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General Assembly spotlights venture investing
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Tennessee private-equity and early-stage venture investment may soon get another boost from the General Assembly.

During a meeting Thursday, venture-capital executives who are members of Tennessee Technology Development Corporation's "Tennessee Capital Formation Board" heard updates on two initiatives - one of which has arisen abruptly in the current session of the legislature.

First came an update on the previously announced, but still-tantalizing work now underway to direct some state pension funds toward "alternative investments."

In 2008, the legislature and Gov. Phil Bredesen produced law that gave the Tennessee Consolidated Retirement System authority to begin investing a portion of the pension assets it manages in private-equity funds.

The VCs convened by TTDC seemed fully attentive to guest speaker Lamar Villere (at right), the man who was recently hired to fill the newly created post of director of TCRS' private-equity investment program.

The Capital Formation Board's members are predominantly partners in Tennessee-based venture-capital and private-equity investment firms. Some of those firms have signalled they are interested in pursuing contracts to serve in fund-management roles with TCRS. Also, many of the VCs have expressed concern their relatively small in-state firms may be crowded-out by larger funds and funds-of-funds base elsewhere, given the rapid pace at which TCRS is committed to placing its investments.

Villere said TCRS will probably begin investing at a pace of $300-to-400 million annually, beginning during the "second half of 2009." The total TCRS investment in alternative investments is currently projected to range up to 3 percent of TCRS assets, which total about $25 billion after being pummeled by the recession and financial cataclysm.

Despite those very large TCRS numbers, it was another agenda item that generated far more energy among the capital-formation executives:

TTDC told its conferees that the Tennessee General Assembly is now contemplating legislation to create new tax credits for insurance companies that invest funds in Tennessee Small Business Investment Companies, which would, in turn, invest in growth companies based in Tennessee, in order to create jobs for Tennesseans.

State Rep. Charles Sargent (R-Franklin, at left) and State Sen. Doug Overbey (R-Maryville, below right) each told VNC in interviews Friday they have filed their respective "Tennessee Small Business Investment Company Credit Act" proposals in an effort to provide benefits to small and medium-sized businesses that do not enjoy economic-development incentives of the sort recently provided by the state to Volkswagen, Hemlock Semiconductor and Wacker Chemie.

Sargent, who is vice chairman of House Finance, confirmed in conversation with VNC that the bills were written by representatives of two out-of-state firms that pursue such "CapCo" legislation and the resultant profitable business in other states: Enhanced Capital Partners, based in New York City; and, St. Louis-based Advantage Capital Partners.

VNC has attempted to obtain comments on this matter from several of the two firms' executives. Enhanced Capital President and CEO Michael Korengold replied to one query, inviting questions, which VNC then provided. He has not yet provided any answers to those questions.

The situation presents at least a minor dilemma for TTDC: First, the nonprofit economic-development advocate has long planned to launch a push to gain further state support for capital formation in the fall of this year, rather than in the midst of the current budget crisis. More significantly, while TTDC's 2008 report to the legislature actually mentioned "CAPCO programs" in passing, among a list (p. 13) of concepts worth examining, TTDC staff and others have since become wary of the model, largely because of reports of disappointing or failed results in some other states where it has been adopted.

In fact, an expert on state venture-funding initiatives told the TTDC conferees last week that CapCo's are a patently bad idea. Dr. Daniel Sandler (at left), a professor at the University of Western Ontario and a prominent critic of CapCo's and the companies pushing them, was a key speaker during the capital-formation meeting.

Sandler made no bones about his disdain for CapCo's, which he views as costing states too much, enriching excessively contractors such as Enhanced and Advantage, and producing too little jobs-producing investment in small and medium-sized enterprises. In a sidebar conversation, Sandler told VNC CapCo's are flatly "a bad idea."

Under one set of CapCo assumptions invoked during Thursday's meeting, $80 million worth of tax credits might produce no more than $37 million in investments over four years [8:54 a.m.: See correction at end of article], while producing guaranteed benefits for insurance companies that would be little, if at all, at-risk in the venture.

In contrast, while emphasizing the potential benefit of fresh legislative interest, TTDC Vice President Dan Schmisseur outlined a scenario in which, with a supposedly smaller amount of front-end resources, TTDC and its allies could create a Tennessee Capital Formation Authority.

The Authority would then employ such existing organizations as Southeast Community Capital, Nashville Capital Network, Memphis BioWorks and universities' technology-transfer offices to pool capital, target technology sectors, make investments and monitor fund-managers' performances.

In separate conversations with VNC, Sargent and Overbey indicated they treated the text provided them as "model legislation," and both men indicated they are entirely amenable to changes in the proposed legislation, and are not attempting to preempt anything else TTDC might have in mind.

Asked whether he'd heard criticism of CapCo's, Overbey told VNC, "no one has made those comments to me."

Meanwhile, according to TTDC President Eric Cromwell (at left), key legislators, including House Finance, Ways and Means Chairman Craig Fitzhugh (D-, have requested that TTDC participate in drafting compromise language.

Both Cromwell and Schmisseur told the capital-formation board that, whereas there is a good deal of evidence that the proposed creation of certified capital companies is flawed, TTDC aims to serve as the state's "trusted advisor" in such matters and thus recognizes the importance of responding in a constructive manner, particularly given the success Enhanced and Advantage have had in advancing the matter, thus far.

At one point, Cromwell stressed that everyone should keep in mind that, without recommendations for improvements or substitutions, the Sargent-Overbey CapCo proposal could win support, meaning "this could be the bill for capital formation for the next fill-in-the-blank number of years."

While acknowledging the TTDC management team's need to be statesmanlike in their response, several members of the capital advisory board made clear they feel no need to pull their own punches for political reasons, and prefer to look at the matter on the merits, alone.

Petra Capital Partners Managing Partner Mike Blackburn (below right) sympathized with TTDC staff's position, but said, "You may be in a difficult position politically, but we [volunteers] are not...," adding "this is really just a boondoggle."

SSM Partners General Partner Casey West described the CapCo proposal as "really dubious" and probably unworkable, and suggested TTDC "put the brakes on this" as not being "in the state's best interest."

Nashville Capital Network Chairman Tom Wylly, a partner in Brentwood Capital Advisors, limited his comments mainly to observing that the information presented suggested CapCo's result in "not much money going into the ground" for advancing ventures.

A few days after participating in the TTDC event, MB Venture Partners Managing Partner Gary Stevenson (at left) told VNC, in part, "...I think the collective wisdom of the Capital Formation Board is that there are much better ways to achieve that goal than is contemplated in the CAPCO proposed legislation - our opinion is influenced greatly by reviewing the experiences of other states who have been disappointed with their CAPCO programs. Of particular concern is how little "bang for the buck" you get for each dollar of tax credit used to fund the CAPCO."

Solidus Company President Townes Duncan noted the potential value of "channeling the profit motive" toward new ventures, but wondered aloud whether, without modifications, the current legislative proposal might ultimately fall far short of the sponsors' hopes.

At another point, Duncan (at right) gave a humorous compliment of sorts to Enhanced and Advantage, exclaiming "I wish I'd thought of it [CapCo's] -- it seems a helluva lot easier than what I do," a reference to the work of his venture-capital firm.

Ultimately, several members of the TCFB agreed to work privately to degree with TTDC staff to develop a response to the Sargent-Overbey legislation. Blackburn was clearest in agreeing to help with that. (Petra Capital is working with groups in Iowa and Arkansas, within somewhat analogous economic development-linked initiatives.)

Asked by VNC for his take on the outcome of the TTDC meeting, Cromwell said, in part, "What I heard from the TCFB members [was] a strong desire to continue in [TTDC's] ongoing planning process that began in November and to engage with legislators and other interested parties to create an efficient program for small business equity investments at the lowest cost to taxpayers."

Cromwell added, "The next step is to have a few representatives of the TCFB volunteer their time and expertise in the coming days/weeks to serve on a working group that will advise on strategies for public officials to consider."

State Economic & Community Development Commissioner Matt Kisber attended part of Thursday's TTDC meeting, but limited his remarks almost entirely to recent industry-recruitment coups and the role of economic-development incentives. The CapCo proposal would be administered by Kisber's ECD.

State Revenue Commissioner Reagan Farr (at left) was also present, with his comments also weighted toward traditional economic development efforts. Farr did, however, make clear that while he has attempted to remain open-minded regarding the CapCo proposal ("an interesting concept") and would like to see initiatives to attract "inbound" venture capital to the state, he is nonetheless uncomfortable anytime legislation is prepared whole-cloth by special interests.

Farr noted that the Sargent-Overbey bill is "an easy piece of legislation to vote 'yes' on," given its pro-jobs rationale. He added that, as a practical matter, ECD cannot simply reject such a bill out-of-hand, without recommendations for improvements or substitutions.

At several points, comments by Cromwell, Farr, Schmisseur and others suggested that if the Sargent-Overbey proposal could not be shaped in a way consistent with TTDC objectives, they would prefer the matter be deferred til the 2010 legislative session.

TTDC staff indicated the organization may submit comments this week on the matter, and the bills are likely to get a further hearing next week.

Correction and amplification:
A note from Schmisseur following publication of the original article above says the passage above "is slightly inaccurate. The $80 million of tax credits is supposed to produce $100 million of investments over 6 years. This is a feature that the bill advocates promote - $100 million of investments. However, only $37 million or so of capital is used to generate those $100 million of investments, because of the mechanics of the model explained by Daniel Sandler. The $100 million mark is accomplished with $37 million of capital by 'churning' investments - low-risk loans are made, harvested, re-loaned, harvested, and then potentially invested for a longer period. The VCs noted that making loans is not the same kind of 'investment' as an equity investment, which by nature has greater risk. Banks make loans to companies with cashflows and collateral to repay the loans. VCs make equity loans and risk getting nothing back if the company fails." We appreciate such reader feedback - Editor. ♦

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Tags: Advantage Capital Partners, Brentwood Capital Advisors, Capcos, capital, Casey West, certified capital corporations, Charles Sargent, Craig Fitzhugh, Dan Schmisseur, Daniel Sandler, Doug Overbey, economic development, Enhanced Capital Partners, Eric Cromwell, Gary Stevenson, General Assembly, Hemlock Semiconductor, incentives, Lamar Villere, legislation, Matt Kisber, MB Venture Partners, Memphis BioWorks, Michael Korengold, Nashville Capital Network, Nissan, Petra Capital Partners, private equity, Reagan Farr, revenue, Southeast Community Capital, SSM Partners, Tennessee Capital Formation Authority, Tennessee Capital Formation Board, Tennessee Consolidated Retirement System, Tennessee Technology Development Corporation, TNInvestco, Tom Wylly, Townes Duncan, TTDC, venture capital, Volkswagen, Wacker Chemie

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