THE MISSISSIPPI LEGISLATURE

Overview

Background of the Venture
Capital Program

The Legislature passed the Venture Capital Act of 1994 to help develop business climates and improve general economic conditions within the state. The act vested major responsibility for program operations in a private for-profit corporation (Magnolia Venture Capital Corporation) which was capitalized through a private non-profit parent corporation (Magnolia Capital Corporation). The Legislature approved the funding of this program through the sale of a $20,000,000 general obligation bond guaranteed by the state.

Actual Costs to Date

MCC and MVCC have incurred $4,515,777 in overhead expenditures (one-third of the $13,791,906 in program funds turned over to MCC and MVCC), which has led to $2,324,124 in program losses. Including the $3,672,964 in bond interest the state has paid to date from general funds, the state's actual losses through February 1, 1997, total $5,997,088.

Projected Total Costs over the
Life of the Program

Based on losses incurred to date and future interest costs of the bonds, PEER estimates total costs of the venture capital program to approximate $26,305,144 from June 1994 through August 2009. The cost estimate includes:

• the actual $2,324,124 loss of capital incurred by MVCC and MCC through January 31, 1997;
• $14,346,668 in actual bond interest the state will pay from general funds over the fifteen-year term (The total $34,346,668 to be paid over fifteen years from the general fund for bond principal and interest includes $20,000,000 in principal payments which the state will recover when a zero coupon bond required by the Venture Capital Act expires in 2009); and,
• $9,634,352 in estimated interest the state could have earned by 2009 if it had not paid the $14,346,668 in actual bond interest over the period.

Summary of Findings

Over the venture capital program's two and one-half year history, private and public entities charged with program oversight have not effectively fulfilled their responsibility. Even though the statutory intent of the program was to provide funding for venture capital investments in Mississippi businesses, the entities have engaged in only one $650,000 venture capital investment. Yet since the venture capital program's inception, MVCC has incurred large losses resulting primarily from questionable and extravagant procurement of goods and services authorized by the CEO and the board. MVCC's former Chairman and CEO conducted corporate operations and program activities in a manner which resulted in loss of substantial venture capital financial resources. The Chairman/CEO personally benefited from many MVCC expenditures, receiving approximately $1,980,938 in direct and indirect payments. MVCC investment practices also increased the losses of program resources.

The venture capital program's one investor withdrew most of the money invested in the program, and as a result, the program currently does not comply with statutory requirements for meeting the minimum private capital threshold for the MVC Fund to make investments. Also, MVCC has not met the statutory requirement for seventy percent of its moneys to be invested in "start-up" companies.

MVCC's lax management and board oversight also contributed to weaknesses in its application review process. Until late 1996, MVCC had not instituted a formal application review process for businesses interested in the venture capital program and had no consistent method of collecting information on such businesses, program components which should have been primary considerations of an equity investment program.

The MVCC board failed to oversee MVCC's business activities by requiring the CEO to disclose detailed financial information on a frequent, regular basis. Magnolia Capital Corporation failed to compel MVCC to produce annual report information which was required by statute to be reported to DECD. Likewise, DECD failed to take timely action to compel MCC and MVCC to comply with the statutory program reporting requirement. Such laxity in oversight led to loss of program resources by permitting the CEO to make procurements and investment actions which did not serve the best interests of the program.

Recommendations

PEER presents recommendations which address the alternatives of:

• continuing venture capital program operations by taking certain corrective measures; or,
• abolishing the program as it currently exists and restructuring the mechanism by which venture capital investment is promoted by the state.

In any event, PEER recommends recovery of funds which appropriate authorities might determine have been misspent by MVCC and prosecution for any determined criminal acts.

Recommendations: If Mississippi Continues
the Present Venture Capital Program

PEER identified several aspects of venture capital program operations that need improvement. These include oversight, procurement, investment management, and compliance with state law governing the program.

Oversight

1. The Legislature should amend the Venture Capital Act to require more frequent and more detailed financial and program activity reporting. The Legislature should amend CODE Section 57-77-21 to require that MCC require MVCC to compile monthly and quarterly financial statements (detailing revenues and expenses) and activity reports and distribute them to the MVCC board of directors, MCC's chairman, the Executive Director of DECD, and the State Auditor. This amendment should require that MVCC pay a penalty if such information is not submitted on a timely basis.

Procurement and Administrative Expenses

2. The MVCC board and officers should make future procurement decisions that are in the best interest of the corporation. Both the MCC and MVCC boards should require MVCC management to use competitive procurement practices for acquisition of goods and services. Engaging in competitive practices could help conserve program resources and make additional funds available for investment.

• • MVCC should competitively bid brokerage services on a regular basis, such as yearly, to hold commission and fees to a minimum.
• • MCC and MVCC should not contract with related parties, such as businesses owned by board members or staff or with relatives of board members or staff or businesses owned by relatives. MCC and MVCC should set policies prohibiting conflicts of interest with regard to contracting and other activities. The boards should use the State of Mississippi's conflict of interest statutes, MISS. CODE ANN. Section 25-4-105 and Section 109 of the Mississippi Constitution, as a guide in developing policies.
• • The MCC board should discuss with its legal counsel the retainer agreement and obtain an understanding of the average number of hours spent by counsel on providing services to MCC and the purposes of the services. Based on those discussions, MCC should consider discontinuing the $5,000 per month retainer agreement and paying for legal services by the hour, or some arrangement which incorporates the most economical form of contractual arrangement. MCC should require that counsel provide an itemized billing for services rendered in order to monitor spending for legal services.

3. The MCC and MVCC boards should develop policies for allowable administrative expenses, especially for salaries and fringe benefits. The boards should request input from the Executive Director of the Department of Economic and Community Development for setting salary levels. The boards should set salary levels based on a survey of venture capital company salaries in southern states and on the venture capital experience of the individuals holding the MVCC positions.

Investment Management

4. In keeping with MVCC's statutory purpose of holding state funds only until such time as venture capital investments in Mississippi businesses can be made:

• MVCC should discontinue its investments in common and preferred stocks and in corporate bonds which have investment ratings below A as designated by Moody's and Standard and Poor's investment rating services.
• The MCC board and the MVCC board should obtain an understanding of and regularly discuss the types of marketable securities investments held by MVCC and MVCF and any risks involved in holding those securities.
• The MVCC board should develop a written plan for temporarily investing funds held until the venture capital investments can be made. The plan should ensure that the funds expected to be used for venture capital in the next one to two years are placed in only the most liquid and conservative investments, such as money market securities. The plan should also prohibit margin loan positions on its investments.

5. In conjunction with any changes to its investment policy, MVCC should adjust its operating revenue and expenditure projections, listed in Appendix D, page 52, to reflect projected reductions in revenue resulting from less risky investments. For example, in the event that MVCC sells its riskier, higher-yielding investments and buys more conservative investments with lower earnings potential, MVCC will realize lower revenues and therefore should reduce its future spending levels in order to continue operations without losses.

Program Compliance With State Law

6. MVCC should cease making investments until the $4,500,000 private investment requirement is met.

7. The MVCC board should approve future business investment applications using statutory criteria that seventy percent of investments be made in "start-up" businesses to bring its business investment portfolio into compliance with the statutory requirement.

Recommendations: If Mississippi Abolishes
the Present Venture Capital Program

If the Legislature chooses to abolish the present venture capital program, the entities involved should take steps to address recouping assets and equity investments, maintaining the program structure until transfer of moneys and duties is accomplished and placement of venture capital duties with state officials is completed. The Legislature should consider various alternative structures when creating a new venture capital program.

Abolition of the Current Program

8. Legislative amendments to abolish the current venture capital program should provide for the systematic liquidation of the subsidiary corporation's (MVCC's) assets and equity investments. The Legislature should require the parent corporation, MCC, to merge MVCC duties and assets under its authority and to continue intact until all assets are transferred to the State Treasurer. Assets of the venture capital program should be deposited into the "State Treasury - Venture Capital Fund" and re-appropriated by the Legislature, should it choose to do so.

Creation of a New Program

9. If the Legislature chooses to create a new venture capital vehicle to channel state resources to private businesses, it should consider several alternatives available for such a program. These alternatives include creating a new venture capital incentive for private organizations to administer the program (such as in North Carolina, which at one time provided state tax credits for investors) or shifting the currently allocated resources to existing business loan or equity investment programs.

Recommendations for Recovery and
Prosecution

10. The Mississippi Ethics Commission should determine whether conflict of interest violations have occurred and pursue recovery of funds in instances where such payments have been made in violation of the ethics laws.

11. The State Auditor should pursue recovery of venture capital program funds where payments have been made on the basis of false invoices or as a result of fraud.

12. The Attorney General should determine whether officers or employees of MVCC committed fraud or other crimes and prosecute those who committed criminal acts.

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