Out-of-state investors leave some states wary
Second in a three-part series:Business reporter Jamie McGee has spent four months examining the TNInvestco program. Her reporting is based on dozens of interviews, legislative archives and data on investment returns. In this installment: Out-of-state investors are not done with Tennessee yet.
When Enhanced Capital CEO Michael Korengold spoke to Tennessee legislators in 2009 to push for a jobs program, now called TNInvestco, it was not his firm’s first go-round with a state legislature.
Korengold, who runs the investment group based in Manhattan, had helped establish “certified capital company” programs, known as CAPCO, in other states. The programs targeted job growth by supporting businesses through loans or equity investments and used state dollars, generated by selling tax credits to insurance companies, to fund existing and startup companies.
Nearly $2 billion had been dedicated to CAPCO programs in Washington, D.C., and states including Alabama, Texas, Louisiana, New York, Florida, Wisconsin and Colorado.
What that gave Enhanced Capital, and at least two other out-of-state investment groups — Advantage Capital Partners in St. Louis and Stonehenge Capital Company in Baton Rouge, La. — was a large stake in any returns. The states got jobs and tax revenue from the new businesses, but few earnings, if any at all.
Tennessee passed an improved version of the CAPCO model in 2009, one that yields more returns for the state and includes more oversights, but it still carries high costs. Enhanced, which partnered with Nashville-based Council Capital, was the only CAPCO fund chosen to participate in the state’s $200 million TNInvestco program.
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Despite failing to secure more lucrative terms for investors, the CAPCO funds have not abandoned their interest in Tennessee. In November lobbyists for Enhanced and Stonehenge reached out to lawmakers and economic development officials to gather support for other capital programs that leaders in other states and policy analysts have described as expensive, exploitative and lacking results to justify the amount of state spending.
“These (CAPCO funds) are actors who consistently exploit the taxpayers and exploit these programs that are intended for stimulating the economy,” said Julia Sass Rubin, a professor at the Edward J. Bloustein School of Planning and Public Policy at Rutgers University whose research includes equity capital and economic development. “They manage to pocket the subsidy and to lobby for more.”
The CAPCO groups’ new concept for Tennessee, which would have targeted rural areas, is no longer on track to be filed this year. While the state has avoided this legislation in 2016, these funds could resurface in the coming years.
New CAPCO bills
The economic development office in Arkansas is also familiar with Enhanced, Advantage and Stonehenge fund managers, those who pushed for CAPCO in Tennessee. In 2013 the Arkansas legislature passed a “New Markets” tax credit program that was lobbied by those three firms and is now underway in 14 states as a means to support low-income communities. The state programs are modeled after a federal New Markets Tax Credit program passed in 2000, but they are typically set up so that only a few firms, namely those who lobby for them, can take advantage of them. That is not the case in the federal program, according to Rubin.
Greg Wolfe, who works in Arkansas’ business finance division, said the program was meant to spur $166 million in investments and cost the state $86 million through tax credits, monetized by insurance companies. The eight funds participating — called community development entities — were each expected to invest or loan $20 million to businesses in low-income areas, with the expectation of receiving 58 percent in tax credits, or about $12 million. But the biggest beneficiaries are the investors, he said.
“This is intentionally written, 18 pages in our case, to confuse legislators so that they don’t try to understand it,” Wolfe said. “They believe the folks that come in and lobby on behalf of Advantage and Stonehenge and Enhanced … that this money is going to promote job creation in rural, underserved parts of the state, and that’s a fallacy. That’s a huge fallacy unless you build in some very strong safeguards.”
The investment amount is whittled down by the credits for insurance companies and hundreds of thousands of dollars in fees going to the managers of the community development entities, Wolfe said. He described a $7 million deal for a media company that cost the state $4 million and became a $2 million investment by the time it reached the business.
“The value of the tax credit goes largely to the insurance company and to the (community development entity),” Wolfe said.
Grant Tennille was executive director of Arkansas Economic Development Commission when the New Markets program passed in 2013. He said his office opposed the bill and sought to improve it as much as possible.
“It’s just incredibly inefficient,” Tennille said. “The state money goes in and starts falling down the waterfall. At every level there are lawyer and investment bankers there raking money out of the deal. The fees and the profits for the investment banks is incredibly high.”
Wolfe said 144 new full-time jobs have come from the program to date, of 1,400 projected.
“For $86 million, that’s piddling,” he said.
In Maine about $100 million in state dollars have been allocated to spur $250 million in investments, with a 39 percent tax credit offered to investors. Until the fall, community development entities were allowed to use one-day loans that would allow them to earn tax credits on previous investments as a refinancing tool.
“We did have some issues and concerns as an organization about the level of public benefit that was obtained from certain transactions that were structured using these one-day loans,” said Chris Roney, general counsel of Financial Authority of Maine. “It’s hard to call something an incentive if you are rewarding something that has already taken place.”
Roney is still supportive of the New Markets program and argues that each transaction has yielded economic benefit.
“If drafted and used properly, it continues to be a good economic development tool,” he said.
In 2015 in Georgia, the governor vetoed a New Markets bill. Wesley Tharpe, senior policy analyst of the Georgia Budget and Policy Institute, a nonpartisan research and advocacy group, advised lawmakers to make significant changes to the program before passing it.
“It is very hard to oversee and to effectively evaluate and hold (New Markets) accountable,” Tharpe said. “It is a program that can get very costly for states and can create all sorts of potential waste, fraud and abuse concerns.”
Enhanced and Stonehenge did not return calls for comment. Advantage said that it has added more than 34,000 jobs nationwide and has helped businesses and their communities grow through these capital programs.
“We have been an active participant in addressing access-to-capital issues for small businesses for over two decades and have helped brainstorm and advise for dozens of programs across the country, many of which we don’t participate in at all,” a company spokeswoman said in an email.
CAPCO's first attempt in Tennessee
Enhanced, Stonehenge and Advantage brought a CAPCO bill to Tennessee in 2009 and hired a team of lobbyists including Bo Johnson, Baylor Swindell, Anna Windrow and Nathan Poss. State Sen. Doug Overbey, R-Maryville, and state Rep. Charles Sargent, R-Franklin, who saw benefits in a jobs bill in the wake of the recession, sponsored the bill. Former Tennessee Revenue Commissioner Reagan Farr and Matt Kisber, Economic and Community Development commissioner in former Gov. Phil Bredesen’s administration, also worked on developing the bill.
After criticisms of the program surfaced, the bill was revised to divide returns in half — both profit and principal — between the state and the investment groups. This would help compensate the taxpayers for their risk, while still rewarding fund managers, but it would achieve less returns for the state than in a traditional venture capital model.
Throughout the TNInvestco bill process, only a handful of lawmakers, namely state Rep. Susan Lynn, R-Mt. Juliet, asked questions about how it worked, and they were often met with misleading responses. In 2009 Lynn expressed skepticism that the state would reap returns, and she was the only lawmaker not to vote for it. By 2010, several lawmakers had objections to the law.
"I am very concerned about some of these deals that put the state at risk and a private company comes out a winner no matter whether the deal flies or folds," said state Sen. Randy McNally, R-Oak Ridge, who voted against additional funding for the program in 2010. "TNInvestco is a good example of that, and I was very concerned about it."
Ideas for Tennessee
When asked about a potential New Markets bill in Tennessee, Economic and Community Development Commissioner Randy Boyd said his office had been approached in November by Johnson, who was acting on behalf of Enhanced Capital. Boyd said he was told that a similar structure had been developing in Ohio.
An Ohio Rural Jobs Act, supported by Enhanced, Advantage and Stonehenge, has passed in Ohio’s Senate. In a structure that resembles New Markets legislation, the rural jobs bill would lead to $75 million in investments, incentivized by $45 million in tax credits, with insurers securing the transactions.
State Rep. Cameron Sexton, R-Crossville, said in mid-November he would be sponsoring a bill that had moved away from the New Markets model to a rural development bill that would be a $100 million investment program.
“Based on what other states have done and what Tennessee has done in the past, we have a very good blueprint of what not to do and what has not worked and (are) putting in place a plan that we think is very successful,” Sexton said. Investments would go "toward existing rural businesses, to help them expand and grow when they might not have enough capital or borrowing power to do it."
The day after Sexton's comments, lobbyist Johnson, hired once again by Enhanced and Stonehenge, said the rural jobs proposal was no longer moving forward.
Johnson said the “idea of a New Markets bill in Tennessee was discussed but never proposed.” Instead, he and other lobbyists had been working on possible legislation for developing existing businesses in rural areas. He declined to describe how the rural development bill would have worked, but said the proposal was not ready for the 2016 session.
“That’s not to say in the future legislation like that won’t come back, but not this year,” Johnson said.
A draft titled “Tennessee Rural Jobs Incentive” describes a program in which $100 million in investments would be incentivized with $70 million in tax credits. It uses a flowchart to show how an investment group creates a fund, qualifies for insurance tax incentives and provides capital to its fund in exchange for investment returns, some of which comes from tax incentives — demonstrating that the investment dollars’ path to the businesses is winding and complex.
Finding a new way to make money
For a similar concept to garner Boyd’s support in Tennessee, there would have to be “dramatic changes,” Boyd said before Johnson's proposal was canceled.
“We are strong believers in accountability and performance, and the way it was proposed it was payment for promise and not payment for performance,” Boyd said. “They would promise the outcomes they would achieve, but then they weren’t accountable for those afterwards.”
Boyd also objected to the use of enlisting tax credits, given the cost to the state, saying if the state deems this program worth funding, it should do so out of its general fund to avoid losing millions in tax revenue.
“If you want to invest $100 million, just invest $100 million,” he said. “You are already putting yourself in a hole by selling insurance tax credits. It still costs the state. It’s false to pretend it’s not real money; it is real money.”
If the Rural Jobs bill takes hold in Ohio, it could mark a new direction for the CAPCO funds. Rubin said the New Markets bill came about after those investment groups struggled with perception issues in other states.
“The CAPCO program became such a hard lift because it became pretty easily accessible on the Web that it’s a rip-off,” Rubin said. “They had to find a new way to make money off the taxpayers because that’s how these funds live.”
Reach Jamie McGee at 615-259-8071 and on Twitter @JamieMcGee_.