Brief ⁽¹⁾

Sub. for HB 2688 would enact the Kansas Certified Capital Formation Company Act as well as an income tax credit for the cost of facility improvements to food locker plants. The Act includes the following provisions:

Statement of Purpose. The purpose of the sections of the Act related to capital formation companies (CFCs) is to enhance the development of seed and venture capital in Kansas and support the modernization and expansion of the state's economy.

Mechanism. Investors in capital formation companies would receive state tax credits for investments in CFCs, which are privately managed, privately funded investment companies. CFCs, in turn, would invest in Kansas companies that are less than five years old and have no more than $1 million in gross sales in any fiscal year. Eligible companies must have a need for venture capital but would be unable to obtain conventional financing. These companies must have a principal business office in Kansas and have at least 50 percent of their employees residing in Kansas or agree to have that percentage within six months of the investment. Qualified business operations include manufacturing, processing, assembling and distributing products, research and development, and services provided through interstate commerce. The bill excludes businesses engaged in real estate, retail and financial services, passive business activities, and oil and gas exploration from receiving CFC funding.

Investors. Any natural person or entity, including a corporation, limited liability company, partnership, or trust, would be permitted to invest in a CFC. However, as an investor safeguard, the bill requires that if the investor is an individual, he or she must have a net worth of at least $1 million and that the investment in a CFC be limited to 10 percent of his or her net worth. A minimum investment by any one investor in a CFC would be $25,000 and a maximum investment would be $2 million. An investor would not be allowed to earn tax credits exceeding $5 million for combined investments in a given CFC.

Precondition for Certification of CFCs. A profit or non-profit entity may be designated by the Department of Commerce and Housing as an authorized CFC if the Department deems the CFC fund manager to be qualified and the principals of the CFC to be of good character. In addition, the entity must demonstrate that at the time of its application for CFC authorization, it has at least $500,000 in liquid assets. This financial requirement does not apply to Innovation and Commercialization Corporations which are subsidiaries of the Kansas Technology Enterprise Corporation (KTEC). If a CFC has been granted authorization status, it has a year to raise the minimum amount required for certification. However, any investment in a CFC during that time period would not be eligible for tax credits until certification by the Department. All moneys raised by a CFC for certification eligibility must be new moneys and cannot be transferred from an existing venture capital fund.

Capitalization and Certification of CFCs. In general, each CFC would be required to have at least $5 million in certified capital investments before its fund could be considered for certification. However, a minimum certified capital investment in any Innovation and Commercialization Corporation which is a subsidiary of the Kansas Technology Enterprise Corporation (KTEC) is $1 million. Although there is no upper limit for the capitalization of any certified CFC, tax credits will not be issued for investments of more than $10 million in any one CFC and $1.5 million in any KTEC Innovation and Commercialization Corporation.

Certification Priorities. The Department of Commerce and Housing will give priority for certification designation to those CFCs which have been most expeditious at raising their maximum cumulative investment amounts by the end of the one-year fund raising period. The Department may certify any fund reaching its maximum cumulative investment at any time during the one-year funding raising period. In general, the maximum amount for CFCs would be $10 million; for KTEC Innovation and Commercialization Centers, it would be $1.5 million; and for CFCs which are formed exclusively for the purpose of investing in nonmetropolitan counties, the amount would be determined in their agreements with the Department of Commerce and Housing. (Nonmetropolitan counties in this context include counties other than Douglas, Johnson, Leavenworth, Sedgwick, Shawnee, and Wyandotte counties.) At the end of the fund raising period, those CFCs that have raised the minimum amount required but have not reached the maximum cumulative investment will be certified in rank order based on the amount raised and the amount of tax credits available. The priority procedure is the same for all CFCs although, as noted, the maximum investment requirements are different for CFCs in general, CFCs which are formed exclusively for the purpose of investing in nonmetropolitan counties, and KTEC Innovation and Commercialization Corporations

Safeguards. The source of funds would be separated from the use of funds because investments in portfolio companies would be made by the manager of the CFC and not by investors in the CFC. Therefore, investors in the CFC would have no control over the companies in which their funds have been invested. The bill also clearly defines and penalizes violations of conflict of interest standards or self-dealing. In addition, principals in a CFC would need to meet strict standards as to their character and integrity and to any business dealings in their past.

Responsibilities of Kansas Department of Commerce and Housing. The Department of Commerce and Housing would have regulatory authority over CFCs. The Department's responsibilities would include: approving fund managers on the basis of experience and character; approving principals of the CFC based on an affirmative background report by the Securities Commissioner; authorizing, certifying and decertifying CFCs based on criteria set forth in the bill; requiring annual financial audits from CFCs; conducting an annual compliance review of each CFC; and preparing an annual report to the Governor and Legislature.

Responsibilities of Securities Commissioner. The Securities Commissioner's responsibilities include, as part of the pre-authorization screening of CFC applicants required by the bill: background checks of prospective principals of a CFC and reports to the Department of Commerce and Housing on the Commissioner's findings. A CFC will not be authorized unless the findings in the Securities Commissioner's report are affirmative.

Tax Credits. The Department of Revenue would administer the tax credits authorized under this Act. Investors in a certified CFC would receive a 100 percent tax credit that could be used against Kansas individual income tax, corporate income tax, premium tax, or privilege tax or fees. However, an investor could claim no more than 10 percent of the credit in any tax year. This credit would be refundable if the amount of the credit exceeds the taxpayer's liability. A total of no more than $5 million in credits would be allowed in any given year. The total amount of tax credits allowed for investments in certified CFCs over the life of the program is $50 million. Investments from outside the state are encouraged as well. Out-of-state investors and other non-Kansas taxpayers could sell investment credits to Kansas taxpayers. Kansas taxpayers, whose credits exceed their liability, will receive a refund for the difference.

Returns to the State. The State would receive 20 percent of any profits that are distributed. As a precondition for making any distributions to investors, a certified CFC would have to invest all of its certified capital in eligible portfolio companies.

Food Locker Plant Tax Credits. The bill would also provide an income tax credit for operators of a food locker plant, equal to the cost of facility improvements to the plant. This credit could not exceed $10,000 in any tax year and would be nonrefundable, but could be carried over to the extent that the amount of the credit exceeds the taxpayer's income tax liability in a given year.

Effective Date of Tax Credits. The food locker plant tax credits would be available beginning in tax year 2000. The CFC tax credits could be claimed beginning in tax year 2003.

Background

The concepts contained in HB 2688 were originally included in SB 315, which was referred to the Senate Committee on Commerce during the 1999 Legislative Session. The Senate Committee held hearings on the bill rather late in the 1999 Session. The Chairman of the Senate Commerce Committee requested the Legislative Coordinating Council refer the bill to the Joint Committee on Economic Development for further review and amendments. The Joint Committee recommended a modified version of SB 315 be referred favorably to the Senate Commerce Committee for its consideration. (Because the House Committee decided to initiate action on a similar bill during the 2000 Session, the Senate Committee has postponed further consideration of SB 315 to date.)

The House Committee on Economic Development recommended a substitute bill to adopt mostly technical changes suggested by the Joint Committee on Economic Development and authorize businesses engaged in agricultural activity to be eligible for program investments. (In the introduced version of the bill, such businesses were expressly excluded.) In addition, the House Committee amended the bill to change the definition of the certified capital companies from Certified Capital Companies (CAPCOs) to Capital Formation Companies (CFCs). A conferee representing a venture capital company in Missouri recommended that the Kansas program use a term other than CAPCO because, in his view, Kansas' program differed significantly from other states' CAPCO programs. One notable example he cited is that Kansas' program allows participation of individual investors whereas CAPCO programs in other states are limited to investments from insurance companies.

The House Committee of the Whole amended the bill to include the income tax credit for the cost of facility improvements to food locker plants. The content of this amendment is also the subject of HB 2865. This bill was introduced by the House Committee on Agriculture and referred to the House Committee on Taxation.

The Senate Committee on Commerce further amended the bill to: change the effective date tax credits may be claimed for CFC investments from January 1, 2002 to January 1, 2003; provide for "authorization" as a precondition for certification of CFCs; authorize any CFC, which is formed exclusively for the purpose of investing in nonmetropolitan counties, to have its minimum and maximum investment requirements determined in an agreement with the Department of Commerce and Housing; outline a priority procedure for designation of certification to CFCs; provide more clarification concerning the certification procedure; specify a maximum investment allowed by any investor in a single CFC; increase from 10 percent to 20 percent the return to the State of any profit distributions; and increase the number of working days from 15 days to 30 days with respect to certain notifications between the CFC and the Department of Commerce and Housing.

Revenue Impact

CFC Tax Credit. The Department of Revenue noted that under the current version of the bill, tax credits would be claimed beginning in 2003 instead of 2002. The Department estimates a revenue reduction of $2,000,000 in FY 2003 and $5,000,000 in each subsequent year. The total amount of tax credits which may be allowed over the life of the program cannot exceed $50,000,000.

Food Locker Tax Credit. With respect to tax credits authorized for food locker plants, the Department of Revenue estimates a fiscal impact of approximately $260,000 for each year after FY 2000. The Department bases this estimate on 130 food locker plants in Kansas (the number of plants assumed to exist in Kansas) claiming a $2,000 credit each year for expenses related to improvements to the plant.

Administrative Expenditures

CFC Program. The Kansas Department of Commerce and Housing projects expenditures of $184,052 in FY 2001 for: salaries of 1.5 FTE ($62,352), operating expenditures ($11,700), furniture and equipment ($10,000), professional assistance in developing rules and regulations ($10,000), and expenditures for conducting due diligence investigations to authorize CFCs ($90,000). The Department projects that application fees assessed against prospective CFCs in subsequent years will significantly offset state funding for expenses incurred during the authorization/certification process.

1. *Supplemental notes are prepared by the Legislative Research Department and do not express legislative intent. The supplemental note and fiscal note for this bill may be accessed on the Internet at http://www.ink.org/public/legislative/bill_search.html