Why Do Really Bad Ideas Diffuse Among States: The CAPCO Experience

1. Why Do Really Bad Ideas Diffuse Among States: The CAPCO Experience Julia Sass Rubin, Ph.D. Edward J. Bloustein School of Planning & Policy Rutgers University EARN Conference - September 13, 2011

2. Certified Capital Companies (CAPCOs) • Insurance tax credit program • Began in Louisiana in 1988 • Between 1997 – 2005 diffused to: • Alabama Colorado • Florida Georgia • Missouri New York • Texas Washington DC • Wisconsin

3. How CAPCOs Work • State provides $100 million in tax credits to insurance companies • Insurance companies lend $100 million to CAPCOs • CAPCOs invest $50 million in 10 year zero coupon bonds to repay that loan • CAPCOs lend/invest other $50 million to in-state businesses, until amount loaned/ invested equals $100 million • CAPCOs “de-certify” and keep all the money not repaid to insurance companies

4. What does the State get? • "I think this state would be hard pressed to design a program that cost the taxpayers more and delivered less.“ Bob Lee, head of Colorado's Office of Economic Development, which administered the CAPCO program • "It's a scam…I don't think there's anyone who thinks this is a good deal for Colorado, with the exception of those companies who lined their own pockets.“ Mike Coffman, former Colorado State Treasurer who is now a Congressperson

5. What does the State get? • Poor quality loans/investments • Demonstration of prior success not required for CAPCO managers • Incentives for low risk and quick repayment • Extraordinarily expensive • Normal venture investors: • repaid $100 million investment • earn 80% of profits • CAPCO states receive $0

6. What does the State get? • Empty promise to “create and foster a local venture capital infrastructure” • Louisiana spent >$630 million 1989 to 1999 • Attracted < 1/1000% of US VC $ from 2000 to 2003 • May price out indigenous VC • Effective alternatives exist • Fund of Funds • InvestMD

7. Why Do States Sign Up? • Solution in search of a problem • Venture Capital? Economic Development? • Flexibility • Change name and terms; keep basic model • Legislators do not understand • How venture capital works • How CAPCOs work

8. Why Do States Sign Up? • Expensive and effective lobbying • Often well-liked former legislators • Hard-ball politics • Smear/threaten critics • Timing • Push through in final days of session

9. Requirements for State-Sponsored Venture Capital Programs • Clear objectives • Venture capital or economic development? • Profits or jobs? • Geographic focus: State wide? Rural? Low-income geographies? • Clear criteria for selecting venture funds, based on program goals • Financial returns • In-state job creation • Targeted economic development

10. Requirements for State-Sponsored Venture Capital Programs • Prioritize • VC funds w/ success investing in-State • Transparent VC selection process • Remove VC selection and investments from political oversight or input • If using tax credits vs. direct appropriations, use competitive monetization process • minimize cost to taxpayers – e.g., InvestMD

11. Requirements for State-Sponsored Venture Capital Programs • State receive same terms as private-sector • Full return of principle • 80% of any profits • Limits on fees to reflect VC norms • Limited financial commitment up-front • Can reassess before disbursing additional funds