Seed Commons’ Approach to Non-Extractive Finance
Non-extraction is one of the key principles of Seed Commons, and it dictates the terms for all of our loans and investments. Non-extraction is defined simply as the returns to the lender not ever exceeding the wealth created by the borrower using the capital. This is often colloquially said as “a borrower will never be worse off than before working with us.”
Why Non-Extractive Finance
Finance is expected to benefit borrowers. However, it often does not work that way. Even when borrowed money is useful, interest rates or other terms can make the cost of borrowing so high that it negates all the benefit and can leave the borrower poorer than they were before borrowing. We know how bad this kind of finance can get: people losing their houses over credit card debt, or whole countries paying more on interest than they spend on healthcare and education combined. Seed Commons uses finance to benefit communities and enrich borrowers both financially and socially. Defining non-extractive finance so that it never impoverishes the borrower but can only benefit them is imperative to ensure we use finance as a force for good and not harm.
Non-Extractive Finance Terms
The conceptual framework for non-extractive financial terms is that the returns to the lender, known as the cost of capital, can never be greater to the borrower than the benefits of the loan to the borrower, or:
Non-Extraction: Cost of Capital <= Investment Profits
Terms that meet this formula ensure that an investment will never be extractive. We practice a stronger interpretation of non-extraction that ensures a meaningful share of profit, typically set at 50%, stays with the borrower. This can be expressed as:
Strong Non-Extraction: Cost of Capital <= 50% of Investment Profits
In addition to these principles of non-extraction, Seed Commons has a principle of sustainability that is applied equally to the environment, the community, and to the business that borrows money. To be sustainable, a borrowing business must be successful enough that it is able to repay faster than the depreciation of what the investment was used for. The full formula for a Seed Commons investment is:
Full Investment Formula: Depreciation < Cost of Capital <= 50% Investment Profits
How Non-Extractive Finance Terms Work in Practice
Non-extraction dictates the financing terms negotiated with enterprises who borrow from Seed Commons. Specifically, non-extraction manifests in the terms of principal repayment, interest rates, and security interests. While Seed Commons makes a number of different types of capital placements (e.g. secured asset purchase loans, working capital loans, line of credit loans, preferred share equity investments, etc.), each deal reflects both non-extractive terms and the needs and capacities of the borrower. The three most common non-extractive terms are:
- No repayments greater than profits: Borrowers are not required to make interest or principal repayments until they are able to cover operating costs, including market-rate salaries
- No personal guarantees: Financing agreements never use assets for security unless the asset has been purchased with the financing agreement proceeds
- No credit scores: Instead of credit scores, Seed Commons uses close relationships between local loan officers and potential loan recipients to establish a borrower’s reliability
In the standard contract of the Seed Commons, these terms get legal form. This first term defining no repayments without profits is rendered as:
In the interest of non-extractive loan repayment: to repay the loan’s principal at [•]% of the Borrower’s monthly Special Net Income with a maximum monthly payment of $[•] until the loan has been paid off in its entirety. For the purposes of this agreement, Special Net Income shall mean revenues from sales minus cost of goods sold and operating expenses and not include interest or taxes, nor depreciation of assets purchased with this loan. For the calculation of Special Net Income, payroll as a portion of operating expenses shall be set at a base of $[•]/hour, all wages above this will be considered part of Special Net Income. Special Net Income is projected to be achieved at a monthly revenue of $[•] on [•]/[•]/[•].
In addition to repayment of the loan principal, Seed Commons also participates in profit sharing when profit is available. Profit sharing from a project is most typically calculated as simple interest, where the interest is only paid if there is enough profit and is forgiven if this profit is not achieved. Profit sharing is used only to cover the labor of Seed Commons staff and to ensure the sustainability of the fund for future borrowers and any cost of capital the Seed Commons must pay. In the standard contract of the Seed Commons, these terms are rendered as:
In the interest of sustainability of the fund: to make profit sharing payments to the Lender should net profit be high enough of: 3% for cost of capital, 2% to cover our community’s historic loss rate, and 2% for fund labor costs, for a total annual rate of 7% on the outstanding principal of the loan, calculated monthly, until the principal is repaid. Additionally, to cover the labor of maintaining the fund, in profitable years, the Borrower will share [•]% of profits to the Lender, with the remaining [•]% paid to members as patronage dividends.
Seed Commons takes no security from any personal guarantees, external property, or future income streams outside of the project being invested in. In the standard contract of the Seed Commons, these terms are rendered as:
In the interest of protecting the fund: to hereby grant to the Lender first priority security interest in all the Project Assets, and not to sell, mortgage, lease, grant a security interest in, or otherwise encumber any of the Project Assets.
In Seed Commons deals, project assets are limited to those assets purchased with Seed Commons financing.
How Risk is Mitigated in a Non-Extractive Deal
These terms of non-extraction impact how Seed Commons mitigates risk. Like an investment, a non-extractive loan has an absence of outside collateral to securitize financing, and so, like business investors, Seed Commons mitigates risk by:
- Rigorously assessing the business plans of prospective borrowing enterprises
- Improving business plans in conjunction with the prospective borrower
- Working with the borrower after the financing is extended to ensure that the borrower receives the technical assistance they require to succeed
This approach puts the borrower and the lender on the same side of the table, as both are deeply incentivized to do all they can to help the enterprise succeed, and this partnership creates a strong mitigant to risk. This means that Seed Commons learns early and clearly what business issues a borrower faces, rather than learning about business problems only after it is too late as happens at times to passive lenders. Focusing on the business prospects rather than securitization also puts Seed Commons in a much better position to diagnose and help solve problems that do emerge. It is these risk mitigants that Seed Commons credits with its low write-off rate and history of successes and that have made the lack of collateral not a source of losses.
Isn’t All Finance Extractive?
At times, we are asked if interest is inherently extractive—or even if repayment of any kind is extractive. Non-extractive finance is defined as no more repayment going to the provider of the finance than the wealth that is created by the borrower’s use of the loan. If no wealth is created, nothing is returned to the lender. If wealth is created, it can be shared, and this is not considered extractive. The created wealth can repay the capital provided so that another party can then borrow it. If enough wealth is created, an extra amount of profit sharing to cover the losses from other loans or to pay for the labor of the investment staff. This type of profit sharing above a return of principle is what makes Seed Commons a productive part of the economy and not simply a charitable vehicle and what will allow it to be self-sustaining in the long-run.
Beyond Non-Extractive Finance
Non-extractive finance sets key limits on the amounts and circumstances of repayment to ensure that finacining is never harmful to the borrower. However, this is only the first way in which Seed Commons finances for the benefit of borrowers and communities. In a mainstream investment relationship, investors are the owners and entitled to all profits. In contrast, Seed Commons opens the door to ownership beyond investors, and our financing is designed to catalyze community ownership for workers, producers, consumers, and the community itself. The goal of Seed Commons is for capital to simply be a tool for people and communities who are the actors using it. This is a goal greater than non-extraction; it is finance that is subordinated to the needs of people. Finance that acts democratically by leaving control in the hands of communities. Finance that regenerates by not extracting from communities but allowing them flourish under their own control. This is Seed Commons: finance that supports people to build the world they want.