Imagine that you’ve just been approved for a huge loan. You take the cash from a bank, step into the lobby of a casino and hand out $100 bills to a handpicked team of gamblers—good gamblers: tight-playing poker players and Blackjack experts. As your rounders hit the tables, the deal is simple: If they win more than they lose, everyone can keep playing. But if the winnings don’t cover the bank loan, you’ll make up the difference by breaking open your kid’s college-fund piggy bank.
That’s what critics say is the idea behind the Utah Fund of Funds, a big-bucks investment program that you might not even know about, despite the fact that it’s using your taxes as a safety net.
The Fund of Funds is a public-private venture-capital partnership backed by $300 million in “contingent” taxpayer dollars that, if necessary, will kick in to pay off major loans from big banks. If everything goes well, that loan money stays in the private sector, paying for itself and fueling the roaring Utah economic engine. But if things go bad, the investments that crap out will be paid off by Utah residents’ tax dollars—more specifically, funds from the Legislature that would otherwise go to public and higher education in Utah.
Critics call it high-risk, high-rolling, low-accountability, government-backed capitalism—state-sponsored gambling.
When the program was launched by the 2003 Legislature as the Utah Capital Venture Enhancement Act, supporters predicted that it would see 5 percent to 6 percent returns annually and suggested that taxpayer dollars might never be needed to cover shortfalls in the program.
Now, managers of the Utah Fund of Funds say that taxpayer dollars likely will have to kick in to pay off bad investments. But, they say, it won’t be for a few years, and Utah has already realized far greater perks in the economic benefits that come from pumping capital investments into private firms. Since the Utah Fund of Funds was implemented in 2006, the program has funded 67 Utah companies, and managers tout the creation of 3,500 direct and indirect jobs and the collection of an estimated $35 million in tax revenue.
But the performance of the fund itself is shrouded in secrecy. While a government board oversees the fund, its meetings aren’t advertised on the FOF’s website. FOF administrators also collect salaries, but the specific information isn’t spelled out in reports to the Legislature. Since 2011, the fund has been in a lawsuit with the State Auditor’s Office over the release of information about the fund. The lack of transparency means the public is in the dark about the fund’s operations or possible conflicts of interest among those who run the fund.
Although many Utahns might be blissfully unaware of the fund’s existence, they could learn about it the hard way in the coming years. According to the FOF’s most recently available report, for 2011, the Legislature will have to start drawing out millions of dollars every year by 2017 in order to pay off $19 million in bad investments by 2021.
According to many critics, like Derek Monson, public-policy director of conservative think tank The Sutherland Institute, public money should not subsidize risky private-sector investments.
“Is the purpose of taxpayer dollars to eliminate the risk of high-risk investments?” Monson asks. “I thought it was for public education and roads, but I guess not.”
Supporters point out that Utah is a state that supports business and the free market and that, like tax benefits offered to companies that relocate to Utah, there’s a place for the government to “prime the pump” for venture capital to rain money on local startups that can bring jobs and tax revenues back to the state.
By its nature, a public-private partnership both invites and rejects scrutiny. On one hand, public money needs to be accounted for, but on the other, activities of private businesses are often hidden from view, with confidentiality required to successfully conduct business.
But Monson says secrecy about the performance of the investments doesn’t make sense when it’s taxpayer money on the line.
“If you want [secrecy], then don’t be asking for tax dollars to pay for your screw-ups,” Monson says.
Dolla Dolla Bill Y’All
In 2003, some forward-thinking entrepreneurs realized the potential for Utah to have its own Silicon Valley—or Silicon Slopes, as the Utah equivalent may be. With the help of some movers and shakers in the technology and biotech industries, a lobby group called the Utah Information Technology Association got the Legislature to push $100 million, secured through a bank loan, toward a professionally managed Fund of Funds program that would invest in experienced venture-capital funds that would then invest in Utah companies, bringing jobs and revenue to the state.
Venture capitalists invest in risky early-stage companies—basically, investing in the potential that the entrepreneurs of that company have what it takes to make the investment pay off, be they developing life-saving medical devices or software and tech innovations.
In a February 2003 Deseret News editorial by David Politis, a spokesman for the lobby group pushing the bill, he pitched the program as one that would be self-sustaining and might not even require taxpayer dollars to bail out poor returns.
He wrote that national venture-capital associations reported returns as high as 16 percent annually, but that a Utah FOF program could count on at least 5 percent to 6 percent annual returns on investments, which would keep the program humming without ever involving the taxpayer.
The bill passed, and by 2006, the FOF had invested the full $100 million approved by the 2003 Legislature. That funding was loaned by Deutsche Bank, now a syndicate of Zions Bank. J.P. Morgan has taken over those debts.
Financially speaking, 2006 was an optimistic time to be in the investing business. The housing bubble wasn’t quite at its dizzying zenith, and investors were too busy enjoying the roller-coaster ride of seemingly nonstop money to realize that the whole economy was about to come off its wheels.
The fund saw “great successes,” the FOF’s former director, Jeremy Neilson, is quoted as saying in a 2007 Deseret News article, and in 2008, the Legislature approved another $200 million to be loaned to the FOF, also to be backed by future taxpayer dollars otherwise designated for education spending.
But when the market crashed, it threw everyone to the ground, from schoolteachers watching their pensions disappear to state governments having to slash spending programs to venture capitalists seeing their returns shrink.
By 2017, all the money the fund has committed will have to be paid back, and any shortfalls from FOF investments will have to be covered by taxpayer dollars.
As of 2013, the FOF has invested $121 million of the $300 million for which it’s authorized. And lawmakers are starting to question the political investment they made back when the economy had everyone convinced the paydays would never end.
Secret Adventures With Your Money
John Dougall was elected as state auditor in 2012 and entered the office in 2013. He hasn’t changed much in the office except to hire more auditors and to give up the old auditor’s window office—he now uses a windowless boardroom for his number-crunching.
Dougall did inherit something from his predecessor—a 2011 lawsuit filed by the FOF against the office under the administration of former state auditor Auston Johnson.
At the time, Johnson’s auditors had been posting financial information for the fund on the auditor’s website, including a one-page schedule of investments. Tim Bridgewater, CEO of the Fund of Funds, says that information had been considered confidential as part of the FOF’s agreement with the venture-capital firms, whose private businesses could suffer if information about investment performance is made public.
Dougall says that the statute exempts that information from being disclosed. But, he says, the lawsuit also blocked any audit information from being published, including information on the overall performance of the FOF.
“According to statute, they don’t have to distinguish, on a fund-by-fund basis, performance information,” Dougall says. “My question has been, ‘What problem do you have with the rest of the information?’ ”
When Bridgewater was asked about this point, he said that the FOF had agreed that information such as management expenses and the auditor’s notes and recommendations could be published. Still, the fund does not disclose that information on its website. Bridgewater considers the action a “friendly” lawsuit and says an agreement has been reached though a settlement has not yet been finalized.
For critics like Monson at the Sutherland Institute, the FOF’s strange makeup leads to an inevitable lack of transparency. With taxpayer money on the line, it would make sense for taxpayers to know if the funds aren’t performing. But since they can’t know that unless things have gotten to the point that taxpayer credits have to be cashed in, it leaves the FOF’s investing arm, the Utah Capital Investment Corporation, acting without accountability.
“It’s not like they’re reporting back to shareholders; they are reporting back to the original investor [Zion’s Bank and JP Morgan], and they are reporting back to them with tax credits if it doesn’t work out,” Monson says. “It’s a no-lose situation for them.”
Bridgewater and FOF Vice President Matthew Peterson argue, however, that the Utah Capital Investment Board does serve as the state’s monitor, since it’s backed with officials like the state treasurer and Spencer Eccles, executive director of the Governor’s Office of Economic Development.
Eccles says the board is serious about ensuring that the FOF’s investments can provide a fiscal return and a benefit to Utah entrepreneurs.
“The Utah Capital Investment Board members have worked diligently to ensure investments are made in a prudent manner,” Eccles says, “and also in a manner so that they could drive not just investment capital into the state, but also human capital, capable of mentoring companies and networking people and entities.”
The UCIB board does receive information from the UCIC, but their meetings aren’t easy to find. The FOF website lists no calendar of when or where they are held, and lists no information about past meeting minutes or agendas.
If one could find a meeting, they might be able to pick up some information about individual companies that have received FOF funding. Otherwise, companies that received funding aren’t publicly disclosed.
By searching financial newswires, City Weekly learned that in two rounds of funding—one in 2009 and another in 2011—FOF members Mercato Partners and the University Venture Fund invested in Control 4 Corporation, a Utah-based company that sells home-automation systems.
The company’s CEO is Will West, chairman of the Utah Capital Investment Corporation, which doles out funding to FOF-approved venture-capital firms—including the ones that also invested millions in his company.
Peterson says there wasn’t an issue because West brought the possible conflict before the UCIB board and asked if the investments should be nixed because of his role. Peterson says the board said the investments were fine. University Venture Fund invested half a million and Mercato Partners invested $6 million in Control 4 Corporation.
Other companies with close ties to the FOF also invested in West’s personal company. FOF portfolio firm vSpring Capital II did not invest in West’s company, but vSpring Capital did. FOF firm Frazier Healthcare didn’t invest in West’s company, but its subsidiary Frazier Technology did.
When City Weekly asked West for comment, an attorney for Control 4 responded that the company is in the process of going public and therefore West is prohibited by federal law from commenting on past investments.
Such conflicts aren’t illegal or even uncommon in the private sector, but there, investors would be tapped in and would be able to vet such a conflict right as it happens. With the FOF, the public isn’t the investor—unless, that is, the funds can’t cover the loan, at which point taxpayer money acts as insurance against poor performance.
What’s Your Impact?
Dougall has kept the State Auditor’s Office primary mission as conducting financial audits, but wants to expand to auditing the performance of programs to see if they talk the talk and walk the walk as far as actually doing what they’re supposed to—including dealing with conflicts of interest and achieving legislated goals.
Dougall has considered the possibility that the FOF may indeed be ripe for a performance audit to see exactly how its taxpayer-backed investments have helped Utah’s economic landscape.
“A performance audit really looks into other factors,” Dougall says. “Like, how much are they really investing in Utah? How much are they driving the economy? How much is it complying with various aspects of the law?”
A former lawmaker and one of only two legislators to vote against approving the FOF for an additional $200 million loan in 2008, Dougall has long been skeptical of the Fund of Funds. He questions how effective the FOF can be, especially when the people who get to invest the money don’t suffer the consequences if their investments crap out.
“Whether it’s banking or the housing sector or whatever else, when someone else protects your risk, you get riskier,” Dougall says.
That’s a point Utah Capital Investment Board member Eccles says isn’t valid. He says that bad fund performances affect the reputation of venture-capital firms, and the diversity of the funds keeps too many taxpayer eggs from being in just one company, or basket, so to speak.
“The investment risk is mitigated when it’s diversified; that’s the whole point of people pooling money together,” Eccles says. “Sometimes, some companies don’t pan out. They may not get Google-type returns, but with [profitable investments], they all balance each other out.”
But the success of the FOF isn’t measured just by a return on its investments, but by what impact it’s brought to the state through wise investments.
Bridgewater says that if the FOF does indeed need taxpayer credits in the next five years, those costs will have been outweighed by the gains already realized in the Utah economy. Since its formation, the FOF has helped inject capital into 67 Utah companies, although seven of them are no longer active.
Bridgewater says that by surveying those companies, the FOF has determined that the companies have created 3,500 direct and indirect jobs. Seventy percent of the FOF’s local firms focus on early-stage development companies that otherwise struggle to get up and running.
But it’s unclear whether the FOF was instrumental in helping the now-successful companies grow and add jobs to the economy. While the FOF has committed $121 million to 28 venture-capital firms, which have spread that money to 67 Utah companies, in a recent Legislative committee hearing, the FOF’s Peterson explained that the FOF is “a very small percentage of the funds invested in most cases, and we’re less than 10 percent in all cases.”
Bridgewater says that by the FOF’s own analysis, about one-third of the 67 companies were definitely impacted by FOF funding; another third were somewhat impacted. Those estimates, however, aren’t based on an independent study, but on the FOF’s own estimations.
“It’s hard to track specifics,” Bridgewater says.
In 2012, the FOF had the University of Utah conduct an analysis of the FOF’s overall performance, which said the fund is performing “above the median” on returns, compared to other portfolios. As for economic impact, FOF touts itself as one of the best state-backed venture-capital programs. At the June Legislative committee hearing, Peterson showed lawmakers that the Utah FOF ranked in the Top 3 of 30 similar programs across the country.
And even that ranking is based on educated guesses. Bridgewater says that they determined that ranking by calling and asking other states about their funds and making their determination based on what information they could glean from other states. It was not possible to get complete data for a number of the other states’ programs.
“We know we are two to three times more effective than they are,” Bridgewater says. “We have not drawn any money, while other states have drawn anywhere from $5 million to $35 million at the high end.”
But Bridgewater says it’s not likely that Utah’s outperformance is thanks solely to the FOF, but is rather a result of the state’s already-strong economy. He points out that states like Oklahoma have had venture-capital programs operating for 20 years, but have supported only half the businesses Utah has.
For Oklahoma, “that may be a grand-slam home run, where we may only be hitting a triple just because our economy is so strong,” Bridgewater says. “So you can’t necessarily compare them on equal footing.”
But it’s hard to find firm footing with many of the statistics surrounding the FOF. On May 14, 2013, KUTV 2 ran a story on the lawsuit between the FOF and the State Auditor’s Office in which Bridgewater was quoted as saying that the fund was $7 million or $8 million in the hole. According to the report for 2011 given to the Legislature, however, the fund will have to begin drawing down on a $19 million debt in 2017, to be paid out over the course of four or five years.
In a July interview with City Weekly, Bridgewater said the number is more likely $15 million.
“It’s hard to put a sure number in the ground,” Bridgewater says. “If the public market opens up, that number could go down significantly.”
Winners & Losers
Another measure of economic impact is the companies themselves. But since those companies aren’t disclosed, it’s hard for policymakers to gauge the success stories.
In defending the FOF to the Legislature, fund VP Peterson did identify several success stories. The fund is proud of helping out companies like MediConnect, a health-care data company that in 2012 was acquired by publicly traded company Verisk Analytics for a net purchase of $348 million. Sera Prognostics has also been invested in by the FOF and has been hailed in various publications for its promising development of a test designed to predict complications during pregnancy and tell if babies will be born prematurely.
The FOF has also helped two local companies become publicly traded corporations. In the legislative committee, Peterson touted local Salt Lake City tech company Fusion IO and Park City-based headphone manufacturer Skullcandy as examples of companies that enjoyed major growth because of the FOF.
Going public is a measure of accomplishment for the FOF, and that’s generally when the FOF will sell off its shares in the company. Both investments, Peterson says, were hugely successful. But the current status of the companies calls into question their lasting impact on the local economy.
Skullcandy went public in the summer of 2011, and the FOF sold its shares of Skullcandy shortly after. Shares hit a high in the fall of 2012, trading at $16.66. But the company has since stumbled in its mission of expanding its product line, resulting in a California office being shut down. As of July 30, shares were trading at $5.62.
Fusion IO went public in June 2011 and originally claimed a $1 billion valuation. Shares traded well for the first five months, hitting a high of $39.60.
The company slipped in May 2013 when the CEO and COO made an unexplained departure from the company. According to Bloomberg, the departure was so that they could begin “pursuing new investing activities.” As of July 30, shares were trading at $14.91.
The FOF’s Peterson says the fund got a healthy return on the investments and the state also enjoyed an economic ripple effect. By being an early investor in Skullcandy, FOF firm Mercato Partners had .9 percent of the company’s shares by the time it went public in 2011.
“We helped take [Skullcandy] from 10 employees to over 200,” Peterson says. “You can’t really ignore that economic impact.”
The Game of Risk
The FOF isn’t just about distributing money. Bridgewater and Peterson host conferences for venture capitalists and entrepreneurs and bring big out-of-state venture-capital firms to Utah to tour factories and facilities and “kick the tires” on Utah investments.
While Bridgewater says he and his team are working on new “quantifiable metrics” to show the governor and the Legislature, he stresses that the FOF’s goal has always been as a matchmaker: marrying venture capital to entrepreneurial ambition, and even, in some cases, referring entrepreneurs to funds outside the FOF’s portfolio. They hope to implement a new round of investments by the end of this year.
“The role we play is to help the entrepreneur know where to go to get capital,” Bridgewater says.
For Rep. Jim Bird, R-West Jordan, however, the concern isn’t where the entrepreneur gets capital but where the FOF gets its capital. Bird, who has a background in securities, is highly skeptical of the FOF and recently called for a legislative audit of the fund.
During the June 2013 Business & Labor Committee hearing, the panel noted that the FOF’s 2011 report listed a “management fee” of $445,718. That sum would include salaries for administrators like Peterson and Bridgewater and other expenses, but did not break them out line by line.
“How much are those people being paid that are working for the FOF? Where’s that money coming from?” Bird asks. “They won’t even tell us that.”
While the report for 2011 that the fund presented to the Legislature didn’t identify salaries, the Utah Capital Investment Corporations tax documents filed as a nonprofit did show director Bridgewater being paid $92,750 and VP Peterson receiving $93,797. 2010 tax documents show previous director Jeremy Neilson receiving $193,000, while Peterson received $83,606.
At the June committee meeting, representatives had plenty of questions for the FOF spokesman and vice president, but the burning question for Rep. Jake Anderegg, R-Lehi, was, “Why in the heck are we doing this?
“I don’t think the taxpayers should be greasing the skids to induce investors for this or any group,” Anderegg said. “I think private venture capital or the private market can be doing this a lot better than we can. As soon as we get the shot, I think we should go ahead and defund this.”
Monson at the Sutherland Institute says the FOF’s lack of transparency fits a classic M.O. for these kinds of risky endeavors.
“If people know what’s going on, then people will know when things are headed south, and that’s when these things blow up for people,” Monson says. “It’s easier to do damage control when suddenly we’re issuing $200 million in tax credits and everyone’s wondering, ‘What’s going on?’ We didn’t get to question them all along, so, then you have your fall guy, you get rid of him and say, ‘Oh, everything’s different now.’ ”
Bird has big concerns about the FOF and plans to draft legislation about it in the 2014 session.
“We have issues trying to fund education as it is; now, we have something in place that if it goes badly, they’ll look to the education fund to fill the gap?” Bird asks. “Then education takes another hit—and that’s a problem for me.”