States, hungry for business, try grubstaking

In their tireless quest to spur economic development and promote entrepreneurship, states are increasingly trying a new - and sometimes controversial - gambit: becoming financiers.Across America, states are putting money into venture-capital programs and other financial avenues aimed at aiding new businesses and budding entrepreneurs.Proponents see this growing pool of state ventures as leading to a new wave of technical innovation and creating thousands of jobs. But critics question how effective states can be in this area - as well as the wisdom of putting public funds into risky ventures.''It (state venture capital) is the glamorous thing now,'' says Michael Kieschnick, senior editor of Politics and Markets, a newsletter on political economy, and vice-president of a San Francisco-based lending firm.At least two dozen states are directly involved in venture financing. Many others are weighing the idea. When added to more traditional aid for small business development - low-interest loans, help in finding private financing, and technical and managerial assistance, for instance - venture financing represents part of what some see as a significant new thrust by states to try to broaden their economies.Behind the push is a growing realization at the state level that small businesses are important in boosting employment. State officials, too, have been taken with the success of the private venture-capital industry, which over the past decade has raised more than $14 billion and been a spark plug for the entrepreneurial movement.But private funding does not reach into every region of the country equally, nor is it available for every tinkerer who wants to peddle an idea. Hence another reason states are starting their own kitties. ''It was a desert here (for financing),'' says Archie Leslie, vice-president of Indiana's Corporation for Innovation Development, a privately run venture-capital group set up through a state tax credit in 1981, which has raised $10 million in two years.The idea of states getting into risk financing is not new. Connecticut, for example, set up a state-operated venture fund in 1972. The Connecticut Product Development Corporation (CPDC), as it's called, helps fund new process or product development, mainly at small high-tech firms in the state. It gets, in return, a 5 percent royalty on products sold. Massachusetts, meanwhile, has three capital pools, including one (the Massachusetts Technology and Development Corporation) that was set up back in 1979.Most state initiatives, though, have been launched more recently. So far, the amounts of money involved are relatively small. States have invested a total of $300 million to $400 million in venture financing programs, compared with $2.8 billion invested by private venture-capital companies last year alone. But states see their efforts as having impact beyond the modest numbers.''This is a very new role for the states ,'' says Roubina Khoylian, director of research at Venture Economics Inc., a Wellesley, Mass., firm that tracks the venture-capital industry. ''Venture capital in general has become more visible, and the whole entrepreneurial climate has been heating up.''Approaches vary. Some states have followed Connecticut's successful lead, setting up public venture-capital pools funded mainly by the state (in this case from a state bond issue) and getting returns through royalty payback setups. Over the years, CPDC has invested some $11.5 million in 56 projects. It has earned close to $2 million on the sale of products it helped to back.New York's Corporation for Innovation Development, run by the state's Science and Technology Foundation, a public corporation encouraging high-tech development, has invested in 14 ventures over the past two years. The corporation has a $2 million fund (half federal, half state money) and plans to recoup part of its money when the companies it backed go public and sell their stock.Another tack is for states to encourage the development of private venture pools by giving tax breaks to companies that chip in money. This is what Indiana did with its Corporation for Innovation Development. The privately run, profit-seeking fund is financed by money from corporations in Indiana, and they, in turn, get a 30 percent state tax credit on their investments of up to $5 million. Maine and Iowa have set up similar funds.One other trend is for states to make public pension funds available for capital financing. In the past, states have shied away from putting retirement funds into such risky areas. But recently some have been easing restrictions on where these funds can be invested. Michigan, Ohio, and New York, for example, now put at least a fraction of their retirement system money into venture financing.The long-term effect of this deepening pool of state aid remains uncertain. There is the high degree of risk involved with any venture financing. Private venture-capital firms have trouble enough picking winners. State-run enterprises trying to make a profit won't find the chore any easier, particularly since many operate under certain restrictions (such as being able to fund only in-state ventures) and aim their aid at businesses in an embryonic stage of development. Nor is state help any guarantee that the entrepreneurs themselves will succeed: One key to their survival, in fact, will be how much private funding they can come up with after the aid from the state.Another concern is political interference: How do you ensure that state legislators or operators of the funds won't parcel out money to friends? A few states - Alaska, for example - have had some problems with this in the past. ''Some of these programs may prosper - but not everyone is going to,'' says an analyst with the Congressional Budget Office , who has studied state industrial-development efforts.