$100 million transfer from R.I. citizens
Providence Journal, 04/29/2003
Julia Sass Rubin

Author: Julia Sass Rubin, M.B.A., Ph.D., a fellow at the Brown University's A. Alfred Taubman Center for Public Policy, and has studied the CAPCO program for more than four years.

The Rhode Island General Assembly is considering legislation to increase the supply of early-stage equity Capital in the state. This is a very worthwhile goal. Unfortunately, the vehicle being proposed to reach that goal, the Certified Capital Company (CAPCO) program, would not accomplish this objective. Rather, it would transfer $100 million from the citizens of Rhode Island to a small group of out-of-state individuals in a particularly egregious form of corporate welfare. The best way to understand what is wrong with the CAPCO model is to compare CAPCOs with normal venture Capital, the kind that this legislation is intended to foster.

Normal venture Capitalists make their money from the profits they earn for their investors. If they make smart investments, they keep 20 percent of the profits. In all cases, however, they must return all of the original investment Capital to their investors.

By contrast, CAPCO managers get to keep almost all of the profits plus the money that they invest. Unlike normal venture-Capital investors, the State of Rhode Island would receive none of the investment Capital that it had originally provided, and, at best, only a tiny portion of the profits.

In addition to being extraordinarily expensive for the state, the CAPCO program would do little to meet the goal of increasing the supply of early-stage equity Capital in Rhode Island. Less than 5 percent of the Capital that the state would provide would be guaranteed to go to very early-stage companies, and most of that would not have to be invested for up to five years. Nor would the legislation require that the investments be in equity; CAPCO managers may instead lend the money to companies.

The CAPCO program would not even create an ongoing source of Capital for future investments in Rhode Island. The CAPCO managers would be required to invest the state's Capital only once before they could walk away with both the Capital and the profits.

CAPCO proponents argue that the state would benefit from the economic development and new tax revenues that the CAPCO investments would produce. Undeniably, any program that spent $100 million in the state would generate both. In fact, were the legislature to divide the money among 1,000 Rhode Island entrepreneurs, it would probably provide more economic stimulus and tax revenues than the CAPCO program, since those entrepreneurs would be more likely to continue to spend the Capital in-state.

There are numerous proven models that would increase the supply of early-stage equity Capital in Rhode Island, and would do so more effectively and for much less money than the CAPCO model.

So why would Rhode Island sign up for such an expensive and ineffective program?

Rhode Island is not alone. So far, CAPCO managers have persuaded nine states to fund and re-fund CAPCO legislation. They have done so despite the obvious deficiencies of the program, and the warnings of officials in such states as Louisiana and Missouri, which were among the first to pass the CAPCO legislation: These states have cautioned others not to follow in their footsteps. Mike Williams, of the Louisiana Department of Economic Development, told a reporter investigating the program: "If you're going to set up something, look at what we did and do the exact opposite."

The nine states to have funded CAPCO legislation have done so despite the findings of numerous studies, such as the one commissioned by Louisiana, which concluded that the CAPCO program is "expensive and inefficient to the state," and that "the greatest and most immediate beneficiaries of the CAPCO program are the CAPCO companies and their owners."

CAPCO managers have succeeded in persuading state legislators to pass the program by carefully selecting well-connected and influential lobbyists, and then sparing no expense in providing them with the resources they need.

In Rhode Island, the CAPCO legislation is now on hold in the Senate, as a deal is sought between the state's Economic Development Corporation and the sponsors of the CAPCO legislation. While such a deal might lower the absolute dollar amount that Rhode Island taxpayers would be required to pay, it would not fundamentally change those aspects of the legislation that make it such a wasteful form of corporate welfare.

In the past, once CAPCO proponents have gained a foothold in a state, they have continued to lobby to obtain future rounds of state funding. Chip Cooper, the director of the Missouri Innovation Center, told a reporter that "with the money they are making, the [CAPCO] industry often has the clout to get legislation for more tax credits approved."

In other words, whatever program Rhode Island's Economic Development Corporation works out with the CAPCO proponents, it is unlikely to be the last round of CAPCO funding to come out of Rhode Island's coffers.

The Rhode Island legislature can provide the state's companies with the early-stage equity Capital they need, and do so in a much less expensive, more effective, and fairer way. Especially in this time of budget cutbacks, the CAPCO program is not the answer to Rhode Island's Capital needs.

Julia Sass Rubin, M.B.A., Ph.D., is a fellow at the Brown University's A. Alfred Taubman Center for Public Policy, and has studied the CAPCO program for more than four years.