INVESTMENT EVALUATION AND FUNDING PROCESS FOR A POTENTIAL INVESTMENT MADE THROUGH THE DISTRICT OF COLUMBIA CERTIFIED CAPITAL COMPANY (CAPCO) PROGRAM
Overview: The District of Columbia’s CAPCO program is an effective economic development tool that channels desperately needed capital into small businesses located within DC. Business owners seeking financing through the DC CAPCO program should be aware that CAPCOs are not part of a grant program. Instead, CAPCOs are venture capital funds that invest private investment dollars into select qualified businesses in DC. These venture capital funds are managed by professional investors with strict investment requirements. The CAPCO funds will only consider qualified businesses as defined by the DC CAPCO statute, but qualification is just the first step in the analysis. The businesses are then rigorously analyzed by the CAPCO funds, with only the best businesses ultimately receiving funding. Businesses are analyzed based on growth prospects, market dynamics, management strength, potential to generate strong investment returns, and potential to generate economic development in DC.
Timing: From initial contact by a business owner to funding, the entire process typically takes between 90 and 120 days. This is faster than the average venture capital fund, which typically takes between four to six months or longer to complete a transaction. The CAPCO funds try to expedite this process in order to aggressively invest capital into DC small businesses, but they still need time to properly analyze potential investments, complete due diligence, and execute sometimes complicated financial transactions.
Selectivity: Typical venture capital funds can evaluate as many as one thousand businesses for each business that they ultimately fund. The DC CAPCO venture funds complete a much higher percentage of transactions that they analyze, but they still turn down many more companies than they ultimately fund. This is the nature of venture investing, as the venture funds are seeking to most efficiently allocate capital to the best businesses that have the highest potential for growth, returns, and job creation.
Transaction Types: CAPCO funds, by statute, do not invest in companies that can obtain conventional bank financing, but only in companies that have a higher risk profile and need to access capital from non‐conventional sources, such as venture capital funds. Accordingly, the transactions typically involve qualified businesses either selling shares to the venture fund, selling warrants to acquire shares sometime in the future, issuing debt, or some combination thereof. In the case of debt, rates are generally higher than bank rates to reflect higher risk but lower than what a business would find from other potential debt sources. Transactions are structured to generate investment returns but also to provide qualified businesses flexibility in their ability to repay obligations and to align incentives among the investors, business owners, and the District so that all parties benefit if a business venture is successful.
Post Financing Involvement: Providing the financing is just the first step in the relationship between qualified businesses and the CAPCO venture funds. Post financing, the investment professionals from the CAPCOs will take an active involvement with the businesses by offering strategic advice on operational improvements, financial advice, management building, strategic partnerships, access to a broad network of business relationships, and – most importantly – new sources of investments. This involvement is particularly helpful in raising additional capital from non‐CAPCO sources and in making contingency plans to survive difficult economic times. In the event that CAPCO funds decline the opportunity to invest in companies, they will try diligently to offer ideas of other sources of capital, such as angel networks, if appropriate.
Financing Process:
After completing a CAPCO Qualification Questionnaire and submitting it to the CAPCOs for their consideration, one or more CAPCOs may invite your business to enter a due diligence process in which more information is requested so that your business may be fully evaluated for a potential investment. Businesses entering the due diligence process should anticipate the following:
- Step One‐‐Initial Screening and Information Submission
(One to Two Weeks) - Business Plan or Executive Summary (Between 5 to 20 pages examining the business opportunity, market, competitors, and growth strategy)
- Detailed bios or resumes of key management
- Three years of historical financial results, and pro forma four year financial projections (income statement, balance sheet, cash flow statements)
- (25% of employees must reside in DC, 75% of employees must work in DC; business must be headquartered in DC, business must be in one of the following industries: healthcare services, information technology, environmental services/technology, internet information providers, communication services, biotechnology/research services, multimedia/graphics software, business management services, financial services – excluding those primarily engaged in insurance – , and restaurants)
- Fund professional will be in contact with business owner with initial feedback within two weeks of submission of information
- Step Two‐‐Business Due Diligence and CAPCO DISB Approval
(Four to Six Weeks)
- In-person meeting with CAPCO fund representatives to discuss the business in more detail and to develop working relationship
- Site visit completed to view business in operation and meet additional employees
- Development of description of what the CAPCO investment would be used for (new hires, sales and marketing expense, capital improvements, or purchases)
- Description of how the CAPCO investment would contribute to the DC’s economic development (job creation, neighborhood improvement, etc.)
- Customer references provided for CAPCO professional to speak with
- Negotiation of potential transaction structure and terms
- Business and CAPCO must submit application to the DISB for approval, which must include:
- A notarized affidavit signed under oath by the Chief Executive Officer or President of the business that attests that the business meets all of the requirements to be a “qualified business” as set forth in Section 2(12)(A) of the Act, is a business in good standing in the District, and is current on all applicable District tax obligations;
- A list of the names, work and home addresses of each employee of the business. The list should also indicate whether each employee is employed on a full or part‐time basis. If an employee works less than forty (40) per week, indicate the number of hours such employee works per week. For purposes of this requirement, an “employee” means a person for whom an IRS Form W‐2 has or will be issued. A person who works on a contractual basis who has or will receive 1099 income is not considered an employee.
- A current payroll tax report or copies of earnings statements showing the wages paid to all employees of the business, which specifies the jurisdiction receiving the withholding tax payments;
- A copy of the driver’s license or government issued non‐driver’s identification card for each employee that resides in the District;
- A copy of two of the following documents: current lease, recent mortgage statement, telephone, utility bill or similar document for each employee who claims to be a resident of the District;
- A copy of the IRS W‐4 form for each employee who claims to be a resident of the District; and
- A copy of the financial institution’s declination letter. The declination letter shall be dated not more than six (6) months prior to the date of the request for an opinion letter.
- Step Three‐‐Legal and Accounting Due Diligence
(Four Weeks)
- Law firms are engaged to complete equity or debt agreements
- Business tax returns for the last three years
- Financial statements for the last years
- Copies of existing contracts
- Partnership agreement or articles of incorporation
- Lease for any rental property
- Description of any past, current or pending legal or tax issues
- Management background checks completed
- CAPCO funds investment committees approve transaction
- Step Four‐‐Funding (Three Days)
- Executed legal documents are exchanged, and funds are wired to the qualified business
The total process is anticipated to take between 90 and 120 days. Small, simple transactions can take shorter periods, while more complicated multi‐million dollar transactions can take slightly longer. The process is designed to provide needed time to perform business analysis and due diligence, as well as to be respectful of business owners’ timing needs.
Post‐Financing Compliance:
For each CAPCO investment approved by DISB, the CAPCO that made the investment is required to obtain and maintain in their files the following information, which is made available to DISB as part of its annual review of the CAPCO, or at any other time, as the Commissioner of DISB deems necessary:
- Copies of all of the information provided to DISB in connection with the request for an opinion letter, as set forth in Section II of the Financing Process described above;
- A copy of the business’ current lease or real property deed, as applicable;
- Copies of the business’ most recently filed:
- Corporate Franchise Tax Return, Unincorporated Business Franchise Tax Return or Partnership Return of Income;
- Employer Withholding Tax Annual Return; and
- Annual Sales and Use Tax Return (if applicable)