Crowdfunding for Main Street

Welcome to episode 9 of season 3 of the CitySCOPE podcast. I’m Kate Cooney, faculty at the Yale School of Management. Over the next two episodes, we’ll be talking about access to capital. Today, we feature our interview with Topiltzin Gomez about the role of crowdfunding platform can play in an entrepreneurial ecosystem.

Topiltzin Gomez (00:45):

My name is Topiltzin Gomez, and I am the chief of staff at Honeycomb Credit.

Kate Cooney (00:50):

Topiltzin is a former student of mine who graduated from Yale College in 2018. Tell us a little bit about the career moves that you made leaving Yale and what were some of the things that you were interested in pursuing coming out of Yale College.

Topiltzin Gomez (01:06):

At Yale, I graduated with a degree in ethics, politics, and economics, and I used that to really focus on community wealth building and poverty alleviation. Those were my academic passions, but I was also very interested in how those passions intersected with entrepreneurship. So after Yale, I became a Venture for America Fellow. Venture for America connects recent grads to startups across the US in cities with developing startup ecosystems. So think about a city like Detroit or Pittsburgh or Baltimore. It connects recent grads to startups in those cities, and that is where I ended up discovering Honeycomb Credit. It’s my current job and Honeycomb’s mission is to help everyday people invest in locally owned small businesses. We’re a loan crowdfunding platform. So it really aligned with all of my passions to one pursue this kind of cutting edge economic development thesis that I had, and also to be in the entrepreneurial world and kind of make a name for myself in business.

Kate Cooney (02:20):

Let’s talk about some of your early experiences in Venture for America before we get into the Honeycomb story. Did you go straight to Pittsburgh or were you in other cities? 

Topiltzin Gomez (02:29):

Venture for America before you go on to your assigned city, you do a one month long training camp. Ours was in Detroit, so it’s kind of like an entrepreneurship boot camp, but also a chance to learn how to engage with a city. So in Detroit, we had this task of figuring out how you can improve the transportation experience of Detroiters and create a product that could do so. So a lot of people focused on insurance, how Detroit has one of the most expensive insurance rates in the world and how might we create a better insurance process and experience for Detroiters? I focused on buses and how we can make buses more fun and enjoyable and also create revenue for cities by installing TVs and advertising things like that. So it was a lot about going out there and talking to people, really getting user feedback and using that to inform socially minded entrepreneurial ventures.

Kate Cooney (03:32):

So the program was actually for the cohort themselves to become entrepreneurial rather than joining in program that was aimed at helping current entrepreneurs.

Topiltzin Gomez (03:46):

That’s right. So after leaving Detroit at Venture for America, I became a full-fledged venture for America Fellow in Pittsburgh, where I teamed up with Honeycomb Credit. And in my free time, I volunteer at the Pittsburgh Hispanic Development Corporation. Pittsburgh is a very interesting city because there are very few Mexican immigrants, very few Latino immigrants in general. It’s only about 3,000 Mexican immigrants in the city of Pittsburgh, according to the Census 2010. So what you had in terms of like nonprofit technical assistance infrastructure in a city like Chicago or in a city like Los Angeles is not seen in Pittsburgh. So what the Pittsburgh Hispanic Development Corporation does is provide that on the ground technical assistance to aspiring entrepreneurs. And it kind of is like a startup because there are very little supports out there. So in that experience, I was able to get to know some entrepreneurs, learn about some of the struggles that they might be facing. A lot of it was interacting with the city, a lot of home based businesses that were you selling out of the back of their cars. But then comes the permit people, and they kind of shut down the operation. So it was a lot of like making sure that the businesses that were running were formalized, and that has been a really formative experience in terms of learning about the accessibility of entrepreneurship in our cities.

Kate Cooney (05:12):

So we’re a lot of those entrepreneurs engaged in wage work and then on the side also having entrepreneurial endeavors.

Topiltzin Gomez (05:21):

That’s right. Or some of them were kind of entrepreneur. There’s a term in the industry called entrepreneurs, but not by choice. So they, this was their source of income and their only income at that. So, you know, if the business was not formalized or if there was a shock to that business, it could be catastrophic.

Kate Cooney (05:37):

So when you moved to Pittsburgh, did you already know about Honeycomb? Were you coming with a venture idea that you were hoping to develop? Tell us a little bit more about whence you first arrived, what you were initially interested in doing and then how you got connected to Honeycomb.

Topiltzin Gomez (05:54):

Even before the training camp process, you apply for a startup position in different companies all across the country. So I was very interested in Honeycomb. I applied to Honeycomb, and after spending that 30 days in training camp, then I came to Pittsburgh and started my first day at Honeycomb.

Kate Cooney (06:15):

How big was Honeycomb at the time? How long have they been around? And tell us a little bit about their founding story.

Topiltzin Gomez (06:21):

I am employee number three or four at Honeycomb. And Honeycomb had been around since January of 2017. And I joined in August of 2018. Honeycomb was founded by two people, George Cook and Ken Martin. They were actually Tuck MBAs. They were working on the idea during business school and then after graduation they said, “All right, let’s do this.” I think that their backgrounds are really important to why they ended up creating Honeycomb. So first, George’s background, he is a sixth generation community banker. He and his family, they own a community bank in rural Appalachia, a small town in Pennsylvania called Somerset. And he saw firsthand how all of the banks, like his community bank, were being consolidated or were being dissolved as the industry started to have the bigger banks buying up those little banks. He saw that firsthand and he saw how that directly impacted communities like his access to capital wasn’t as available as it used to be. On the other side, you have Ken Martin. Ken Martin was an investment banker, but he also ran two coffee shops in Kansas City, so he actually got to see firsthand the process of applying for a business loan. He could not get one. So here you have a MBA, you know, investment banker knows all about the financial system. But he was not approved for an SBA loan. So they put their heads together and we’re like, “OK, you know, we can’t figure out this SBA loan process. Who can?” And what that really spoke to was a bigger problem in the small business lending industry. So they put their heads together and created Honeycomb Credit as we know it today.

Kate Cooney (08:10):

So can you tell us more about how these founders and now you joining the team as employee number three or four, how you’re conceiving of the problem that Honeycomb is trying to solve? What are what are some of the factors that are driving this gap in access to capital for small businesses?

Topiltzin Gomez (08:31):

For small businesses, there are a lot of factors that prevent them from accessing capital. It’s kind of a multifaceted problem, but the way that we’re thinking about it, it boils down to the loss of community banks across the US. Historically, community banks used to be the ones that were deploying capital to small businesses. But after the 2008 recession, even before that, more and more community banks started to get bought up by bigger banks. So all of a sudden you have fewer community banks in communities and we see a disproportionate decrease in access to capital as a result. But that’s not the only story at play. I think that, you know, access to capital, particularly for small businesses and low wealth communities, has always been a challenge, particularly for Black entrepreneurs and Latinx entrepreneurs. So you also have a very low net worth population that’s trying to access capital that usually requires collateral and personal guarantees. So the rungs to bankability are really, really steep. And unfortunately, not a lot of entrepreneurs are able to climb it. There was a study done by the Kauffman Foundation that found that 83% of entrepreneurs launch their venture without receiving outside funding. So that means no venture capital, no bank loans. That leads to a situation where you have a lot of businesses that might be launching into their venture undercapitalized.

Kate Cooney (10:04):

So part of what community banks used to provide is a lower rung in terms of those rungs to bankability? Is that what you would say? That that’s what we’ve lost is a local community embedded set of banks that because of that embeddedness in the community, both had a mission that was oriented around directing capital locally, but also embedded in networks and relationships such that it would be easier to mobilize your networks into a bankable relationship.

Topiltzin Gomez (10:42):

That’s exactly right. So the nature of small businesses has not changed, yet access to capital has. When the bank used to be across the street, they actually might have even known the business owner, or they might have known the public’s perception of that business, and that was the tiebreaker in those kind of iffy situations. But when the bank is no longer across the street, now it’s in Manhattan or it’s an algorithm made in San Francisco, it becomes a lot harder for that local context to get baked in. And it’s not like banks were doing this out of the goodness of their heart. They also got to internalize some of those externalities of that lending. So if I lent to the coffee shop down the street, that improves the commercial corridor for maybe the beauty salon that I lent to 30 years ago. So they were able to make better investments by deploying capital locally. Now that community banks are starting to disappear, we don’t see enough of that. So that’s another reason why that decrease is happening.

Kate Cooney (11:42):

So we see that kind of explosion of fintech and online lending. How does honeycomb fit into that broader trend?

Topiltzin Gomez (11:52):

When access to capital was falling, a lot of fintech players came into the space saying, “You know, that’s a real big problem and you know, we can create a solution for that.” The approach that many of them have taken has been to create better models for lending to a wider set of people. So, for example, you can submit an application, we might plug that into a machine learning algorithm and then we might decide whether or not you get access to capital and we can deploy that capital to you within a matter of days. That is awesome if you’re comparing it to a bank process that might take months or, you know, maybe half a year at times, and they have been able to do this quite profitably. We have Kabbage, we have OnDeck, Square, PayPal, Amazon, they’re all getting into this small business lending game. But one concern that came out as a result of that is that when you’re lending fast capital to a bunch of businesses seeking fast capital, you might run into some selection bias. Only the riskiest businesses want capital in two days. So the way that they mitigate the losses that might come from lending to this riskier population is that they raise those interest rates for the entire group. So what you actually see in the industry, and I think a Wall Street Journal article quoted this as well is that these loans are on average lending at 45% APR with very quick turnarounds. So we’re talking about six month loans or maybe one year loans. And entrepreneurs that that might help them get out of the cash flow need that they have right now, but come time to pay it off, all of a sudden, all your revenue’s going to debt servicing. So the way that I think Honeycomb fits into that picture, where the pendulum has swung one way, we want to swing it back the other way. We want to be the community bank of the 21st century, and we’re doing this by creating a first of its kind loan crowdfunding platform. So a couple of ways that we are approaching the market. First, we are turning everyone into a small business lender. So the source of capital that we are borrowing from are the everyday customers, fans, family, friends of that business. So we are not borrowing from hedge funds like Kabbage or PayPal or OnDeck and then lending that money at a premium. It’s, you know, direct investment from everyday people. The other way that we’re approaching this is that selection bias, right, we are actually having a positive selection bias, and the businesses that work with us, they have growth projects that they’re advertising to their community. They’re recruiting local investors who can then tell us better than almost any other underwriting committee that, “Hey, that business, I like it so much, I’m going to invest in it.” So we’re leveraging the knowledge of the crowd to get investment flowing to creditworthy small businesses that might have a short operating history or might not have the personal guarantee or net worth that a bank might expect.

Kate Cooney (15:13):

Tell us a little bit about the experience of the lender when you go on the platform. There was a book a couple of years ago now about the emergence of crowdfunding, and I remember being kind of fascinated by how they described all the different potential of the space where some of the examples had to do with gates that could be set up so that you could only lend to businesses that someone in your social media network was lending to. Or maybe there’s a gate that allows you to only select businesses that are committed to paying above a living wage. Are there ways that you can observe potential investments in this kind of gated way? Tell us a little bit about the platform itself.

Topiltzin Gomez (16:02):

On the platform, you will find many investment opportunities. These are businesses from all across the country. Honeycomb has run campaigns in 17 states. We’ve run 120 of them so far. Anyone can lend to a small business. You don’t have to be from that community. But what we do see is that most lenders, about 70% of them are from either that zip code or the surrounding zip codes to that business. So it’s truly a hyperlocal lending experience for most. Now, the lending experience, it’s very easy, it’s as if you were kind of checking out at Amazon, except you might have to give a couple of more details about your income and net worth for the SEC, but it’s kind of like a mix between Robinhood and Amazon, right? Simple experience, you’re deploying capital to a small business. But that’s not really where the magic happens, the magic happens before where you’re trying to evaluate a business, you might have heard of it or you might not. And you might actually go out and do some on the ground due diligence. You might actually go to the juice shop and check it out, whether the juice they’re making is any good, whether customer service looks good, whether the model looks scalable to you, so that on the ground underwriting is kind of like you can do your own fieldwork with your investments. So rather than, you know, going on Google and searching on financial markets, you can actually go outside and check out the local investment opportunities in your area. After you make your investment. that’s also where the magic can happen. You are directly responsible in a way for how that investment performs. So if you support that business and if you shared stuff on social media, if you encourage your friends to go to that business with you, then that business is more likely to repay that loan. That is kind of the magic of the Honeycomb experience. And we’ve seen investors go from making their first investment, all the way to getting to know that business owner personally and talking to that business owner before they make an investment. That’s one thing to talk about financial capital and making that accessible to small businesses. But one thing that I think we’re also unlocking here is that social capital, connecting that business owner with the movers and shakers of the community that want to see that community thrive.

Kate Cooney (18:24):

Tell us a little bit about what a campaign looks like. Do you pick a group of businesses in a certain city and build a campaign around them? Is there a time period through which people have to raise and if it doesn’t achieve, it’s not a go? 

Topiltzin Gomez (18:41):

Let’s talk about it from the perspective of a business owner. So if I’m a business owner and I want to raise capital on Honeycomb, I would go to Honeycomb’s website, get on the phone with one of our reps, and then submit a financial application. So that includes the financials of my business. We’re taking a look at credit. We’re taking a look at potential collateral or personal guarantees. But we’re also taking a look at your social media following, whether there’s a community around your business that would be excited to crowdfund. If your financial application is approved, then we go ahead and we price that offering. So we are kind of the umpires in the interaction where we’re saying this is a riskier loan, so we’re going to make it at 12% versus this is a relatively safe loan, so we might make it 6 or 8%. After that, we start getting to work on building your campaign page. So a business owner would work one on one with our technical assistance providers, our customer success team, and they help them capture their story and really follow crowdfunding best practices so that they do end up making the best campaign page possible. For a campaign to be successful, they have to hit a minimum goal. That’s a goal that we set before during the underwriting stage. If they hit that minimum goal, the money gets deployed to them. There’s also maximum goals since this is loan crowd funding, we don’t want to saddle businesses with humongous debts. So their goal is to promote that page, encourage their customers, fans, and family members to come to that website and invest directly in their campaign.

Kate Cooney (20:22):

What kind of pricing do you have on the loan or what’s the return for the investor? And how does that compare with the 45 annual that you reported as maybe emerging as an industry standard for some of the other hedge fund backed online lending that you identified earlier as part of that ecosystem of competitors?

Topiltzin Gomez (20:47):

I think Honeycomb is more easily compared to the CDFI industry or maybe even SBA loans. On the low end, our loans are 6%. On the high end, we go up to 12%. So these are three to five year term loans, usually backed by collateral and personal guarantee, and they’re going to businesses that have at least six months of operating history. So if you are an investor in a Honeycomb loan, you have the potential of making that 6, 7, or 8% in interest, what the interest rate you see on the platform is the interest rate that you would be receiving on your investment. So Honeycomb doesn’t take any of the principal and interest. We believe that that should go directly to the community members were supporting this project.

Kate Cooney (21:31):

How does Honeycomb make money? What’s your revenue strategy?

Topiltzin Gomez (21:36):

The way that Honeycomb makes its money is primarily through a success fee. If a business successfully raises beyond their minimum goal, then we are taking about 6-8% off of what they raise with a cashless transaction. And it really helps align the incentives. So we only succeed if you’re successful at raising that money. On top of that, we also charge a very small investor fee, and we also align incentives at the beginning by charging a small posting fee to get on the platform.

Kate Cooney (22:08):

What have you learned about the kinds of uses of funds that small businesses are coming to the platform to fulfill? What kind of categories of need? Is it all expansion? Is it working capital?

Topiltzin Gomez (22:25):

If I had to pick a top two, the first would be expansion capital, and that would be for purchasing equipment, hiring new employees, getting the working capital that you might need to launch your second location, or to go from a catering company to a brick and mortar, right, the capital that helps you scale up when you’re in that first or second year of your business, proving out your minimum viable product. Now you’re ready to introduce yourself to Main Street. That’s perfect for Honeycomb. But another source of need that we’re seeing is in refinancing that online lender debt. So many businesses that we’re talking to are coming to us with a Square loan or with a Kabbage loan, and all of a sudden all of their operating revenue is going towards that debt service. So what we can do, is we can actually have them stop paying a really high interest rate to those merchants and instead get a refinance loan that is repaying their customers.

Kate Cooney (23:29):

I have a question here about your sources of competitive advantage. Are there certain parts of the way this kind of work is done, whether it’s borrower acquisition, the experience of the borrower, you know, their satisfaction, the customer and product mix, the cost of underwriting? Are there things in any of these areas where the online modality allows for some competitive advantage over the old brick and mortar?

Topiltzin Gomez (24:04):

I think there are two key competitive advantages. First, there is our source of capital. We are one of the few lenders out there that are actively using community capital, not money from the Treasury or money from private investors. We are actually getting everyday people’s money and deploying that to small businesses, kind of like small business by small business. So that helps us in many, many ways. First, by getting retail capital involved. We’re actually able to have the retail capital check our math, right. We can say that the business looks good on paper, but it’s only the customers of that business that can tell us whether it’s actually any good, whether it’s a place that they want to see, stay and thrive in their community. So there’s a bunch of knowledge unlocked from the crowd. Second, it’s the crowd funding model itself, helps us better acquire customers than our competitors. So when a local business is running a campaign, they are shouting from the rooftops that they’re raising money. Local media might even get involved and write a nice press article about that. Compare that to the experience of getting a loan from a big bank. You know, no one is really tweeting about it like, “Hey, I just got a bank loan.” You know, the press isn’t really writing about the local business that got a bank loan. So in that we have a customer acquisition engine. We see that when a business is running a campaign, all of a sudden we are getting the attention of that tight knit network of small businesses around it. So that helps us establish trust in an industry that has a high threshold for trust, as well as you know, it serves as a marketing engine so that our sales team can, you know, instead of just introduce a concept brush, we can instead introduce something as, “Hey, do you remember that restaurant on the street when they ran their campaign?” And it becomes a lot easier to sell. 

Kate Cooney (26:13):

So you said that you started in Pittsburgh, but you’ve moved to other cities. How do you go about entering a new city? What are some of the things that you need to do to make this model work as you expand?

Topiltzin Gomez (26:27):

I can talk about Cleveland, which was the second city that we expanded to. And a lot of it was figuring out how this Honeycomb fit into a city’s existing small business ecosystem. Each city has maybe their own micro-lending program, their own network of CDFIs, maybe their own network of technical assistance providers. What we were very keen to do was to be a part of that ecosystem, to be a supplement to it. We didn’t want to be the far away fintech that just makes a sale and moves on. So we actually took the time to get to know the local ecosystem, and that has paid dividends. All of a sudden, Honeycomb is now listed as a trusted partner for SPDC or for a local CDFI. And that has helped us not only access more entrepreneurs, but more importantly, it has helped us access many entrepreneurs of color that might be using these resources as well. So that has been a powerful way for us to be able to have 50% of our entrepreneurs be women business owners, 25% of the businesses we work with being minority owned.

Kate Cooney (27:41):

Can you give us an example of a business that was a real success story through this model? And then maybe one where things didn’t work out and what you learned from each of those scenarios?

Topiltzin Gomez (27:56):

One success story that I really enjoy is the story of Casa Brasil. So Casa Brasil is a Brazilian restaurant based in Pittsburgh, and this is going to get a little bit into the weeds of Pennsylvania liquor law, but a liquor license in Pennsylvania is actually super expensive. It costs Casa Brasil about $70,000 to acquire that. In Philadelphia, it’s about $100,000, so a liquor license can unlock a bunch of revenue for a restaurant, right? Not only are you now selling food, you’re also selling a higher margin product, alcohol and drinks. So that was huge in scaling up any food concept. But Casa Brasil faced the $70,000 hurdle in the way. And there are very few banks out there that would lend money just for a liquor license. It’s a hard thing to collateralized. How do you even collateralize a liquor license? So that’s where Honeycomb came in. Casa Brasil ran a Honeycomb campaign. They were able to raise $90,000 from their passionate following of community investors, and by the end of it, they were able to purchase that liquor license. And that has been really important for them during the pandemic. It has been able to have them sell higher margin products to their customers and ultimately stay in a better position than they would have otherwise. So that can show the transformative component of community capital. It’s in helping businesses actualize the needs that they actually have, and community members can obviously see how a liquor license can help them be a better business. But our traditional system might have a harder time fitting that into their check boxes.

Kate Cooney (29:46):

I can’t even remember what city it was, but there was one of our favorite restaurants that didn’t have a liquor license, and I can imagine how a community would come together to make that happen in their own self-interest. Right? You talked at the very beginning about these rungs to bankability. I know you’re still in startup mode to some degree or early in your, in your journey. But have you seen businesses graduate into bankability or come back to the platform for a second round?

Topiltzin Gomez (30:16):

Absolutely. So our first customer, the Pittsburgh Juice Company, they used Honeycomb to build out a juice delivery truck. Two years after they borrowed their Honeycomb loan, it was a 60-month long, five years. They actually became bankable. They had expanded to a second location. Business was going really well and they used a bank to refinance out of Honeycomb, which means that all of the investors got paid back early and then they could go back and reinvest their earnings into other Honeycomb campaigns. So that is really beautiful. We also see businesses launch multiple campaigns as they scale. So we had this business GO Buddha. They do like vegan plant based food delivery boxes in Cleveland. They ran a Honeycomb campaign and then they ran a second one to support their interstate expansion. So that was really fun to see. I think that it’s really like in the rung between that $15,000 loan and that $200,000 loan, that Honeycomb is most ideal. After you get beyond that, you’re probably trying to weigh the options of like, “Hey, what’s the cost of capital versus what’s the cost of running a Honeycomb campaign and engaging my community?” Although we do see some businesses that are bankable run Honeycomb campaigns purely for the marketing and the community engagement and the mission alignment.

Kate Cooney (31:47):

How important is the volume of a social media following in qualifying for a campaign on Honeycomb?

Topiltzin Gomez (31:53):

It’s just one part of our underwriting process. We’re also taking a look at those financial statements. We’re also taking a look at the credit of that business owner. So it’s an additive part to what we do, and it also correlates with the success that a business has in raising capital. So a business has very little following, then many of our marketing toolkits don’t work, and that business ends up having a bad time at Honeycomb. So having that baseline restriction improves the customer experience and lets us turn away businesses that might not be there in terms of social capital.

Kate Cooney (32:29):

Do you think that others might enter and compete with you and how sustainable is your competitive advantage and where do you see competitor threats on the horizon?

Topiltzin Gomez (32:47):

The investment crowdfunding industry is relatively new. It became kind of in law in 2012. It took the SEC about four years to finalize those laws. If you want to look it up, it’s the JOBS Act. Honeycomb itself is operating under the Reg CF model. That’s what lets us do our work, which means that investment crowdfunding has only been around for four years and Honeycomb is about three years old. So we’re like one of the early adopters of the platform, and we’re one of the first to do it for small businesses specifically. Most people have been doing it for equity crowdfunding, helping everyday folks like you all invest in the next Facebook or in the next great startup. So if you want to check out like WeFund or Republic, cool equity crowdfunding platforms. On small business side, I think we were one of the first, and there are others saying to check out like NextSeed or Mainvest. They are also doing this type of work. But the universe is just so big and the idea is so new in the industry, so new, that I don’t see them as you know, they’re going to eat away at your bottom line. I think that there is so much education that this field needs, because when most people think about, “Hey, I need a loan.” They think about, “I’m going to go to the bank.” They don’t think about going to their community. So this competitive landscape right now is beneficial to the entire industry. We have more people talking about community capital for Main Street lending, that is a positive for us. I think that our defensibility lies in a couple of things. First, that we are able to have one of the highest success rates in the industry, so we dedicate a lot of time to that customer success process. 83% of Honeycomb loans meet that minimum goal compared to the Kickstarter industry average of 35. So that is pretty awesome in that we are kind of crowdfunding, but we work. The other thing is that we are kind of at the cutting edge of seeing where the innovations lie, particularly in the impact investment space. So we are intentionally building a product that mission driven industry capital can understand so that we think is also going to be a key advantage to our growth.

Kate Cooney (35:07):

I wonder if your vantage point has given you a perspective into emerging business models on Main Street, you talked about an incubator, you know, a food incubator. I don’t know if that was in Cleveland or one of the other cities that you’re working in, but what’s happening on Main Street these days and what do you see emerging as interesting kind of business models and some of the things we’re experimenting here are things like community production. So not just that WeWork, but a kitchen that many different people can rent or other kinds of community production spaces. Are you seeing those kind of models through your work?

Topiltzin Gomez (35:46):

Yes. And I love them. So one thing that gets me really excited about this space is that many economic development players are thinking about how can you lower the threshold to entrepreneurship? So before if you want to start a restaurant, you had to kind of pony up the cash for a whole building. Now you can just participate in like a commercial kitchen, and they might have education so you can scale up your concept. If it’s a food product, they might help you get into store shelves. So lowering the threshold to get a pilot out into the market is super critical. So I love food incubators, I love co-packing spaces, maker spaces, things like that. They help entrepreneurs get that early traction, build that social media following, build some financial history, and that makes them ready for any sort of capital, whether that be Honeycomb or otherwise. So that gets me really excited. Another thing that I am seeing that’s really cool is lending networks popping up. Philadelphia has this really cool thing called the Philadelphia Business Lending Network that we are members of. But basically, it’s turning the process of seeking financing on its head. Right now, you know, if you are in any other city, you would have to look through all of your financing options and pick the ones that makes sense for you and then apply. In Philadelphia, you just apply. Submit an interest form to the Philadelphia Business Lending Network that gets sent out to lenders, and then they come to you if they want your business. So I think that really trying to experiment with the UX of building a business, and if our ecosystem players can be better at just making, building a business user friendly, it can go a long way to getting to where we got to be.

Kate Cooney (37:34):

Another question I had was about loans as the product. You differentiated between other platforms that are doing equity funding. I was talking about, at the end of class, when you popped in, about Ujima in Boston, and they’re experimenting with royalty based lending, which looks a little bit like equity in that you’re not saddled with a monthly debt payment, but it looks a little bit like a loan because you repay over time and you’re not giving up any ownership, right? You’re just paying some percentage of your profits in that kind of royalty model until that debt and whatever x, 2x, 3x return that’s been agreed on is paid off. Have you thought about expanding into other kinds of products or are you wanting to stay exclusively with the loan?

Topiltzin Gomez (38:33):

So we have experimented with revenue share notes. We’ve also done one equity crowdfunding campaign just because it was like a friend of ours in the Pittsburgh ecosystem. But specifically on royalty based or revenue based lending, I think that the industry as a whole is very enthusiastic about it, but the way that we’re seeing it applied is kind of concerning to us. It’s very similar to the way that Square issues out their loans. So they take from your transactions at the cash register to repay your loan and usually repay it early for you, which if you go back and calculate that APR, it becomes really, really high since you’re prepaying capital that costed you in a fixed amount to access. So we think that, yes, it is really cool to experiment with new models, especially ones that are more flexible, but it’s really important to look at the numbers and see whether an entrepreneur is actually, you know, losing more money as a result and would have probably been better served by a traditional loan. So it’s all about the situationals. But I think that it’s good to see new things pop up.

Kate Cooney (39:50):

So tell us about an experience where things didn’t work out, and what did you learn from that experience?

Topiltzin Gomez (39:57):

One experience that did not work out was when we were working with an artisan in Philadelphia. So they made very awesome clay pottery, very popular on Instagram, huge following. The campaign itself, never really took off as explosively as we thought it would. It ended up not meeting its minimum goal. And I think one thing we ran into was this artist’s discomfort with financializing the product. All his followers on Instagram saw him as an artisan that was making every single clay pot by hand, you know, toiling away in the workshop. What he did not want people to see was that this was actually a whole operation, it was a whole business. He thought of that clashed with the artistic concept that most people saw. So I think that that taught us a very powerful lesson in one thinking about maybe what industries might be a better fit for investment crowdfunding. This is a financial product, and you know, most artists you see are typically using donation based crowdfunding. So one being a little bit more selective in who we work with. But two, I think that it also told us to be more mindful on how we empower entrepreneurs to talk about their growth journey. I think that many people would have benefited from the entrepreneur communicating this as an opportunity to scale up that artistry rather than as a way to water that down. So it was a lot more of like it’s always going to be TLC for entrepreneurs, and we need to be always mindful of the mental roadblocks that might be in the way.

Kate Cooney (41:37):

Where might the bottlenecks in your model be as you scale? It sounds like there is a lot of human side to, kind of high touch to, each campaign that’s run on behalf of an entrepreneur. 

Topiltzin Gomez (41:53):

I would start by saying that even though it is high touch, that high touch is how we scale. So by providing a great experience, by encouraging the entrepreneur to share their campaign broadly with their community, that’s how we’re able to acquire more customers. So if we need to invest more on the front end to build that relationship, that pays dividends in the long term. But when we also identify that as kind of like an operational area for improvement. So we’ve really gotten smarter about creating processes and really templates for how entrepreneurs reach out to their communities. We’re operationalizing a bunch of that and making it so that there’s very little guesswork in the crowdfunding process. So we want to make sure that we’re spending more time executing and less time on teaching and imparting.

Kate Cooney (42:46):

The publication of Richard Rothstein’s book, The Color of Law, and Mehrsa Baradaran’s book, The Color of Money, and many other, you know, current events, scholarly work, has drawn our collective attention to the way that the history of redlining continues to structure the geographies that we live in and the wealth gap and even a small business lending. How does redlining factor into your business model at Honeycomb? How do you think about your work in relationship to redlining and are you able to collect some data that can help counter some of the bias and discrimination that operates in these markets?

Topiltzin Gomez (43:39):

I think that one of the places I like to start this conversation with is that the SBA in 2019, out of all of its loans that it gave to small businesses, only 3% of its loans went to Black entrepreneurs. And Black entrepreneurs make up 11% of the total population of entrepreneurs in the U.S., so there is a clear, disproportionately low number of small business loans going to Black entrepreneurs in the traditional financing system. On Honeycomb, that’s 25%, and there’s still a long way to go to kind of right the racial wealth gap. But I think on Honeycomb, where we’re thinking about it from two ways. First, we see that businesses that have been affected by this legacy of redlining, they tend to have lower net worths, so their personal guarantees mean quite a lot less in the underwriting process. It also affects credit. These businesses are probably more likely to not have the greatest credit scores. So we understand that that’s a part of the financial picture. The way that we counter that is, by one, changing the people who are funding these businesses. So everyday people, they are more likely to lend to a business that might have had a blip on their credit report than a traditional institution might. So the model itself by opening up the lending market to everybody, we are changing the preferences of that lending market and we are seeing that in the numbers. But I still think there’s quite a ways to go. We have gathered some data on success rates by demographics, whether a zip code is low income or not. And we see that businesses in low income zip codes, they hit their minimum goal at the same rate as businesses in high income zip codes, but they don’t hit their maximum goal at the same rate. So they might be moving heaven and earth to get local community investors into that project, but there’s still a gap missing and that gap is primarily attributed to just the lower wealth of their network. This is where interventions are needed. So at Honeycomb, we have been trying to partner with banks, foundations, mission driven investors, so that they could deploy capital into a market rate investment that has already been vetted by the community. So that is kind of the next phase of Honeycomb. Using retail capital, and that signal to unlock institutional capital that has a mission. It might be a little bit risky for your foundation to invest its portfolio into the small business down the block. But now that Honeycomb has vetted it, now that the community has said, “Hey, there’s a need. We want that business to have a liquor license.” Now it’s a little bit easier. Now it’s an asset class that is drastically different from the universe of small business loans. So that’s what we’re trying to do on the small business side. On the investor side, we understand that not everyone is able to deploy thousands of dollars to a small business. On Honeycomb, we’ve made strides to democratize that by making the minimum investment $100. So we believe that anyone with disposable income can become a local investor. But we also understand that there’s a lot of work to do in financially empowering these communities to see local assets as something that they can invest in. For most people, when it comes to building wealth, it’s either the stock market or buying a house. And funnily enough, most of the time those returns tend to go outside of the community. You’re buying a house, the returns of that investment are probably going to bank  and that bank is probably investing that somewhere else. You’re buying stocks. You know, that’s going to New York City or San Francisco. So we want to diversify that and we want to make it so that local investments are a possibility. Because I mean, I fundamentally believe that to me, wealth building should be accessible to everyone. It’s not just the foundations and the anchor institutions doing it, it should be everyone. Because then you get this really cool behavior change where people see themselves not just as consumers of their local economy, but as creators of that local economy. So that gets me really excited, but I think that there’s a lot of work that we need to do on the consumer education side, both in terms of like financial education savings and then ultimately introducing people to this new asset class that might be a little bit riskier than others.

Kate Cooney (48:34):

We read some work coming out of Brookings that was looking at the difference in the size of networks across different demographic groups in four cities. One study highlighted how Black men have the smallest networks on average in these four cities. White men have the largest. On the other hand, white men’s networks happen to be extremely homogenously white when compared to white women and men and women of color. Have you done any research into the network size of the crowd that’s funding loans across zip codes? And if there are differences, there are people investing broadly in their city or just in the neighborhoods they live in. What have you learned on that dimension?

Topiltzin Gomez (49:23):

It’s a little bit too early to say since we have about 3,000 investors so far, but I think we need to get that n a little bit higher to really tease out the effects. But one thing we’re seeing is that people are investing across zip codes, across neighborhood lines, across racial lines. And that is really exciting because if it weren’t for Honeycomb, they wouldn’t have this connection to that business and that financial connection and “hey, I’ve lent this business money. I’m an investor in them,” that can also become a human connection in that now it’s a brewery or a hair salon that you’re a part of. And that can be a really cool way to humanize our markets, to make it so that everyday people are not disconnected from the small businesses across the street. And I think that’s just beautiful from like an economic development perspective. Another thing that we are seeing is that there are businesses in lower income communities that tend to receive more $100 investments. So it’s like people are providing quite a lot like when economic power is low, people power rises up. So that’s something that we’re seeing in a lot of these, well, small businesses that might be in low to moderate communities. The other thing that we’re seeing is the action of kind of like these honeycomb angel investors, people who are investing $5,000 or $10,000, $40000 loan. So the actions of these higher net worth individuals can sometimes tip the scale in whether a business is medium capitalized or fully capitalized, and that capital has not had a place to go directly to small businesses prior to Honeycomb. So we want to be the place where it goes.

Kate Cooney (51:15):

We’re a year into a global pandemic. It’s had a huge impact on small business community. How has this affected the businesses that you work with and your business at Honeycomb?

Topiltzin Gomez (51:31):

So let’s talk about the portfolio first. There are, this is a really cool story. So on Honeycomb, the kind of process for dealing with loans that are not paying is quite different. The first thing we did at Honeycomb is we said, “OK, we think that something is going to happen to the small business industry.” We extended a loan forgiveness period to all of our businesses that were in the portfolio at the time of the pandemic. We asked investors whether we could do that on their behalf, since we are just the platform under which their loan is issued. So they’re the ones ultimately that can give the thumbs up or thumbs down. 97% of investors said “yes, extend that payment forgiveness.” That is not hedge fund behavior, that is not private financial institution behavior, that’s people’s behavior, and they chose not to receive their kind of $8 repayment or $80 repayment. Instead, they said, “Hey, let’s put a pause on that and wait for things to cool down a little bit.” So that was really heartening, that when you change who is funding the business, you also change the incentives at play and the priorities. So despite that, some businesses did end up closing. We’ve had a couple of them close in the Honeycomb portfolio. When a business closes on the Honeycomb portfolio, they have broken the terms of their note. They no longer exist, so you technically defaulted. What we do is quite different. We have this community of investors who have invested in their business. They vote pro-rata based on how much they invested on what course of action that business should take. So there’s kind of three options. Option one, they can choose to forgive that investor’s portion of the debt entirely. So if I’ve lent $1,000 to a small business and the business went bust because of the pandemic, I can just choose to forgive that, and about 30% of our investors did. Two, they can go with the workout plan proposed by the business owner. So it might be like, “Hey, you know, I can’t make these repayments now, but I might get a full time job and I should be on track in maybe six months,” that’s an option. And the third option is, you know, you can pursue collections and, you know, you can lawyer up and go after the collateral of that business. Almost no one has chosen that in the five case studies that we have. So that is really heartening that most people are going with that workout plan for the business owner and or with the loan forgiveness option. So that makes it so that the business is actually in a better financial position than they would have been if they had borrowed from another lender.

Kate Cooney (54:29):

Are you seeing people making multiple investments? Are there people taking portfolio approaches as an investor? Or do you just see one time boosters of favorite businesses? 

Topiltzin Gomez (54:42):

So we see about 20% of Honeycomb investors are repeat investors, which is great and they take a bunch of different approaches. Some people are kind of more like an angel investor. They kind of are doing heavy due diligence and they’re looking for that one business that’s right for their large investments. Other people are just like sprinkling all the love around and putting $100 in each of these businesses. So it really is a choose your own adventure kind of thing.

Kate Cooney (55:10):

Have you seen that a certain type of business is a good match for Honeycomb? One of the things that we’ve been working on in New Haven is thinking about supply chain oriented businesses and those larger businesses that have, you know, 20 plus employees that are building capacity and doing business in large anchor supply chains or corporate supply chains, public supply chains. Are you mostly working with smaller Main Street businesses, or do you also see some of these larger kinds of firms getting involved with Honeycomb?

Topiltzin Gomez (55:53):

So the majority of our portfolio is in the food and beverage industry. One requirement to run your campaign is that you must have 500 social media followers, so the supplier of, you know, logistics branch might not be all that trending on Twitter. So we’re typically seeing most of our businesses come from food and beverage. One kind of shadow reason for that is that those are the businesses the banks and traditional lenders aren’t touching. So that’s a big reason why they’re a big part of our portfolio. I do think the model has great flexibility. We are not the only investment crowdfunding platform out there. There’s a bunch of platforms that focus on equity crowdfunding, helping tech startups scale up or already established firms get to their next level of growth. So for those, it might work out better for a different crowd. But I do think that we might see a future where those firms, because of their economic impact and because of their economic significance, might do really well, engaging the crowd as well. But if the model has its early adopters, it’s the food and beverage space.

Kate Cooney (57:04):

We didn’t talk about how Honeycomb has fared through the pandemic. Any reflections there? 

Topiltzin Gomez (57:11):

Honeycomb, like a lot of tech companies, has actually really grown in the face of the pandemic. I was doing the numbers and we deployed about 160% more capital in 2020 than we did in 2019. So that has been a mixture of, you know, Honeycomb getting better as a a business, but also just the level of need out there. A lot of private lenders are not lending right now. And if you look at an American banker, there’s this article that said it’s crickets in small business lending industry. A lot of public dollars are getting scooped up as soon as they become available. And I should also add a lot of the fintech players are actually getting acquired or maybe selling themselves to other larger players right now because their models took on a lot of risk and weren’t expecting a pandemic. I mean, no one was. So it’s kind of become a time where community capital is one of the few viable, resilient alternatives on the block. And I think that has led to a lot of growth and a lot of new interest in crowdfunding.

Kate Cooney (58:20):

How would someone draw you down to their city? Do they have to wait for Honeycomb to get interested in the regional economy where you happen to be living? Is it flexible enough to sign a platform that you can just log in and begin a process from a city where you might not have a presence yet?

Topiltzin Gomez (58:37):

So we can serve all 50 states. Our license lets us do that. If a business owner is interested in launching a campaign, they’re more than welcome to. I think your question was a little bit bigger and like, how can we get ecosystems to play and start playing with investment crowdfunding? And we have a couple of ideas. First, it’s kind of like letting the market dictate where we go. So if we’ve launched maybe four or five campaigns in a given geography, we might make some people investments there, hire someone to build out that market further. But another way that we’ve been exploring is having institutional capital tell us where to go. There is a foundation that’s really passionate about experimenting with this community wealth building model. Can they create a loan matching fund so that maybe lower income entrepreneurs can get to that maximum raise at the same rate as their higher income counterparts? That would be a very powerful signal for Honeycomb to come to a geography. So we’re actively working on those conversations. 

Kate Cooney (59:40):

I’m going to ask you my last question. You know, you’ve been involved in the emergence of this new type of crowdfunding, this community capital model. What would be the ideal evolution of the online lending space in the next 10 years from your perspective of wanting to develop more relational capital, more community capital? And then if you forecast 10 years into the future and imagine that ideal future state, what are two to three things that we’ve done to get from here to there.

Topiltzin Gomez (01:00:14):

In kind of my ideal world, this becomes a way that we can start generating wealth in our own communities. And that it is reparative rather than just maybe responding to where the market goes, because applying kind of market philosophy to unequal conditions will perpetuate that inequality. So one thing I would like to see is a system. I would love to see, you know, how SBA loans are guaranteed by the government. You know, a bank is issuing a private loan, but that SBA guarantee sits on top of it in case that loan goes bad. I would love to see something similar for everyday people lending to small businesses, right? It, you know, it is risky to lend to a brick and mortar small business, but you know, it’s very similar to what banks are already doing, and that is a guaranteed return for many banks. So I would love to see federal action to incentivize us investing in our smallest units of economic development, which is our small businesses. And I would also like to see a reparative angle on that where we deploy maybe even additional guarantees or maybe subsidies to Black owned businesses. One thing that I would also like to see is, you know, having institutions promote, who is like promoting these offerings to the people from that community. So, you know, it’s great that capital comes from these super angels or from these foundations. But I would love for that economic relationship to happen at the ground level as well. How we get there, I think we built the first part and that we’ve proven the community capital can weather a crisis and can weather a crisis differently. The second part is getting institutional capital to start deploying money on platforms. Third, it’s to have this become a key part of every city’s economic development plan. So instead of maybe focusing on wrangling up the next Amazon HQ2, we might be able to create programs that encourage entrepreneurs to scale up and be fully capitalized that could create a more resilient local economy.

Kate Cooney (01:02:30):

Well, we want to thank you so much for sharing your exciting work in this area.

Topiltzin Gomez (01:02:34):

Thank you, Kate.

Kate Cooney (01:02:36):

Stay tuned for our next episode, where we continue our exploration of access to capital for Black owned and Black led businesses. See you then.

Manuel Morales (01:02:49):

This podcast was created by Kate Cooney in collaboration with James Johnson-Piett and the students of the Spring 2021 Lab.

Eun Sun Cho (01:02:58):

All engineering and production by Ryan McAvoy and Kate Cooney.

Kate Cooney (01:03:01):

Special thanks to Rhona Ceppos for administrative support and to Ryan Carpenter for assistance with Zoom.

Eun Sun Cho (01:03:08):

Music from the album City Trees, composed and performed by the artist K-Dub.

Manuel Morales (01:03:14):

For more information and show notes, visit our website at IEDL.yale.edu.

Eun Sun Cho (01:03:19):

Thank you for listening.

[Music]