The biggest differences between typical venture funds and those with a stated community mission are the size and location of the investments.

However, one of the key advantages in focusing on overlooked areas—less competition—also presents one of its significant challenges: Funds often struggle to find talent. Kip Moore, a former partner at a New York–based firm, now lives in Maine, where he invests in a fund run by Portland-based CEI Ventures. Half-joking, he notes that a company must find either a homesick Maine native or someone with a passion for sailing (a big pastime in the "vacationland" state).

Returning capital presents another challenge in less liquid markets. High-tech companies in Silicon Valley offer clear exit paths for investors through IPOs or acquisitions. A low-skilled manufacturing company in small-town West Virginia doesn’t present the same options. (One exception: The market currently favors companies pursuing clean-energy innovations.) Strategic buyers acquire many of the companies even if they are not located nearby, and private equity firms may take over a maturing company in order to grow it to the point where there are more liquidity options. In rare cases, employees buy out a company.

Picking a Winner
It is still too early to fully assess the results of community development venture capital funds. Most of the 10-year funds have not completed their investments, and most managers have only closed one or two funds to date. "To some extent, the jury is still out," admits the CDVCA’s Tesdell.

Yet the performance so far shows attractive returns. A composite portfolio of first-generation community development venture capital funds produced a 15.5 percent internal rate of return (IRR), Tesdell says. This compares to a 21 percent average annualized gain for traditional VC firms over 10 years through August, according to Thomson Financial and the National Venture Capital Association. (No special tax breaks accrue to investors to offset the difference.)

"Do I expect those kinds of returns? The answer is yes. Will I be terribly upset if they don’t get that level of return? No. They get a little bit of a lower bar because they do demonstrate this social return," says Sunil Paul, who has invested six figures with Pacific Community Ventures.

But fund managers and investors anticipate that second-generation funds will outperform the first as managers become more experienced in satisfying a commitment to the first and second bottom lines. This might even mean passing on deals that would be good for a community but not for investors. When CEI Ventures closed its first fund in 1996, its top managers had backgrounds in business and finance, but little venture capital experience. Nat Henshaw, CEI’s president, concedes that his first fund of $5.54 million "is not blowing the cover off the vault; it’s looking like a small, single-digit IRR." However, the $20 million second fund, which closed in 2001, has returned 24 percent of capital so far.