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Barkley et al. / CERTIFIED CAPITAL COMPANIES

number 1 rated investment by the National Association of Insurance Commissioners. The insurance company receives a guaranteed rate of return on its investment in the CAPCO rather than a share of future profits. In this way, the insurance com- pany is basically investing in a guaranteed security rather than in a relatively risky equity investment. More detail regarding the structure of the investment instrument is provided in the discussion of the Louisiana program.

3. In most states, the amount of certified capital raised from insurance companies (and the resulting tax credits requested) exceeds the amount of tax credits approved by the state. In these situations, states have allocated tax credits among eligible CAPCOs in one of three ways: first come, first served; a pro rata distribution based on share of total tax cred- its requested; and an equal split of tax credits among all eligible CAPCOs. The first come, first served and pro rata methods are advantageous to existing CAPCOs (CAPCOs currently operating in other states) because these CAPCOs have well- developed investment instruments and contacts within the insurance industry.

4. State legislation also provides a means for CAPCOs to decertify, either voluntarily or as a result of noncompliance with the rules governing CAPCOs. In most cases, voluntary decertification occurs either when a CAPCO fails to meet requirements for raising certified capital or when a CAPCO has met the investment requirements under the legislation. Based on the experience in Louisiana, decertification for noncompliance and decertification because of fund-raising con- straints occur rarely. With the exception of Louisiana, however, CAPCOs can voluntarily decertify once an amount equiva- lent to 100% of certified capital is invested. After decertification, the CAPCO is no longer required to invest capital in quali- fied businesses as defined by the state.

5. The Small Business Administration (SBA) definition of small businesses varies by major industry group (e.g., man- ufacturing, services, retail), and exceptions exist for industries within these major groups. However, in general, the SBA definition for small business is fewer than 500 employees for manufacturing and less than $5.0 million in annual sales for retail trade and services. SBA regulations are available at http://www.sba.gov/regulations/121/210.htm.

6. The Massachusetts Capital Resource Company (MCRC), started in 1978, has similarities with CAPCOs, and its existence may have influenced the design of the Louisiana CAPCO program in 1983. According to Markley and McKee (1992), MCRC was created as a result of a deal struck between the governor of Massachusetts and the state’s life insurance industry. The insurance companies agreed to create and manage a $100 million venture capital fund in exchange for repeal of a 1% tax on gross income.

7. The state profit sharing program selected by Louisiana (25% of returns above the amount necessary to achieve a 15% internal rate of return [IRR]) will not likely result in sufficient returns to the state to cover the cost of future tax credits. In a hypothetical analysis of a CAPCO program (Barkley, Markley, & Rubin, 1999, pp. 53-56), it was estimated that the Louisiana profit sharing program will provide returns (present value) to the state treasury exceeding costs of tax credits (present value) only if CAPCOs realized an IRR on their investments exceeding 22%. An IRR above 20% may not be easily attained by CAPCOs if a significant portion (e.g., 40%) of the CAPCOs’ certified capital is held in zero-coupon bonds as collateral on insurance company loans to CAPCOs.

8. The lack of seed capital investment in Missouri led to the creation of the Missouri Seed Capital Coalition and the passage of legislation (SB518) in 1999 designed to encourage professional venture capital management to give greater attention to the issue of commercializing university research and other early-stage ventures.

9. The state of Kansas developed CAPCO legislation (HB2688) that differed significantly from CAPCO legislation in other states. The Kansas legislation included (a) tax credits for certified capital provided by individuals, (b) 365 days to raise certified capital, (c) a requirement that 70% of certified capital be invested within 7 years, and (d) a restriction on CAPCO investments to businesses with annual sales less than $1 million. Pressure was brought on Kansas legislators (through the Growth Capital Alliance, a CAPCO lobbying organization) to change their legislation to permit only insurance company investors, increase the size of qualified businesses, reduce CAPCO fund-raising time to 30 to 60 days, and require a less restrictive investment schedule. The Growth Capital Alliance agreed to cease lobbying against the Kansas legislation only if drafters of the legislation agreed not to use the name CAPCO. In the Kansas legislation, Capital Formation Companies was selected as the compromise name for the new venture capital firms.

10. Public venture capital firms and publicly assisted private venture capital firms also may have a cost advantage rela- tive to private venture capital firms. However, the potential for crowding out private venture capital firms is generally greater with CAPCO programs than with other publicly assisted programs because of the relatively large size of CAPCO programs ($50 million or larger).

11. The most thorough study of a CAPCO program to date is the CAPCO Study prepared in 1999 for the Louisiana Department of Economic Development by Postlethwaite and Netterville (1999), a professional accounting corporation located in Baton Rouge, Louisiana. A copy of the study is available on the department Web site (http://www.lded. state.la.usa). The Postlethwaite and Netterville study compared the present value of tax credits to the present value of new state tax revenues resulting from the Louisiana CAPCO program (under alternative scenarios regarding the future growth rate of the funded businesses and the percentage of the businesses’financing attributable to CAPCO investments). The Lou- isiana study found that program costs exceeded new tax revenues for most of the growth rate business financing scenarios estimated.

REFERENCES

Barkley, D. L., Ferland, C., Ferdinand, D., Freshwater, D., Markley, D. M., Rubin, J. S., & Shaffer, R. (2000). Directory of state-assisted venture capital programs, 2000 [Online]. Columbia, MO: Rural Policy Research Institute. Available: http://www.rupri.org

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