Posted on: Sunday, February 29, 2004
Idea offers help for startups
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By Sean Hao
Advertiser Staff Writer
With its borders in the South Plains, Oklahoma doesn't share many obvious similarities with Hawai'i — except, perhaps, the need to attract investment capital for their home-grown companies.
Now it looks like the two states will take a similar approach to solving that problem.
State lawmakers and Gov. Linda Lingle are enthusiastically backing the creation of a state-backed venture capital program pioneered by Oklahoma during the 1990s. Much of their support rests on the promise that the program could spur millions of dollars in investment for local companies without costing the state a dime.
While that may sound too good to be true, several experts who have studied state-assisted venture capital programs agree the Oklahoma model presents the least downside risk to state coffers.
"The Oklahoma model is one of the better ones," said David Barkley, an economics professor at Clemson University in South Carolina. "It's more efficient from a state standpoint because it provides incentives without sacrificing state tax revenues."
The program's approach would be markedly different from the state's seed capital, or "angel" investment, incentives created under Act 221. Those are expected to cost $48.4 million in the current fiscal year, and forecast to reach $76.7 million in fiscal 2005.
The State Private Investment Fund, or SPIF, venture capital program would augment Act 221 by providing local businesses with access to later-stage financing or expansion capital.
Capital sought
State and technology industry officials maintain that both startup and later financing are critically needed. Hawai'i companies will need $138 million from venture capitalists outside the state in the next five years, according to an Enterprise Honolulu study.
Without such investments, officials fear some local companies will be forced to move to the Mainland to find investors — a situation that occurred only last week when networking company Firetide Inc. announced its headquarters was moving from Honolulu to Los Gatos, Calif.
Hawai'i lawmakers are considering a proposal backed by the Lingle administration that would have the state borrowing between $50 million and $100 million over perhaps a decade. The money would be placed with venture capital funds, which would leverage the money with private capital to invest in startup companies.
The investments create tax credits, but these would not immediately drain the state's general fund, because they aren't sold until the fund is terminated — and then only if there's a shortfall after management and interest fees are accounted for.
Historically, such venture capital funds have generated annual returns of 15 percent to 20 percent, according to the bill's backers. The tax credits essentially provide a guarantee on repayment of the state's loans.
Oklahoma model
Oklahoma has never yet had to sell such tax credits, though the state has invested $30.7 million in 13 funds since 1993, according to the Oklahoma Capital Investment Board. Overall, those venture capital funds have invested $93.5 million, some in companies outside Oklahoma. The program provides that flexibility to attract venture capitalists and ensure a return on the state's investment — a feature also being considered for SPIF.
"From a fund management perspective, we want the returns off of good deals that may not be based here in Hawai'i," said Ted Liu, director of the state Department of Business, Economic Development and Tourism.
Apart from an initial appropriation of $600,000, the program has not cost any Oklahoma taxpayer dollars. And according to Robert Heard, president of the Oklahoma Capital Investment Board, the fund's investment portfolio is likely "break even."
The economic benefits of the program are unclear, however, because Oklahoma officials don't track job creation. Officials in charge of the program also could not provide data on the survival rate of companies benefiting from the program.
The track record of similar programs beyond Oklahoma also is sparse, because states that have used the same model have not invested money with local entrepreneurs. That highlights one downside of the program: It can take years to set up the program, said Deborah Markley, co-director of the Rural Policy Research Institute's Center for Rural Entrepreneurship at the University of Missouri.
Arkansas, which passed legislation to create its venture capital program in 2001, made its first commitments to venture capital funds only late last year. Part of the delay resulted from objections to the state's choice of managers for the Arkansas Institutional Fund.
In Idaho, Gov. Kirk Kempthorne vetoed a bill establishing a similar program in 2002 because of concerns it violated the state's constitution. Utah faced similar issues.
Results take time
Once investments in companies are made, it can take five to seven years before states can assess any positive impact.
"That's the difficult thing about state-sponsored venture capital: No legislature wants to wait for seven years to see if this is going to work," Markley said. "It's a tough thing, and needs really strong political leadership."
Outside Hawai'i, the success rate for state-sponsored venture capital programs is mixed, and was dismal in the case of Mississippi.
In the 1990s, Mississippi pumped $20 million raised through bond sales into Magnolia Venture Capital Corp., which was supposed to fund cash-needy businesses. But the company funded only one business during its three-year lifespan, and its former chief was convicted of mail fraud and money laundering after charges that he profited from Magnolia through various schemes.
At least one expert who has studied the Oklahoma model maintains that such government-sponsored venture capital investments aren't good public policy.
"Some businesses will be subsidized that would have been created anyway, and some businesses will be created that are bad credit risks that will likely go bankrupt," said Benjamin Powell, an economics professor at San Jose State University. "Investment decisions are best left to the market, where they are free from political interests and lobbying."
No final solution
Still, the Oklahoma model can be exported successfully to other states, Barkley said. At least five states have adopted it since 2000 — Arkansas, Iowa, Ohio, Utah and Michigan. Hawai'i, Illinois and South Carolina are considering following suit.
Still, the program is not a final solution to problems that states face in trying to attract investors.
"If you have a fairly reasonable venture capital market ... then the Oklahoma model will be much more successful than if you have an environment that has been poor for entrepreneurs," Barkley said.
If adopted, SPIF essentially would follow on the work of the Hawai'i Strategic Development Corp., which oversees about $14 million in state money invested in venture capital funds that help finance local companies. The success of that program is hard to gauge because many of the investments have yet to mature, although HSDC did reap about $3 million on a $450,000 investment in the Internet company Digital Island Inc.
HSDC's operations were curtailed last year when the Legislature decided to repeal the agency's special fund. The Department of Business, Economic Development and Tourism, which wants HSDC to oversee the new venture capital program, seeks to reverse that decision.
Reach Sean Hao at shao@honoluluadvertiser.com or 525-8093.
