Brief ⁽¹⁾

HB 2505 would enact the Kansas Certified Capital Formation Company Act. The act includes the following provisions.

Statement of Purpose. The purpose of the act 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 certified 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 other CFCs, affiliates of CFCs, and investors in CFCs, as well as 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 not less than 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 nonprofit 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. 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. Exceptions would be the Kansas Technology Enterprise Corporation (KTEC) Innovation and Commercialization lenders and CFCs formed exclusively for the purpose of investing in nonmetropolitan areas. Innovation and Commercialization Centers would only be required to raise a minimum of $1.0 million and CFCs investing exclusively in nonmetropolitan counties would have minimum investment requirements that are subject to negotiation with the Secretary of Commerce and Housing. (Nonmetropolitan counties in this context include counties other than Douglas, Johnson, Leavenworth, Sedgwick, Shawnee, and Wyandotte.) 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.

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; and for CFCs which are formed exclusively for the purpose of investing in nonmetropolitan counties, the Secretary of Commerce and Housing could establish a lower minimum or maximum investment. 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 would be the same for all CFCs.

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 50 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 $2.5 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 would be $25 million. Out-of-state investors and other non-Kansas taxpayers could transfer investment credits to Kansas taxpayers. Only the full amount of the credit for any one investment could be transferred and it could only be transferred one time. Kansas taxpayers, whose credits exceed their liability, would receive a refund for the difference.

Liquidations and Returns to the State. The state would receive 10 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 or the fair value plus any prior qualified and liquidating distributions which equal or exceed 110 percent of its certified capital. When marketable securities have been received in liquidation of a qualified venture capital investment, the securities could be distributed in liquidating distributions. This would have the effect of transferring liability for the performance of the securities to the investor. The bill would also allow for cash liquidating distributions for the purpose of providing funds to investors to pay income taxes attributable to earnings of the CFC.

Effective Date of Tax Credits. The CFC tax credits could be claimed beginning in tax year 2003.

Background

The concepts contained in HB 2505 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. This bill was HB 2688, which passed the House and after being amended by the Senate Committee, died in the Senate Committee of the Whole.

HB 2505 was separately referred to the House Taxation Committee and the House New Economy Committee. The House Taxation Committee held a hearing on HB 2505, at which time Representative Mason and representatives of Kansas, Inc., and the Kansas Chamber of Commerce and Industry testified regarding the bill. The House Taxation Committee recommended the bill favorable for passage without making amendments.

The House New Economy Committee held a hearing on HB 2505, at which time representatives of Kansas, Inc.; KTEC; the Kansas Chamber of Commerce and Industry; American Century Ventures; Kansas Venture Capital, Inc.; and the Secretary of the Department of Commerce and Housing offered testimony regarding the bill. The New Economy Committee amended the bill to do the following:

• •Add language specifically including debt instruments secured by a lien on intellectual property in the definition of "capital in a qualified Kansas business";
• 
  
  
• •Define the term "maximum cumulative investment" for purposes of the bill;
• 
  
  
• •Strike Section 5(a)(5) which would have required the Secretary of Commerce and Housing to approve all initial qualified venture capital investments 30 days in advance and sets out procedures regarding this requirement; and
• 
  
  
• •Make technical amendments.

The Senate Committee held hearings on the bill at which time representatives of Kansas, Inc., the Kansas Technology Enterprise Corporation, the Department of Commerce and Housing and Black & Veatch offered testimony.

The Senate Committee amended the bill to do the following:

• Allow a CFC, as an alternative to investing an aggregate amount equal to 100 percent of its certified capital in qualified venture capital, to make liquidating distributions if it has invested the fair value of its assets plus any prior qualified and liquidating distributions which equal or exceed 110 percent of its certified capital.
• 
  
  
• Allow for marketable securities which have been received in liquidation of a qualified capital investment to be distributed as liquidating distributions.
• 
  
  
• Allow for cash liquidating distributions for the purpose of providing funds to investors to pay income taxes attributable to earnings of the CFC.
• 
  
  
• Allow the greater of the original certified capital investment in a CFC or the original certified capital investment plus the amount equal to the net gains, losses, income, and expenses realized by the CFC to fulfill the requirement that no more than 20 percent would be invested by a CFC in a single qualified Kansas business at any one time.

Revenue Impact

CFC Tax Credit. The Division of the Budget notes that, under the bill, tax credits could be claimed beginning for tax year 2003. The Division estimates a revenue reduction of $1,000,000 in fiscal year 2003 and $2,500,000 in each subsequent year. The total amount of tax credits which may be allowed over the life of the program could not exceed $25,000,000.

Administrative Expenditures

Kansas Department of Commerce and Housing. The Department projects total first-year expenditures of $170,528. This would include $52,128 for 1.5 FTE positions and $118,400 for operating costs for investigations. Of this, $69,690 would be from the State General Fund and the balance would be from application fees of $20,000 each.

Kansas Department of Revenue. The Department projects that passage of HB 2505 would require $83,800 in State General Fund expenditures in FY 2002. This would include funding for personnel and associated operating costs as well as expansion of databases and changing tax forms. The Department estimates annual costs of $57,507 in subsequent years.

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/fulltext.cgi