CAPCO Concerns

Thanks to local leadership, Washington has become much more business-friendly than it used to be. However, the venture capital investment strategy now being pursued by District leadership merits careful watching.

By:
An Editorial
Washington Times

http://www.nasvf.org/web/allpress.nsf/pages/8869

Last November, the D.C. Council unanimously passed the "Certified Capital Companies Act of 2003." The legislation (B15-0200), sponsored by council member Sharon Ambrose, permits the establishment of certified capital companies (CAPCOs) and provides substantial tax credits to the companies that invest in them. It took effect on March 10 with nary a peep in the local papers.

That spending deserves far more scrutiny. In his article, "Risky Ventures," in the April issue of Governing, Christopher Swope pointed out that CAPCOs are sometimes used to build the bottom lines of their parent companies while costing their communities badly. The initial investment usually comes from insurance companies, who put up the money in return for its equivalent in tax credits. That money is supposed to then be funneled into struggling or risky start-ups, with high potential for return. However, CAPCO investors put less at risk than it appears on paper, since they receive the tax credit and then negotiate with the CAPCOs for a guaranteed rate of return on their capital. While CAPCOs are required to invest in in-state start-ups, as Mr. Swope noted, they "are not required to show any economic benefits . . . the laws gauge success by how quickly the CAPCOs pump out dollars." The need to produce steady returns to their parent companies causes CAPCOs to make safe investments with some of the money. CAPCOs also charge substantial start-up and management fees, a gain to their investors but a loss to taxpayers. Mr. Swope pointed out that, "The question . . . is not whether the CAPCOs might produce some positive results. The issue is cost-efficiency."

States have set aside about $2 billion for CAPCOs, but concerns with them are growing. Last month, Colorado Gov. Bill Owens signed legislation that shut down the state’s CAPCO due to its excessive costs, which included about half a million dollar for lobbying fees.

The structure of the District’s strictures may avoid a few abuses. CAPCOs are not allowed to charge annual management fees of more than 2 1/2 percent of their capital. If the CAPCOs’ internal rate of return exceeds 15 percent, it is required to pay the commissioner of Insurance, Securities and Banking agency 15 percent of the amount above that.

Time will demonstrate if D.C.’s CAPCO produces their desired dividends. The council and the mayor should keep careful watch to ensure that D.C. residents are receiving the best return for their tax dollars on such capital investments.