CONSIDERATIONS WITH HIGH RISK CAPITAL INVESTMENTS

A Brief Exploration of Practices by Development Finance Authorities October 26, 2014

AIDEA’s 2010 Strategic Plan lists strategies to Improve and Add Programs in the Development Finance Division.

1. Ramp up development project sponsorship to 1-3 projects per year and a total of $150-$200 million…

2. Develop capacity for “equity” ownership in entities/assets beyond “projects” and consistent with the mission and a target of up to $50 million…

3. Set aside “risk capital” to fund R&D and other “seed” activities that could drive larger economic development opportunities.

4. Develop structures for “pooled” development project(s) and/or business financing segments of the portfolio in order to expand financing availability while maintaining portfolio creditworthiness.

(AIDEA Strategic Plan – 2.2, 1-3 Year Objectives – Improve and Add Programs, Development Finance, page 19)

Because of the concern over the potential impact of Strategy #3 on AIDEA’s credit rating, a greater demand for efforts related to the other strategies, and uncertainty of how to most effectively implement Strategy # 3, implementation of a risk capital investment strategy was deferred. With a potential renewed interest in such a strategy, the question of how to effectively implement a risk capital investment strategy without having an undo impact on AIDEA’s credit rating has re-emerged. This interest has come from several sources. In conducting a best practices evaluation of other Development Finance Authorities (DFAs), it was discovered that the New Jersey Economic Development Authority (NJEDA) makes direct investments in Venture Capital funds. Additionally, the request by the Municipality of Anchorage for AIDEA to take over management of their Angel Fund, raises the question of whether AIDEA can or should take this on and if so, how? While this paper is not an exhaustive exploration, investigations of other DFAs reveals that risk capital investing is part of DFA economic development strategies but through many different approaches. Some do direct investments, some do loans, some do grants, and some do partnerships providing expertise and/or grants. For

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most DFAs, a risk investment is to an undeveloped or untested idea or business but whose potential for economic development impact is moderate to high. For most of the DFAs investigated, funding for seed capital and early stage businesses tends to focus on knowledge based technology sectors but some of the specific projects funded involve technologies that facilitate more effective business practices in non-technology companies—resource development, transportation, utilities and other infrastructure. These findings from this limited investigation are summarized here with additional material in the Appendix. New Jersey Economic Development Authority (NJEDA)

With two of NJEDA’s economic development targets—life sciences and biotechnology— at least part of their investing strategy is directly with Venture Capital Funds (VC). Qualified VC Funds are those who invest entirely in New Jersey or at least to the level of NJEDA’s investment in the fund and the VC funds are required to place a majority of their investments in these target industries in New Jersey. NJEDA chose to take this approach in part from their recognition that they simply didn’t have the expertise and in-depth knowledge of these industries to be effective in evaluating potential investments. They see these VC Funds as having that knowledge so for NJEDA, being a passive investor is a better strategy than making direct industry investments. Furthermore, their level of investment was not sufficient to warrant cost associated with the retention of a third party manager (e.g. Morgan Stanley, etc.) to manage their funds for them. Exactly how they measure the success of those investments is not known but they did indicate that they have gotten meaningful cash returns on capital through distributions. In response to questions of how their Board decided to embark on such a strategy, it was best described as a “stick your toe in the water” approach and as long as they didn’t fall in, they got increasingly comfortable with continuing the strategy. Some investments have worked better than others but overall, they seem to feel that this has been a successful approach. More exploration of the details of this strategy would be useful. Kentucky Cabinet for Economic Development – Office of Commercialization and Innovation (KCED / OCI)

KCED is one of the state DFAs that were explored in the best practices evaluation that was done prior to the 2010 Strategic Plan.1 Revisiting that information now it was discovered that within the Kentucky Economic Development Finance Authority, a sub-organization of KCED, there is a Division focused on economic development using seed and venture capital as a tool to achieve their goals. 1 AIDEA Strategic Plan, Investing in Alaskans, pp 63-65

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Commonwealth Seed Capital, LLC (CSC) This is an independent, non-profit fund that makes investments in early-stage Kentucky businesses to facilitate the commercialization of innovative ideas and technologies. Investment criteria is focused on businesses that have a significant Kentucky presence, the prospect for substantial growth, and the potential to generate an appropriate rate of return. From information provided, it appears CSC also invests in VC funds as well. Performance since 2001 has been:

$7.8 million invested in Kentucky businesses $14.2 million invested in venture funds which has resulted in $49,181,452 in

investments in 39 Kentucky companies $4.01 million in distributions from investments

Kentucky New Energy Ventures Fund (KNEV) KNEV ($5 million initial funding) was created in 2007 by the Legislature to enable Kentucky based companies to undertake research, development and commercialization in the field of alternative fuels and renewable energy. For example, KNEV funds were used to help a company develop a process that would convert natural gas into electricity onsite at remote (“stranded”) wells which lack pipeline access. The fund is managed by the Kentucky Science and Technology Corporation (KSTC) under contract with the OCI. KSTC is a private, non-profit corporation. Vermont Economic Development Authority (VEDA)

Entrepreneurial Loan Program This program provides financing for seed, start-up and growth stage businesses that may not have access to conventional means of financing. Businesses must be Vermont based, be unable to obtain capital because its assets are intellectual property or other nontangible assets and can demonstrate a viable business model. Proceeds can be used for capital assets, working capital or refinancing of other debt. Collateral can be security interests in project machinery, equipment, customer contracts, and proprietary technology. Loans are guaranteed by individuals with over 20% control. VEDA’s interest rate is based on VEDA’s Base Rate Index plus 3.0%. VEDA may not fund more than 90% of the cost of the project. Vermont Seed Capital Fund The Vermont Seed Capital Fund, LP looks for select investment opportunities in early stage, high opportunity, and technology based companies in Vermont. Objectives are to impact next generation job and wealth creation in Vermont by providing companies and entrepreneurs access to early stage risk capital. The fund is a revolving, “evergreen” equity fund with $5 million of initial capitalization from the State of

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Vermont and U.S. Senator Patrick J. Leahy. The Vermont Economic Development Authority (VEDA) is a strategic partner in this fund. This is a professionally managed venture capital fund which invests exclusively into Vermont start-ups and growing firms determined as offering high growth potential, financial return commensurate with risk, and public benefit for Vermonters. Portfolio firms also have access to programs, facilities, partners, and value-adding services offered via a strategic relationship with the non-profit VCET incubator. Investment transactions range from $50,000 to $250,000. The fund can act as lead investor or as part of investment syndicate. Wisconsin Economic Development Corporation (“In Wisconsin”) (WEDC)

WEDC is Wisconsin’s lead economic development agency. With FY 2015 forecast revenues of $63 million (51% from the General Fund; 30% from the State Economic Development Fund) and a forecast FY2015 Net Position of $110 million, this public-private entity relies heavily 600 + /- regional and local partners to support job creation and to achieve its mission. Their fundamental approach to economic development is characterized by their statement that “our collaborative, customer-centric approach aligns resources, partners and industries (emphasis added) to accelerate long-term, sustainable growth.” In this role they see themselves as a facilitator enabling programs run through other organizations to effectively stimulate targeted economic development goals. While WEDC does not make direct project or business investments with an expectation of an ultimate return of capital, it does promote investments in high risk ideas and early stage businesses through grants. Three such programs which are focused on seed and early stage companies are: Seed Accelerator This is a grant program (vs. a risk capital investment) designed to help fund other organizations on a 1:1 basis who are working with pre-seed business entrepreneurs in programs that incorporate training, mentoring and financial assistance. Capital Catalyst This too is a grant program ranging from $50,000 to $500,000 going to highly structured and well-funded organizations who make grants, debt and/or investments in startups and early-stage and innovative businesses. Qualified New Business Venture (QNBV) Early stage businesses developing innovative products, processes or services may be designated as a QNBV. Investments made by angel investors, angel investment networks and qualified venture capital funds are eligible to receive a tax credit equal to 25% of the amount of the equity investment through the Early State Business Investment Program.

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Community Development Venture Capital Alliance (CDVCA) The CDVCA is a network of 45 Venture Capital funds for the field of community development venture capital (CDVC). CDVC funds provide equity capital to businesses in underinvested markets, seeking market-rate financial returns, as well as the creation of good jobs, wealth, and entrepreneurial capacity. CDVCA works to strengthen the CDVC field through conferences and workshops and provides consulting services and technical assistance. CDVCA also manages its own investment vehicle, the Central Fund. The Fund specialized in identifying areas with untapped market potential, investing in rapidly growing businesses across diverse industries. The CDVCA Central Fund invests in conjunction with member funds through Fund of Funds investments and Co-investment Fund investments. Fund of Funds investments are made in CDVCA member funds that have missions of creating high-quality jobs and wealth that improve the lives of low-income people and benefit distressed communities. Co-investment Fund investments, direct equity investments made in partnership with other funds, are made in companies that meet CDVCA’s financial and social criteria and will be made in any industry sector except real estate. SBA New Markets Venture Capital Program (NMVC)

The NMVC program is designed to promote economic development and the creation of wealth and job opportunities in low-income geographic areas by addressing the unmet equity investment needs of small businesses in those areas. SBA selected, privately owned and managed NMVC companies provide funding and operational assistance using private capital the NMVC company has raised and up to 150% of that amount from the sale of SBA guaranteed 10 year debentures. At least 80% of the investments must be in small businesses in low income areas.

Additional Information

Council of Development Finance Agencies (CDFA)

CDFA’s Seed & Venture Capital Finance Course (November 19, 2014) explores the growing seed, venture capital and angel investment industry and provides clear direction for designing and implementing capital formation models at the local, regional, and state levels. This course differs from other capital formation curriculums in that it focuses more concretely on designing a program that uses public-sector connections, resources and coordination to drive long-term and sustainable private-sector investment. The nation’s top seed and venture leaders will discuss how to develop a capital formation program and establish a long-term private-sector driven, but public-sector supported initiative. In addition, the course will highlight successful programs that are

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working throughout the country in communities with varying levels of capacity, sophistication, and size. The Seed & Venture Capital Finance Course will provide development finance agencies a roadmap for building a seed and venture capital initiative that supports entrepreneurship, business investment, job creation, and 21st century technology development. Topics covered include:

How seed and venture capital can enhance your economic development strategy

How to design and establish an investment program How to manage, market, and promote a program The decision making process Pre- and post-investment closing Managing an investment portfolio

Public Funds Transparency Requirements

Public Employee Retirement System funds (PERS) constitute the largest source of public funds available for investment. Their goal is straight forward - invest public funds to preserve capital combined with obtaining returns that equals or exceeds the accumulated and future liability to fund public employee retirement. In the State of Oregon, the PERS portion of publically invested funds is almost $70 billion. The total managed public funds for investment is almost $90 billion. The Oregon Investment Council (OIC) which manages these funds, hires numerous third party managers to manage its investments in a wide variety of funds, venture capital funds being part of those investments. The Board of OIC provides broad guidance on the performance of its overall portfolio and specific guidance to individual third party managers with regard to specific investment sectors.

Despite the size of its investment portfolio, not all investment options are available to the OIC. As a public entity, established under legislative authority and with public accountability, with some exceptions, it is required to make its transactions public. Not all potential investments are willing to meet the public exposure requirements that come with a public funds investment.

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APPENDIX

Kentucky Cabinet for Economic Development – Office of Commercialization and Innovation Annual Report for July 1, 2011 to June 30, 2012 (selected pages) Wisconsin Economic Development Corporation Seed Accelerator Program Capital Catalyst Program

Qualified New Business Venture Program Community Development Venture Capital Alliance – Mission, History, CDVCA Funds SBA New Markets Venture Capital Program - Summary

ABOUT The 49th State Angel Fund (49SAF) is fueled by a $13.2 million allocation from US Treasury. This venture capital allocation finances and helps grow early-stage businesses within Alaska. Our Mission:

1. Provide a source of capital to high-growth businesses to promote entrepreneurship and foster innovation, creating jobs and economic benefit for Anchorage.

2. Help strengthen the local angel investment network and attract additional venture capital to the city.

3. Assist early stage and disadvantaged businesses.

BY THE NUMBERS As of September 30 2014, 49SAF has $8.25 million of investment obligations, most in third party investment funds. These “Partner Funds” place capital into Anchorage Businesses. 49SAF also has over 40 stakeholders:

o 8 Committee Members o 10 “Partner Fund” Investment Managers o >24 private investors who invest alongside 49SAF

We’re helping Alaskans invest in Alaska and it shows: Our leverage ratio is over 3:1; for every public dollar 49SAF invests, more than three private sector dollars are invested. “In the last nine months,” said one fund manager, “I’ve seen more activity in this area than in all my years in Alaska previously.”

PIPELINE 49SAF may commit for investment up to $1.25 million more in Anchorage Equity Partners, $500,000 in the 49th Fund, and $1.2 million in the Alaska Accelerator Fund.

49SAF INVESTMENTS

Beginning Balance $13,168,350

A. Investments – September 30, 2014 49SAF Obligation Total Capitalization Managers Fund: Anchorage Opportunity

$2,000,000 $4,000,000 M. Kroloff J. Rubini

Fund: Alaska Accelerator

$800,000 $1,600,000 A. Hermann F. Nabors K. Holland

Fund: 49th

$2,000,000 $4,000,000 J. Kenworthy C. Howarth J. Bassoul

Fund: Anchorage Equity Partners

$3,250,000 $7,000,000 N. Gunn P. Wiltse

Direct: CallDR $200,000 >$400,000 Raised S. Colligan B. Other 49SAF Obligation Total Obligations $8,597,643 Admin Expended $347,643 Left to Invest $4,436,390 Admin Reserved $134,317

PROPOSED RELATIONSHIP The 49th State Angel Fund is currently directly managed by the Municipality of Anchorage (“MOA”). The Sullivan Administration is asking AIDEA to contract for management of the fund. Thesis: 49SAF launched at MOA, where quick decisions could be made under the supervision of the Program Manager and Anchorage CFO. This fast initial phase allowed us to identify strong potential private sector fund managers, open the startup dialogue and educate the community, seek proposals, and undertake significant work with regard to policies and procedures, operations, legal matters and compliance. Now that fund operations are solid, our goal is sustainability. MOA believes this is most likely to be accomplished under the guidance of a skilled economic developer like AIDEA rather than directly in government. Details: 49SAF will remain “owned” by MOA and legally, the allocant in a legal relationship with US Treasury. AIDEA will manage the 49SAF function for the Municipality; MOA will exercise oversight on the contract. 49SAF’s Investment decisions and other high-level matters will occur at the 49SAF Committee level, functioning much like an independent board. Operational decisions will occur within AIDEA, executed by the Program Manager who works for the agency, and who leverages the institution’s expertise, resources and infrastructure. AIDEA will receive any unexpended federal administrative funds to operate this program (estimate $100,000); subsequently it will forward-fund 49SAF operations annually, receiving a) a first right to eligible returns to pay for such funding; and b) 20% of 49SAF’s post-capital contribution returns (less a).

Budget: The quarterly “burn rate” for 49SAF has consistently been ~$40,000. This may decline as 49SAF obligates all initial capital, but two core drivers remain: An FTE dedicated to 49SAF (67% of cost) and the regular utilization of external counsel and consulting needs related to venture capital (15%). Other consistent costs include education of staff, travel and conferences, and hosting the annual “angel forum” to grow skills within Alaska’s startup community. Note that while the program transitions to AIDEA—anticipated to take no more than a quarter—slightly higher costs may occur.

Expand to All Alaska: As part of moving the contract to AIDEA, Anchorage staff intends to request that US Treasury modify our allocation agreement to allow for any unobligated funds to be deployed anywhere within the state, allowing this unique financial resource to be leveraged elsewhere. 49SAF is out of startup phase, and entering into an “operations and maintenance” mode. Our current goal: Ensure maximum sustainability and lasting expertise within risk capital, as well as appropriate private sector engagement. We want to make 49SAF an evergreen fund, a permanent and recycling source of value for Alaska. To accomplish this, we need help, and we’re asking AIDEA: With your institution’s stated mission “to promote, develop, and advance economic growth and diversification in Alaska by providing various means of financing and investment,” there’s no better fit.

$200,000 Annual Budget LABOR FTE Salary (DPE) $84,000 Benefits @.6x $50,400 $134,400 NONLABOR External Legal & Consultants $30,000 Events & Marketing $17,500 Other $18,100 $65,600