BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 32 HEARING: 5/1/13
AUTHOR: Price FISCAL: Yes
VERSION: 3/11/13 TAX LEVY: No
CONSULTANT: Grinnell
BUSINESS INVESTMENT: TAX CREDITS
Enacts the California Jobs Act; requires the Treasurer to
sell tax credits to fund investments in early stage
companies.
Background and Existing Law
California provides various tax credits designed to provide
incentives for taxpayers that incur certain expenses, such
as child adoption, or to influence behavior, including
business practices and decisions, such as research and
development credits and Geographically Targeted Economic
Development Area credits. The Legislature typically enacts
such tax incentives to encourage taxpayers to do something,
but for the tax credit, they would not otherwise do.
Generally, the state doesn't allow taxpayers to buy and
sell credits against its taxes: however, the motion picture
production tax credit allows taxpayers that make
independent films to sell tax credits (ABx3 15 Krekorian,
2009/SBx3 15 Calderon, 2009). The California Tax Credit
Allocation Committee allocates Low Income Housing Tax
Credit to housing developers, who then form partnership
agreements with private investors who provide capital
contributions necessary to build a housing project in
exchange for tax credits. Additionally, corporations may
transfer tax credits from one subsidiary or affiliate to
another within its commonly-controlled group (AB 1452,
Committee on Budget, 2008).
State law assigns the duty of selling general obligation
and other debt instruments of the state to the State
Treasurer, a Constitutionally-elected office. The state
has never sold tax credits.
The California Capital Access Company Law provides for the
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licensure and regulation of capital access companies by the
California Commissioner of Corporations (SB 2189,
Vasconcellos, 1998). The law allows for the formation of
small business investment funds exempt from Securities and
Exchange Commission oversight. However, the Commissioner
has never granted a license, and has only received between
one and three applications for designation since the
Legislature enacted the law. A comprehensive revision of
the law has not generated any new applications (SB 1155,
Dutton, 2010).
Proposed Law
Senate Bill 32 enacts the California Jobs Act, which
directs the State Treasurer to sell $200 million in tax
credits to investors at auction, and then creates a Board
to allocate the proceeds of the sale to early-stage
companies. The bill has five major parts: the California
Jobs Act Board, selling tax credits, designating qualified
capital access companies, investments and allocation, and
management and distributions.
I. California Jobs Act Board. SB 32 creates the
California Jobs Act Board, composed of the following
members:
Three members appointed by the Governor with at
least five years of experience managing or consulting
with emerging growth companies.
Two members appointed by the Senate Committee on
Rules with at least five years of experience in
investing in emerging growth companies,
Two members appointed by the Speaker of the
Assembly with at least five years of experience
investing in emerging growth companies.
Board members must comply with the Fair Political Practices
Act, and serve without compensation. The Board may employ
and set compensation for an executive director, who serves
at the pleasure of the board, and may delegate to him or
her its power to make contracts. The Board may issue
regulations in compliance with the Administrative
Procedures Act, including emergency regulations. SB 32
also grants the Board powers consistent with the bill's
requirements, and allows it to charge fees to cover its
reasonable costs to administer the Act.
II. Tax Credit Sale. SB 32 directs the Treasurer to sell
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$200 million in tax credits to investors at auction, in
allocations between $10 million and $20 million. The
Treasurer shall evidence the sale using any written
instrument he or she deems fit for the purpose, and shall
provide the instrument to the taxpayer within 30 days of
sale. The instrument shall include the amount of tax
credits purchased by the taxpayer and the tax against which
the credit applies.
The Treasurer then deposits the proceeds of the tax credit
sale in the California Jobs Act Investment Fund, which the
bill creates. The Legislature must then appropriate moneys
in the Fund to the Board for allocations to qualified
capital access companies. The Treasurer then notifies the
Franchise Tax Board and the Department of Insurance of the
names, identification numbers, and amounts of tax credits
purchased by each taxpayer.
The bill authorizes tax credits against the Personal Income
Tax, Corporation Tax, and Gross Premiums Tax equal to the
amount stated on the written instrument the Treasurer sends
to the taxpayer. Taxpayers can only claim the tax credit
in the following amounts:
For the 2015 to 2019 taxable years, 15% of the
total.
For the 2019 to 2022 taxable years, 10% of the
total.
Taxpayers can carry forward any remainders for four years,
but not past the 2023 taxable year, after which the bill
sunsets the tax credits.
III. Capital Access Company Designation. The bill
requires the Board to create application forms that require
specified information, and uniform provisions for
submission and review for capital access companies seeking
designation as qualified capital access companies, and
therefore eligible for allocations from the board to fund
investments. Capital access companies can apply on or
before September 1, 2014. The Board may require any
information from an applicant it deems necessary.
The Board shall only designate as qualified capital access
companies those capital access companies that:
Submit an audited balance sheet with a certified
public accountant's opinion that the firm has equity
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capitalization of at least $5 million,
Directly employ at least two managers with at least
five years of investment experience primarily in
California-domiciled companies,
Have its principal office in California for the
last five years,
Have a proposed investment strategy for achieving
transformational development outcomes through focused
investment of capital in early stage companies with
high-growth potential, and
Have a demonstrated ability to lead investment
rounds, advise and mentor entrepreneurs, facilitate
follow-on investments, and execute investment exits.
On or before January 1, 2015, the Board shall designate
capital access companies as qualified capital access
companies in a public meeting. The Board shall notify the
firms within one month of designation.
IV. Allocations and Investments. Within 180 days of the
sale of the tax credits, the Board must publish a notice
that applications are available for allocations of tax
credit capital, and the deadlines for application. The
Board shall allocate tax credit capital, or the proceeds of
the tax credit sale conducted by the Treasurer, to
qualified capital access companies in amounts between $10
million and $20 million. The Board shall deposit any
remainder back into the General Fund.
Qualified capital access companies may only invest the tax
credit capital into businesses where they have a contract
for an irrevocable commitment of cash from an unrelated
investor to match the state's contribution. Additionally,
qualified capital access companies may only invest in firms
that:
Have a net worth of not more than $18 million and
average after-tax income of under $6 million,
Have headquarters in California,
Has its principal business activity in California,
Does not employ more than 100 persons directly or
indirectly,
Is not engaged in professional services, as
defined, and
Is not a franchise of, or within the commonly
controlled group of the qualified capital access
company?
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The above criteria are deemed met if the qualified capital
access company represents in its application that the
business will meet the criteria by the closing date of the
investment. The qualified capital access company may
request that the Board certify a firm as meeting the
criteria, and the Board must notify the company of the
determination within ten days.
To maintain its designation as a qualified capital access
company, the firm must maintain certain levels of
investment in businesses that meet the above criteria, such
as:
At least 50% of its allocation within two years of
the allocation date,
At least 70% within three years,
At least 80% within four years, and
At least 90% within six years,
Qualified capital access companies cannot invest more than
10% of its allocation in any one business, or sell any
interest in a business without Board approval. Any
allocations made by the Board to the qualified capital
access company but not yet invested in a firm must be held
in an escrow account maintained by the Board.
The Board may revoke designation at a public hearing for
any qualified capital access company that has
misrepresented any information to the Board, fails to
perform any required duty, or loses its license as a
capital access company. The now unqualified capital access
company must repay any amount of tax credit capital the
Board allocated, which is deposited in the General Fund.
The Board may additionally apply a penalty of up to
$250,000 or 10% of the allocation, whichever is less, also
deposited in the General Fund.
V. Management and Distributions. SB 32 sets forth a
structure for management fees charged by persons who create
and manage qualified capital access company's investments:
First, the fund manager can charge the qualified
capital access company 2% of its total capital, or
$500,000, whichever is less, for forming, syndicating,
and organizing it, subject to Board approval,
Second, the fund manager can charge commissions up
to 10% of the capital received,
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Third, the fund manager can charge an ongoing
management fee of:
o 3% of total capital per annum in the
first five years,
o 2% of total capital per annum in the next
five years, and
Reasonably necessary charges calculated in
accordance with industry custom for professional
services.
When the qualified capital access company sells its
investment in a business on or before January 1, 2023, it
must distribute gains in the following manner:
75% to investors in the qualified capital access
company that matched the state's investment, and 25%
to the state for deposit in the General Fund until all
investors have received 100% of capital contributions
returned,
100% to the state until its entire allocation is
returned, then
20% to the fund manager, 40% to qualified capital
access company investors, and 40% to the state for
deposit in the General Fund.
On or before January 1, 2023, the qualified capital access
company must liquidate its investments made with tax credit
capital and distribute all cash and assets in kind
according to the division listed above.
VI. Miscellaneous. On or before January 1, 2023, the
Board shall report to the Legislature regarding the results
of the Jobs Act, including:
The number and amount of investments made,
An estimate of the number of jobs created,
The number of qualified capital access companies
designated,
The amount of allocations made to each qualified
capital access company, and
The amount of cash distributed to the state and
deposited in the General Fund.
The bill provides definitions for many of its terms, and
sunsets on January 1, 2027.
State Revenue Impact
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According to FTB, SB 32 results in revenue losses of $46
million in 2015-16, $34 million in 2016-17, and
approximately $30 million per year thereafter until
2021-22.
Comments
1. Purpose of the bill . According to the Author, "Senate
Bill 32 will create the State Development Fund, to be
overseen by the State Development Fund Board, a 7-person
board of experienced venture capitalists and small business
executives. The fund's structure would be based on the
highly successful TN INVESTCO Program launched by the State
of Tennessee in 2009. The fund would match dollar for
dollar money that private investors invest in California
Capital Access Companies - state-regulated investment
companies that provide financing and managerial assistance
to the state's small businesses. The incentive for
investing would be a preferred-return status for private
investors: they would recoup their investments more quickly
than usual and before the state recoups its investments;
after the private investors and the state have recouped
their capital, profits would be split 20% to the fund
manager, 40% to the private investors, and 40% to the
state. Plus, being part of a pool of funds, investors
would enjoy diversification and professional management in
early-stage ventures. The state's role would be to offer
$200 million worth of tax credits to insurance companies
that invest in California Access Companies through the
State Development Fund. The tax credits would be amortized
over eight years and could be leveraged into approximately
$400 million of investments in small businesses in
California, resulting in potentially thousands of new jobs.
In a few years, the state would recoup its investment by
sharing in a portion of the profits."
2. Do what you're good at . State government has many
responsibilities: public education, criminal incarceration,
public health, resource protection, and environmental
regulation, among others. SB 32 would add venture capital
investor to that list, which appears an odd match for a
state that's had a hard time delivering services in recent
years due to budgetary challenges, the state's size and
population, and its troubled system of disconnected service
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delivery responsibility, revenue authority, and governance.
Shouldn't the state focus on improving program delivery
before wading into the waters of business investment? The
Committee may wish to consider whether SB 32 is consistent
with the responsibilities of state government.
3. Sure, but will it work ? Built largely from a program
deployed in Tennessee, SB 32 takes a different approach
than other economic development proposals the Committee has
considered. Instead of ongoing tax credits, the measure
directs the Treasurer to have a one-time auction of tax
credits to taxpayers who can only claim them in limited
amounts over eight years, spreading the fiscal loss. The
proceeds from the sale are then allocated by a
newly-created board to investment firms with specified
qualifications that have commitments from unrelated
investors to match the state's investment. When the firm
sells the stake in the investment, private investors get
capital returned first, then the state. If the program
works, a future Legislature can try it again.
However, like many economic development proposals, there
are significant risks: the state has to trust that the
board SB 32 creates will make money for it by investing in
intermediaries who then deploy capital in businesses that
become profitable. Additionally, making money investing in
early-stage business isn't as easy as in other asset
classes; business models and competitive advantages change
quickly; small businesses often fail, don't have the market
power of their larger competitors, and have a hard time
navigating the state's myriad laws and regulations.
Lastly, SB 32's revenue losses will result in cuts in other
services or increased taxes on other taxpayers. Why will
SB 32 lead to more employment than other uses of the money?
The Committee may wish to consider whether SB 32's
different approach will result in employment gains.
4. Something new . The Treasurer sells the state's bonds,
and invests its cash. However, selling tax credits as
called for in SB 32 is entirely new for the state, although
other states have successfully conducted auctions, and
California does allow sales or transfers of some tax
credits in some circumstances. However, does the
Treasurer's infrastructure for interacting with capital
markets accommodate tax credit sales? Also, how will the
state know it received good value for its tax credits? The
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Committee may wish to consider amending the bill to
allocate the money from the General Fund before directing
the Treasurer to try an unprecedented California tax credit
auction.
5. Enough already ? California doesn't lack for venture
capital. According to the Venture Capital Association,
California received $11.6 billion in venture capital
investment in 2010, outpacing second-place Massachusetts's
$2.5 billion total by almost five times. With this level
of venture capital, why should the state get involved?
Supporters counter that venture capital in California flows
disproportionately to technology ventures in the Silicon
Valley, and SB 32 would ensure other regions and industries
in California would receive needed capital. The City of
Mountain View receives $400 million in new venture capital
each quarter despite its 12 square mile size. The
Committee may wish to consider whether the state should
insert itself in an already flush market.
6. Trust me . SB 32 sets up the California Jobs Act Board,
a seven-member body comprised entirely of individuals with
expertise in small business management and investing.
These individuals will likely have more skill in making
money for the state than public employees, but California
doesn't often create boards that lack representation from
the public or other government agencies. Additionally,
does the bill ensure that these experts are accountable to
the state's best interest? The Committee may wish to
consider whether the current composition of the board under
SB 32 reflects the appropriate balance between government
and the private sector.
7. Cart and horse . Under the bill, the only firms
eligible to become qualified capital access companies are
licensed capital access companies. However, according to
the Department of Corporations, it hasn't granted a license
as a capital access company in the 15 year history of the
law, which grants a significant exemption from federal
oversight for certain small-business focused investment
funds. Shouldn't the state work with investment funds to
first license some capital access companies, and see how
these funds work before allocating $200 million to them?
Also, what happens if the state can't qualify any capital
access companies if none exist? The measure doesn't
provide that funds flow back to the general fund, or cancel
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the tax credits sold. The Committee may wish to consider
whether SB 32 puts the cart before the horse.
8. Technicals . Committee Staff recommend the following
amendments:
Add the power to contract to the Board's powers.
Change "concern" to "firm" on Page 8, Line 32.
Add "non-tax credit" before "capital" on Page 10,
Line 2.
Disallow business expense deductions for costs
incurred by taxpayers when buying a credit.
Clarify that credit carryovers would be subject to
the percentage limitation.
Provide consistent treatment for S-Corporations as
other tax credits.
Allow the credit to reduce the franchise tax as
well as the corporate income tax.
Support and Opposition (04/25/13)
Support : Small Business California; PortTechLA; Phoenix
Business Development Group
Opposition : None received.