ECONOMIC DEVELOPMENT QUARTERLY / November 2001
Interest in establishing state-assisted venture capital programs is unlikely to diminish. As state policy makers consider how best to organize these programs, they must consider the relative strengths and limitations of alternative models. Publicly funded and managed programs and pub- licly funded, privately managed programs offer states more control over investment decisions; however, these programs also suffer from potential political interference that can jeopardize the effectiveness of the program. The creation of CAPCOs provides a means for the state to attract pri- vate sector resources into privately managed venture funds, in this case by using state tax credits to encourage insurance company investments in CAPCOs.
Although CAPCO programs may insulate the capitalization and investment decisions from political pressure, the programs have important disadvantages for policy makers to consider. The principal disadvantage of CAPCOs relative to alternative state-assisted programs is the cost to the state treasury resulting from (a) losses of future tax revenues and (b) little or no return to the state from CAPCO profits. A study prepared by the Louisiana Department of Economic Development (1999) concluded that “the CAPCO program, in its current form, is expensive and inefficient to the state” (p. 64). The study’s principal concern is that CAPCOs typically have a significant amount of overhead, in terms of capital used to provide collateral on insurance company loans, rather than having that capital available for investments in qualified businesses.
The potential high cost of CAPCOs compared to alternative state-assisted venture capital pro- grams should encourage in-depth analysis of the state’s venture capital market and great care in drafting legislation before a CAPCO program is introduced to the state legislature. Recommended analysis includes a cost-benefit study of CAPCOs versus publicly funded–publicly managed funds and publicly funded–privately managed funds. This cost-benefit study should include estimates of jobs generated and costs per job associated with the program alternatives.11
If the above cost-benefit analysis indicates that CAPCOs are cost effective, then further research should be undertaken to assess the availability of investment opportunities (deal flow) to determine the appropriate amount of tax credits to be provided in the legislation. Excess tax credits (relative to good venture capital deals) will encourage questionable investments, whereas too few credits will preclude worthy companies from obtaining financing. Next, CAPCO legislation should be carefully written to focus investments on desired recipients or goals. CAPCOs are profit- maximizing entities, and they will seek investments that provide the highest expected rate of return. Thus, if the state wishes to target venture capital at a specific group of businesses, this group must be identified explicitly in the enabling legislation. Third, the state should investigate means of sig- nificantly sharing in the upside gains of CAPCOs to reduce the costs to the state treasury. Finally, CAPCOs do not appear to be a panacea for all venture capital needs of state businesses. Entrepre- neurs and businesses needing seed or start-up capital are not well served by CAPCOs; thus, legisla- tion and programs addressing the needs of early stage businesses should be considered in conjunction with CAPCO legislation.
1. On-site or telephone interviews were conducted with the following individuals: Dennis Manshack and Mike Wil- liams, Louisiana Economic Development Corporation; Darin Domingue, Louisiana Office of Financial Institutions; Thomas J. Adamek and Michael Kirby, BancOne Stonehenge Capital, Baton Rouge, Louisiana; Bill Bergmeyer and Stacey Hurst, Missouri Department of Economic Development; Chip Cooper, Missouri Innovation Center; Scott A. Zajac, Advan- tage Capital Partners, St. Louis, Missouri; Monique Cheek, Florida Governor’s Office; Mike Ramsden, Florida Department of Banking and Finance; Colleen Holtan, Wisconsin Department of Commerce; Anna Lemecha, State of New York Insur- ance Department; Tim Roche, New York State Senate Information Office; George Lipper, Iowa Department of Economic Development; Charles Ranson and Mikel Miller, Kansas, Inc.; and Kevin Carr and Michael J. Wojcicki, Kansas Technol- ogy Enterprise Corporation, Topeka, Kansas. This research effort was part of a larger project funded by the U.S. Depart- ment of Agriculture’s Fund for Rural America and the Rural Policy Research Institute.
2. The regulated nature of the insurance industry usually precludes insurance companies from investing in Certified Capital Companies (CAPCOs) as limited partners, a model common to more traditional venture capital funds. As a result, the CAPCOs have created an investment instrument that is attractive to insurance companies because it is classified as a