V. Principles for Risk Capital Initiatives
Principle #3 – Select managers competitively “The State should not pick winners and losers.” Never mind that state agencies do exactly this with various procurement processes designed to get the best value for taxpayers and insulate decisions from political influence. All 50 states have pension funds with carefully designed processes to make investment allocations to venture capital funds. The same processes can be readily adapted to select credible, independent fund managers for economic development programs. The best state programs do exactly this, while others go to great lengths to avoid making competitive selections, even to the extent of implementing suboptimal “first come, first served” allocation methods. Another type of program gaining in popularity relies on the legislative process to establish qualifications for fund managers rather than allowing state agencies to implement competitive selection processes. The model, marketed by proponents as a “mirror” to a popular federal program, uses the federally-managed competitive selection process as a proxy for the state, even when this excludes funds with far greater experience investing in the region merely because they do not participate in the federal program. Rather than legislating narrow requirements, there are better, more effective methods for state agencies to design fund selection processes that are open, fair and far more likely to produce the best possible economic development outcomes. Recommendation: Be good stewards of state resources by using effective governance processes and conflicts of interest policies to enable qualified agents with a fiduciary duty to the state design program requirements and select the best managers. Principle #4 – Require pari passu financial returns to funding partners, including the State When states finance risk capital programs for economic development purposes, they need two types of returns to justify the investment – direct financial returns and indirect economic impact returns. Too many states implement programs where the state sets its expectations of direct financial returns at zero. These programs generally allocate tax returns to funds in exchange for the funds making investments that meet certain objectives, such as making investments in low-income communities or making qualifying investments of certain amounts by certain dates instead of evaluating fund performance on reasonable financial measures. When the objectives are met, the funds and their investors keep the value of the tax credit. No capital is returned to the state. Effectively, these programs constitute a direct transfer of wealth from the public to private sector, and very often to funds that, prior to the legislation, had no base of operations in the state. The challenge for promoters of these programs is demonstrating that the economic value of the investments they make exceeds the cost of the tax credits. Very often, creative accounting methods are employed. Participants commonly claim that every job in the company at the time of an investment was “retained” by their investment, even when the investment is merely a loan to an established, profitable company. Participants also commonly claim that every job subsequently © The Arizona Bioscience Board and Cromwell Schmisseur LLC, 2016
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