HOUSE BILL REPORT

EHB 1124

BYRepresentatives Day, Vekich, Schoon, McMullen, B. Williams, Jesernig, P. King, Ferguson and Holm

Revising provisions on industrial development corporations.

House Committe on Trade & Economic Development

Majority Report:  Do pass.  (19)

      Signed by Representatives Vekich, Chair; Wineberry, Vice Chair; Amondson, Beck, Belcher, Braddock, Cantwell, Doty, Grant, Hargrove, Holm, Kremen, McLean, McMullen, Moyer, Rasmussen, Schoon, B. Williams and J. Williams.

House Staff:Stephen Hodes (786-7092)

AS PASSED HOUSE MARCH 20, 1987

BACKGROUND:

The Industrial Development Corporation Act of 1963 was intended to stimulate the Washington economy via equity investments and loans through the creation of industrial development corporations.  Only two such corporations have been formed, neither of which are currently operating in the state.  The need for an effective program to increase investment in Washington businesses is underscored by the low rate of new business incorporation in the state relative to other states.

One of the most important factors for the development of new enterprises is the availability of capital resources of the right type for an enterprise at the right time.  There appears to be a gap in the state's capital markets for intermediate-term debt: loans and equity investments which involve more risk and greater patience regarding profitability than the debt financing provided by commercial banks, but which involve less risk and patience than the initial equity investments provided by venture capital companies or partnerships.

Intermediate-term debt is lent for periods of three to ten years, allowing time for a firm's markets to expand and for its sales and earnings to grow. Unlike loans for fixed assets, such as buildings or equipment, such loans are not backed by collateral to protect a lender in case of default.  Requirements for fully secured lending place heavy burdens on small businesses which often do not have substantial assets or capital reserves.  Intermediate-term debt which is unsecured or subordinated involves lenders taking a higher risk than is required in short-term lending by commercial banks.  In exchange, lenders receive higher returns in the form of higher interest rates charged on such loans.

The need for mid-risk financing is met in different ways in states around the country.  Some states have authorized the creation of large privately financed intermediary institutions.  Other states, most notably California and Michigan, have authorized the creation of a new class of financial institutions, business investment development corporations, known as BIDCOs, to help meet these financing needs.  BIDCOs have access to Small Business Administration loan guarantee programs, which provide them with the ability to leverage additional private funds.  The success of these intermediaries in California and Michigan has led to substantial interest in them in states around the country in recent years.  Proposed amendments to Washington's industrial development corporation law would result in authorizing the creation of institutions resembling BIDCOs.

Among the most significant differences between those state economies which are performing well in recent years and those which are not is the rate at which new enterprises are created in the regional economy and the survival rate of those new firms.  A key factor in economic health in the current period is new job creation, and the most important sources of new jobs are the start-up of new enterprises, and the introduction of new products into commercial markets.

In the 1970s, the availability of venture capital for equity investments in new firms was geographically restricted to only a few states in the U.S., while venture capital became more widely available in the 1980s in many areas of the country, including Washington state.  Venture capital investments tended to be heavily concentrated in high technology firms, and funds were often unavailable for enterprises in other types of firms.  More recently, there has been a growing tendency on the part of venture capital firms and partnerships toward greater risk aversion, and a rapid growth in venture capital investments in such fields as financing leveraged corporate acquisitions and buy-outs.  The Tax Reform Act of 1986 is expected to have significant negative impacts on the level of investment in venture capital in coming years as a result of the lower return on capital gains resulting from the provisions of the act.

There has been a severe shortage of venture capital available to finance the initial capital requirements of new enterprises and of new product development.  Such investments involve more risk than conventional venture capital, most often provided to firms with longer track records which require major infusions of capital to increase the scale of production for broader commercialization.  The most important source of funds for new enterprise start-ups is the savings of family and friends.

There has been growing interest in public and public-private partnership involvement in stimulating seed capital investments in other states.  Programs in other states range from state financial intermediaries (which invest funds in new product development and recover their investments through a share in royalty payments from successful products) to limited partnerships of private firms and pension funds which invest in new enterprise start-ups.

There is a tradition in Washington State, dating to the passage of the port district statutes in the early years of the century, of the state authorizing local involvement in economic activity.  There are over 65 separate types of local special purpose districts authorized in state law, some with extremely broad economic powers.

SUMMARY:

The Industrial Development Corporation (IDC) Act of 1963 is amended.  The requirement that financial institutions be members and have voting control is eliminated.  Industrial development corporation investments are to be in firms with a majority of their workforce in Washington state and with fewer than 250 employees.  Fewer people are required to form an industrial development corporation and they are given greater flexibility in operations.

The amount of capital necessary to start an industrial development corporation is increased to $2 million.  The amount of earned surplus required is changed from one-half of the capital stock to one-quarter, which serves as a reserve to cover losses.  The main loan limitations placed on financial institutions in the 1963 Act remain unchanged.  The limitations protect the depositors and stockholders of those companies from excessive risk-taking. The reporting requirements on industrial development corporations are increased.  Existing industrial development corporations are permitted to incorporate under the provisions of 31.24.020 RCW in force when articles of incorporation were filed or under new provisions.

Local counties, cities, and towns are authorized to create a local seed capital pool to operate within their boundaries.  Such pools shall provide funds in the form of loans or the purchase of qualified securities to finance new enterprises or to assist in the development of new products.  Local seed capital pools shall be governed by seven-member boards appointed by the local governing body.  Board members shall be local citizens with expertise in small business, new business development, and business finance, and shall include members of the general public.  County commissions in contiguous counties may combine to form multi-county seed capital pools.  Procedures for determining the eligibility of corporations for local seed capital pool investments shall be determined by local governing bodies.

Local governing bodies may request utilities providing water distribution and sewerage collection services to include printed materials in their billings to consumers providing for consumer check-off of at least one five dollar per month to finance local seed capital pools.  Utilities shall permit consumers to denote the amount of funds to be donated monthly, if any.  Water and sewer utilities shall collect such sums as consumers indicate they want to donate, and shall forward monies to county seed capital pools.  Utilities are permitted to charge local seed capital pools up to three percent of the funds collected to defray billing and processing costs.

EFFECT OF SENATE AMENDMENT(S):  The $2 million of capital necessary to start an industrial development corporation are specified to consist of $1 million in equity and $1 million in lendable funds.

The Department of Trade and Economic Development is directed to provide technical assistance to industrial development corporations in formation.  The Department of Trade and Economic Development is enabled to enter into up to five contracts with industrial development corporations to deliver management assistance to firms they are financing, if one-half of the loans and investments of the corporation are subject to first-source hiring agreements. Contracts are limited to $250,000 per corporation.  Priority for such contracts shall be given to industrial development corporations which invest in distressed areas.

Tax credits are made available on the business and occupation tax, the insurance premium tax, or the public utility tax to investors in industrial development corporations starting at 25 percent in fiscal year 1988 and declining by 5 percent per year to a zero percent tax credit in 1993.

Utilities providing water distribution and sewerage collection services which would provide printed materials to permit consumer check-off to finance local seed capital pools are limited to public utilities, defined as public entities which provide water and/or sewer service.

Fiscal Note:      Requested February 25, 1987.

House Committee ‑ Testified For:    Representative Day.

House Committee - Testified Against:      None Presented.

House Committee - Testimony For:    The availability of capital for new and existing businesses would be enhanced by the authorizing of new financing entities to provide medium-risk capital.

House Committee - Testimony Against:      None Presented.

VOTE ON FINAL PASSAGE:

      Yeas 72; Nays 24; Excused 2

Voting Nay: Representatives Appelwick, Armstrong, Belcher, Braddock, Brekke, Cole, Fisher, Haugen, Heavey, Hine, Holland, Jacobsen, Leonard, Locke, Lux, Nelson, Niemi, Nutley, Patrick, H. Sommers, Unsoeld, Walker, Wang and K. Wilson

Excused:    Representatives Chandler and Padden