Avoid Uninformed Knee-Jerk Decisions

On Sunday the Milwaukee Journal Sentinel ran a story about the venture capital legislation that was passed in Wisconsin in 1999. The story focuses on the one company that appeared to game the system and exploit the loopholes left by legislators and a governor that didn’t fully understand how to implement a venture capital (VC)program. In fact some of the same legislators involved in 1999 currently have an influence on the new venture capital legislation.

Sunday’s story focuses exclusively on one bad actor that took advantage of legislator’s lack of understanding in 1999. What concerns me is that legislators today seem to be positioning themselves to make even worse mistakes. Many of them seem to believe that by simply picking a different VC program that they will magically avoid such complications, bad actors and other problems. As a result some seem to be fast tracking what is known as a “fund of funds” based program. But there are serious questions that need to be asked about this venture capital approach and we shouldn’t rush into this or any specific program without having a full understanding of its risks and history.

Over the last few months I have repeatedly focused on the venture capital program in Oklahoma. That state has had a “fund of funds” program since the 1980’s. In fact “fund of funds” programs are sometimes referred to as the “Oklahoma Program”. What I learned about Oklahoma’s venture capital program was certainly alarming and legislators should certainly take note and avoid their mistakes.

Here are a few of the alarming details that jumped out at me:

• In 2006 a state audit was done of the Oklahoma Capital Investment Board and it "found $31 million in debt and more questions than there are answers". It also found that the OCIB had $26 million in other unfunded commitments.
• A state auditor also identified other areas of concern including a lack of transparency and no real way to track performance.
• A bipartisan group of lawmakers recently criticized the OCIB on several levels. Including the fact that 85 to 95 cents of every dollar that Oklahoma invested through its program was invested in start-up companies located outside of the state and at least one was outside of the country.
  

Sunday’s Milwaukee Journal Sentinel story also highlights the fees involved in the previous VC program in Wisconsin. But it didn’t mention that all venture capital funds collect a 2.0-2.5% (even higher in Silicon Valley) management fee per year and that is not exclusive to just one specific kind of VC program. If legislators have an aversion to such fees, I certainly hope that they fully examine the subject. I especially hope that those who are trying to fast track the “fund of funds” approach actually check the level of fees often involved in that kind of program. They can end up being double the cost of fees in other programs. In fact in many “fund of funds” programs the fund managers end up collecting just as much in fees as the underlying VC firms that are actually doing the work.

As I have said in previous blog postings on this subject, I am not particularly dogmatic about the exact venture capital program that Wisconsin chooses. But I am concerned that some legislators don’t appear to have all of the information and yet they seem ready to rubber stamp one specific approach. Right now it appears that they are planning to fast track a “fund of funds” program without fully doing their due diligence. Legislators need to slow down, fully understand the details and the possible motives of those trying to influence them. They also must study what has happened in states like Oklahoma so that we don’t make the same costly mistakes. Venture capital policy is a complicated issue and what we certainly don’t need right now are uninformed knee-jerk decisions.

What’s with the “Fund of Funds” Fast Track?

When the original venture capital legislation was introduced, opponents of it repeatedly called for the legislature to slow down and more deliberately evaluate the various options. That is certainly a notion that I agreed with because this is an important issue and regardless of the exact approach we must proceed in a thoughtful manner. But now that the focus of many has changed entirely to a “fund of funds” approach, suddenly some are ready to take a fast track. This is the exact kind of blatant inconsistency that makes me wonder about what is going on behind the scenes and what motivations lie there.

Let me be clear. I’m not saying that a “fund of funds” approach shouldn't be a part of our venture capital planning but I am saying that we better make sure that we do things right the first time. A few weeks ago I gave the Oklahoma example to show that using a “fund of funds” approach should not be looked at as the Holy Grail of venture capital programs. Oklahoma has had the “fund of funds” program the longest and in fact it is frequently referred to as the “Oklahoma program”. After using this program for decades, recent reports and audits in that state are hardly inspiring.

Since my last blog posting about the venture capital complications in Oklahoma, a bipartisan group of state officials have written an editorial about their flawed system. In it they highlight the fact that 85 to 95 cents of every dollar that Oklahoma invested through its program was invested in start-up companies located outside of the state and at least one was outside of the country. A state audit in 2006 found “$31 million in debt and more questions than answers.” While the private fund managers in that state have collected generous fees for years, state officials described it in the recent op-ed as a “failed program that has become too costly...”

Surely Oklahoma originally thought that their program was a good one but due to its complexity, problematic issues remained relatively hidden for years. That is until the state faced paying multiple millions of dollars to cover losses. Since a private entity was allowed to run the program it took public officials longer to detect such problems. In fact the entity that ran the program was not even subject to public records requests, open meetings laws or to the inquiries of state legislators.

The State of Wisconsin certainly shouldn't be rushing to replicate these kinds of mistakes; rather we should take the time to learn from them and carefully arrive at a solution that fits our specific needs. We should also ensure that all entities associated with our venture capital program are open and fully subject to public scrutiny.

Scott Walker has assembled a venture capital commission to apparently advise the legislature on this issue. However even this commission seems to be moving very quickly. Apparently they have already had their first meeting and I’m still trying to find out who exactly is involved. Some reports have given a few names but it would be nice to have a full listing before this commission goes too far too fast. For example, I think that we should know if any conflicts of interest exist on the commission. I further think that its deliberations should be made fully available to the public.

Bringing in a much larger share of venture capital dollars is certainly an important goal for our state but we should plan it carefully and with full disclosure. We certainly shouldn't repeat other state's mistakes whether it is on a “fund of funds” fast track or on some other overly rushed route.

UPDATE: I just happened across this News from West Virginia, which I believe uses the "Oklahoma Program". They started it in 2002 and a recent audit has revealed a $20.8 million loss.

More Disclosure Please

There is no doubt that Wisconsin must increase the share of venture capital dollars that it attracts. Elected officials of both parties, business leaders and activists of all kinds have known that for decades. I am not overly dogmatic about the exact method that we choose to accomplish that goal as long as it is done in a thoughtful manner that gives our state the best chance for long term success. But the last thing that we need is to just blindly accept any one approach without asking all of the hard questions and doing our due diligence.

It is also just as important to have this discussion openly. That openness should not only include elected officials but also the high profile individuals that have been most aggressive in trying to influence the eventual outcome. There are certainly people with financial and other interests that are publicly engaged in this policy debate. But what concerns me most is the strong agenda pushing that seems to be occurring behind-the-scenes.

When the initial legislation on this issue was first presented, former insurance company CEO Tom Hefty went on the attack. I read his comments in multiple media outlets and wondered if he was representing someone in particular. I went to the “Eye on Lobbying” website and was fairly surprised, based on his activity, that he was not listed as a registered lobbyist. Later I learned that Mr. Hefty was also writing regular emails personally pressuring a number of legislators. One legislator that does not actually represent Mr. Hefty got at least 7 emails from him in less than a month.

In his emails to at least some of the legislators Tom Hefty repeatedly suggested that the proposed legislation would specifically disadvantage New Berlin insurance company, United Heartland. Hefty goes on to state that he “…served as CEO of Blue Cross for seventeen years and we founded United Heartland in 1990.”(emphasis mine) In his previous comments in the media and in his public statements, I don't recall him specifically advocating for the interests of any one company much less one that he had a hand in founding. So why was he doing so via email to legislators? An explanation would be helpful because without one we are left guessing.

In 2002 the Milwaukee Journal Sentinel estimated that then-CEO Tom Hefty owned 30,000 shares in then-Blue Cross(Cobalt) stock. The report also said that he had options at the time to buy about 680,000 shares. Given his email advocacy, it seems fair to ask if a portion of that financial interest included United Heartland. In other words, does Mr. Hefty currently have a financial interest in that company? Obviously I don't know but perhaps that is another piece of information that he might consider disclosing. [Milwaukee Journal Sentinel, 6/2/02]

My point here is not a statement on the details of the venture capital legislation itself nor is it a challenge of Mr. Hefty’s right to voice his own personal opinions about it. It is to simply state that Wisconsin deserves an open and fully transparent discussion. If powerful individuals in our state are trying to influence legislators in one way or the other, they should also give the public a clear and consistent understanding of their motivations.

Don't Venture into Oklahoma Territory

There is no doubt that Wisconsin must increase its share of venture capital dollars. The big question is exactly how we will accomplish that goal. Recently the Milwaukee Journal Sentinel put its unquestioning seal of approval on what is known as a "Fund of Funds" approach. Curiously missing from their endorsement was any mention of how to best safeguard public investment if that is the approach that we in fact use.

The Milwaukee Journal Sentinel endorsement simply says that the "fund of funds" approach has "...worked well elsewhere". It would have been nice if they at least offered one quick case study. Given their lack of detail, I looked for other states that have used similar approaches. One state that I found clearly stood out to me and unfortunately it was not in a good way.

The State of Oklahoma established the Oklahoma Capital Investment Board (OCIB) in the late 1980's. It borrows money that it then invests in private venture capital funds. Here are some of the reported problems that I've found with their system and I certainly hope Wisconsin is not planning on repeating any of them:

• In 2006 a state audit was done of the Oklahoma Capital Investment Board and it "found $31 million in debt and more questions than there are answers". It also found that the OCIB had $26 million in other unfunded commitments. In fact the agency has a long record of carrying debt during most of its existence. A state auditor also identified other areas of concern including a lack of transparency and no real way to track performance.
• Just last week a bipartisan group of lawmakers criticized the OCIB on several levels. Including the fact that too many dollars were being invested in companies and corporations outside of state's borders. Legislators also accused the OCIB of not even being fully transparent with them much less with the public.
• During the same hearing one Republican legislator actually questioned whether OCIB was even operating legally because although it was originally created as a public entity and received public funding, it was later made private and still received public funding. This privatization reportedly added to the many transparency problems that were already present.
  

While I was researching this Oklahoma example, I also discovered another curious pattern. There seems to be a lot of free movement between the OCIB itself and private venture capital firms that deal directly with the board, contract with it, and profit from it. In my view it seems that such an arrangement could cause conflict questions. In fact it appears that some have already suggested as much.

If Wisconsin continues to pursue the "Fund of Funds" route, I certainly hope that we don't fall into the same kind of dysfunctional pattern that exists in Oklahoma. And I certainly hope that no one involved in that state's venture capital strategy is trying to influence our debate here.