ECONOMIC DEVELOPMENT QUARTERLY / November 2001
CAPCO legislation has evolved over time and across states as state legislatures attempted to address concerns in earlier legislation and better direct the program to the needs of individual states. Changes in CAPCO legislation include a reduction in tax credits for certified capital from 200% to 120% to 100%, limitations on the amount of tax credits available to insurance companies, limitations on the size of individual CAPCOs, greater targeting of the CAPCO investments through more restrictive definitions of qualified businesses, procedures for the state to recoup a portion of CAPCO program costs through state profit sharing with the CAPCOs, the availability of tax credits for investors in CAPCOs other than insurance companies, and attempts to use CAPCO legislation to facilitate the funding of specialized venture capital programs such as Kansas’s innovation and commercialization corporations. It should be noted, however, that most changes in CAPCO pro- grams over time are little more than fine-tuning a generic model. The CAPCO industry (i.e., estab- lished CAPCOs) is aggressively involved in state legislation to ensure that the basic program design is preserved.
The experiences of CAPCOs in the five states with enabling legislation provide insights into the strengths and limitations of CAPCO programs as compared to two alternative state-assisted ven- ture capital programs (publicly funded–publicly managed funds and publicly funded–privately managed funds). These strengths and limitations are summarized below, along with suggestions for ways that public policy might mitigate program shortcomings. Policy makers can use this infor- mation to assess the attractiveness of a CAPCO program versus other available alternatives and, if the CAPCO model is considered appropriate, develop CAPCO legislation that best meets the needs of their state.
State-assisted venture capital programs capitalized via tax credits, such as CAPCOs, do not require current state budget expenditures or bond sales (as do public venture capital funds and publicly funded private venture capital funds). Moreover, the actual cost (present value) of tax credit programs to the state, including the CAPCO program, is reduced by the alloca- tion of tax credits over time. For example, tax credits generally are taken in Years 2 to 11 of the CAPCO program; thus, the present value of $100 million in tax credits (assuming a 7% discount rate) is $65,640,960. Funding CAPCOs with tax credits and spreading tax credits over 10 years make CAPCOs an attractive alternative when compared to programs that commit the state to additional current expenditures or debt.
According to interviews with managers of public venture funds, state funding for these pro- grams is often insufficient to achieve an optimum program size relative to the desired num- ber of investments in portfolio companies and availability of capital for follow-on invest- ments (Barkley et al., 1999). The 100% tax credits provided in a CAPCO program are a way of raising significant funds ($50 million plus) from insurance companies to capitalize ven- ture capital funds. Through the use of 100% tax credits, in conjunction with an investment instrument providing a guaranteed rate of return, CAPCOs were able to attract funding from insurance companies in a relatively short period of time. These resources, in turn, have con- tributed to an expansion of venture capital infrastructure, management capacity, and invest- ments in those states with CAPCO legislation.
One weakness of publicly funded and managed venture capital programs is the potential for political interference in investment decisions. Similarly, for publicly funded and privately managed venture capital programs, there is the potential for political interference in the selection of the private funds in which the public monies will be placed. With CAPCO pro- grams, political pressure to place state monies in specific private venture capital firms is