New Model for Funding Support to Small Businesses Passes Tennessee "Fund of Funds" Legislature

After near unanimous passing in both chambers of the state legislature, the “Tennessee Small Business Investment Company Credit Act” was sent this week to Gov. Phil Bredesen for his signature. The legislation, designed to create a pool of at least $84 million in capital, utilizes a competitive process to select several venture capital funds to make direct investments in small business headquartered in Tennessee. These venture capital funds can be for-profit or non-profit partnerships, corporations, trusts, or limited liability companies.

Similar to the CAPCO mechanism utilized by a handful of states to attain investment capital, the Tennessee legislation specifies the investment capital is to be derived from deferred insurance premium tax credits. These tax credits are offered to insurance companies in exchange for commitments of investment capital. However, unlike the CAPCO model, the Tennessee legislation does not have clawback provisions on the tax credits that have required funds in other states to purchase a performance bond to guarantee that the insurance companies receive the value of the tax credits. Instead, the program levies substantial fines on the funds that are not meeting specified performance requirements.

The Tennessee legislation requires 50 percent of the investment principal and 50 percent of the profits to be returned to the state over the life of the program. Participating venture capital funds making these investments to small businesses are able to keep 50 percent of the funds’ value.

As a result of the legislation, it is expected $120 million in tax credits will be offered, or $20 million each to six venture capital funds. Each fund is required to secure at least $14 million of the $20 million of tax credits for investment capital. The securitization amount could be greater, but it cannot be less. The difference between the tax credit allocation and the base investment capital exists because there are financing costs associated with pooling the capital in the present for future tax credits. While the six venture capital funds will be chosen by the end of the year, the participating insurance companies cannot claim the tax credits until years 2012 through 2019.

The six venture capital funds will also be mandated to make their investments within a specified time period. For example, within two years after its allocation date, the third party funding entity must invest at least 50 percent of its base investment. Within three years, this grows to at least 70 percent of the base must be invested; within four years, 80 percent; and within six years, 90 percent. These aggressive pacing requirements will be easier to achieve for funds that invest in seed and early stage companies, as such investments will be multiplied by 300% during the first four years for purposes of measuring fund compliance. Failure to meet the performance measures in any calendar year will result in a $250,000 penalty.

The result is a model intended to minimize the expense to the state, provide incentives for participation by venture capital groups, and encourage funds to invest in seed and early stage small businesses in Tennessee within a designated time period.

The language of the Tennessee Small Business Investment Company Credit Act is available at:

http://wapp.capitol.tn.gov/apps/BillInfo/Default.aspx?BillNumber=HB2085

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Vol. 14, Issue 17