Venturing capital, or, If not this, then what?

When people on opposite sides of the ideological divide are skeptical about something, you too should be skeptical. (When they agree on something, you should also be skeptical, but that’s a subject for another day.)

Milwaukee Magazine’s Bruce Murphy and the Milwaukee Journal Sentinel’s Patrick McIlheran are similarly skeptical about the venture capital bill in the Legislature. So is Thomas Hefty, who has for years campaigned for a better business climate in this state.

One reason for our business climate problems is the small amount of venture capital — money invested in companies that usually fit in the “high risk/high reward” investment category. Promoting venture capital was part of nearly every economic development study conducted in 2010 in advance of the election.

The Milwaukee Journal Sentinel reports:

The program is called the Jobs Now Fund and represents part of the $400 million Wisconsin Jobs Act. It aims to jump-start job creation in Wisconsin by promising $200 million in future tax credits in exchange for $250 million raised from insurance companies.

The money would be invested in Wisconsin businesses through management companies known as certified capital companies, or “CAPCOs.” …

In written testimony submitted for the hearing, Tom Hefty, the former chief executive of Blue Cross/Blue Shield of Wisconsin, called the program “the largest special interest Wisconsin tax cut in history masquerading as an economic development initiative.”

The $200 million in tax credits would never have to be repaid to the state. The payback, supporters say, would come from the job creation and business growth that would result from the investments.

There is no question this state needs more business investors. Not only have we lagged the national average in personal income growth for the past three decades, but we are low on business start-ups as well. (And for all the left’s braying about the evil “rich,” Wisconsin has very few people who could be defined as really “rich,” which helps show the state’s economic problems as well. The fact that the really “rich” can be named by those who pay attention to such things shows we don’t have nearly enough of them.) The question is how to encourage business investment, particularly in the fast-growth companies that were meant for venture capital.

Wisconsin Technology Council President Tom Still explains how the bill would work:

 The bill would create two funds totaling $400 million under the umbrella of a new Wisconsin Venture Capital Authority. The complementary funds — the Jobs Now Fund and the Badger Jobs Fund — are designed, respectively, to address Wisconsin’s short-term and long-term investment needs.

The proposal builds on the success of the widely acclaimed and often duplicated Act 255 Tax Credits, which were passed in 2005 and enhanced in 2009. Those tax credits have helped enhance early-stage investing in Wisconsin — but largely at the “angel” capital level, thus creating a need for follow-up investing by venture capital firms in emerging companies.

The credits helped spawn angel networks across Wisconsin, and those networks have dramatically increased both the number of deals and the dollars invested in those deals. But many angels are tapped out. They need “exits” — company mergers, acquisitions or venture investments — to recoup their money. And the companies in which those angels have invested are struggling to survive.

Senate Bill 94 would create the Wisconsin Venture Capital Authority and two funds:

The Jobs Now Fund is envisioned as rapid-response fund. It would issue $200 million in tax credits to insurance companies over time in return for investments in certified capital funds. The tax credits would be for 80% of the value of the investments made, so $200 million in credits could attract $250 million in investments. The credits could not be claimed for a minimum of five years, so the money would be put to work well before the credits are paid. It would invest only in Wisconsin companies that meet specific guidelines. In other states, this approach is called a “certified capital company,” or CAPCO, approach.

The Badger Jobs Fund is the longer-term tool. It would invest in qualified venture capital funds on a “fund of funds” basis. The authority could issue up to $200 million in private placement bonds for the Badger Jobs Fund, with the bonds supported by investment returns, the incremental growth of state tax collections from financed companies and contingent tax credits. Bonds would not be a debt of the state, and no more than 15% of the funds could go to any single venture capital firm. For every $1 a qualified venture capital fund receives from the Badger Jobs Fund, it would need to raise $3 on its own.

Murphy goes so far, commenting on the Journal Sentinel story, as calling the Jobs Now Fund a scam:

… the law allows the CAPCOs to keep all the money invested in them by the state, plus 80 percent of the profits generated.  Critics have called it a “massive corporate giveaway,” [reporter Kathleen Gallagher] writes.

One new point in her story is a Minnesota study of Wisconsin’s earlier CAPCO program, which found that rather than increasing it may have actually displaced the total amount of venture capital funding in Wisconsin. …

The language of the bill is quite convoluted, and most legislators never understand it.  I’d love to hear a detailed explanation of the Wisconsin bill by its sponsors, Sen. Randy Hopper (R-Fond du Lac) and Rep. Gary Tauchen (R-Bonduel).

The CAPCOs have a set game plan and typically grab all the state funding before any real venture capital companies can get a dollar of it. “Local venture capital people often support the bill because they think they’ll get the money,” says [Rutgers University Prof. Sass] Rubin. “But they never do. It’s a con.” …

Rubin cites an earlier law passed in Wisconsin, a 25 percent tax credit for angel investors, as a far more sensible way to go. “It’s just enough money to encourage investment, but you’re not screwing up the market and becoming the only reason they invest.”

Rubin’s aforementioned position happens to dovetail with a previous Murphy column that describes CAPCOs thusly:

Wisconsin previously passed a CAPCO bill in 1998 which created a $50 million venture capital fund.  Normally, experts say, a venture capital fund attracts money from investors, invests it in start-up companies and then returns the principal plus 70 to 80 percent of the profits to the investors. But under the CAPCO model, the state was the investor and got nothing back: None of the profits flowed back to it, and none of the principal was returned.

The state Legislative Audit Bureau found it cost $90,000 per job for that CAPCO program. That’s an outrageous cost, but actually better than the experience in most states. Florida spent $150 million and lost 150 jobs. New York spent $280 million but lost 88 jobs.

A study done for the National Association of Seed and Venture Funds found that state subsidized CAPCOs  gained  “10 times the return” of unsubsidized companies.

One problem is that your favorite lefty (go here and find the list under “Left” for starters) inevitably describes anything that promotes business development, including business investment, as a giveaway for the “rich.” The same people President Obama has been ordering to hire more employees are the same people accused of trying to run the state (the Koch brothers, owners of Georgia–Pacific, one of this state’s largest employers), ruin the state (any business that objects to the overregulation of the Department of Natural Resources), or rob the state (any business person who complains about the state’s tax hell, as in the fourth highest state and local taxes in the U.S.).

Tax credits for business should not be used because businesses should not be taxed on their income. The benefits of a profitable business — employees being paid, customers being served and contributions made to their communities — are sufficient to our society if a business was not taxed on any of its income. And businesses don’t pay taxes anyway; every tax assessed on a business — corporate income taxes, personal property taxes, payroll taxes, and taxes to fund Unemployment Compensation, among others — is part of what the business charges for its products or services. Every dollar of cost government dumps upon a business means one less dollar that can go into employee salaries, into owner dividends (and half the households in this country are in the stock market, directly or indirectly), or back into the business.

McIlheran identifies the specific problem and the general solution:

The plan would offer $200 million in future tax credits to insurers not because anyone likes them but because they’re giant pools of investment money. They’d put up the cash, $250 million, that other management companies would parcel out to entrepreneurs, and the tax credits would ensure they wouldn’t lose their shirts. The credits are a lure, nothing more.

Still, why the special inducements? Why the tax gimmicks, which are what high-tax, regulatory hells offer? Why not stick with the program of making taxes more reasonable generally and regulation more rational for all? Sen. Glenn Grothman called it “the most dubious giveaway I’ve seen since I’ve been in the legislature,” and Tom Hefty, Mr. Business Climate, calls it suspect. Experts get quoted by the Journal Sentinel as saying it’s a deal of dubious worth.

Hit the brakes. Read the prospectus carefully, as they say in those ads, because if forgoing future tax revenue is to be considered an investment in luring capital to Wisconsin start-ups, it isn’t an investment that state lawmakers have spent enough time examining.

The “tax gimmicks, which are what high-tax, regulatory hells offer,” were the preferred approach of the Doyle Administration. They worked well for the companies that were able to take advantage of them. They were better than no tax incentives at all, but the state’s business climate certainly did not improve during the 2000s. Had the state’s business climate improved at all, then the trend of per-capita personal income growth trailing the nation’s, which started during the Patrick Lucey administration (for those ignorant of Wisconsin political history, Lucey was governor in the 1970s), would have ended during the Doyle administration. It hasn’t.

There is also a potential problem with any kind of state-sponsored venture capital approach that has been demonstrated  by the alternative energy industry in the past few years. The Obama administration has offered huge amounts of tax credits to encourage use of wind and solar power and other green energy technology. People and businesses take advantage of the tax credits, and then when they expire, business drops off the face of the earth, so to speak. And one should hesitate when the government anoints a preferred business sector (in the present case, any business with the word “green” in its title), because government operates on politics and not on what is the best potential investment.

I do not believe the proponents of this bill are trying to perpetuate a scam on the state. I think there are reasonable objections to what they propose that are more meaningful than the reflexive anti-business attitude we’ve seen in this state for far too long. It is, for one thing, easier to pass one bill than to pass an entire program, contained within several pieces of legislation, to eliminate business taxes, cut personal income taxes, reduce regulation and defang the regulators. That is what needs to happen in Wisconsin.