When states become venture capitalists

Nation's Business, April, 1985 by Mary-Margaret Wantuck

When States Become Venture Capitalists

STATES ONCE tried to keep or attract businesses by offering tax incentives or streamlining licensing and location procedures. Now they are taking the next step by providing capital to promote entrepreneurial activity.

New Hampshire has created the Venture Capital Network to match investors and entrepreneurs. Maine and Massachusetts have created venture capital corporations. Hawaii has a capital loan program for plant construction, conversion and expansion.

"More and more states are realizing that the way to gain stability in their economic base is to create jobs within the state and nurture those already there through financial and management assistance,' says Miles Friedman, executive director of the National Association of State Development Agencies. Every state is making the expansion and retention of business a top priority, Friedman says. And small business, which creates jobs, gets the most attention.

States are using a variety of financial incentives to foster economic growth:

Industrial revenue bonds are the most widely used. State and local agencies issue these bonds--selling them to private and public investors--and use the proceeds to construct or expand plants or other facilities. These plants are then leased to companies for the life of the bonds (15-25 years). When the leases expire, the companies can usually buy the plants for nominal amounts.

Almost half the states provide direct loan programs through which businesses can apply for below-market-rate financing.

Several states offer loan guarantee programs or interest subsidies to help businesses obtain lower interest rates on private loans.

Many states have set up privately operated development banks. These business development corporations sell their stock to large companies or banks in the state or are given bank lines of credit. In turn, the corporations make loans, primarily to small businesses, for working capital or expansion.

Beyond these widely used methods, individual states have come up with other creative financing techniques.

New Hampshire was inspired to create the Venture Capital Network by studies showing that the process by which entrepreneurs and so-called informal investors find each other is both haphazard and inefficient.

Informal investors--wealthy individuals who invest capital and experience in ventures--represent the largest pool of risk capital in the country and finance perhaps five times as many ventures as the public equity markets and professional venture capitalists combined, according to William Wetzel, Jr., a University of New Hampshire business school professor who researched the informal investor market.

The Venture Capital Network is a computerized data base that will get these investors together with entrepreneurs who need between $20,000 and $500,000 to launch innovative projects. William Osgood, director of the University of New Hampshire office of small business programs, says these informal investors generally look for "technology, invention and maunfacturing' projects, and favor companies with the potential to grow into $5 million or $10 million businesses within five years.

Still in its infancy, VCN will accept out-of-state investors and entrepreneurs. For instance, a Maine investor might finance a Connecticut business. But James Hoeveler, network executive secretary, says that "the probability that the company will be in New Hampshire is fairly high.' Hoeveler adds that once the network has made a compatible match between the investor and entrepreneur and introduced both parties, it "steps aside from any further negotiations.' VCN requires a $100 annual subscription fee from entrepreneurs to keep their applications in the data bank. The application is updated every six months.

MASSACHUSETTS provides a bevy of financial assistance options to small business. A venture capital firm, the Massachusetts Community Development Finance Corporation, was started in 1978 with $10 million of state funds. It is now investing about $2.5 million annually and has $9 million invested so far. Approximately 75 percent of its funds go toward expansions and relocations of existing firms; the remainder is for start-ups.

The company generally provides up to one third of the financing a business is looking for--on the average, about $300,000.

One of the firm's criteria, according to investment officer Nancy Nye, is that the business be located in certain target areas within the state--areas that have physically deteriorated infrastructures, particulary high unemployment and large low-income populations.

In exchange for some relief from very high tax rates, nine state life insurance companies formed a 25-year private partnership, the Massachusetts Capital Resource Corporation, with $100 million to provide funding to fastgrowing small companies that cannot go the traditional financing routes.

"We're a source of more permanent, long-term debt capital for the smaller firms and less exciting industries spurned by the venture capitalists and the riskier, high tech companies avoided by banks and insurance firms,' says President Bill Torpey.