By Alyssa A. Lappen
The New York Times | October 5, 1980
VENTURE capital enterprises – concerns that invest in fledgling companies in hopes of returns of 38 percent a year or higher, and accept the risk of losing a good part of their investment on occasion – are turning increasingly to Connecticut as a base of operations. Motivation for the buildup of these investment concerns in the state ranges from efforts to escape the drudgery of commuting into Manhattan to avoiding the New York tax rates.
Connecticut has a capital gains tax of 7 percent and a dividend tax with a ceiling of 9 percent. Those rates compare unfavorably with New Hampshire’s or other states where there are no such taxes. But the capital gains bite in Connecticut is effectively much lower than in New York and Massachusetts.
The tax situation helps explain why Connecticut has a sizable and growing number of venture capital funds investing in startup and cash-starved companies nationwide. The state is the home of at least six venture capital funds and two large small-business investment companies (The latter can obtain three or four times their private capital, up to a ceiling of $35 million, from the Federal Small Business Administration at interest rates pegged to one-half of 1 percent over the Government’s borrowing rate.). Available capital here is now at a conservatively estimated $250 million, and several more venture capital pools are in the making.
The hope is that recipient companies, which issue common stock or convertible securities to investors, will grow into major corporations or be acquired, providing the venture capitalists and small-business investment companies with large profits. Investors generally look for a minimum for each investment of five times their money in five years, or about a 38 percent annual pretax return. But large profits can entail large risks.
The state’s venture capital pools and S.B.I.C.’s, together with bank representatives, wealthy individuals, deal brokers and public corporation executives, form the loosely organized, 70-member Connecticut Venture Group, which was founded in the early 1970’s by a former Forbes magazine columnist, Thomas Murphy. Mr. Murphy, whose Partnership Dankist has holdings in seven companies, said the state’s venture community had grown from virtually nothing 10 years ago.
”Wall Street had serious problems after the bull market collapsed in 1968,” said Mr. Murphy. ”Things slowed up downtown, and there were massive layoffs. Many who weren’t laid off, quit.”
”The refugees from the Street started moving up here,” he said, ”and then it became a self-perpetuating kind of thing. People knew you could work in venture capital up here.”
When Edward Glassmeyer and Stewart Greenfield decided to leave the Sprout Group, the venture capital arm of Donaldson, Lufkin & Jenrette, in the spring of 1974 to form their own venture capital pool, they moved to Fairfield County, where both already lived. They were able to base Oak Management in Connecticut because of their years of experience in the venture capital community, their network of contacts and the telephone.
Last July, Robert Williams and George Thomassy 3d opened shop in Stamford at Regional Financial Enterprises, which with $45.6 million in available capital is the fourth-largest nonbank small business investment company (S.B.I.C.) in the country.
Mr. Williams, the company’s chairman, holds a master’s degree in business administration from the University of Bridgeport but had been away from the state for several years. ”I wanted to come back to the Northeast,” he said. ”We had Boston and New York to pick from, but Connecticut was a perfect place. It’s pleasant to live here, and it’s close to airports and the venture capital hubs of New York, Massachusetts and New Hampshire.”
When Robert Gustavson left the Clabir Corporation in Old Greenwich last summer to set up the Incentive Group, the venture capital subsidiary of Sweden’s Incentive A.B., he wanted to stay in Connecticut. ”I live here,” he said. ”I also think things are becoming more interesting out here.”
Others have reportedly moved their venture capital businesses here from New York to avoid personal income taxes. And some, like Pedro Castillo, president of General Electric’s Business Development Services, are in Connecticut partly because it is home to their parent companies.
The state’s amenities aside, the growth in venture capital funds here is due largely to a growth in the business nationwide, prompted by an improvement in the economy since the mid-1970’s and by the 1978 reduction of the Federal maximum capital gains tax from 49.5 percent to 28 percent.
Mr. Glassmeyer and Mr. Greenfield, for example, were unable to raise Oak’s $25 million pool until 1978 – four years after they had moved. They had backed Advanced Micro Devices, now a $325 million semiconductor company, while with Sprout Group in 1969 and 1971. But in 1974, A.M.D. was still small, they didn’t have a track record and capital was tight. Only after they had consulted for Xerox and 3M and worked on seven mergers did the two find 12 limited partners, including the Connecticut General Life Insurance Company, to get started.
Since then, Oak Investment Partners has invested an average $650,000 in each of 13 companies. The firm limits itself mostly to high technology investments, many based in California. ”The office of the future has and, we believe, will continue to experience tremendous growth,” said Mr. Glassmeyer, Oak’s president. ”It’s also an area that we know a lot about. And you should never, in venture capital, invest in something you don’t know about.”
The S.B.I.C.’s such as Regional Financial Enterprises are at the low-risk end of the spectrum because they must repay their cheap Government loans. With $10.6 million in capital from its 12 partners, Regional can eventually borrow $35 million. But, said Mr. Thomassy, ”Once we start to leverage ourselves, we owe Uncle Sam those dollars. We have to be bloody sure we don’t lose any of them.”
According to Mr. Thomassy, the fledgling S.B.I.C. will risk only 10 percent of its capital – about $4 milion -in early-stage companies. Mature venture firms with $3 million to $20 million in sales will get 60 percent, and 30 percent will go to leveraged buyouts, in which companies borrow heavily against existing assets to raise capitol to buy other firms.
Business Development Services, with $80 million in assets, is at the high-risk end of the spectrum, and can afford to be. Its parent, General Electric, provides the capital. It has no loans to repay. It has no partners. ”I’m perfectly willing to lose all my money,” said Mr. Castillo, its president. ”But I have to see big profit potential.”
The fund was started in 1968. Mr. Castillo took over a portfolio of $5.3 million when he took the helm in April 1976 and has invested $7.5 million more since then. The firm’s big winner has been Aplicon, a computer company that went public last July; a $5 million total investment is now worth about $50 million. The $1 million Mr. Castillo put into Tandem Computers three years ago is worth $12.5 million now.
”Every now and then, I must confess, we have thrown good money after bad,” said Mr. Castillo, noting another pitfall of his trade. ”It’s a struggle. You look at a company and say, well, just another $1 million. What you should ask is, ‘If I didn’t have money here, would I put money in?’ ” Of 23 Business Development Services investments, he added, only six are ”shaky.”
In spite of Connecticut’s growing pool of venture capital, little, to date, has found its way to Connecticut-based companies. That may be partly because the state offers relatively few opportunities. As Mr. Gustavson, president and chief executive of Incentive, said, ”The guy with an idea for a new company is spawned in a technology-oriented atmosphere.”
He said that Connecticut lacked the dozens of universities that the Boston area has – Massachusetts Institute of Technology, Harvard, Tufts, Brandeis, to name a few. People are also most likely to start a business in New Hampshire to avoid taxes, he said. Mr. Greenfield of Oak pointed to ”a New England mentality” at work here: ”The habit is to build a small business, not to plan to a national market.”
All this may be true. But Stanley Pratt, editor and publisher of Venture Capital Journal, is optimistic about Connecticut’s future. Of $4 billion in venture capital funds available nationwide, he said, $1 billion is with funds within 200 miles of Connecticut. Furthermore, entrepreneurs don’t come out of the woodwork. He said they evolved in companies like Xerox, General Electric and United Technologies – all based in Connecticut. ”Entrepreneurs operate on perception,” said Mr. Pratt, discussing how businesses come to be established. ”If they see money nearby, they’ll start up.”
Alyssa A. Lappen is on the staff of Forbes magazine.
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