O'Malley's $100 million plan to fuel innovation economy

Hoping to spur jobs, innovation and economic growth, Gov. Martin O'Malley wants to tap tax revenue to invest $100 million in fledgling technology, life sciences and other companies across the state.

O'Malley, a Democrat, plans to unveil details of the "Invest Maryland" program Monday as a centerpiece of his economic agenda in this year's General Assembly session. The state would invest in small businesses and start-up companies — partially through the dormant Maryland Venture Fund — and would reap both the risks and rewards.

Christian S. Johansson, secretary of the state Department of Business and Economic Development, which would spearhead the initiative if it becomes law, said the public is concerned about the economy and job prospects. The state needs to move beyond spending on one-time stimulus projects, he said.

"There's a climate of budget cuts and deficits," Johansson said. "But the bigger issue in people's minds is what are we going to do to create jobs that aren't gimmicks, jobs that will be here today and tomorrow."

Several states have adopted government-funded venture capital investment programs, some of which have been criticized as taxpayer-funded boondoggles. O'Malley's proposal also comes at a time of fiscal belt-tightening, and it's unclear whether legislators would support the investment program when budget deficits have dogged the state for several years.

But administration officials said the state has had past success with venture capital investing and that this program could fuel a cycle of reinvestment. And market experts who reviewed the Maryland proposal said it has been crafted to avoid pitfalls experienced by other states.

The venture capital industry in Maryland and the Mid-Atlantic region is improving, but it is nowhere near the high-flying years just before the dot-com bust, when the region attracted $5.2 billion in venture capital in 2000. In 2007, before the recession hit, the region saw a $1.2 billion infusion of venture capital, according to the National Venture Capital Association.

Desperate to create jobs, many states have enacted legislation that enables them to pump tax dollars into local businesses, usually technology and science-based companies, according to Jim Jaffe, chief executive of the National Association of Seed and Venture Funds, which represents investors.

O'Malley's plan would invest $20 million a year for five years. By comparison, the amount of venture capital invested in the Baltimore-Washington-Northern Virginia market topped $690 million last year — nearly $100 million more than during the previous year, according to the association.

Jaffe worries that O'Malley's proposal is too conservative. He pointed to other states that are spending more, including Ohio, which is in the middle of funding a 10-year, $1.35 billion investment in its state's technology businesses.

"There are a number of states who have taken a big gulp, looked around, and said the future is technology," Jaffe said.

The Invest Maryland plan is designed to address a need among start-up businesses, which have trouble luring deep-pocketed venture capitalists. Young companies need start-up funds to experiment, to patent technologies, do market research and perhaps clinical studies — and it could be years before many see profits, or even revenue.

So there's greater risk in investing in newer, unproven companies, but that's where the state can play a key role, said Douglas M. Schmidt, CEO of Chessiecap Securities Inc., a Mid-Atlantic investment banking firm.

"For this region and Maryland in particular, the future of the economy is not in large headquarter companies," Schmidt added. "The future is small new business."

O'Malley's plan, which would be funded through tax revenue from insurance companies, has been received with general support from the business and technology communities in Maryland, who have heard the outlines of the program, but not the details.

"We're very excited about the proposal and the fact the governor has his hand on this," said Renee Winsky, CEO of the Tech Council of Maryland, the state's largest technology trade association.

Under O'Malley's plan, half the money would be invested by the state's Maryland Venture Fund, a program with a track record of returns on investments, state officials note.

Since its formation in 1994, the Maryland Venture Fund has invested $25 million in companies based here and returned $61 million to the state, according to state officials. But the venture fund, which at one time was self-sustaining, was largely depleted during the recession as venture capital deals slowed to a crawl and the state didn't replenish the fund.

The other half of the money would be doled out to three or four private venture capital firms that would invest the money in Maryland businesses as well, according to state officials.

Initially, the program could fund 20 to 40 companies a year, with investments up to $500,000. State officials said the companies would be chosen by third-party professionals, and not state bureaucrats, to avoid any appearance of impropriety.

But state Del. Warren E. Miller, a Howard County Republican who sits on the Economic Matters Committee, said he isn't a fan of government playing the role of investment banker and "picking winners and losers in our economy." He also said he is concerned about the program's price in light of budget shortfalls, this year put at $1.6 billion.

"I really have a big problem risking $100 million the way the economy is," Miller said.

Several states have launched programs that divert future tax revenue from the insurance industry for investment in homegrown companies. The insurance premium tax is often targeted in these initiatives because the funds are a relatively stable, predictable revenue stream.

The programs, known generally as certified capital companies, or CAPCOs, have been criticized in Louisiana, Colorado, Florida, Missouri, Texas and the District of Columbia for being expensive and ineffective in terms of creating jobs and new businesses.

Maryland legislators have tried to pass CAPCO legislation in the past, including an attempt last year, and venture capital firms that profit from such legislation have lobbied in Maryland in recent years.

O'Malley's plan has some similarities to a traditional CAPCO, but it diverges on several important fronts, according to Julia Sass Rubin, a professor at Rutgers University who is one of the most outspoken critics of state-funded venture capital programs and who was paid by the O'Malley administration to review the proposed legislation.

"It's a great model," Rubin said. "If states want to do something, this is the way it should be done."

Under O'Malley's plan, the state would set up an auction to sell access to tax credits, which would take effect in 2015. Also, Maryland would invest in companies with expectations of recouping its entire principal investment, plus 80 percent of the profits.

Such an approach is the industry norm in the venture capital world, Rubin said. CAPCOs, on the other hand, don't have to return the principal investment amount to the state, and sometimes only return a small portion of profits, she said.

"CAPCOs are basically nothing but corporate welfare, whereas this actually makes sense," Rubin said.

Rubin said the state should open up the tax credit auction to other industries beyond insurance. Allowing more kinds of companies to bid on tax credits could help ensure the state gets the best deal and raises the most revenue, she said.

Another feature of the Invest Maryland plan is that there would not be "carve-outs" for specific sectors. Some state venture capital programs dictate that they must invest fixed percentages in different sectors.

But Johansson would rather the state remain able to invest when fast-moving opportunities arise in the market. He said some of the most promising sectors now are biotechnology, cybersecurity and information technology, all of which would likely attract investments.

"I probably get a call a day asking for a carve-out," Johansson said. "But we're not pushing for allocation for specific industries."

Winsky said the state should invest in the best opportunities, regardless of the sector. "That's actually the fairest and best bang for the buck," Winsky said.

O'Malley's Invest Maryland proposal

•Sell $100 million worth of future tax credits to insurance companies through 2015.

•Use the insurance tax revenue to make annual $20 million investments in early-stage Maryland technology businesses. Insurance can claim tax credits from 2015 to 2019.

•A Maryland Venture Capital Authority would be created to handle the sale of tax credits and select third-party professionals who would guide the state's investments.

•State would recoup principal investment plus 80 percent of profits.