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Venture capital and South Dakota economic development.

About the author: Robert J. Tosterud, Ph.D., is holder of the Freeman Chair in Entrepreneurial Studies and Professor of Economics at the School of Business, University of South Dakota in Vermillion.

Background and National Perspective

The importance of new business formation to economic development and employment in the United States is well established and recognized. A recent study by the U. S. Small Business Administration found that new business entries created 37.6 million jobs between 1976 and 1984. In comparison, business expansions during this same period accounted for 13.2 million jobs. Subtracting job losses of 33.8 million due to business exits and contractions, net new job growth during this eight year period was 17.0 million. Without new business ventures, the economy would have suffered a net loss of over 20 million jobs.

During the late 1980's, Americans started, on average, 700,000 new corporations, 100,000 new partnerships, and 500,000 new sole proprietorships-about 1.3 million new enterprises in all. By comparison, less than 100,000 new business enterprises were started in 1950. Demographers estimate that by the year 2000, there will be 30 million firms in the United States, up substantially from the 19 million in existence today. It is little wonder that many see the stimulation of new business creation as the most important source of economic development. Converting an idea into an opportunity, and that opportunity into a business--entrepreneurship--is the fuel, engine and throttle of the U.S. economy.

Much of our economic system concerns itself with the financing of business growth and creation. While there are dozens of variations, the two primary methods of securing capital for business start-ups and expansion are debt and equity financing. The focus of this paper is a relatively new form of equity financing called venture capital.

The National Venture Capital Association defines venture capital as "capital provided by firms of full-time professionals who invest alongside management in young, rapidly growing or rapidly changing companies that have the potential to develop into significant competitors in regional, national and global markets." Typically, the venture capitalist, in return for the investment, takes an equity position in the new firm with no cash repayment schedule. In addition, the venture capital firm will actively participate in the management of the new start-up. In contrast and in complement to traditional funding sources, the business financing "niche" of the professional venture capital firm is its willingness to assume inordinate risk, place uncollateralized investments, surrender rights to cash repayments, and participate in management decisions of the young company. The challenge and contribution of the "VC" firm is to develop merits of company proposals and thereby minimize the risk of "picking losers." It is no accident that VC investors have consistently invested in just 1 to 3 percent of all the proposed ventures they review. Industry sources estimate that $35 billion of venture capital funds are available from professional sources. This is an eight-fold increase over the last ten years. This pool is supplemented by an additional $50 billion to $60 billion of informal risk capital, all in search of the right opportunity. In essence, the venture capitalist has given value to, and created a market for bright ideas and creativity---very source of change and economic growth. The U.S. Department of Commerce has estimated that since World War II, 50 percent of all innovations, and 95 percent of all "radical" innovations, e.g., the microcomputer, the pacemaker, the X-ray machine, have come from new and smaller firms.

Professional venture capital investments in young and small companies have yielded important economic returns to the nation. Coopers & Lybrand, a leading national public accounting and management consulting firm, performed a recent survey of venture-backed companies and identified the following:

The cost of creating a job in a venture-backed company was 28 percent less equity per job than the cost of creating similar positions in Fortune 500 companies.

These young companies invest nearly four times as much of their equity in research and development as Fortune 500 companies.

Export sales of venture-backed companies grow seven times faster than Fortune 500 firms.

Venture-backed companies needed $59 in equity to generate $100 in assets, nearly three times more equity than Fortune 500 companies required to produce the same amount of assets.

The average equity investment required to found a survey company in 1985-1989 was $10 million-43 percent more than four years earlier.

* Fifty-five percent of this risk equity came from professional venture capitalists; 23 percent came from founders; 13 percent came from private investors; and 9 percent from other sources.

The source of funds of private venture capital firms was:
Pension funds 45%
Corporations 13%
Endowments and
Foundations 12%
Foreign investors 11%
Insurance companies 10%
Individuals and
families 8%


(The capital commitment of corporations fell dramatically

between 1989 and 1990, dropping from $483 million to $125

million.)

The distribution of investments by industry of these

venture-backed companies was:
 Medical health 23%
 Computer related 19%
 Biotechnology 16%
 Communications 13%
 Other electronics 10%
 Other 19%


The private venture capital industry is subdivided into three segments: "independent funds" consisting largely of private and public firms, family groups and affiliated and nonaffiliated Small Business Investment Companies (SBIC's); corporate financial" which includes venture capital subsidiaries, affiliates and SBIC's of banks, insurance companies and other financial corporations; and corporate industrial groups" composed of venture capital subsidiaries and affiliates of industrial corporations and their SBIC's.

Independent funds account for 80 percent of all industry venture capital under management.

The professional venture capital industry has only taken on "industry" status the last 7 or 8 years. The size of this industry, as measured by total venture capital under management, grew slowly from approximately $2.5 billion in 1969 to $7.6 billion in 1982. It then exploded to $36 billion in 1990.

This $36 billion is presently managed by 2,602 professionals in 664 firms. The average venture capital firm has $54 million under management. The largest 100 companies control 62 percent of all venture capital under management; the average size of these firms is $221 million. Twetity-nine percent of the industry-192 firms--had less than $10 million under management and accounted for 2 percent of the total industry venture capital pool. It is not surprising that 80 percent of the industry's capital is managed by funds with partners who have five or more years of experience.

It is also not surprising that the Northeast and the West Coast dominate as sources of venture capital. Massachusetts, New York, California, Connecticut and Illinois account for 78 percent of the capital under management in the venture capital industry. This geographic concentration has not changed in 15 years.

The professional venture capital industry disbursed approximately $2 billion in 1990, of which only 10 percent-$200 million-was devoted to seed and start-up ventures. The remaining $1.8 billion was disbursed to help existing businesses finance expansions (52 percent), early stage startup (17 percent), and leveraged buyouts and acquisitions ( 18 percent). Seed/start-up financing usually refers to capital obtained by a company before it has completed developing a prototype of its product, or a modification of a working or almost working prototype product. More specifically, Clinton Richardson, in his book The Growth Company Guide to Investors, Deal Structures, and Legal Strategies, differentiates "seed capital" and "start-up capital" as follows:

Seed Capital refers to financing obtained by a company before it has completed developing a prototype of its product. Sometimes it refers to capital raised after a company has developed a prototype of its product but before it has manufactured any production units. This is the most difficult and expensive money to raise because it is needed before management can prove that the product will sell or that it can be produced and distributed at a competitive price. The entrepreneur's family, friends, and relatives and his personal savings are the primary source of seed capital.

Start-up Capital usually refers to money raised to modify a working or almost-working prototype product into a product that can be manufactured at a cost that allows the company to make a profit. It can be the first or second stage of a company's financing. Start-up capital is used to test market products and prepare companies for their first round of product sales. This money is more readily available than seed capital. This money costs companies less equity per dollar of funding than seed capital does but more than latter-stage financings.

The high cost of seed and start-up financing is reflective of the imbedded risks in the proposed or new venture. Firms offering seed and start-up financing represent a special dimension of the venture capital industry. Dr. Richard T. Meyer of the Emory Business School recently completed a 1991 survey of the characteristics and performances of 58 seed capital funds, which represents, he believes, 72 percent of all existing funds that are fully dedicated to seed and start-up financings.

The extreme degree of risk inherent in these ventures has drawn public involvement into this segment of the venture capital industry. Of the 58 funds included in the Meyer survey, 32 are private funds, 14 are public and 12 are public/private combinations. These 58 funds currently have under management 817 million and have outstanding investments of $438 million. In contrast to the average "professional" or private venture capital firm which reported $54 million under management, the average seed fund is much smaller, having under management $14 million. Meyer draws a number of conclusions from his survey:

Eighty-two percent of the funds were targeted at investment technology based companies.

The State was the source of 72 percent of public monies invested.

Out of $438 million invested by these funds, only $46.7 million had been lost.

The average number of failed investments per fund was 4.

1 Poor management was identified as the cause of 80 percent of the failures.

The revenue generated by the financed enterprises was $4.1 billion, or 9.4 times the amount invested. Only $12,000 was invested for every job created.

The average number of investments per fund was 26, with an average investment per "deal" of $470,000.

At origination, 89 percent of the 58 funds surveyed started with less than $15 million undermanagement, and 31 percent were under $2 million.

On a number of investments basis, private funds had the highest failure rate at 22 percent, public/private funds had the lowest at less than 3 percent.

As could be expected, the sources of funding for these seed/ start-up, private/public, and combination private-public venture capital funds are varied and dependent upon the degree of involvement of the public sector. According to the Meyer survey, the most frequently cited source of money for private and combination funds was corporations (64 percent), followed by private investors (58 percent), pensions and institutions (55 percent), and mutual funds and other sources (5 percent and 12 percent, respectively). Wholly public and combination funds, on the other hand, garnered 72 percent of their aggregate capital from state agencies, 10 percent from the U.S. Economic Development Administration, 7 percent from city governments, and the remainder equally from pensions, corporations and trusts; insurance companies; and general obligation bonds.

Capsulizing Meyer's summary: "..... seed capital funds provide an important and valuable financing source for seed and start-up enterprises in many economic regions of the country. They do help to fill the 'capital gap' that has always existed but that has become more pronounced in recent years. ";"...... government sources of seed capital .... remain crucial to the financing of young companies."; and "..... well managed seed capital funds provide a low-cost, low-risk means of new job creation for local and regional economies."

While the Meyer study of seed and start-up funds clearly shows expansion for this segment of the venture capital industry, the latest Annual Report of the National Venture Capital Association states:

"The venture capital industry experienced a decrease in growth for the third year in a row in 1990. Both new capital committed to private partnerships and disbursements to portfolio companies have dropped steadily since the industry's peak in 1987. The venture industry is shrinking as corporations exit the business and funds that have not produced above average returns fail in their attempts to raise new partnerships." And, ".... 1990 marks the first time in over a decade that there has been a decline in the number of venture capital firms." Perhaps the coincidental increase in public sector involvement with the declining participation of the private sector in business venture financing is not so curious. Also coincidental was the large capital gains tax increases of 1987 and 1988.

There is yet a third category or approach to venture capital financing: bank-sponsored Community Development Corporations. First introduced in 1978, bank CDCs are organizations funded by one or more banks and bank holding companies which are allowed, following approval by state and federal regulators, to make investments not otherwise permitted by regulation. Such investments include obtaining equity positions in local real estate and business projects if there are public benefits such as economic development, jobs for low and moderate income people, affordable housing, capital for small businesses, or other "public purpose" investments. While there are many hybrid forms of equity investments, the best known forms are common stock in corporations and limited partnerships in real estate projects. Bank CDCs provide debt financing as well. The size of bank CDC investments are relatively small and usually target a business in need of debt/equity capital due to the business experiencing rapid growth, introducing a new product, diversifying or lacking sufficient collateral for a bank commercial loan. CDC investments are intended to supplement rather than compete with bank or other available sources of investment capital, and thereby fill a perceived "capital gap." A mission statement for a typical bank CDC might read, "To establish and build an investment fund to foster/stimulate community development by making debt and/or equity investments in small businesses which have growth opportunities and do not qualify for conventional financing due to lack of equity. Also to demonstrate the feasibility of such investments to attract additional capital by making prudent investment decisions."

The CDC corporate structure allows banks to be more flexible with investments than with conventional bank loans. Bank CDCs can be organized as either for-profit or nonprofit; as wholly-owned subsidiaries of a single bank or as a bank holding company; funded by a number of banks and other financial institutions or corporate investors; and as partnerships and joint ventures with community-based or other private or public investors.

The venture capital "services menu" is comprehensive. Firms exist to assist and exploit virtually every phase of business creation, expansion, and harvest. They run the gamut, from public/nonprofit to private/for-profit; from seed capital to acquisitions; from debt to equity financing; from professionally to publicly managed; from profit maximizers to promoters of community welfare; from corporate financed to tax supported. The venture capital industry-in all of it's variants-is a full-service economic development tool.

Regional Characteristics of the Venture Capital Industry

As indicated earlier, the private, professional venture capital industry is highly concentrated geographically. In fact, almost one-half of all venture capital investments were made in two states in 1990, California and Massachusetts. The New England states and the West Coast accounted for almost 70 percent of the $2 billion of venture capital disbursements or placements in 1990. In contrast, seven states reported no venture capital placements. As perhaps anticipated, the Upper Great Plains states of South Dakota, North Dakota, Montana, Wyoming and Nebraska had negligible venture capital investments in 1990, according to the National Venture Capital Association. Montana was the only state of these five which showed any venture capital activity that year $1.4 million). Other states in the region which drew venture capital investments were Colorado $49.4 million), Minnesota $44.0 million) and Iowa $1 million).

The other half of the venture capital equation is capital commitments or originations-where the capital is raised. Only 21 states originated venture capital in 1990 with four of them, California, Massachusetts, Connecticut, and New Jersey accounting for over 60 percent of the nationwide commitment of nearly $2 billion. Only Minnesota and Colorado are shown as sources of venture capital in this region, contributing less than 5 percent of the national total.

Comparing venture capital disbursements (placements or terminations) with commitments (originations) on a state-by-state basis, identifies those states which are net "importers" and "exporters" of private, professional venture capital. The results are shown in the following table.

[Tabular Data Omitted]

Connecticut is the largest net exporter of venture capital, followed by Massachusetts, New York and Maryland. The largest importers of venture capital are California, Rhode Island, Arizona, Washington, and Virginia. The capital flows" shown above lead to a great deal of speculation and many hypotheses, e.g., the influence of income, wealth, quality of educational/research institutions, state fiscal characteristics, business climate, population, urban/rural demographics, etc...

The Richard T. Meyer study alluded to earlier, surveyed 58 of the nations' 75 identified capital funds, which were fully dedicated to seed and start-up capital financing and some venture capital funds, which earmarked a certain percentage of their investments to seed and start-up financings. This list of firms was composed of 32 private funds, 14 public funds, and 12 public/private combination funds. The location of these funds is as follows:
 14 California
 8 Massachusetts
 6 Pennsylvania
 4 each: Illinois, Maryland, Missouri, Michigan
 3 each: Kansas, Georgia, Ohio
 2 each: Colorado, Connecticut, New York, Iowa, Indiana,
 Utah
 1 each: Arkansas, Louisiana, Minnesota, Montana, North
 Carolina, Nebraska, New Mexico, Oregon, South
 Carolina, Texas


Merging this list with the previous one showing the location of private/professional venture capital funds, the venture capital industry extends to 45 states and the District of Columbia. Therefore, based on the studies quoted here, five states have no formal, identifiable venture capital industry. This is not to say, however, that no individuals, businesses, or institutions in South Dakota, North Dakota, Idaho, Alaska, or Hawaii commit to and/or receive disbursements from venture capital funds. For example, a check drawn on a South Dakota bank payable to a venture capital fund in Massachusetts will be seen as a Massachusetts commitment. Also, a disbursement to a Minnesota company for the purpose of expanding, operations into North Dakota, will be recorded as a Minnesota disbursement. Unfortunately, such transactions are impossible to document without extensive surveying and research. In addition, these states may well have substantial as yet untapped supplies of venture or risk capital, and often the mere awareness of venture capital availability will stimulate new ideas, innovations, and business investment opportunities and economic development.

South Dakota Venture Capital Needs"

Available evidence suggests that South Dakota is one of only five states in the nation that has no formal venture capital outlet, to either commit or disburse financing-no professional venture capital firm, no private or public or combination seed and start-up fund, or bank Community Development Corporation. The absence of South Dakota in the disbursements list where 42 states and the District of Columbia are identified as receiving venture capital funds in 1990, is particularly telling. If South Dakota expressed a "need" for venture capital, the venture capital industry either felt no obligation to satisfy it or saw insufficient economic opportunity. Or, perhaps, South Dakota is yet to effectively express its need.

Identifying and measuring "need" is one of the most subjective forms of economic research, particularly when the context is public policy. While an individual has insatiable wants, a citizenry has insatiable needs. It is intuitively obvious that any economy which desires to create more businesses and jobs, foster higher incomes and levels of wealth, spur economic diversification and innovation, reduce poverty and state-dependency, increase population and educational achievement-in a word, grow-has a need for capital investment, including venture and risk capital investment. Viewed in this way, comparatively speaking, few states are in greater need than South Dakota. But venture capital, at least private venture capital, is not allocated on a needs basis, and this is clearly demonstrated by the above analyses.

Being one of the last states to assess its venture capital status has its advantages-the trail is well worn, bridges have been built and potholes filled. In the summer of 1988, the University of Nebraska conducted a comprehensive venture capital needs study for the Nebraska Bankers Association. One of the discoveries of this study was that 92 percent of the venture capital firms responding to the Nebraska survey were unaware that Nebraska even had a public venture capital fund. The study lamented:

"Without investors who are willing to invest in businesses at a higher level of risk than is customary for traditional sources of financing, the birth and nurture of new technologies and companies will continue at a very slow pace in Nebraska. Thus, the securing of venture capital is vital to both the expansion of business and the economic vitality of the state. Failure to obtain such capital for state businesses will mean a lessening of business activity and a forced reduction in economic "development goals."

Assuming that Nebraska is a reasonable proxy for South Dakota, the findings of this study are very instructive:

Ninety-one percent of the venture capital firms surveyed had a geographic preference other than the Midwest.

Awareness of the Nebraska business climate was generally very low, and opinions of its economic environment rated only fair to poor among those who were aware of its programs.

The availability of good venture proposals in the state and the level of entrepreneurial activity in the state were rated especially low.

Around 25 percent of the surveyed firms currently had agribusiness investments or proposals under consideration.

Venture firms viewed the willingness of states to participate in venture capital endeavors as a sign of commitment, which can have a positive effect on their propensity to invest.

Over 70 percent of the surveyed respondents said they had never seen a business proposal from Nebraska.

The flow of venture capital into Nebraskacan be improved by presenting the best proposals accompanied by the best management teams, but the venture industry must be made aware that these opportunities exist first.

Surveyed firms were asked to judge" Nebraska in a number of categories where " I meant excellent, 3" meant fair, and 5" meant terrible.
University resources and research capability 2.9
Availability of good venture proposals 4.2
Tax and investment incentives 3.1
Level of entrepreneurial activity 3.7
Transportation network 3.1


Most surveyed venture capital firms that were asked to select from a number of state economic incentives chose tax policy incentives as the most important. Other factors considered important were infrastructure improvements, people incubators for entrepreneurs, and state investment issues.

* Venture capital firms made a number of recommendations for increasing Nebraska's "deal appeal"; 20.3 percent of the firms recommended publication of successes and opportunities.

* The fourth most mentioned recommendation-by 12 percent of the respondents-was "You can do nothing-geography or other issues preclude our participation."

A combination of circumstances and events strongly suggests that South Dakota look in other places than the professional venture capital industry to acquire business financing to stimulate state economic growth. in addition to South Dakota's late arrival on the scene-vis-a-vis 45 states and the District of Columbia-already have commitment and/or disbursement experience and programs in place-the industry remains highly entrenched in the Northeast and West Coast, and both commitments and disbursements are presently in severe contraction. Basically, more and better programs are chasing fewer and fewer dollars.

An integral characteristic of the South Dakota psyche is the "boot-strap" mentality: The best problem-solvers are usually those impacted by the problem. While the professional venture capital industry must be made aware and be presented with the opportunity to invest in South Dakota business ventures, other alternatives to stimulate economic growth through venture capital investments should be explored.

A venture capital fund of, by, and for the people of South Dakota can take a variety of institutional or corporate forms. The source of the commitment to the fund is the key issue, i.e., whether or not the public is an investor. If the public is an investor through tax revenues, the needs analysis becomes a public fiscal policy issue. Every tax-supported government program has opportunity costs the cost of the lost opportunity of the taxpayer to privately purchase a good or service of his or her choosing. Also, when a government selects to allocate taxes to the support of one public service the opportunity to provide those tax resources in the support of alternative public services is foregone. Problems arise when it is preceived that the benefits of the tax-supported government program is less than the opportunity cost. In this event, society is a net loser. The opportunity cost of a tax-subsidized public venture capital fund would be either a lower level of South Dakota disposable income, or the sacrifice associated with the commensurate reduction in other public services. Ask the question "Should South Dakota have a taxpayer financed venture capital fund?", an economist must respond, "In lieu of what'?" It's best not to ask.

The last venture capital option on the menu is the bank Community Development Corporation. The bank CDC is a hybrid: typically a wholly-owned, financed, and managed and for-profit private enterprise, but one with a public purpose and spirit. They can be organized as subsidiaries of a single bank or bank holding company, or they can be funded by a number of banks and other financial institutions or corporate investors, or as partnerships and joint ventures with comnmunity-based or other private or public investors. Some might say the best of all worlds. A pilot program supported by the Economic Development Administration proved that bank CDCs could be effective private sector sources of funding different types of local economic development in both large and small communities. The program helped establish the first six bank CDCs by the end of 1989.

Is South Dakota in need of economic development and diversification? Absolutely. Do South Dakotan's possess the entrepreneurial spirit and innovative capacity to generate new ideas and new businesses? Absolutely. Would any of these businesses justify a venture capital investment by a bank CDC? Absolutely. These are rhetorical questions, especially in light of a 1988 survey conducted by the South Dakota Office of Economic Development of banks, manufacturers and processors, development corporations, chambers of commerce, small business development centers and accountants, most of whom responded that venture capital was needed in the state. Therefore, essentially only one question remains: Do the people and institutions of South Dakota have the critical mass of risk capital necessary to organize and implement a useful and profitable bank CDC? One can only speculate.

An indicator-and only an indicator-can be derived from the regulations establishing bank CDCs. The Federal Reserve Board regulates bank CDCs organized by bank holding companies. According to the Federal Reserve publication Community Development Investments, "Although the Federal Reserve sets no minimum or maximum levels for capital investment by bank holding companies in CDCs or community development projects, it does expect that use of holding company equity for such purposes will be 1) appropriate to the nature and scope of anticipated investment activities, and (2) prudent with respect to the size, financial condition and capitalization of the holding company." The Office of the Comptroller of the Currency (OCC) regulates those CDCs sponsored by national banks. The OCC regulations are pertinent here and are quoted below as excerpted from a Department of Commerce sponsored publication:

The OCC's involvement with Bank CDCs started with

Interpretive Ruling 7.7480 in 1963, which stated that a national bank may contribute to 'community funds ..... charitable, philanthropic, or benevolent instrumentalities conducive to public welfare." In 1971, the ruling was expanded to authorize investments in CDCs, and it now states: "Occasionally banks are asked to contribute to a community development corporation, wherein the bank will receive an equity interest in or evidence of debt which may have value in the future, but which is clearly not a bankable asset by ordinary standards.

Such 'investment' may be made and charged off as a contribution. If the bank wishes to carry the investment as an asset, the examiners will treat it as permissible under paragraph Eight of USC 24 provided that the following conditions are met: a) the project must be of predominantly civic, community or public nature and not merely private and entrepreneurial, b) the banks investment in any one project does not exceed 2 percent of its capital and surplus and its aggregate investment in all such projects does not exceed 5 percent of its capital and surplus, c) such investments are accounted for on the bank's books under 'other' assets." (emphasis added).

Relatedly, in 1986 the South Dakota legislature passed a law permitting State Chartered non-federal Reserve members to devote an aggregate maximum of 10 percent of their paid-up capital and surplus to community-purpose venture investments. A bank's capital and surplus is basically the bank owners' equity and the account where any "charge offs" from investment defaults are laid, not depositor's deposit base. If a venture investment fails the owners of the bank absorb the loss.

The venture "deal flow" of South Dakota, current or potential, is unknown. To the extent that private and corporate venture risk capital is available in South Dakota, in-state venture capital fundsCDCs or otherwise-and investment projects. would have to compete against a national market of highly experienced, diverse, entrenched and hungry professional venture capitalists. Even state institutions such as the South Dakota Investment Council, which manages the South Dakota Retirement System Fund among others, is obligated to search for best-yet-prudent investment outlets. What remains-other than state and local government appropriations-- philanthropic, altruistic individuals and community-based businesses.. banks which are "captured investors" by state and federal regulation. And even here, of course, there is no obligation to participate in a bank CDC.

The only identifiable and quantifiable source of venture funds for a South Dakota bank CDC is South Dakota bank capital and surplus accounts. (Note: The Office of the Comptroller of the Currency, the regulator of National banks, views capital and surplus in a more liberal sense than the State of South Dakota, including in this account some of the undivided profits and reserves.) The South Dakota Bankers Association reports that there are 127 banks, both state chartered and federally chartered, located in the state of South Dakota. According to Sheshunoff Information Services, Inc., South Dakota banks had combined C&S accounts totalling about $600 million at the beginning of 1991. Not all of these banks, however, would or could participate in a South Dakota Bank CDC. It is reasonable to exclude from this potential investor list, at least initially, the very large credit card and "North American" banks whose primary interests are not local", and the very small banks with limited resources ("small" is defined here as banks with less than $100 million in assets). This is not to say, however, that Norwest Bank, for example, couldn't be a major player and, in fact, make the difference between a "go" and "no go" situation for a South Dakota Bank CDC. It is just that estimating on the conservative side is the safest policy. After applying these subjective exclusionary rules, the potential CDC client list consists of 16 banks with a combined capital and surplus account of a little more than 100 million. Applying the OCC 5 percent investment cap and interpreting it as "appropriate and prudent" for Federal Reserve purposes, if all 16 of these banks "max'd out" at 5 percent, a South Dakota Bank CDC could be capitalized-solely through bank investors-at $5 million. (Note: Norwest Bank, by itself, could contribute $2.5 million if it so chose).

Conclusion

Whatever else it might be, the venture capital industry is a product of need and opportunity: the young, struggling business has a financial need and the venture capitalist sees opportunity in that need. Potentially, it is a win-win situation. Often times it is not. Ambiguity, uncertainty, and risk are inherent in a world where the only constant is change.

By definition, economic development is adapting to or causing change. Therefore, economic development requires risk financing, and professional venture capitalists do not need to be told that financing new businesses in South Dakota is fraught with risk. Bragging about our pioneer heritage and inherent innovativeness and entrepreneurship will not bring any takers. Ultimately, South Dakotans must bear the risks that come with being South Dakotans. Attempts to avoid risk by stopping, ignoring, or being content to be isolated from change is, in the end, the strategy of greatest risk.

If economic development is to be lasting and meaningful, financed ventures must be profitable. Given preciously limited resources, political or "social investing" would be counterproductive. In addition, the risks inherent in financing a new business venture should be diversified among many investors. These investors become stakeholders in the future of the venture capital fund, anxiously lending their personal commitment as well as investment expertise. A multi-bank Community Development Corporation offers the best promise as a venture capital vehicle to stimulate economic development in South Dakota. The big question is whether a critical mass of South Dakota bank interest and investment exists to make the the Bank CDC itself a viable new business venture.
COPYRIGHT 1991 The Business Research Bureau
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Author:Tosterud, Robert J.
Publication:South Dakota Business Review
Date:Dec 1, 1991
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