Kentucky Highlands Investment Corporation:
An Experienced Fund Sponsor

By L. Ray Moncrief, Executive Vice President and Chief Operating Officer,
Kentucky Highlands Investment Corp.

The Kentucky Highlands Investment Corporation’s (KHIC) three-decade long track record of success in the community development venture capital (CDVC) line of business has demonstrated that it is possible to profit from investments that promote job and wealth creation in poverty-stricken regions, such as Southern Appalachia.

KHIC’s target market is a hilly, 22-county rural Appalachian area that has only four population centers with more than 5,000 residents. Its good highways, loyal employees, and low cost of living offset the area’s challenges of chronically high rates of poverty and unemployment.

Like most of rural America, Appalachia is not an area to which large venture capital firms are typically drawn. Currently, less than one percent of private equity raised through venture capital firms is invested in rural markets. Interestingly, traditional venture capital firms do invest in KHIC, which they view as a conduit to a market that they find difficult to enter because of its remote location.

KHIC is proud of its track record using CDVC for job creation and economic development.  It has created or retained more than 10,300 jobs by investing in 455 businesses, including 168 farm-related recipients and industries.  KHIC has been a vibrant catalyst for change in its target area.  Its investment portfolio produces annual sales revenues of $1.1 billion and annual wages of $120 million.  

KHIC began its mission as Job Start Corporation, founded in London, Kentucky as part of President Johnson’s War on Poverty. Its focus on promoting, initiating, and coordinating community, economic and social development efforts got a boost when KHIC created one of the first CDVC funds in 1976.

Today, KHIC’s operational funds include Meritus Ventures (a $36.4 million Rural Business Investment Corporation), the Southern Appalachian Fund (a $12.5 million New Markets Venture Capital Fund), and Mountain Ventures, Inc. (a $8.5 million debenture Small Business Investment Company).

Both Meritus and SAF funds invest in early, and expansion-stage companies in the areas of specialized manufacturing, technology, life sciences, distribution, service, and healthcare industries that have strong entrepreneurial teams capable of leading substantial growth in three to five years.  The investments are in the form of convertible preferred stock. Mountain Ventures provides both debt and equity financing for similar companies, but not in the form of preferred stock.  All three funds may be a sole investor but most likely will lead an investment syndicate or co-invest in a round led by another institutional investor. 

Double Bottom Line Returns

KHIC and other CDVC funds can be valuable community development partners to banks in two ways. First, we offer a direct investment opportunity. Some banks may be reluctant to invest in a CDVC fund because they believe that returns on socially relevant investments are inherently small or that the minimum investment is too large.

In reality, KHIC’s minimum investment is $100,000. And, over the last 20 years, KHIC has posted an internal rate of return approaching 20 percent. While that’s only about half of the return traditional venture capital firms typically aspire to, banks that invest in KHIC may also be eligible for Community Reinvestment Act (CRA) consideration.

Another common concern about CDVC funds is that they do not pay any returns for long periods. While KHIC has created a 10-year limited partnership with two, one-year extensions, the structure does not preclude a bank from receiving returns for a dozen years. Each investment KHIC makes in local companies includes an exit strategy, and it is common for our funds to start returning cash within three years, or even earlier.

For example, in 2005, SAF invested in Eon Streams, Inc. and exited 14 months later, providing a 260 percent rate of return, and creating a gain that we passed along to our limited partners. Not all of the companies in which KHIC, SAF, Meritus or Mountain Ventures invests exit that quickly, nor do they typically provide such significant gains.

The second way that KHIC participates with banks occurs later in the business cycle of the companies in which we invest. It is our hope that institutions that do not participate as direct investors will agree to follow up with hard asset and building equipment financing for the businesses whose growth has been nurtured by KHIC.

KHIC’s Unique Role

KHIC deploys a range of investment instruments that help start-up and expanding companies provide jobs to chronically poverty-stricken Appalachian east Kentucky, including equity investment, subordinated debt, term loans for real estate and equipment, revolving lines of credit, and micro loans. 

In addition to fiscal support, KHIC supplies business assistance that most entrepreneurs could neither obtain nor afford. KHIC provides management assistance in the areas of finance, systems analysis, personnel recruitment, training, accounting, cash management, and financial restructuring.  Its staff also has skills in negotiation with both secured and unsecured creditors and local governments and offers management assistance in troubled situations, as well as technical support to troubled IT projects.

This level of support is vital to smaller enterprises in rural Appalachia, where low population densities often make enterprise operations more costly and negatively affect productivity.  These challenges create disadvantages for struggling entrepreneurs as they try to attract workers with skills important to today’s knowledge-based economy. 

KHIC tailors its operational assistance to meet the specific needs of each individual company, which may include activities, such as investing in the preparation of business plans, development of marketing strategies, creation of Internet and Web site capabilities, supporting the establishment of accounting systems, providing technical assistance to optimize a production process, management recruitment, and legal advice on preservation of intellectual property.  The funds can provide some of the services to the companies and  contract with appropriate professionals to provide these services when they are not qualified to do so. 

A Winning Combination

With the right support, the companies capitalized by KHIC’s funds not only grow, they thrive. One such firm, Tricycle, Inc., Chattanooga, Tennessee, earned a 2006 Excellence Award from the Community Development Venture Capital Alliance for its innovative human initiatives; creation of sustainable, quality jobs; significant progress toward its financial goals; performance in the marketplace; and outstanding management capacity.

Tricycle’s business is both unique and specialized. The company serves the commercial carpet industry, in particular the high-end market for carpets designed by decorators and interior designers. The company’s idea was an innovation that replaced the then-current practice of having carpet manufacturers make actual samples of the interior floor coverings drawn by designers. The innovation Tricycle brought to this industry was the use of technology to create a paper carpet sample that mimics the color and texture of an actual carpet sample. In 2005, Tricycle’s digital carpet modeling services helped interior product manufacturers conserve 9,425 gallons of oil, kept 56,500 pounds of carpet out of landfills, and saved more than $5 million.

Another example of KHIC’s success is Cumberland Gap Provision Company, Middlesboro, Kentucky. Founded in 1979 by Ray McGregor to produce the wonderfully tasty local cured hams, Cumberland Gap turned to KHIC in 1991 when it needed help developing an employee-owned company. At that time, KHIC also invested equity in Cumberland.

In 1996, the company repurchased KHIC’s stock, but KHIC continued its involvement in the expansion of the company through a grant from the Office of Community Services to expand Cumberland Gap’s operation.  In 2003, Smithfield Foods purchased Cumberland Gap. Today, Cumberland makes products under its own label, as well as for a number of nationally recognized brands, and employs 320 people in a facility that has been expanded four times and is now more than 100,000 square feet.

Repeatedly, where banks have come to the table and taken a chance on a community business that has private equity supplied by KHIC, the results have been positive. Many of the companies KHIC has invested in during the past three decades are still in business – hiring employees who turn those dollars over in the local community purchasing and financing autos and homes.

Years Ahead

The investments of KHIC’s CDVC will continue to have a direct impact on economically disadvantaged communities and people in Appalachia for years to come. 

Investment in low-income areas provides job and wealth creation for entrepreneurs, communities, and investors.  The financial support and development services help small businesses grow and reach a level of financial sustainability.  The investment in companies and people leverages other community development efforts and creates an environment where entrepreneurship will thrive.  KHIC was implementing the double bottom-line theory before there was a name for what it was doing, Community Development Venture Capital.

It is our hope that banks will become comfortable getting off the sidelines, suiting up, and playing on our field. When institutions join in our efforts, local businesses, and economies and therefore local banks, can all end up as winners.

For more information contact Ray Moncrief at: (606) 864-5175 or lrmoncrief@khic.org.