At Long Last, Venture Capital Tax Credits

It has taken a couple of years to get all the parts in motion, but legislation approved by the General Assembly in 2001 may finally be about to help attract venture capital investment to the state.

Act 1791 of 2001, the Venture Capital Investment Act, “sent a signal” to investors that Arkansas thinks venture capital is important, said Leslie Lane, vice president of finance for the Arkansas Science and Technology Authority. The Pricewaterhouse Coopers/ Thomson Venture Economics/ National Venture Capital Association MoneyTree Survey estimates venture capital investment in Arkansas at $33 million for the 2000-02 period.

But, Lane said, a reliable figure is hard to come by because no reporting is required.

Lane said there are six or eight reporting agencies but not much is ever reported to them. Lane’s own informal survey of attorneys who routinely work with private investors found that there was $10 million worth of deals done in Arkansas in one quarter of 2002 alone. None of that was reported by the agencies.

“We may have more than we thought we had,” Lane said.

And look for that to grow as the state gets itself on the radar screen of more venture capital firms now that it is more feasible to invest in Arkansas companies. Nationwide, some $18 billion in venture capital was reported in 2003.

What’s going on now is “the beginning of a partnership between the state and private businesses,” said Watt Gregory, a lawyer with Kutak Rock LLP in Little Rock and cochairman of the Arkansas Venture Capital Conference held April 13-14.

“The state has recognized its need to foster growth of new businesses in the state,” Gregory said.

The state, through the Venture Capital Investment Act, authorized the Arkansas Development Finance Authority to develop an indirect method of investing by establishing what is being called the “Fund of Funds.”

The fund is authorized to invest in professionally managed venture capital funds, which, in turn, make investments.

ADFA hopes to attract investors and venture capital funds to Arkansas by extending a guaranty of principal and interest to the fund and its investors and also by income tax credits that can be used to reduce tax liability. Commitments by the fund will only be made to funds that meet the objectives of ADFA in aiding Arkansas companies and range from $3 million-$10 million in size.

The Long Delay

The fund’s establishment comes after a prolonged delay caused by several factors, said Gene Eagle, vice president for development finance at ADFA.

Arkansas’ VC act is modeled after the highly successful Oklahoma system of contingent income tax credits, which provide a sort of safety net for investors.

The act calls for ADFA to choose a designated investor group. It did that early in 2003, selecting the U.S. Partnership for State Investment LLC after a competitive bidding process. USPSI’s managing director in Little Rock, Mike Tharp, was in on the establishment of the Oklahoma program.

The final selection came, however, after Stonehenge Capital of Louisiana complained about the selection process and a review had to be performed.

Another slowdown, Eagle said, was the change in the leadership at ADFA with the resignation of Rush Deacon and the appointment of current president Mac Dodson at the end of 2001.

There also have been new members named to the board of directors who had to be educated about how the program works. Well into the process, Eagle said, ADFA realized it needed to set up a trust, into which the state’s part of any earnings would have to go.

State Board of Finance approval of the ADFA setup didn’t come until last December. Since that time, both ADFA and USPSI have been busy, Eagle said.

Two commitments were made — to Delta Capital and SSM Ventures, both of Memphis — and there’s been one closing, with SSM after Delta withdrew, Eagle said. SSM is one of the largest and most experienced venture capital firms in the Southeast, investing primarily in expansion and later-stage companies and occasionally in early-stage businesses where it has industry expertise.

“The Venture Capital Investment Act,” said Tharp, “caused SSM to take an interest in Arkansas.”

It has already established a board to look at Arkansas-based companies to invest in.

“There’s no report card yet on the 2001 act,” said Gregory, “but the basic building blocks to grow are in place. What’s needed is a poster child — a world-class success story — to show the world we can do it here.”

Former state Sen. Kevin Smith, the author of Act 1791, said he’s bit disappointed that it took ADFA so long to get the program set up, but “it’s understandable that ADFA needs to be cautious since it exposes the state for up to $60 million.”

And he added that interest in venture capital hasn’t been high in the past couple of years because of the slowed economy.

Now running the Smith Agency at Helena, Smith maintains the measure is the best way to promote economic growth in Arkansas.

“In the past, development in Arkansas focused on giving away the tax base to get jobs. With this act, there’s no tax revenue lost,” but healthy development is promoted by a system that guarantees tax credits on a contingency basis.

Diamond State

The state’s only institutional-based venture capital fund is Diamond State Ventures, a $56 million fund that’s part of the Arkansas Capital Corporation Group of Little Rock. It operates as a federally licensed Small Business Investment Company under the Small Business Investment Act of 1958.

Joe Hays, president of DSV, said only about 60 percent is invested in Arkansas-based companies, but that’s by design.

“It doesn’t make sense economically,” he said. “And we want to build relationships by becoming co-investors with funds in other states. If we want them to come into Arkansas to invest, we have to be willing to invest in their funds. We need more sharing of resources.”

Hays said he thinks DSV has done a great deal with the tools it had available. “It takes organization and commitment to utilize them.”

And that’s a place ADFA can have a big impact on venture capital now that the tools are in place.

DSV only wants to do five to six deals a year. It primarily seeks to be a value-added partner in any deal by providing capital for expansion-stage companies, either through internal growth or by acquisition and for management buyouts, such as the $2 million it invested to help the management of HealthScope Benefits Inc. of Little Rock buy the business from CNA Insurance Co. in 2001. Although it wasn’t announced at the time, HealthScope was sold to Central Benefits Mutual Insurance Co. of Columbus, Ohio, in August 2002.

Hays said he thinks it will take another 10 years for the venture capital business to mature in the state. That will come from adding infrastructure that includes sources of dedicated capital that know how to do venture capital, he said. But he added it’s not just the money that’s needed, it’s also human resources, such as accountants, attorneys and knowledgeable businessmen willing to serve on boards.

“It takes time to build that critical mass,” he said.

The Last Element

There’s an attempt under way to organize one of the last pieces of the venture capital puzzle in the state — angel investors.

Although angels — high net-worth investors who risk their money on what they believe to be good companies that eventually will give them a good return — have always been around, they’ve never acted in a consolidated way, said Gregory.

Jeff Stinson, an accountant who has his own business, Stinson Advisory Services PLLC, and is an administrator and investor with Venture Capital Investors LLC of Little Rock, agrees that it’s very fragmented.

VCI was founded in 1999 by William H. “Bill” Bowen, the retired lawyer and former chairman and CEO of First Commercial Corp., to invest in companies engaged in “technology intensive enterprises” with significant potential for capital appreciation in three to five years.

Several members of VCI are in the process of gathering investors from around the state to start the Fund for Arkansas’ Future.

Investors have been attracted to the fund, Stinson said, because it is a vehicle for efficiency in investing.

Rather than an angel doing it on his own, there will be a pool of money and an organization that will give the investor the needed due diligence as well as some diversity for safety.

The four who are heading the effort are Dr. Mary Good, dean of the Donaghey College of Information Science and Systems Engineering at the University of Arkansas at Little Rock; John Steuri, the former CEO of Alltel Information Services Inc.; James Hendren, the former CEO of ArkSys as well as head of the Task Force for the Creation of Knowledge-based Jobs; and Mike Coulson, president of Coulson Oil Co. and this year’s president of the Little Rock Regional Chamber of Commerce.

The group has seen very good response from Little Rock-area investors, Stinson said of the four-month effort, and he’s now looking for investors in the rest of the state. He said he has a target date of Sept. 1 to close the fund.

It is the intent of the $10 million fund to limit its activity to growing early-stage Arkansas companies.

ADFA’s Lane said he thinks the tax credits available under the Venture Capital Investment Act have stimulated a lot of the excitement about the Fund for Arkansas’ Future.

Venture capital is a high-risk business, but the return to investors in seed companies averages 34 percent, Stinson said.

“Arkansans are beginning to see the potential here,” said Gregory, “with research by the University of Arkansas and the University of Arkansas for Medical Sciences. We’re beginning to put wealth to work with the technology coming from those institutions. We can create a company just as good as any.”