ECONOMIC DEVELOPMENT QUARTERLY / November 2001
incentive to select CAPCOs that have the most qualified venture capital investors is dimin- ished. Insurance companies do not benefit from any upside in the CAPCO’s performance or risk losing money should the CAPCO investments fail to perform. As a result, insurance companies make investments in CAPCOs based on familiarity and the CAPCO’s ability to design a debt instrument that the insurance companies find attractive.
States concerned with the quality and experience of CAPCO management should institute a system that ensures adequate due diligence in certifying CAPCO managers.
States concerned with the quality and experience of CAPCO management should institute a system that ensures adequate due diligence in certifying CAPCO managers. One alternative would be to use a review team of professional venture capitalists to assess the qualifications of CAPCO applicants. States also may include more specific and restrictive language in the enabling legisla- tion regarding required managerial experience. For example, Florida legislation requires that man- agers have at least 5 years of venture investing experience, including investing in early-stage busi- nesses. And proposed Kansas legislation requires that CAPCO managers meet the standards estab- lished by SBA for small business investment company programs.
3. CAPCOs make limited seed and start-up investments. CAPCOs try to maximize profitabil- ity within the parameters allotted by individual state requirements. As such, they tend to invest at the upper end of the size limit permitted by state law because such investments gen- erally have lower risk and cost than seed and start-up investments. States have attempted to address the limited seed and start-up investment problem with more restrictive legislation regarding qualified businesses, limitations on the size of individual CAPCOs, or with sepa- rate (non-CAPCO) venture programs focusing on technology commercialization and seed investments.
In addition to the strengths and limitations of CAPCO programs, three attributes of CAPCO programs were observed that may influence the attractiveness of the program to a state. First, CAPCOs and insurance companies devote considerable resources to lobbying for additional appropriations in states with existing CAPCO programs and for new CAPCO legislation in states where CAPCOs do not already exist. In all the states that currently have CAPCO legislation, except Louisiana, the legislation was introduced through the efforts and financial investment of the exist- ing CAPCO industry. In general, CAPCOs identified champions in the state legislature to promote the concept and hired lobbyists to push for the legislation’s passage. The advantage existing CAPCOs have in obtaining new capital commitments and the program’s profitability also encour- age CAPCOs to devote resources to lobbying for additional rounds of appropriations. The lobby- ing efforts by CAPCOs and their supporters may result in an information base that is somewhat biased. States may ensure that more balanced information is available by making time and resources available for an independent review of the state venture capital market and the proposed CAPCO legislation.
Second, the CAPCO industry will resist (lobby against) efforts by states to be too innovative in developing CAPCO legislation in terms of sources of certified capital other than insurance compa- nies or tax credits less than 100%.9 The reliance on insurance companies as the sole source of certi- fied capital gives existing CAPCOs (i.e., CAPCOs established in other states) a significant advantage over new CAPCOs in obtaining commitments of capital. There are several reasons why this may occur. Existing CAPCOs have an established relationship with insurance companies and a ready-made debt investment instrument that is attractive to the insurance industry and difficult and costly to imitate. Moreover, state legislation does not always provide sufficient time for new CAPCOs to develop a competitive debt investment instrument and market it to insurance compa- nies. Finally, even those in-state funds that are able to obtain some capital commitments may not be able to meet the minimum capitalization stipulated in the state legislation.
Evidence of the dominance of established CAPCOs in raising funds from insurance companies is provided in Table 3. Advantage Capital and BancOne (both established Louisiana CAPCOs)