New York State Seal
STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

David A. Paterson
Governor

Eric R. Dinallo
Superintendent

OGC Op. No. 09-02-03

The Office of General Counsel issued the following opinion on February 4, 2009 representing the position of the New York State Insurance Department.

Re: Investments by Certified Capital Companies

Question Presented:

Does an investment by one CAPCO in a qualified business preclude subsequent investments by other CAPCOs in that qualified business under N.Y. Tax Law § 11(a)(7)(E)?

Conclusion:

No. New York Tax Law § 11(a)(7)(E) does not appear to prohibit subsequent follow-on investments by more than one CAPCO in a single qualified business.

Facts:

The inquiry is general in nature, without reference to specific facts.

Analysis:

Central to the operation of the CAPCO programs, which are supervised by the Superintendent of Insurance, are the concepts of “qualified business” and “qualified investments”, which are defined, respectively, by New York Tax Law §§ 11(a)(7) & 11(a)(10)(McKinney 2007). Those statutes read in pertinent part as follows:

(7) "Qualified business" - an independently owned and operated business that meets all of the following conditions as of the time of the first investment in the business:

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(D) The business was not organized by a certified capital company or an affiliate of a certified capital company, but this paragraph shall not prohibit a certified capital company from providing financial, technical or similar advice to a business before making an investment in such business.

(E) The business does not have a financial relationship, such as an ownership interest, investment interest, or compensation agreement, with a certified capital company or any affiliate of a certified capital company before the date on which a certified capital company makes its first investment in the business, but this paragraph shall not prohibit a certified capital company from providing financial, technical or similar advice to a business before making an investment in such business.

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(10) "Qualified investment" - the investment of cash by a certified capital company in a qualified business for the purchase of any debt, equity or hybrid security, of any nature and description whatever, including a debt instrument or security which has the characteristics of debt but which provides for conversion into equity or equity participation instruments such as options or warrants… Furthermore, except in the case of a follow-on investment, if a certified capital company owns more than fifteen percent of the equity in a company or has a seat on the board of directors of such company, then a certified capital company cannot invest in such company unless the following conditions are met: (i) at least one other investor who is not an affiliate of the certified capital company participates in the same round of investment on the same terms and conditions as the certified capital company; and (ii) the certified capital company and its affiliates invest no more than fifty percent of the total investment made in that round of investment.

Also relevant to the instant inquiry is Tax Law §11(c)(2), which provides:

(2) Any business which is classified as a qualified business at the time of the first investment in said business by a certified capital company shall remain classified as a qualified business and may receive follow-on investments from any certified capital company, and such follow-on investments shall be qualified investments even though such business may not meet the definition of a qualified business at the time of such follow-on investments, provided, however, that such business continues to meet the requirements set forth in subparagraphs (A) and (C) of paragraph seven of subdivision (a) of this section, and such business reaffirms its intention to maintain its headquarters in New York and conduct its primary business operations in the state of New York as required in subparagraph (D) of paragraph one of this subdivision. (Emphasis added.)

In the Insurance Department’s view, Tax Law § 11(a)(7)(D) appears to preclude a CAPCO from forming or organizing an entity that could be characterized as a qualified business, and Tax Law § 11(a)(7)(E) prohibits a CAPCO from making an initial qualified investment in a business that already had an existing investment relationship with another CAPCO. These provisions seem directed at preventing “self-dealing” by CAPCOs, as where a CAPCO might seek to make qualified investments in a purported qualified business that is a subsidiary or affiliate of the CAPCO.

A concern was raised that the Department’s interpretation of these statutes would prohibit multiple CAPCOs from investing in a single qualified business, and that preventing more than one CAPCO from investing in any qualified business could potentially prevent qualified businesses from receiving sufficient CAPCO funding. Such concern is unfounded. Tax Law §11(c)(2) expressly permits more than one CAPCO to make follow-on qualified investments in any given qualified business; Tax Law § 11(a)(7)(E) only prevents a CAPCO from making an initial qualified investment in a business that already has an economic relationship with another CAPCO. Accordingly, New York Tax Law § 11(a)(7)(E) appears not to prohibit qualified follow-on investments by more than one CAPCO in a single qualified business. Please be advised, however, that it may be advisable to confer with the New York State Department of Taxation and Finance to ascertain whether its construction of the Tax Law provisions in question conforms to that of the Insurance Department.

For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.