Capco Draws Firms, and Doubts, to D.C.
Washington Post, October 27, 2005
By Ellen McCarthy
Last month, Adam Goozh, chief executive of CreateHope Inc., a firm that sells software to manage corporate giving programs, asked his 45 employees to pack up their desks and move their office from Bethesda to the District.
The relocation qualified CreateHope for $3.8 million in funding through the District's little-known venture capital program.
Unlike Maryland, which proudly promotes its venture fund as the most active investor in the region, and Virginia, which issues big news releases each time it makes an investment through its Center for Innovative Technology, the District has been largely quiet about its $50 million venture funding initiative.
That may be because the fund is relatively new, or because it's a complicated system. Or it might be because similar programs have worked out poorly in other states and not everyone is convinced this is a good use of taxpayers' money.
The District's Certified Capital Companies [Capco] program, passed in 2004 and officially kicked off in May, operates differently from most state-run venture funds. Rather than set aside a portion of its existing budget, the city agreed to issue tax credits to insurance companies that invest in three designated venture capital firms. In turn, the firms will pump funds into growing District-based businesses.
The three venture firms, Wilshire DC Partners, Advantage Capital Partners and Enhanced Capital Partners, must invest in or lend money to small businesses that are based in, and have 75 percent of their employees located in, the District. The idea is that the taxes generated from expanding firms like CreateHope, which got its funding from Enhanced Capital Partners, will more than make up for the $50 million in taxes the city will not be getting from insurance companies participating in the program.
"The Capco program is just a way of trying to capitalize small companies and bring them into the city," said Thomas E. Hampton, acting commissioner of the Department of Insurance, Securities and Banking, which oversees the program. "We're just trying to compete with the other jurisdictions to attract companies."
Proponents of the system say it generates a quick source of funding for small companies without placing an immediate burden on the city, which will spread the tax credits over 10 years.
"Washington has typically lagged behind Virginia and Maryland in terms of deployment of capital, and I think D.C. figured out this was an interesting way to fill that gap," said Tom Davidson, managing director of Enhanced Capital's Washington fund.
But not everyone is convinced this is a good deal for the District.
The venture firms involved generally put at least half of the money into a secure bond to make sure they will be able to repay the insurance companies. Executives of the fund also take a management fee of **2.5 to 5 percent -- or more -- of the total amount they raise. The firms invest the remainder of the money in qualified businesses but also have the option to structure the deals as loans. And once the loans or investments are recouped, the venture firm keeps the bulk of the money. The District does not take any stake in the companies that receive investments, Hampton said.
** Ed note: 2.5 to 5 percent per year was the amount protrayed in the beginning. After the results and hidden fees other states found this to be as much as 50 to 66% of the total.
"It's a straight transfer from the taxpayer to the Capco [venture firms]. It's one of the biggest rip-offs out there, and there are some real doozies," said Julia Sass Rubin, an assistant professor of public policy at Rutgers University who has studied Capco programs. "It's a very convoluted and complicated piece of legislation. . . . It's difficult to understand why anyone would do this, except that they don't understand it."
A $200 million Capco program in Colorado was suspended last year after state legislators concluded it was not creating the economic boon they had expected. An audit of the program found that only $14.3 million of the first $100 million raised by the venture firms had been invested in small businesses three years after the start of the initiative and that the impact on job creation was questionable.
Mark Hillman, now the state's treasurer, wrote in an editorial last year that "the program amounts to corporate welfare at its worst" and that it is "destined to do little more than soak taxpayers."
Hampton said it is too early to judge the success of the District's Capco program because only five investments have been made. The D.C. Council's special committee on small and disadvantaged businesses will hold a hearing today to discuss this and other programs aimed at increasing entrepreneurship in the city, and several Capco venture fund managers will meet with local bankers to promote the initiative.
As for CreateHope, Goozh says his employees are enjoying the city. For them the Capco program worked perfectly.