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Steve Berneman began working on a gaming startup in Austin, Texas. In 2012, he moved to Nashville, where he could access investment capital for the company through a new $200 million program funded by the state of Tennessee called TNInvestco.
His company, Overdog, grew to about 15 employees before it was acquired by a New York gaming company in 2016. The team “employed a bunch of people, built a really great product,” Berneman said, but did not achieve the economic outcome he and investors were hoping for.
Still, the value of the TNInvestco investment drawing Berneman to Tennessee extended beyond the Overdog transaction. Berneman stayed in Nashville and now leads a tech-forward title insurance company that employs about 90 people, half of whom live in Nashville.
“There are a number of people who came to Nashville or who flourished because there were greater investment funds,” Berneman said. “The thing that Nashville really needed, from an entrepreneurial standpoint, was a spotlight.”
As the now 12-year program winds down, many investors and entrepreneurs credit TNInvestco for helping strengthen the state’s venture capital community and startup momentum and describe it as a clear positive for the state. Among current state officials and lawmakers, many of whom approved the program in 2009, criticism of TNInvestco abounds. They point to underwhelming investment returns, accountability issues, lackluster job creation, high cost to taxpayers and a structure that rewards participating investors regardless of outcome.
Former lawmakers sponsoring TNInvestco in 2009 forecast the program would be copied by other states in the years ahead, but given lawmakers’ and current officials’ take on the program more than a decade later, it’s unlikely it will be replicated even in Tennessee.
“Is this something (Economic and Community Development) would endorse today? The answer is absolutely, 100 percent, no,” said Tennessee Economic and Community Development Commissioner Bob Rolfe, whose office oversees the program.
TNInvestco passed with the objectives of creating jobs, boosting small business growth and increasing investment dollars available to Tennessee startups. There was also an expectation that the state would be made whole on the $200 million dedicated to the program.
There were no specific goal posts set for the program and annual reports provide just a few data points on the program as a whole. The overall economic impact has not been evaluated, which limits conclusions on the program and hampers insights when other economic initiatives are considered.
What the latest annual report does show is that 186 companies received funding and more than $750 million in private capital followed those investments. About 1,880 jobs have been added, costing the state about $91,000 per new job when accounting for investment returns. The state has recouped about $28 million from investment returns, leaving a $172 million cost to taxpayers.
“When you go back to 30,000 feet and look at the program, there are some nice intangibles — bringing capital to the state, bringing other investors to the state,” Rolfe said. “If you look at it strictly from an ROI perspective, those are dismal results.”
Other benefits not evaluated in annual reports include greater awareness surrounding the startup community, additional funds created by TNInvestco investors, more people moving to Tennessee to start or grow businesses, indirect jobs tied to the program and additional tax revenue from TNInvestco businesses.
“The goals of the program, of creating a more vibrant venture and startup entrepreneurial economy in Tennessee, really has borne fruit,” said Reagan Farr, who helped develop TNInvestco as former revenue commissioner under former Democrat Gov. Phil Bredesen. “The hope when it was done was that the positive economic benefits would outweigh the costs. I think you can look at it in a multitude of ways and say the benefits are there.”
How TNInvestco works:
In 2009, in the wake of the Great Recession, Tennessee officials and lawmakers on both sides of the aisle championed a new TNInvestco program, promoting it as a jobs bill. TNInvestco was pitched as an alternative to similar CAPCO investment programs underway in other states that out-of-state investors were lobbying for in Tennessee. The program’s design was complicated and several lawmakers’ questions indicated confusion on how it worked. Still, TNInvestco received nearly unanimous, bipartisan support and was expanded the following year.
Ten investment groups were selected to participate in TNInvestco. The $200 million in tax credits were sold to insurers at a discount, costing the state about $53 million from the sale alone. Each firm was allocated about $14 million for investments and to cover management fees.
Investment groups ultimately were required to share proceeds made with the state in a 50/50 split. The arrangement is more lucrative than in the private sector, where when a deal is successful, an investor is often paid back their original investment, along with 80 percent of any profit. The investment manager often will take 20 percent of profits, along with fees.
A TNInvestco investor is given incentive to find companies with strong potential because they will make more money if the business does well. But, the investors face no penalty if their deals fall flat. They still stand to gain if only some profit is generated. Simply put, if an investment group invests $12 million and recoups just $6 million, it profits $3 million. The state, which put up all the funding, loses $9 million.
Is this something (Economic and Community Development) would endorse today? The answer is absolutely, 100 percent, no.
– Bob Rolfe, Commissioner, Tennessee Department of Economic and Community Development
Measuring TNInvestco’s success in jobs, business creation, investment landscape
TNInvestco’s purpose, according to Tennessee’s website, is to develop “entrepreneurial infrastructure,” bring new capital to the state, diversify the economy and create jobs. Lawmakers sponsoring the TNInvestco program in 2009 included those points in their pitch to colleagues, describing the difficulties early stage entrepreneurs in Tennessee faced in accessing investment, and they emphasized job creation and business growth as primary objectives.
“This bill is about two things — growth of small business and creation of jobs,” the late Republican State Rep. Charles Sargent said when he sponsored the legislation in 2009. His co-sponsor, former State Sen. Doug Overbey dubbed it “job-creation legislation” in 2010.
If the program is assessed based on small business growth, there are several successful companies to point to, as well as dozens that have floundered — which is not unusual for early stage venture capital investments. It is difficult to determine how critical the state’s contributions were to the thriving companies’ success, but several fund managers and founders have credited the program’s role as a meaningful support.
Change Healthcare, a health payment company in Brentwood formed in 2007, received its first TNInvestco investment in 2010 when it employed nine people, according to TNInvestco reports. It sold to Emdeon in 2014 for as much as $185 million when it employed about 80 people.
Digital Reasoning, an artificial intelligence company formed in 2010 in Franklin, Tenn., gained $750,000 in TNInvestco dollars when it employed about 70 people. It subsequently raised at least $60 million from investors, including Goldman Sachs, and had more than doubled in size as of 2019, according to TNInvestco reports. It sold in 2020.
Criterion Security, a Nashville security staffing firm formed in 2010, added about 500 jobs since its $525,000 TNInvestco investment. The company merged with a Canadian company in 2017.
Stratasan, a health tech company, began with two employees at the time of its $1.2 million TNInvestco investment. It raised $26 million in 2019 and employs 75 people.
Founder Jason Moore said the TNInvestco investment was “critical in giving us the opportunity to continue launching Stratasan.”
No job target was established for the program. The $91,000 per-job estimate is based on added jobs and program cost, and it drops to $58,000 per job when retained jobs are also calculated. Both estimates are significantly higher than what the state has spent per job through its FastTrack economic development program in recent years, which ranges from $4,000 per job and $6,500 per job, according to the state’s website. They fall in the middle of recent, large economic development incentive packages. Amazon received commitments of about $17,500 per job in cash grants and tax credits in 2018 for its 5,000 job operation center in Nashville. Ford Motor Company received a $152,000 per job commitment for its new West Tennessee plant that is expected to employ about 5,800 people.
Current Tennessee economic officials said the TNInvestco program is different from other economic development initiatives recruiting established, often publicly traded, companies adding thousands of jobs. Instead of direct job creation, TNInvestco’s emphasis was more on supporting the entrepreneurial and investment landscape that would facilitate job growth, a point echoed by Farr.
“It was really, sprinkle these seeds across multiple dozen companies, create other pools of capital that can then do the follow-on rounds and see these companies grow and help create that ecosystem,” Farr said.
While it is difficult to determine TNInvestco’s direct impact on the state’s entrepreneurial infrastructure, there is evidence of growth. The number of firms qualifying for tax exemptions as venture capital funds nearly doubled from 2009 to 2020 to more than 600, according to the Tennessee Department of Revenue. Tennessee’s venture capital assets under management more than doubled from 2009 to 2019, a growth rate that exceeded the national average during the same time period, according to a 2020 report from the National Venture Capital Association.
In 2009, Tennessee had an early startup survival rate of about 76 percent, and ranked 21st in the nation, according to research by the Ewing Marion Kauffman Foundation. In 2020, the rate was nearly 80 percent and it ranked 13th.
At least a few of the TNInvestco portfolio groups have launched subsequent investment funds after they invested the state’s money. TriStar Health Partners raised more than $20 million for a second fund. Solidus, another TNInvestco portfolio, used the TNInvestco allocation to create Nashville startup accelerator Jumpstart Foundry. The program evolved into a private capital fund that has raised nine subsequent funds and invested in at least 128 healthcare companies, about a dozen of which are in Tennessee.
“People will criticize it, but it created Jumpstart,” Vic Gatto , who managed the Solidus TNInvestco portfolio, said of TNInvestco. “The people who put it in place did a decent job trying to set up a pretty creative structure.”
There have been other private and publicly-funded efforts across the state that also have likely contributed to boosting entrepreneurism across the state, but participants argue TNInvestco has been a significant catalyst. “TNInvestco played a role,” Farr said.
How the investment groups performed, based on job data through 2019:
(Portfolio manager names were provided by state officials, the state’s website and other media reports.
Council & Enhanced:
Portfolio managers: Tyler Augusty, Dennis Bottorff, Katie Gambil, Andrew Paul, Michael Korengold, Rick Apple
Notable investments: Skuid, The Rehab Documentation Company, PlayMaker CRM, Shareholder Insite
Total jobs: 679
Portfolio managers: Ken Woody, Jan Bouten, Barham Ray
Notable investments: NuScriptRx, ExtraOrtho
Total jobs: 148
Portfolio managers: Joe Cook III, Joe Cook, Jr., Steve Singleton, Byron Smith
Notable investments: MedCenter Display
Total jobs: 99
Portfolio managers: Gary Stevenson, Stephen Snowdy, Mike Sherman
Notable investments: CrossRoads, now OrthoDiscovery
Total jobs: 108
Portfolio managers: Dan Marcum, Fran Marcum, Cameron Newton, E. Brac Thoma, Richard Bendis, Matthew Wiltshire, Joseph Binkley III.
Notable Investments: Consensus Point, Passport Parking
Total jobs: 491.5
Portfolio managers: Vic Gatto, Townes Duncan
Notable investments: Change Healthcare, Amplion (formerly Dalcon), LiveSchool, UtilizeHealth
Total jobs: 138
Tennessee Angel Fund:
Portfolio managers: Sid Chambless
Notable investments: Complete Holdings Group, Digital Reasoning, Inova Payroll, NeighborMD
Total jobs: 684
Tennessee Community Ventures:
Portfolio managers: Eric Satz, William Guttman, John Hopkins, Eduardo Rallo
Notable investments: American Hometown Media
Total jobs: 11
Portfolio managers: Harry Jacobson, Christopher Rand, Brian Laden
Notable investments: MedCenter Display,
Total jobs: 64
Portfolio managers: Jim Phillips, Michael Schmerling, Thomas Cigarran, Steven Gerringer
Notable investments: Criterion Holdings, RLCL (Gray Line of Tennessee), Stratasan, Provider Trust
Total jobs: 1,067
Investors fall short on returning capital to taxpayers
TNInvestco was pitched as having a neutral fiscal impact. Farr forecast that the program would break even through its investment returns, not counting tax revenue. Proceeds that exceeded the $200 million price tag, were designated for the state’s Rural Opportunity Fund, a point emphasized by Farr and TNInvestco sponsors when the program was approved to assure the benefits would be spread statewide.
“We all believe, even with very conservative projections, that this program will not only pay for itself, it will potentially pay dividends which we can use to support our rural economic development efforts,” Farr said in 2010.
Farr said in 2021 recouping the $200 million directly through investment returns was not the program’s goal, but there was a hope the overall benefits exceeded the costs. “It was an economic development program, not an investment program,” he said.
Tax revenue totals produced by TNInvestco companies will not be disclosed until all of the $200 million is recouped. Rolfe said he does not anticipate that happening based on conversations with each of the 10 portfolio teams, who still have 71 active TNInvestco companies. He is hopeful the state could receive another $28 million.
No portfolios have made the state whole on their allocation and at least a few of the 10 TNInvestco portfolios have failed to generate any investment profits for themselves or the state, Rolfe said.
“There are some that may have a real chance to generate an extraordinary return. There are others that probably aren’t on that kind of trajectory,” Rolfe said.
The investment groups have collectively profited by $28 million, or on average, about $2.8 million per portfolio group, as of 2019, in addition to earning management fees, which Rolfe estimated as about $3 million per investment group over the life of the program.
“It was one of the greatest gigs,” Rolfe said of the portfolio manager role. “I don’t know anybody who wouldn’t want to have gotten $150 million to go invest with no penalties, no shareholders, no limited partner responsibilities.”
Farr emphasized that under the CAPCO program that was initially pitched by financial firms seeking to participate in the program, the state did not capture any returns. The TNInvestco outcome was much more beneficial to taxpayers, by comparison.
“It was novel at the time for Tennessee to say we are going to share in the upside,” Farr said.
If the program were to be repeated in the current investment environment, Farr said the percentages earned by investors would likely be lower, and other changes would likely be made. But, he said, it is unfair to view the program through the current lens because the investment community is much more developed than it was a decade ago.
“You wouldn’t do it today because it’s a completely different landscape,” Farr said.
State officials would not disclose specifics on portfolio returns, citing TNInvestco statutes, but annual reports show investment amounts that followed TNInvestco deals and job totals for each group, which range from 11 to more than 1,000.
Although the Tennessee Community Ventures portfolio produced few jobs, as shown in annual reports, portfolio manager Eric Satz said his portfolio made important contributions, with lasting impact, to the entrepreneurial ecosystem. He invested in Overdog and other companies that helped develop enduring tech and entrepreneurial talent in Nashville.
“The type of companies we funded attracted talented engineers who are interested in solving difficult problems,” Satz said. “Even though those particular companies didn’t work, they stayed and have gone to play pivotal roles with other companies here in Nashville.”
Jim Phillips, who leads XMI portfolio, said he is confident his portfolio will make the state whole on his investment allocation, but he also pointed out restrictions on TNInvestco investments that made returns more challenging. The 10 investment groups had to meet investment thresholds in the program’s early years and all investments had to be in Tennessee, where an early stage and seed investment community barely existed, he said.
“No manager does that normally,” Phillips said. “That is going to, obviously, drive down the returns.”
TNInvestco wind-down period extended
TNInvestco courted controversy from the beginning. A lawsuit demanding transparency on how investors were chosen was filed in 2010 by an investment group that was passed over. When the program was expanded in 2010, several lawmakers objected and asked more pointed questions about returns, accountability, profit percentages, involvement of minority-owned businesses and transparency than they had the previous year. Republican State Sen. Frank Niceley of Strawberry Plains, Tenn., said the state should not be funding businesses and called his previous support of the program his “worst vote.”
A state audit in 2012 found “serious and pervasive problems” with the program and highlighted accountability shortcomings. In 2016, an audit highlighted a lack of returns.
When a financial group, among those who initiated the TNInvestco discussions in 2009, sought to push for a $100 million state investment program in 2021, TNInvestco was mentioned repeatedly by lawmakers as an outcome to avoid. TNInvestco “had a bad smell from the very beginning,” Niceley said. In May, State Rep. G.A. Hardaway, a Memphis Democrat, called it the “biggest rip-off” during his time at the legislature.
“It hasn’t been as successful as we anticipated,” State Sen. Bo Watson, R-Hixson, who voted for TNInvestco in 2009 and 2010, said. “I don’t think we saw the innovative developments we anticipated.”
TNInvestco was scheduled to end this year, but the original legislation did not spell out how to wind it down. Forcing an end this year would lead to a fire sale of each remaining investment, a move that would ultimately hurt taxpayers, Rolfe said. In May, Tennessee lawmakers approved a program extension that allows the portfolio managers three more years to exit stakes in companies with the same profit shares. Rolfe called it “the best option of not many really good options for the state.”
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