation assets” which includes factors such as the number of scientists and en-gineers employed and in school, internet accessibility, research and development expenditures, Small Business Innova-tion Research Grants, patents issued, and businesses created via technology transfer from universities. When looking in more detail at the report indicators, Michigan ranks 4th in the nation in the amount of privately funded R&D expenditures, generally associated with larger corporate activities. Other promising signs from the CFED report show Michigan ranked 9th in terms of royalties and licenses in gross license income per worker for 2003, a measure of university-based research ac-

Indicator RankInnovation activity 4

Venture capital 6Industry density 6

Research activity 8

Table 11. Michigan’s Rankings on

Micro- and Nanotechnology

Industry Indices

Source: Smalltimes Magazine.

Indicator RankPrivately funded R&D activities 4

Gross license income per worker 9Patents per million residents 12

Innovation assets 18

Table 10. Michigan’s Rankings

on the Development Report Card

for the States

Source: Corporation for Enterprise Development, “2007 Development Report Card for the States.”


11

tivity, and 12th in terms of patents issued per 1 million residents in 2005, a measure of a state’s innovation capacity (CFED 2007). Each of these indicators provides a glimpse into the culture and the economic context defi ning Michigan’s capacity for establishing a knowledge economy, where factors like education and innovation are critical.

In the micro- and nanotechnology in-dustries, among the most innovative and promising fronts for developing break-through technologies, Michigan scores particularly well compared to other states, as seen in Table 11. According to Small-times, a leading trade publication for the micro- and nanotechnology industries, Michigan ranks 8th in research activity, 6th in industry density, 6th in venture capital, and 4th in terms of innovation activity (Forman 2007). With future ap-plications in numerous core areas of the knowledge economy, from medicine to national security to energy and advanced manufacturing, nanotechnology holds

the promise of provid-ing enormous economic impact. Michigan is well positioned to ride that future wave to success in a new economy.

The NSF data also con-fi rm Michigan’s strengths in R&D activities, dis-played in Table 12. Accord-ing to NSF’s 2006 report,

Michigan ranks number 1 in terms of industry performed R&D as a percentage of private-industry output for 2003, num-ber 2 in terms of total R&D expenditures from all funding sources, and number 9 for R&D performed by universities and colleges. In order to get a more standard-ized state comparison that controls for factors like population size, geographic size, natural resources, etc., NSF also cal-culates a measure of “R&D intensity” by dividing total R&D expenditures by gross state product. For 2003, Michigan ranked 4th in the nation in terms of R&D inten-sity (NSF 2006).

As shown in Table 13, Michigan also scores well on a number of metrics in a new report from the Information Tech-nology and Innovation Foundation (ITIF) (Atkinson and Correa 2007) entitled The 2007 State New Economy Index. Michigan’s state government leads the way, rank-ing number 1 in online e-government services. According to the ITIF report, “State governments that fully embrace the potential of networked information technologies will not only increase the quality and cut the costs of government services, but also help to foster broader use of information technologies among residents and businesses.” (Atkinson and Correa 2007, p. 42). In terms of overall innovation capacity, measuring things like high-tech industries, science and engineering employment, patents, R&D activity and venture capital, Michigan ranks 16th, well above the national aver-

age. Michigan scores particularly well in the trend regarding high-tech jobs as a percentage of all jobs, where the state has moved up from a rank of 35th in 2002 to 20th in 2007, the second highest rate of positive change in the nation. Other met-rics on which the state scores above the national average include knowledge jobs (Michigan ranks 17th), managerial, pro-fessional and technical jobs (11th), foreign direct investment (10th) and immigration of knowledge workers (6th) (Atkinson and Correa 2007).

For the overall summary score on the new economy index, Michigan ranks 19th. Importantly, this 2007 score shows a signifi cant positive trend, with Michigan moving up from a rank of 34th in 1999 and 22nd in 2002 (Atkinson and Correa 2007). In terms of growing a new econ-omy, the ITIF assessment shows Michigan on a positive path with forward momen-tum, despite the enormous losses in the automotive and manufacturing sectors. Again, these indicators point to economic transformation, not economic implosion.

ENTREPRENEURIALISM Michigan is not yet an entrepreneurial

state, as the ITIF report shows by ranking the state 40th on overall entrepreneurial activity (ITIF 2007). There are signs, how-ever, of movement in the right direction.

The Corporation for Enterprise De-velopment (CFED) surprisingly ranks Michigan fi rst out of the 50 states in job creation by startup businesses for the pe-riod 2002-2003 (CFED 2007). According to the report, this particular indicator “… gives a picture of the infl uence of local entrepreneurs on a state economy through the creation of new jobs” (CFED 2007).

Indicator Description RankE-government services 1

Immigration of knowledge workers 6Foreign direct investment 10

Managerial, professional and technical jobs 11Innovation capacity 16

Knowledge jobs 17Overall score, New Economy Index 19

Table 13. Michigan’s Rankings on the

2007 State New Economy Indices

Source: Information Technology and Innovation Founda-tion, “The 2007 State New Economy Index.”

Michigan ranks 1st in jobs created by startup businesses during 2002-2003

Indicator RankIndustry performed R&D as a share of private industry output 1

Total R&D expenditures from all funding sources 2R&D intensity (R&D expenditures as a share of gross state product) 4

R&D performed by universities and colleges 9

Table 12. Michigan’s Rankings on Research and

Development Activities and Expenditures

Source: National Science Foundation, “Science and Engineering Indicators, 2006.”


12

For its overall entrepreneurial index score, CFED ranks Michigan 24th, signfi cantly better than the ITIF report. In addition, and confi rming the data reported above regarding positive growth in the number of small fi rms, a related CFED indica-tor measures the percentage change in the number of new companies created per 100 workers over a 5 year period of time, to gauge trends in entrepreneurial activity. Using this data from the period 2000 through 2005, the CFED report ranks Michigan number 13 in terms of these new business startups. This is clearly evidence of improving entrepreneurial activity, refuting the accepted view of Michigan as a lethargic and hulking eco-nomic has-been.

SummaryThis report is not intended to argue that

Michigan’s economy is in good shape or that it will be in good shape soon. There is no question that the direct and indi-rect job losses resulting from the Big 3’s decreased automotive market share have devastated Michigan’s economy. Nor is there a question that these problems will persist for years to come. Policymakers and the public will continue grappling with the effects of additional manufactur-ing job losses over the coming years.

In addition, there are numerous other problems facing the state, including too little venture capital, too many young talented citizens moving away, and dys-functional state government that has taken far too long to enact reforms or taxes for investing in the state’s future, thereby contributing to the sense of eco-nomic crises in communities throughout the state. Numerous recent reports have offered policy recommendations for many of these problems, and so this report is not intended to repeat those prescriptions.

The intent of this report is to argue that descriptions of Michigan’s economy as imploding are inaccurate and counter-

Regents of the University of Michigan Julia Donovan Darlow, Ann Arbor; Laurence B. Deitch, Bingham Farms; Olivia P. Maynard, Goodrich; Rebecca McGowan, Ann Arbor; Andrea Fischer Newman, Ann Arbor; Andrew C. Richner, Grosse Pointe Park; S. Martin Taylor, Grosse Pointe Farms; Katherine E. White, Ann Arbor; Mary Sue Coleman (ex offi cio)

Contact Information

Center for Local, State, and Urban PolicyGerald R. Ford School of Public Policy

University of Michigan

Joan and Sanford Weill Hall, Suite 5310

735 South State Street

Ann Arbor, MI 48109-3091

734-647-4091 (phone)

734-615-5389 (fax)

http://closup.umich.edu

[email protected]

Paul N. Courant, Director

Thomas Ivacko, Program Manager

Stephanie James, Sr. Administrative Asst.

productive. In place of those one-sided descriptions of an economic meltdown, this report presents evidence that Mich-igan’s economy is in a period of historic transformation, with nascent growth of a new economy occurring alongside the enormous losses from the decay of the old system. Michigan is undergoing economic diversifi cation during a period of transi-tion from a dying economic model to an emerging one.

If the way forward to a new economy requires talent, entrepreneurialism, inno-vation, risk-taking, and a more educated workforce, then focusing only on negative news will hinder the state’s ability to take the positive steps required to reach that brighter future. The sense of gloom has to be overcome. The self-image of a rust-belt wasteland has to be replaced by a more complete view of a state in transition. The new economy requires vision, optimism and hope. If Michiganians are to move the state forward, we must fi nd a way to motivate and inspire ourselves. This report is intended to provide a step on that path, by highlighting the new economy growth that is already occurring, as well as the state’s capacity to continue and expand that growth.

Works CitedAtkinson, Robert D., and Daniel K. Correa. 2007. “The 2007 State New Economy Index.” Washington D.C.: Information Technology and Innovation Foundation.

Barth, James R., Glenn Yago, and Betsy Zeidman. 2006. “Barriers to Entrepreneurship in Emerging Domestic Markets: Analysis and Recommendations.” Santa Monica, CA: The Milken Institute.

Bartik, Timothy, George Erickcek, Wei-Jang Huang, and Brad Watts. 2006. “Michigan’s Economic Compet-itiveness and Public Policy.” Kalamazoo, MI: The W.E. Upjohn Institute for Employment Research.

Corporation for Enterprise Development. 2007. Development Report Card for the States. http://www.cfed.org/go/drc.

Drake, Douglas C. 2006. “A Look at Michigan’s Emerg-ing New Economy.” Lansing, MI: Public Policy Associ-ates, Inc.

EPIC-MRA, Inc. 2005. “Your Child Survey: Michigan Parents, Culture of Education.” http://www.yourchild-michigan.org/studyIII.

Forman, David. 2007. “State Rankings.” SmallTimes Magazine. http://www.smalltimes.com.

Friedman, Thomas L. 2005. The World is Flat: A Brief History of the Twenty-fi rst Century. New York: Farrar, Straus and Giroux.

Gongwer News Service, Inc. 2007. Michigan Report March 16. http://www.gongwer.com.

Hollins III, Harvey, Steven M. Webster, and Cynthia Wilbanks. 2006. “What Michigan Needs to Compete.” University Research Corridor, Michigan State Univer-sity, University of Michigan, Wayne State University.http://www.urcmich.org.

Johnson, Dana. 2006. “Darkest Before the Dawn.” Michigan Brief 2006 No. 4. http://www.comerica.com/Comerica_Content/Corporate_Communications/Docs/MichiganEconomicBrief_2006_04.PDF.

Michigan Future, Inc. 2006. “A New Agenda for a New Michigan.” http://www.michiganfuture.org.

Mrozowksi, Jennifer, and Mike Wilkinson. 2007. “More Michigan Parents See College as Essential.” Detroit News, April 17. http://detnews.com/apps/pbcs.dll/article?AID=/20070417/SCHOOLS/704170465.

National Science Board. 2006. Science and Engineer-ing Indicators 2006. Two volumes. Arlington, VA: National Science Foundation (volume 1, NSB 06-01; volume 2, NSB 06-01A).

Plante and Moran, LLC. 2007. Great Lakes Strengths: A Time for Real Regional Growth. http://www.plantemo-ran.com/greatlakes.

Schmid, John. 2006. “Upper Midwest ‘Needs’ a Future.” Milwaukee Journal Sentinel JSOnline, Octo-ber 22. http://www.jsonline.com/story/index.aspx?id=521745.

Schumpeter, Joseph. 1975. “Capitalism, Socialism, and Democracy.” New York: Harper.

Credit Unions prosper as business loans rise - Business Impact - MLive.com http://blog.mlive.com/business_impact/2008/03/credit_unions_prosper_...

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Credit Unions prosper as business loans risePosted by Pamela A. Zinkosky | Ann Arbor Business Review March 13, 2008 03:28AM

Ten years ago, credit unions primarily dealt in savings and checking accounts supplemented with personal auto and home loans.

Business loans were left to banks.

That has changed. Many Michigan credit unions are not only providing business loans, but actively marketing them. Some credit unions' business lending numbers are nearing their caps - 12.25 percent of assets, per 1998 legislation.

The shift is in part because select credit unions are marketing themselves as commercial lenders - and also because these nonprofit, member-owned banking alternatives are attractive to many small-business owners.

"The reason that credit unions are doing well is because they are more relevant now," said David Adams, president and CEO of the Michigan Credit Union League.

Customers seek lower-cost options and better value when money is tight, Adams said.

"They're looking for value and no-nonsense service. The credit union model puts service and value first."

There are 88 million credit union members nationwide, and that number grows 2 percent to 3 percent annually, Adams said. In Michigan, there are 4.4 million members - one of the highest state penetration ratios, with 42 percent of the population belonging to a credit union.

The state's tough economy and the number of manufacturing jobs with middle class workers makes credit unions attractive, Adams said.

Adams compared Michigan's once-largest bank, Comerica, with its largest credit union, DFCU Financial. Whereas Comerica relocated itsheadquarters to Texas last year, Dearborn-based DFCU in 2007 paid out a record $17 million in patronage dividends. Members received checks averaging a half-percent of their savings or loan balances.

Troy-based Michigan Catholic Credit Union, with about 32,000 members and $229 million in assets, increased its business lending 200 percent to about $12 million over the last couple of years. MCCU is one of eight owners in the Commercial Alliance credit union service organization. The organization lets multiple credit unions finance loans and share the risk.

Jim Schram, MCCU vice president of business development, is the liaison between the credit union and Commercial Alliance. "Big box banks have left a substantial group of business people that are barely considered small business," many of which turn to credit unions for financing, he said.

Through Commercial Alliance, credit union owners can better manage the risk that comes with commercial lending, Schram said. In a $1 million deal, "we'll keep $400,000 and the rest will be shopped out," he said. Other credit unions that are part-owners or affiliates of Commercial Alliance bid for their part of the deal, he said.

Credit union service organizations provide a buffer for lending risk. In 2004, Ann Arbor-based MidWest Financial partnered with other credit unions to pool risk through Michigan Business Connection.

"We were interested in doing commercial lending, but we needed to do it well," said Mike Stevens, MidWest president and CEO. "So we decided to bring someone in who knows how to do this."

Michigan's economy still provides business lending opportunities, Stevens said. MidWest recently financed a $12 million deal for a cardiovascular surgery unit. "We probably wouldn't have seen that a year ago," he said. "We were able to step in because of the current turmoil in the market."

Like Commercial Alliance, Michigan Business Connection handles the commercial loan process and allows credit unions to share the risk, but MCCU is active in seeking loan customers, Schram said.

Schram does cold calls to obtain business loans, and tellers at MCCU's eight branches canvas for potential loan customers and refer them to Schram, he said.

Credit Unions prosper as business loans rise - Business Impact - MLive.com http://blog.mlive.com/business_impact/2008/03/credit_unions_prosper_...

2 of 2 4/10/2008 10:40 AM

But not all credit unions are jumping on the business lending bandwagon. "Credit unions are either all in or they want no part of them," Schram said.

DFCU, the $1.8 billion asset credit union that last year paid out record patronage dividends, made no new business loans in 2007, and only one in 2006, according to data from the National Credit Union Administration.

MCCU's legal business lending limit is $24 million, or 12.25 percent of its assets, and the loans are at about half that now, Schram said.

MidWest can lend only about $10 million more than it already has lent, said Stevens.

If a proposed federal Credit Union Regulatory Improvements Act passes, credit unions' lending limit will be raised to 20 percent of assets,and loans under $100,000 won't count towards that limit.

Many banks view the legislation as an unfair advantage, because credit unions pay no taxes as nonprofit entities, but Adams disagrees with that viewpoint. Credit unions hold only 15 percent of deposits in Michigan and 6 percent nationwide, Adams said. Credit unions hold only 1 percent of Michigan commercial loans. The number would increase slightly with higher lending limits, but that's just good market competition, he said.

"We don't think credit unions pose a threat to banks," Adams said. "It's important to have a vibrant for-profit sector and also a nonprofit sector. We've never been a threat and are still not a threat."

There are trade-offs in how credit unions and banks are structured, Adams said. "Any bank can convert to a credit union, and any credit union can convert to a bank. When banks point out our supposed unfair advantage, we say, 'Why don't you convert to a credit union?'"

Mergers among credit unions these days are as common as they have been among banks. There are currently 226 state-chartered credit unions, compared to 234 at the end of last year. The number of credit unions decreases by 4 percent to 5 percent each year, Adams said.

Like banks, credit unions are finding it necessary to merge for better market share and economies of scale. MCCU merged twice in 2007 -with Lansing Area Catholic Credit Union in January and Member's Choice of Redford in November. "We continue to look for mergers," Schram said. "That's a way to grow."

Credit unions are poised to prosper, Adams said. They're well-capitalized, they operate conservatively and they do a good job of taking care of their risks, he said.

"As banks get bigger, credit unions look better," he said. "Credit unions will always be much smaller and much more personable."

Pamela A. Zinkosky is a freelance writer.

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