Jul. 20–It was an idea as patriotic as breaking into the strains of “Oregon, My Oregon” during a meeting of the state Legislature.

House members on July 10 unanimously ordered the Oregon Investment Council to make every effort to invest in Oregon small businesses to help stimulate economic growth in the midst of a job-starved recession.

The bill pressures the state to place a total of at least $100 million from the Oregon Public Employees Retirement System into Oregon venture capital during the next 4-1/2 years. Gov. Ted Kulongoski is expected to sign the bill into law on Wednesday.

A review of the state’s portfolio shows that some of Oregon’s past forays have generated some large returns from venture capital, but the state has also lost in some high-stakes gambles on small companies. And the state’s most successful venture investments have largely gone to companies outside of Oregon.

Venture capital is one of the highest risk investments on the market. It gives loads of cash to new, often money-losing companies, on the expectation the firm’s business plan will eventually lead it to success — typically in the form of a public offering of stock or acquisition by a larger company. During the Oregon boom of technology startups in the 1980s, companies such as Sequent Computer Systems and Mentor Graphics went from nothing to mega-successes, making early backers rich.

But Oregon startup successes today are scarce. Critics of the bill question whether attempting to invest only in Oregon companies might lead to losses rather than rewards. Venture capital, they say, is too risky for state pension funds — including Oregon’s, which faces a shortfall of $9.7 billion below its long-term obligations.

“You invest in venture capital when you have surplus assets,” said Ralph Shaw, a longtime Oregon venture capitalist. “You don’t take that kind of risk when you’re deeply in debt.”

Further, trying to place the money in Oregon increases the risk, because most venture capitalists scour the nation looking for opportunities.

The public pension fund is no stranger to venture capital investing. As of March 31, it had poured nearly $300 million into funds invested heavily or completely in venture capital since 1993. The strategy — while not producing stellar results — has been profitable with a gain of more than $100 million. But many of those returns came during the tech boom of the late ’90s, when many venture funds were thriving as much or more.

Many say those heady times will never return. And unlike the investments under the bill, those investments were not made with any geographic limitations.

Other Oregon attempts at venture capital, with goals to invest within the state, however, have been less successful than those of the public pension fund. The former Oregon Technology Development Fund turned $12.3 million into $7.9 million in 14 years of existence.

While successful during much of its run, the fund ran afoul of state law for owning equity in companies. Its portfolio of investments was frozen during a two-year period beginning in 1997. Many plunged in value during that time.

High-tech support By passing House Bill 3613, the Legislature granted a longtime wish to the heavy hitters of the state technology sector. The industry has long requested the Oregon Investment Council allocate public pension investments to Oregon startups. Rather than funneling millions to startups in Silicon Valley and Austin, Texas, they argued, the state should fund promising home-grown businesses.

“They need to create the potential of an equity market here,” said the bill’s sponsor, Rep. Mitch Greenlick, D-Portland. “Startups move to where they believe there’s an equity market.”

The idea gained momentum when Associated Oregon Industries began to champion it. In past legislative sessions, the group had largely lobbied for old-economy businesses such as timber, but it has taken a new direction.

Harvey Mathews , a relatively new Associated Oregon Industries staffer, lobbies for technology and education issues.

“It’s recognizing the maturity of the technology industry in Oregon, as opposed to where it was previously,” Mathews said.

Mathews was the primary proponent of the bill, backed up by venture capitalists and technology business advisers.

State Treasurer Randall Edwards, however, had opposed the initial draft of the bill.

“This is analogous to somebody coming in and saying we’ll take a percentage of your money and invest it a certain way, whether you like it or not,” Edwards said.

Edwards sits on the Oregon Investment Council, and his staff manages state investments. Further, the council’s chair, Gerard Drummond, was lukewarm to the idea.

“It doesn’t do much more than we are already doing,” he said.

But proponents met with Edwards and other potential opponents, such as public employee unions, and changed the bill to require the Oregon venture capital investments only when prudent. It also no longer ties a percentage of overall pension investments to venture capital.

In other words, the state shouldn’t sacrifice profits to invest in Oregon. Edwards no longer opposes the bill.

“My initial concern with the bill was around the mandate of forcing investment in Oregon without going through a prudent standard of investing,” Edwards said.

That restriction for prudent investments hopefully will prevent unwise investments, said Mary Botkin, a lobbyist for the American Federation of State, County and Municipal Employees.

That’s not to say that the Oregon Investment Council will be able to hide behind the loophole and avoid any venture capital investments.

“When it becomes law, the Legislature and the governor would be saying that we should be looking at venture capital in Oregon,” said Mark Gardiner, a council member.

Appetite for risk The Oregon Investment Council recently decided to increase its investments in venture capital, independent of the bill. Like many large pension funds, it wants some exposure to high-risk investments, because they typically have the potential of providing greater average returns.

Yet they carry the risk not only of losses, but of being stuck with bad investment advisers. When the council hires a manager for traditional equity investments, it can fire that manager with 30 days’ notice. Venture capital firms are typically retained for years at a time to manage the startup companies and are paid management fees whether or not the investments perform.

As of March 31, the council had invested $293.4 million in 10 funds with much or all of their investments in venture capital. The state has received $280.1 million back from the funds, and the fair market value of the remaining investments is $127.4 million. Some experts say that valuation is debatable, because unlike publicly traded stock, investments in venture-backed startups are more difficult to value, because they are not frequently sold.

The total value of the investments and their returns — $407.57 million — exceeds the initial $293.4 million investment, leading the state to claim a total gain of $114.2 million.

The state has committed an additional $595.9 million to those 10 funds, but the fund managers have yet to invest the money.

The six funds the pension system has invested in since 1999 have lost value, but the state says that’s to be expected. Venture funds typically take many years to produce significant returns, experts say.

The pension system’s venture capital success comes from four funds, with which it signed deals from 1993 to 1997. Two of the funds, managed by OVP Venture Partners, invest directly in startups. The other two are managed by HarbourVest Partners, which in turn invests the money in a variety of investments. Between 40 percent and 80 percent of those investments are in venture capital funds.

OVP’s Olympic Venture Partners IV fund, to which the state committed $14 million in May 1997, has been the most successful venture-related investment for Oregon’s pension system.

The state invested $14 million in the fund, and it has received $50.8 million in payouts from it, with the remaining investments valued at $2.2 million as of March 31.

Although OVP’s offices are in Portland and Kirkland, Wash., the fund’s investments largely went outside of Oregon.

According to a Dec. 31 report by the state’s investment consultant, Pacific Corporate Group, of the 19 companies backed by the OVP fund, two were based in Oregon. Nine of the fund’s investments are in Washington state.

Gerry Langeler, an OVP partner in Portland, said the fund has a greater number of Washington companies largely because the population there is larger. Also, ’90s venture investments often went to software startups, which were abundant in Washington.

Langeler said he would not sacrifice returns for the Public Employees Retirement System to invest in a specific location.

“Yes, you want to look at Oregon first, but your responsibility is to maximize returns to PERS retirees,” he said. “The retirees earned that money. They didn’t put their time in as teachers and firefighters in order to help out with economic development.”

Greenlick, former director of the Kaiser Permanente Center for Health Research, said public investments should serve a social purpose in addition to maximizing returns.

“The money should be producing useful wealth,” Greenlick said.

A difficult start Oregon’s first plunge into venture capital, with an Oregon focus, was not as successful as the PERS investments.

In 1985, the Legislature created the Oregon Research and Technology Development Corp. The intent was to invest in Oregon startup companies, with an eye toward funding research that derived from Oregon universities. During the next six years, the Legislature handed over $12.3 million for the fund.

The corporation then invested in about 40 companies during 12 years’ time.

But the fund faced continual difficulties. For a time — due to the state constitution — the corporation could not invest directly in company equities. A later ruling by the state Department of Justice allowed the fund to hold stakes in companies, and the investments started to pay off. By 1995, the fund’s value had increased to $25 million.

“It was very successful,” said Wayne Embree, then one of the fund managers.

However, in 1997, the Department of Justice changed its mind, ruling that holding equities directly by a state fund violated the Oregon Constitution.

“It literally came to a screeching halt,” Embree said.

With the account frozen, fund managers could not buy or sell. The companies languished in the portfolio as the state and fund managers tried to resolve the legal difficulties. When they could not, in 1999 fund managers transferred all assets to the state Treasurer.

Simultaneously, the technology bubble burst. Startup companies failed rapidly. The corporation, now called the Oregon Research and Technology Fund, plummeted in value as it languished in the state’s hands.

A state audit showed that the fund assets dropped in value from $24.6 million as of June 30, 1997, to $7.9 million when its assets were handed over to a successor fund, the Oregon Growth Account.

The Oregon Growth Account began investing in 1999, a time when the venture capital market was expensive and highly competitive. Many of its investments are in venture capital, but two of its five fund managers also hold other types of investments, including slightly older private companies.

Fueled by annual appropriations of lottery funds, the Oregon Growth Account has since committed more than $34 million to Oregon venture capital firms. It is too early to judge the performance of the funds — venture capital investments typically lose money in the early years. Usually from the start, venture capitalists begin collecting annual fees equal to a small percent of the money committed to their funds.

At the Oregon Growth Account, five firms have collectively earned management fees of more than $1.2 million since 1999, with no return on the equity to state accounts. The funds typically return those fees to their investors before splitting profits on successful investments.

By Jeffrey Kosseff and Peter Sleeth

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