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10.11.99  
The Pot of Gold on the Other Side of the Tracks
Harvard's Michael Porter explains why inner-city entrepreneurs are a great investment

Professor Michael Porter

Prof. Michael Porter

Inner-city businesses know about fair-weather friends. During election years, the rigors they face -- poor infrastructure, discrimination from lenders, lack of access to markets -- get lots of promises from politicians, corporations, and institutions, who vanish come a downturn. Lately, struggling urban entrepreneurs have become a cause celebre again, with President Bill Clinton and others preaching the need to share the fruits of the New Economy.

Michael Porter, C.Roland Christensen Professor of Business Administration at Harvard Business School and an authority on competitiveness, contends the do-gooders are missing the point: With the right support, inner-city businesses can be excellent financial investments. In 1994, he founded the Initiative for a Competitive Inner City, a private program devoted to bringing management and investment to entrepreneurs in Boston, Baltimore, Oakland, and Kansas City. Now, Porter and New York-based American Securities Capital Partners are starting the Inner City Ventures Fund, which will invest in businesses with strong potential for growth in distressed urban cores. They plan to raise between $100 million and $150 million and will start making investments within the next 12 months.

Porter spoke with Business Week Online's Jeremy Quittner about the fund and the outlook for businesses in U.S. inner cities. An edited transcript follows:

Q: What is the goal of ICIC?
A:
[Instead of] social programs and trying to redistribute income, I believe that the only way we can address the problems of the disadvantaged in the U.S. is to help our disadvantaged communities actually succeed in the market system. The problem is not going to be jobs. The demographics we have now are going to lead to tight labor markets for the forseeable future. I think the real issue is income and wealth. How can we create opportunities for all of our citizens to really be part of the American Dream?

Q: Is this a public-private partnership?
A:
I founded the ICIC because I felt that the private sector needed to take this agenda on. So our principal support has been from corporations, corporate foundations, entrepreneurs, and wealthy individuals.

Q: What is the point of the fund?
A:
We believe that the problem today in inner cities is really equity capital because of the limited wealth [there]. Private-equity investors, by and large, have ignored this opportunity.

Q: How much are you trying to raise? What kind of returns on investment are you looking for?
A:
We are targeting $100 million. I think we should be able to go up to $150 million. Its objective is to make high returns. We are telling our investors that 30% is our hope.

Q: How are you going to get 30% returns?
A:
The same way other types of equity investors have earned those returns elsewhere in the economy. With equity capital, you can accelerate the growth process and also upgrade the capacity of management in a way that will allow them to move to the next level.

Q: What kinds of businesses are you looking at specifically?
A:
We will be looking for companies that need $5 million to $10 million, especially companies that have minority ownership and management. A lot of them are business-services companies. Things like information-technology related services, printing, publishing, repair, and maintenance. We also see some manufacturing companies, some technology companies. They will almost never be startups. The philosophy of the fund is [to bet on] going concerns that in general will be profitable. They have much less risk.

Q: How will you get significant returns? Venture-capital firms put tremendous pressures on businesses to generate returns quickly. Can these businesses live up to that?
A:
This is not a venture-capital fund. Our partner, American Securities, has the philosophy of keeping money in the companies for three to six years. If you're in the Internet startup world, you have nine failures for every one success. This is a fund that is going to pick 10 growth companies. The goal is all of them will be at least moderately successful.

Q: The talk about the potential in inner cities coincides with a period when assets are expensive. Is the inner city just seen as a bargain?
A:
The inner cities are really the last pools of underemployed workers. The growth rate of the workforce is forecast to be less than 1%. You have companies moving into urban cores because that is the best place to access workers that they can retain. This is going to be an enduring trend. It is not just a business cycle.

Q: Does that mean large corporations turning inner cities into malls or fostering small businesses as well?
A:
In the past, mayors have tried essentially to bribe large companies to put plants in the inner cities. That is what empowerment zones are all about. That is what all these tax subsidies are all about. We believe the right strategy is to help improve the business environment and to help large companies realize that the inner city could be a good location. More than that, it is to create an environment where all little companies in these areas can start to grow more robustly.

Q: How do you get beyond the boom and bust cycles with the inner city?
A:
If the inner city is a place where [large companies] locate businesses out of social conscience, that leads to boom and bust because -- of course -- when things get bad, those are the first plants to be closed and the first jobs to get cut. If you think of the inner cities as a place where there is a real economic opportunity, then you get away from boom and bust.

Q: What do you mean by "inner-city business?" Is that a code word for black and Hispanic?
A:
We mean one that is actually based in and employs from these communities. We are particularly anxious to support companies with minority ownership. But we also believe that white-owned businesses in inner cities that employ inner-city residents are a very good thing as well.

Q: You said that debt capital is not really a problem. Yet we hear over and over again that minority entrepreneurs have trouble getting loans.
A:
We have found that because of the [Community Reinvestment Act] and because many communities have set up loan funds of various types, any business that is really creditworthy, has a business plan, and is profitable can get financing. We don't see that as nearly so great a problem as equity capital.

Q: Clinton and Gore have declared their interest in the inner cities. What if we have a Republican administration?
A:
: I would simply say that Governor [George W.] Bush, a former student of mine, is riveted on this issue. Both parties and both candidates will be talking about this in this new way. There is a sea-change in thinking about our distressed communities, and it could not be more overdue.


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