“The result is a very conservative investment that fleshes out and stabilizes a portfolio,” Agriculture Secretary Tom Vilsack said in an interview before the conference. At the moment, with interests rates so low, even those pokey yields can look attractive to an institutional investor, he argued. “So this is an opportunity for them to actually ramp up their income.”
It’s a strategy that America’s cities have long embraced: Attracting private capital to finance public goods, because the government doesn’t have the cash up front to get them built. In rural areas, however, the USDA — which, if it were a bank, would rank among the nation’s largest — has customarily taken care of those needs through a liberal sprinkling of grants and loans.
There’s less money for that kind of thing to go around these days, and in the absence of a large-scale federal infrastructure program, the backlog of needed upgrades and new facilities is immense. Start-up businesses, meanwhile, have a hard time getting off the ground without access to the kind of capital available in big cities on the coasts.
So the federal government is asking private sector types to step into the breach, and trying to ease their way. Historically, it's been difficult for Wall Street and Silicon Valley to see that far into these markets, which haven’t been primed to take their cash; agricultural lenders tend to operate far differently from that of VCs and big-time investors.
“There is a cultural dissonance between where the debt and equity capital communities of our nation are and where the USDA sits,” said Charles Fluharty, president of the Rural Policy Research Institute. Part of the problem is that each opportunity is too small, requiring individualized attention, rather than a pile of money all at once (like a large urban transit system might require, for example).
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“Most of those entities need several more zeroes behind their deals than most rural regions can put together on their own,” Fluharty said. "This is an effort to get past that.”
The strategy has two main components: Construction projects and small businesses.
The first part of the strategy tries to tackle the problem of luring funding for smaller, high-growth companies in rural areas. They tend to escape the attention of venture capitalists who have plenty of startups to choose from in their own backyards.
“It is not a market that has attracted lots of attention, and I think that the geography is one of the challenges. It’s tough to get to a bunch of different deals,” said Scott Murphy, chief investment officer with Advantage Capital.
To that end, USDA sanctioned a new kind of investment vehicle that can help the heavily-regulated farm credit system channel money with private investors into rural businesses. Advantage Capital runs one of those new entities, called a “Rural Business Investment Company,” and has thus far done three deals. "You have to take a different approach to make this work,” Murphy said. "That’s why it’s necessary for us to do a little cheerleading.”
The second component is meant to help with those facility and infrastructure improvements. This past year, the USDA helped line up needy projects for a private fund managed by Capitol Peak Asset Management, which says it’s found lots of enthusiasm for the prospect of taking over where the government comes up short.
“Investors are incredibly intrigued and excited about the prospect of entirely new markets opening to them,” said Leo Tilman, Capitol Peak’s executive chairman. “Markets that used to be largely financed by federal, state, and local governments now are available to them through rigorously designed investment products.”
The first batch of projects includes university student housing in Mansfield, Pa., a Montessori school in Carbondale, Co., and a daycare facility in Canton., Miss., along with an ambulance storage facility, two hospitals, five nursing homes and eleven water projects. Capitol Peak says it has a long waiting list of projects under review, from energy to transportation to waste.
Over the long term, Capitol Peak hopes to develop a way to bundle and securitize these projects, to make them more attractive places for institutional investors to park hundreds of millions of dollars at once without dealing with the particularities of individual small towns. But starting now, to get the funding, local leaders need to learn that the federal government won’t always be there for them.
“A lot of those organizations are willing to wait years until they can get on the USDA grant list. They’ll run it right to the edge,” said Bob Engel, chief executive of Cobank, which is serving as an anchor investor in the fund. "Now USDA has to send a message — 'don’t sit and wait, because you might not get it.' ”
It’s that second part of the strategy that might make some rural communities a little nervous: Taking private money means that your infrastructure project has to generate a revenue stream for shareholders, rather than just pay itself back, as it would have under direct government financing.
“If I’m the public entity — that hospital or school — I want the lowest cost of capital for the funds that I need to build whatever I’m building,” said Thomas Adamek of Stonehenge Capital. “And the lowest cost of capital will always come from the public sector. To the extent that public sector money is available, I would want to use it.”
In the absence of taxpayer dollars, in order to make the project happen at all, local leaders would have to offer private investors an attractive return on their investment. That means a water infrastructure upgrade — for example — might require slightly higher fees in order to pay them off.
“A part of the reason that these types of projects are attractive to the private sector is because the demand is constant, and there might be less price elasticity around something like water,” said Justin Marlowe, a professor of public finance at the University of Washington. “If you can gradually increase the rate users are paying, that becomes that much more of a steady, predictable revenue stream."
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In some cases, Marlowe said, a private entity might also seek efficiencies through making a facility run with fewer people, which could take some jobs out of the community.
Vilsack argued that in today’s funding environment, with the sheer volume of infrastructure investment that’s needed, bringing in private investors for projects that can pay for themselves is the best way to preserve money for those that often can’t, like rural broadband and electricity. Besides, he said, this isn’t the kind of “privatization” that’s gotten a bad rap in cities for jacking up rates on thing like parking meters; loaning money isn’t the same thing as owning or leasing a whole piece of public infrastructure.
And Engel said that when Cobank is in a deal, it will try to make sure the deals work well for rural communities. “We know these people in the rural areas, we care about them,” he said. “That’s the thing that’s going to provide the buffer of protection.”
Still, there’s a debate over just how far the government should go in letting the private sector finance these public necessities. Fluharty, of the Rural Policy Research Institute, breaks down the sides.
"One pole says, 'we should be careful that we don’t let the government off the hook on its obligations,’” he explained. “The other pole says, ‘if the private sector is willing to invest in this, it is clearly an acknowledgment that government need not do it.’”
Of course, that still all depends on whether the private sector actually steps up to put in cash. The rural business investment companies aren’t necessarily as attractive as other vehicles run by the Small Business Administration, for example, which allow for more leverage and don’t restrict investments by geography. And the infrastructure projects don’t yet have enough of a track record to prove they can be profitable investments in places where population is sparse and declining.
“At the end of the day, it’s all about sharing and managing risks,” Marlowe said. "I think rural areas represent some unique risks, particularly around the demand for the service, and whether it can really produce the revenues that we think it can.”