Barkley et al. / CERTIFIED CAPITAL COMPANIES
eliminated because the state’s role is limited to certifying the capital companies. The partici- pating insurance companies individually select in which of the CAPCOs to place their funds. In addition, political pressure for CAPCOs to make investments in specific busi- nesses also is diminished because the CAPCOs receive no direct state funding.
Private venture capital funds are reluctant to coinvest with state-supported funds (both pub- lic funds and publicly funded, privately managed funds) because of the perception of poten- tial political interference in fund selection and management. However, private venture funds may be willing to coinvest with the privately managed CAPCOs, thus increasing the funds’ ability to participate in syndicated deals and leverage their certified capital.
Publicly managed funds in some states are limited by state pay regulations in the amount they can compensate the managers of the public fund. Experienced venture capitalists com- mand significant compensation in the private sector, and such individuals may not be easily attracted to a public fund. CAPCOs do not have restrictions on compensation packages for fund managers; thus, CAPCOs may be able to more easily attract experienced fund manag- ers because of higher salary, profit sharing, and benefit offerings.
Some states (e.g., Maine and Iowa) are constitutionally restricted from making direct equity investments in private businesses. In these situations, tax credit programs like CAPCOs may provide the only opportunity for state support for venture capital programs.
1. CAPCOs may be a costly way of increasing equity capital in a state. All state-sponsored venture capital programs result in new costs (state appropriations, debt payments, or tax rev- enues forgone) and new revenues (returns from investments, new tax revenues) for the state’s treasury. The net cost of CAPCOs to the state treasury (costs minus revenues) relative to that of similar-sized alternative programs (publicly funded and managed or publicly funded and privately managed) depends on the performance of the fund. For CAPCOs, the cost to the state is the present value of future tax revenues lost due to tax credits over the 10- year period. For public investments in public or private venture capital funds, the cost to the state is typically the current lump sum value of state funds invested. If returns from program investments were poor, the state treasury would lose less with a program financed with 10 years of tax credits than with a program funded with one lump sum payment.
However, in situations where CAPCOs and alternative publicly assisted programs recoup much of their original investment or realize a profit, CAPCOs will have a higher net cost to the state than a comparable state investment in a publicly or privately managed fund. Publicly or privately man- aged funds will be less costly than CAPCOs because the cost to the state of its investment in these funds will be offset to the extent that proceeds from the funds are distributed to the state as the prin- cipal or limited partner in the funds. Alternatively, proceeds from CAPCO investments generally are distributed to the insurance companies providing capital to the CAPCOs and to CAPCO man- agement. Thus, the state does not receive a share of returns from CAPCO investments to help defray program costs.
The net cost of CAPCOs to the state treasury (costs minus revenues) relative to that of similar- sized alternative programs (publicly funded and managed or publicly funded and privately managed) depends on the performance of the fund.
The potential cost disadvantages of a CAPCO program may be reduced with requirements in the enabling legislation that stipulate a return of a share of CAPCO’s liquidating distributions to the state treasury (e.g., the Louisiana and Missouri model). However, even the Missouri and Louisiana legislation does not eliminate the cost disadvantage of the CAPCO alternative. For venture capital programs that provide fair or good returns on their investments, the net cost to the state is less with state investments in publicly or privately managed funds than with tax credits and profit sharing with CAPCOs.
2. With CAPCOs, as opposed to public funds or publicly supported private funds, the state has less control over the quality of the fund managers. Moreover, the CAPCO structure does not include a strong incentive for the CAPCOs to hire the best fund managers. Most insurance companies invest in CAPCOs in exchange for a guaranteed fixed debt instrument; thus, the