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The Texas Certified Capital Company Program (CAPCO), Administered by the Texas Treasury Safekeeping Trust Company

History of The Texas Certified Capital Company Program

The Texas CAPCO Program is characterized by the following:

  1. Premium tax credits are defined and authorized.
  2. A single insurance company may claim and invest a maximum of 15 percent of the total tax credit allocation amount.
  3. Each CAPCO must have an initial capitalization of $500,000.
  4. Each CAPCO must have two principals or employees with investment management experience in the venture capital industry.
  5. CAPCO Certification requirements are established:
    • Investments must be placed in "qualified businesses," headquartered or having a principal office in Texas.
    • Timing: 30 percent of certified capital must be placed in qualified businesses within 3 years; 50 percent within 5 years.
    • Diversification of investments, with no more than 15 percent of certified capital in any single portfolio company.
    • Compliance with various regulations and reporting requirements.
As of Year End 2007, CAPCO's in Program One have invested in a total of 58 companies here in Texas

Insurance Companies as Investors

In Texas, only insurers who are required to pay a premium tax on insurance policies issued in Texas are eligible to invest in CAPCO-issued debt instruments. Insurers then use applicable tax credits to reduce future tax obligations on revenue from insurance premiums. When investing insurance companies file annual premium tax returns, they are allowed a dollar-for-dollar reduction of taxes on policy premiums. Texas collects almost $1 billion in premium taxes each year.

CAPCOs must compete for available funds from a limited pool of insurance company investors. Investments in CAPCOs are facilitated by debt instruments in the form of notes or bonds that, in turn, are repaid via the tax credits earned by the CAPCOs. The insurance companies evaluate the offerings of the CAPCOs by comparing several factors including:

  • The management team's experience and record of success
  • Expected rates of return
  • Risk of decertification as CAPCO entity

Decertification insurance is a unique feature of almost all CAPCO debt instruments (essentially a performance bond), in order to guarantee that the investing insurance companies will receive all tax credits they are expecting as repayment under the terms of the CAPCO note, in the event that the CAPCO fails to perform or is decertified for violating the program rules. CAPCOs market their notes/bonds by either directly contacting an insurance company, or by hiring a broker to make the initial sales pitch on their behalf. The document of approach is a sophisticated sales brochure commonly known as a private placement memorandum (PPM). The PPM typically includes sections outlining the rate and repayment terms of the note, an executive summary of the CAPCO program, background information on the CAPCO's management team, the rules of the CAPCO program, a business plan, and information about its decertification insurance.

Remaining a Certified Capital Company

In order to remain certified, all CAPCOs file a prescribed annual report with the Comptroller by January 31 of each year with specific information about certain aspects of the firm's activity during the previous year, including how the CAPCO distributed and invested its funds. There are several restrictions and limitations on CAPCO expenditures, and violations can result in assessment of penalties or, in severe cases, decertification of the CAPCO.

Investments in qualified businesses must be reported along with certain key employment metrics of particular interest to the state. CAPCOs are required to provide details about the dollar amount of investments in their portfolio companies. They must report the North American Industry Classification System (NAICS) number of the businesses and employment levels at the time of investment and at the end of the year. Very specific employment data must be disclosed. The data includes their portfolio businesses' employee head counts, average wages, and the number of jobs created or retained as a result of the investment.

The CAPCO must also file a financial report audited by a Texas licensed certified public accountant. Once the CAPCO has complied with its annual reporting requirements, the Comptroller's office conducts a thorough review of the information to verify its accuracy and confirm whether the CAPCO is in compliance with the statute and regulations. The annual review may include site visits to portfolio companies and an examination of accounting records and state and federal employment reports filed by the CAPCO's portfolio companies. In turn, the Comptroller reports all CAPCO investment and employment information to the Governor, Lt. Governor, and the Speaker of the House of Representatives by December 15 of each even-numbered year.

Qualified Investments by CAPCO's

Unlike typical venture capital funds, the rules governing the types of businesses and the structures of CAPCO investments are targeted and restrictive. The CAPCO legislation was designed to support strategically located and early-stage businesses, businesses that have at least 80 percent of their employees (either head count or payroll amount) located in Texas, and entrepreneurs who are developing new products or services and are in need of seed or expansion capital. If investments fail to meet prescribed tests, they may be disallowed as qualified CAPCO investments. To safeguard against having specific investments disqualified because of company status, CAPCOs may request the Comptroller to determine a business as prequalified before investments are placed.

Once the CAPCO managers have access to investor cash, they must start a fairly aggressive effort to deploy the money by investing in qualified Texas businesses. By statute, the CAPCO must invest 30 percent of its certified capital within three years of funding and 50 percent by the end of the fifth year. It must invest 50 percent of its capital in operations defined as early-stage businesses and 30 percent into businesses with principal business operations in strategic investment areas.

Early-stage businesses are defined under the rules as those that meet at least one of three criteria. Revenues of the early-stage business must be under $2 million during the previous fiscal year or, the business must not be more than two years old or, the business must be involved in the development of a new product or service.

Strategic investments have their principal business operations located in an area of the state that is classified as a strategic investment area (SIA). The State Comptroller makes an annual determination of what constitutes an SIA, based on unemployment and per-capita income and also including locations identified as federal urban empowerment zones. The SIA designation is a state economic development tool that permits companies located in these areas to take credits against state franchise taxes for research activities, job creation, and investment in machinery and equipment.

A qualified business is one that, at the time of a CAPCO's first investment in the business:

  • Is headquartered in Texas
  • Has no more than 100 employees and pays at least 80 percent of its payroll to employees residing in Texas, and is primarily engaged in
  • Manufacturing, processing, or assembling products
    • Conducting research & development
    • Providing Services
  • Is not primarily engaged in any of the following:
    • Retail sales
    • Real estate development
    • Business of insurance, banking, or lending
    • Professional services

Conclusion

The need for accessible growth capital in Texas is undeniable. There are positive signs that the Texas' CAPCO program partially addresses this pressing need. It will be many years before the full impact of the CAPCO program on the Texas economy is known. However, it is encouraging that at this early stage, participation among insurance company investors has been deep and wide. Additionally, several venture capital companies either have returned to the state or established new operations here, with the hope that VC activity in general will pick up across the state. Concurrently, demand from young businesses for the growth capital exceeds the supply, which means that CAPCO investment managers have a plethora of investment options from which to choose.

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