A State Legislator’s Guide to
Small Business Investment Programs
National Conference of State Legislatures
August 4, 2015
Confidential
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Session Outline
• The Changing Economic Development Landscape
• Components of an “Innovation Agenda” for States
• Small Business Finance – Credit vs. Equity Support
• State Case Studies – Lessons Learned from Mistakes
• Best Practices/Principles for an Actionable Plan
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The Changing Economic Development Landscape
• From “smokestack chasing” to “innovation ecosystems”
– Economic development has become more complicated – more
people, more strategies, more investments, more economists
Let’s Recruit One of These!
Let’s Do More of This!
• The result is an increased burden on state legislators to
evaluate more information and know who to trust.
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The Changing Economic Development Landscape
State economic development efforts are increasingly
focused on nurturing innovation and supporting
entrepreneurial development/growth:
From This
To This
Workforce
Training
Infrastructure
Tax Incentives
Business Recruitment
Risk Capital
Research &
Technology
Transfer
HighGrowth
Companies
Grow Your Own
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State Economic
Development Model for
an Innovation Economy
Source: Regional
Innovation Accelerator
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Network (RIAN)
Capital for Small Businesses: Banks vs. Venture Capital
Banks lend capital to
small businesses with…
Venture capital funds invest
in small businesses with…
• Assets that can be used as
collateral for debt financing
• Innovative products or services
backed by proprietary business
methods or intellectual property
• Multi-year history of established
operations with cashflows
sufficient to service debt
• Growth potential to capture a
significant share of a large market
• Owners with assets to provide
personal guaranties
• Exit strategy to provide investors
with 3X to 10X returns on capital
• 99.5% probability of returning
principal plus interest
• 30-40% probability of write-off
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Philosophical Considerations – “The Why”
Why are states involved in capital formation?
INNOVATION!
ECONOMIC GROWTH!
JOBS!
• Innovation drives economic growth, and equity
investment drives innovation with commercial value
• But venture capital is geographically concentrated
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Extreme Concentration of Risk Capital Supply
Venture Capital
Invested
Venture Capital
Managed
Remaining
47 States,
25%
Remaining
47 States,
30%
CA, MA, NY
Remaining 47 States
CA, MA, NY
Remaining 47 States
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If You’re Not from CA, MA or NY…
You are a “fly-over” or “drive-through” state!
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Philosophical Perspectives – “The Why”
Why are states involved in capital formation?
• Early-stage investing is a local activity – without local
investors, regions will underperform on potential.
• Capital programs offer “comprehensive returns”
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Strategic Perspectives – “The What”
What are states doing to spur investment?
• A majority of states support early-stage venture
development and experiment with capital programs
– But not all are good!
• State Venture Capital Programs are often described
inaccurately as “Public Venture Funds” when really…
– Well-designed state programs utilize credible, private
investment managers (for-profit and nonprofit)
– Programs are not states “picking winners and losers”
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Capitalization Options for Innovation Finance Programs
Pay It
Forward
Found
Money
Investor Tax
Credits
Contingent
Credits
Deferred
Appropriation
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Principles to Guide Smart, Responsible Policy
1. Capitalize program efficiently
2. Address market needs not met by existing private investors
3. Investment manager selection process must be competitive
4. Policy should deliver “comprehensive returns”
Best Practice Programs Utilize Private Sector Processes and
Principles to Achieve Public Sector Economic Development Goals.
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$3.9 billion of wasteful state investment programs
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What’s Wrong with CAPCO and State New Markets?
1.
2.
3.
4.
5.
Mismatch of rhetoric versus reality
Unnecessary complexity
Adverse selection process for state resource allocations
Use of “sham transactions”
States can always do better than these models towards
achieving policy goals of supporting small businesses
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Arkansas – State New Markets
Arkansas tax credit program drawing scrutiny
Submitted by The City Wire Staff on Mon, 11/11/2013 - 3:42pm
story by Ryan Saylor
rsaylor@thecitywire.com
Bryan Scoggins, director of business finance at the Arkansas Economic
Development Commission (AEDC), said it initially appeared to be a responsible
bill, which is why he believes it received such strong bi-partisan support.
“It has a lot of phrases and terms and things that sound very good. But it’s
not until you read it several times and get down in the weeds (that you can see
loopholes). It looks (good). Who’s not going to go for jobs?”
“The best we’ve been able to determine looking at this program and similar
programs across the country, somewhere between 25% and 30% of the value
of the tax credits make it to the end-project company. That means 70% of the
value of the tax credit is going someplace else. Where? I’m not sure anyone
is completely sure,” (AEDC Director Grant Tennille) said.
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Florida – Nothing Ventured, Millions Gained
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Missouri – CAPCO and State New Markets
Job totals trail expectations
for Mo. tax credit
Monday, April 15, 2013
By DAVID A. LIEB ~ Associated Press
JEFFERSON CITY, Mo. -- Missouri has authorized
more than $120 million of tax credits through a
program intended to entice wealthy investors to pour
money into businesses in low-income areas, but the
initiative has yet to produce even half the jobs that
were anticipated, according to state figures provided to
The Associated Press.
***
At the request of the AP, the state Department of
Economic Development compiled a spreadsheet
documenting every New Markets tax credit that has
been authorized. The 9,679 "anticipated jobs"
associated with the tax credits far exceeds the 823
"actual new jobs" and 3,141 "jobs retained" under the
program, though those numbers could continue to rise.
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Maine – Payday at the Mill (2015)
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Lessons Learned…
1. Do your homework
• Private equity investors call it “due diligence”
• Investigate the source of proposed legislation and related interests
• Don’t accept candy from strangers….and don’t accept “awards” from
outside groups that want you to promote substandard legislation
2. If it sounds too good to be true…
•
•
“Double bottom line” – there is no such thing
Indirect economic benefits alone will not exceed the fiscal impact
3. Match the rhetoric with the bill language
• If you want “venture capital,” don’t allow managers to make loans
• If you want to create jobs, don’t allow proponents to count the jobs
you already have
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Lessons Learned…
4. Competition is a good thing
• “First come, first-served” is bad public policy
• When proponents say “the state shouldn’t pick winners and losers,”
what they really mean is “we don’t want competition”
5. Demand a “square deal”
• “Pari passu” = at the same rate, or on equal footing
• If private investors get 100% of principal returned before profit
distributions, so should the state, for any investment program
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Always Look for a Better Deal…
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Maryland – a “Better Deal than CAPCO”
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Recommendations for Designing New Programs
1. Understand the specific capital needs in your state –
what is the supply of risk capital and what is the
realistic demand?
2. Meet with in-state “TBED” leaders, private investors
and high-growth company founders
3. Study state venture capital program experiments in
other states (e.g. InvestMaryland and Innovate PA)
4. Invest at significant scale to spur private investment
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Innovation in Economic Development
Eric Cromwell
eric@cromwellschmisseur.com
615-428-0857
Dan Schmisseur
dan@cromwellschmisseur.com
615-290-2515
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