CAPCOs Statutes/Rules
Commentary


August 5, 2002

Following the passage of HB 267, the Louisiana Department of Economic Development (LED) and the Office of Financial Institutions (OFI) have begun the process of developing regulations to clarify various aspects of the legislation.  This process includes determining "qualified investments" under the statute, including, as provided by the statute, defining "by rule" whether an investment "in substance and in form furthers economic development in Louisiana."  According to the statute, this standard must be met in order to meet the definition of a qualified investment and for application of Section 1923(5)(a) through (5)(d), including approval by the Secretary of a "qualified technology fund."

Since this is a very significant issue with respect to representations being made to potential investors, LED and OFI are putting everyone on notice that regulations consistent with the statutory scheme will be issued shortly implementing this position.  CAPCOs will be kept informed as the process develops.


September 12, 2002

In January 2001, Louisiana Legislative Auditor Dan Kyle issued a Performance Audit to present his findings as a result of a Review of the Louisiana CAPCO Program.  The Auditor classified certain types of transactions as "job neutral acquisitions."  These were situations where CAPCOs provide funding to businesses to acquire other businesses, but the acquired business would have continued to operate if they had not been acquired.  Thus, the CAPCO funding did not have an effect on jobs in the acquired companies.  These types of investments are essentially leveraged buy-outs of companies either by senior management or by unaffiliated parties.  As a result of this determination, the Auditor issued Audit Recommendation 4, which states, "To help examine acquisitions more closely, the OFI and the DED should establish other methods to use in addition to current criteria for determining whether acquisitions will further economic development in Louisiana.  These additional methods could include acquiring definitive evidence that the acquired businesses would move out of state or reduce employment if CAPCO financing does not assist in the acquisitions."

During the course of the current and proceeding examination cycles, we have seen increased examples of the types of "job neutral acquisitions" described in the Legislative Auditor's Report.  Since CAPCOs have attempted to count these types of investments as qualified investments, we are increasingly concerned because of the need for CAPCOs to make qualified investments pursuant to the continuing certification requirements of LSA-R.S. 51:1926.

Several CAPCOs have suggested that these types of transactions should be counted as qualified investments.  Almost universally, the businesses are sound companies with long histories of profitable operations where the long-time owner elects to retire and sell the business.  In our opinion, the financing of this transaction will not result in the investment being designated as a qualified investment.  Even though the CAPCO is generally only financing the acquisition of the assets and the new owner is purchasing the goodwill, we will no longer consider this type of transaction to qualify as an investment that furthers economic development within Louisiana.

In an attempt to review whether these potentially "job neutral acquisitions" have a place in the CAPCO program; we looked to both the rule and the applicable statutes for guidance.

The logic we are applying to this scenario is that the definition of a certified Louisiana capital company is one that "has as its primary business activity the investment of cash in such a manner as to acquire equity in or provide financing assistance as a licensed business and industrial development corporation to qualified Louisiana businesses that are in need of capital for survival, expansion, new product development, or similar business purposes..."  In the cases we have observed, the CAPCO has attempted to qualify the leverage buy-out using the argument that if these companies are not sold, they would simply close and liquidate collateral.  In our opinion, a company in need of capital for survival is one that is in danger of failure, not one that is a financially strong company that may close if the existing owner is not able to affect a sale of the business.  It is generally difficult to accept that an existing business that has generated goodwill where an owner is ready to sell or retire would be simply closed and the assets sold or liquidated.

We then looked to the definition of a qualified investment, which is one that "in substance and in form furthers economic development within Louisiana."  In the CAPCO Rule, the definition of an investment which furthers economic development within Louisiana contains the following eligible areas: to directly purchase or lease furniture, fixtures, land, or equipment that will be used in the Louisiana operations of the business; to preserve or expand Louisiana corporate headquarters, etc.

With respect to the definition of furthering economic development within Louisiana, we have determined that "to directly purchase," means the initial purchase of these assets and not subsequent sales of these assets by the owner of a company.  We have also determined that to "preserve" Louisiana corporate headquarters means investing in a company that is failing or is contemplating a move out of state, not one where the only substantive change in the business is a change in ownership.

Another area that is of growing concern is debt refinancing.  Increasingly, CAPCOs are asking that we consider as qualified investments structures that use a large portion of the proceeds to pay off another lender.  While the payoff of another institution may be part of an overall investment structure, and while it may lead to increased cash flow for the borrower, in those cases where the majority of the proceeds are used for debt refinancing, the investment will generally not be counted as a qualified investment.

In our opinion, it is generally difficult to count these types of investments as a qualified investment because of the job neutral nature of the refinancing.  The decision as to whether or not a debt refinance will count will be driven on the condition of the business at the time of the investment.  For those companies that are basically sound but the current lender is unwilling to lend additional funds, the refinanced portion of an investment will not be a qualified investment.  However, if the company is in danger of failing without the investment by the CAPCO, the refinance will be allowed to count towards a qualified investment.  Additionally, we are considering an amendment to the existing rule to provide a limitation as to the amount of funds that can be used to refinance debt.


October 17, 2002

In correspondence dated September 12, 2002, this office provided guidance regarding qualified investments.  One of the areas we discussed was that of debt refinancing.  We have had several requests that we provide additional clarification on this matter.  This correspondence will address those questions.

As part of an investment in a qualified Louisiana business, a CAPCO must determine if two or more of the uses as set forth in LAC 10:XV.303 Investments (b)(I) - (viii) are attained in order for that investment to be considered a qualified investment.  In those cases where proceeds are being used for debt refinancing, the CAPCO must ensure that at least 50% or more of the proceeds meet the requirements of LAC 10:XV.303 Investments (b)(I) - (viii), excluding any amounts used for debt refinancing.

This should more accurately describe this office’s position with respect to investments which may include a portion of the proceeds used for debt refinancing.