Next month, leaders of Rhode Island’s entrepreneurial community plan to take to Smith Hill with their most comprehensive legislative package yet to help fuel the state’s startup companies.
Officials from the Economic Policy Council in recent weeks have hammered out a legislative agenda that they say would enhance startups’ access to seed capital while building a new venture-capital fund. The three key components of the package include:
• Doubling the Slater Technology Fund – the state-funded technology commercialization fund – from $2.5 million to $5 million.
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• Creating a $30 million early stage venture capital fund, backed by state tax credits.
• Beefing up the state’s pool of “angel investors” – wealthy individuals who invest in fledgling companies – via state tax credits.
It’s an ambitious package, especially in light of the legislature’s apparent ambivalence toward technology commercialization efforts during the 2002 session. Despite a request for more Slater funding, the General Assembly slashed its budget by $500,000 this year, to $2.5 million. And a handful of legislators sought to wrest control of the fund away from the EPC, claiming the money was being mismanaged.
What’s more, the one venture-capital bill floated last year – a plan that would have created tax incentives for insurance companies to invest in a venture-capital fund for Rhode Island startups – didn’t pass.
But EPC officials remain undaunted. They say the state needs to look past its present budget constraints (an estimated $175 million shortfall) to a future in which high-paying technology jobs are the new engine of the state’s economy.
“The fact that we’re in difficult times heightens the need to make this investment,” said Christopher “Kip” Bergstrom, director of the EPC. “If we invest in a down cycle, it positions our portfolio companies to be magnets for venture funding when it comes back. If we don’t do that, then we miss the boat again.”
While the proposed early stage venture fund is the most innovative component of the EPC’s three-pronged legislative package, it takes a backseat to the Slater request, Bergstrom said.
“There’s no sense in doing the early stage venture fund if we don’t crank up the Slater fund,” he said. “There won’t be enough good companies to invest in.”
The idea is that the Slater fund nurtures startups – through mentoring and seed money – until those firms are able to attract early stage venture capital. If Slater’s budget is half what it should be, the stable of viable candidates for venture funding shrinks.
And the EPC cites another problem: The gap is widening between seed-funding stage – when startups scrape together grants and angel investments – and the next phase, when they’re able to tap institutional investors.
“Venture capitalists have raised the bar; they’re demanding better business plans, better management and actual customers,” said Jerry Schaufeld, director of the Slater Fund. “All of that takes more time and more money.”
Since the Slater program was started in 1997, a portfolio of 66 technology startups have raised more than $110 million in venture capital and seed funding.
Meanwhile, the EPC will change course from the strategy it pursued last year to build a venture capital fund for early stage companies. That legislation would have forged private entities called certified capital companies, or “CAPCOs,” to manage investments from insurance companies. The investors were to be enticed by credits on the 2 percent tax they pay on premium collections, creating a $100 million fund over 10 years. Nine states have passed CAPCO legislation.
Instead, the EPC has crafted a proposal after a newer – and less tested – model, recently enacted by the state of Iowa, called a “contingent tax credit” model. The Rhode Island proposal would create a $30 million pool of equity financing for startup companies.
Big investors like banks and insurance companies would be persuaded to invest in the fund – which would be managed by a nonprofit entity – because their money would be secured by state tax credits. If investors don’t get back all of their principal and an agreed-upon rate of return, they get state tax credits to bridge the shortfall.
That’s where the “contingent” part comes in: As long as the fund does well, no state money is used. EPC officials concede, however, that the state’s exposure is the value of the entire fund.
Bergstrom said the EPC is outlining the model to its members – representatives from Fleet Bank, CVS, Citizens Bank and Brown University, among others – who are the most likely candidates to invest in the program, at least initially. If the plan passes muster with those heavyweights, Bergstrom says, “It’s hard to fault it as a model, because it has so many advantages over CAPCO.”
But the pitch for CAPCO is not dead.
Richard Licht, a member of the Rhode Island Technology Council board of directors, lobbied for the CAPCO legislation last year on behalf of five out-of-state venture-capital firms interested in running a fund in Rhode Island. He said those clients still are interested, and he plans to push for another CAPCO bill this session regardless of the EPC’s plans.
“There’s a record of success with CAPCO, whereas the so-called Iowa plan I think has only been done in two states, and doesn’t have the same track record,” Licht said.
Licht added that the CAPCO model allows for multiple venture-capital firms to participate, rather than putting all the money under the control of one entity, like the EPC plan proposes.
Licht, a former lieutenant governor, said he wants to work with the EPC on a comprehensive venture-capital strategy for 2003. He downplays the notion that putting competing venture-capital bills in front of the General Assembly could nullify the two efforts.
