6Capitalization and Sustainability

The history of state-level revolving loan funds for employee ownership suggests that the hurdle for a comprehensive state employee ownership finance program is not authorizing it but funding it.

Capitalization, then, is not a downstream, post facto implementation detail, but a design consideration that warrants an answer at the same time as legislative drafting. A program that does not solve this by enactment risks being a program that will not lend.

This chapter surveys the range of capitalization sources available to states across their toolkit. Each tool can be funded only by certain sources, as each source differs in the conditions attached to it and the problem it is trying to solve. A grant can capitalize a revolving loan fund but not a market-rate fund-offunds. The state’s investment portfolio can anchor a fund-of-funds, but cannot fund a subsidized loan program. SSBCI 2.0 can stand behind a loan guarantee or fund a loan participation, but cannot be deposited into a revolving loan fund.

Table 9 shows that the revolving loan fund has the widest set of capitalization sources, and the fund-of-funds the narrowest. Only philanthropic capital and state appropriations can fund all three, with philanthropic capital able to take the form of a grant, a below-market rate loan, or a market-rate investment, depending on the tool it funds.

State appropriations

A direct state appropriation is the simplest and most flexible way to capitalize any tool, and the only one that can fund all three of the tools in Table 9. If a legislature accepts that business succession is an economic development risk worth addressing, it can capitalize any of these tools as it sees fit (for a revolving loan fund, a one-time appropriation becomes permanent infrastructure as the capital recycles).

The constraint on this source is political, as state appropriations compete with every other political priority of every other political actor in the state: schools, hospitals, pensions, and infrastructure, to name a few. A state appropriation is often a vital component of a diversified capitalization base, but because of the scale many of these tools demand, it cannot often be the lone source (nor should it be, as it would put the durability and sustainability of a program to the whims of the annual appropriations cycle, representing an annual veto point to be defunded).

Federal grants: EDA Economic Adjustment Assistance

The federal Economic Adjustment Assistance (EAA) grant from the Economic Development Administration is the most direct route for capitalizing a revolving loan fund if a state has a non-federal match, meets EDA’s economic distress requirements, and has an approved fund plan with a private leverage target.⁸³ The federal share of the RLF covers up to half of its capitalization (or, in the most distressed regions, up to 80 percent), and the non-federal match can come from state appropriations, philanthropy, or other sources; it cannot come from other federal funds.⁸⁴ An EAA grant therefore can never capitalize an RLF alone, as it is designed to pull in a second source.

Because eligibility is constrained to states (or, more often, regions within a state) that experience economic distress as measured by an above average unemployment rate or below average per capita income, an RLF with an EAA-capitalized component may need to focus that sleeve’s lending territory around distressed areas. There is also a “Special Need” category that makes a state eligible, which has historically been used for plant closures or the loss of a major employer.⁸⁵ The most durable framing for an EAA award, then, would involve a Comprehensive Economic Development Strategy (CEDS) that identifies succession-driven business loss as an economic resilience risk, positions employee ownership as a response, and fits the agency’s stated priorities within the CEDS.

SSBCI 2.0

SSBCI is the most durable and flexible federal capitalization source, but it comes with real constraints due to its conditions on what types of programs it can fund and the amount of private capital it must crowd in.

As Chapter 5 explains, its capital must be deployed through Treasury-approved structures such as collateral support, loan participation, or guarantees, and cannot be deposited into a freestanding revolving loan fund. It can, however, hold the same subordinated junior position the RLF would take through a participation or companion loan, contingent upon SSBCI’s match and size requirements/limits.

Table 9 records this distinction by qualifying that functionally, SSBCI can reach the function of an RLF, even if it is not capable of mechanically capitalizing the vehicle.

Through its equity and venture capital pathway, SSBCI can also commit capital as a limited partner in, or alongside, private funds that finance employee ownership conversions. In this way, SSBCI can help seed the employee ownership fund market.

Program income and released federal legacy capital

Two sources sit entirely inside the state’s own development finance institutions. The first is program income: the fees and earnings a development finance agency generates across its portfolio, a portion of which its board can direct into any of the finance tools described in this playbook. It requires no appropriation, scales with the agency’s activity and success, and lets the agency build the fund deliberately over several years. New Jersey’s 2026 employee ownership statute (P.L.2026, c.83) expressly names this capitalization source.

The second source is released legacy capital from federal interest. Under a 2020 federal statute, a state holding a decades-old EDA revolving loan fund can request release of the federal interest seven years after final disbursement and redeploy that capital so long as it continues to serve an economic development purpose. New Jersey defederalized five such funds in 2021 (among them the original 1976 Okonite award), freeing the same federal capital that financed the first wave of conversions to finance the next.⁸⁶ It is a one-time source, but for a state that has it, it is capital already on the balance sheet.

The state investment portfolio

The investment portfolio occupies the narrowest position in the matrix because of the fiduciary requirements of the capital that would capitalize a fund-of-funds. The treasurer’s portfolio is invested under an obligation to earn a competitive risk-adjusted return, which a market-rate fund-of-funds can deliver but a subsidized loan fund or a first-loss reserve, by design and by definition, cannot. A state cannot lend its investment portfolio concessionally or place it in a loss-absorbing reserve without breaching the standard to which it is held. It can, however, commit a small, capped share, as an anchor LP to a fund-of-funds built to earn a market return, just as ILGIF and the FIRST Fund have done in Illinois.

Philanthropic and private capital

Philanthropic capital, like state appropriations, can span all three tools. But unlike state appropriations, this is because it can take three distinct forms, and it is important to match the form of philanthropic capital to its exact finance tool.

A grant is the fully concessionary instrument. Because it is a gift expecting no return, it is suited to the parts of the toolkit that no repayable capital will fund. A program-related investment (PRI) is the belowmarket instrument. Its primary purpose is still charitable and no significant purpose is income, which permits below-market return and counts toward the foundation’s required annual payout, making it a natural match for a concessionary revolving loan fund. A mission-related investment (MRI) is the marketrate instrument in the foundation’s toolkit, made from the endowment and seeking both a competitive return and mission alignment. This is the philanthropic capitalization source best suited to a market-rate fund-of-funds, willing to be an early anchor LP in a nascent capital market.

Foundations and family offices are by now an established and growing class of investors in employee ownership. They have been vital LPs in growing the fund marketplace and legitimizing employee ownership investing, and can play a similar role in shaping the role of state development finance agencies in further building out the capital market for employee ownership.

Blending capitalization sources for sustainability

Given the range of capitalization sources, capitalization is best thought of as a sequence as opposed to a single event. There are three principles and strategic considerations that govern how capitalization is sequenced, and how these sources are blended:

1. Aligning the capitalization source with the tool: A program is seeded with the sources that supply capital at scale initially (e.g., state appropriation or an EDA grant) and is sustained, once lending or investing, by the sources that renew themselves, namely the repayments that recycle into a revolving loan fund, the returns that return through an evergreen fund-of-funds, or the program income an agency directs into an RLF year over year. A fund designed to recycle converts a one-time capitalization into permanent capacity.
2. A blend of capitalization sources is more durable than any single source: The lesson of state-level RLFs is that transaction-level tools and credit enhancements in particular must be capitalized by sources that are not solely state appropriations, which are at the whim of the annual budget cycle. This should include program income controlled by the agency, released capital already on the balance sheet, or philanthropic contributions so that the program’s survival does not turn on political will.
3. A disciplined blend of capitalization must match the toolkit: Sustainability comes from matching each tool to the sources it can accept and assembling a capital structure across the toolkit in which the revolving loan fund is seeded by state appropriations, philanthropic investments or grants, and federal grants (and sustained by repayments and program income); the credit enhancements are funded by SSBCI; and the fund-of-funds is anchored by the investment portfolio and philanthropic mission-related investments.

Sources

Source numbering follows the full playbook.

83. See Chapter 5; 13 C.F.R. Part 307, subpart B; U.S. Economic Development Administration, Public Works and Economic Adjustment Assistance Notice of Funding Opportunity (rolling applications; capitalization of revolving loan funds an eligible activity).
84. 13 C.F.R. § 301.4 (investment rates of up to 50 percent of project cost, rising to as much as 80 percent based on regional distress); § 301.5 (the matching share must be committed, available, and unencumbered; other federal funds generally ineligible as match).
85. 13 C.F.R. § 301.3 (regional distress criteria, applied to the region in which the project is located); § 300.3 (defining “Special Need,” with triggers that are predominantly discrete, acute shocks); 13 C.F.R. § 303.7(b)(1) (“each CEDS must promote Regional resiliency”); U.S. Economic Development Administration, Investment Priorities (“Economic Recovery & Resilience”) and CEDS Content Guidelines (naming business retention and expansion among economic resilience initiatives). EDA’s priorities do not name employee ownership or business succession.
86. Reinvigorating Lending for the Future Act, Pub. L. No. 116-192 (Oct. 30, 2020), 42 U.S.C. § 3211(d)(2)(B) (release of the federal interest on request, no earlier than seven years after final disbursement); New Jersey Economic Development Authority, Board Book (June 9, 2021), “Request for Release of USEDA Federal Interest in Revolving Loan Funds” (five funds, the first the 1976 Okonite award).