Angel Tax Credit

Michael Schley

Shareholder

Larkin Hoffman Daly & Lindgren Ltd.

mschley@larkinhoffman.com

larkinhoffman.com

Topic: Accounting

Minnesota's economy and growth require us to persuade new businesses to start here and to help young businesses grow here.  We have a long tradition of supporting such companies in many ways including providing strong sources for early-stage equity financing.  In the early '80s, the SEC staff told me, a rookie enforcement attorney, that the Twin Cities had an equity capital market for young and growing companies unlike anywhere else in the region.  I found that to be true into the '90s.  But things change.  Very early stage equity capital has become much harder to find.  Particularly hard hit have been entrepreneurs from outside the wealthier suburbs who don't have personal relationships with potential "Angel Investors." 

As an attorney helping businesses with their equity and other capital raising, I am very frustrated when young businesses fail or when entrepreneurs with exciting business plans never even get started because they don't have a Rolodex of Angel Investors.  Even worse is watching Minnesotans move their businesses and potential businesses to Wisconsin or Iowa because of tax credits and other incentives then watching them flourish.  One client that moved for these reasons has employed 25 people in Wisconsin for years.

One way that many companies (including companies now well known) had access to early-stage equity capital was through the smaller broker-dealers who conducted private placements and public offerings for companies in their "idea" and "development" stages.  But most of those broker-dealers have closed their doors as a result of tougher regulations, higher capital requirements and other factors.  (Perversely, the strong market of the '90s was a factor: why invest in early-stage companies when you could "buy the Dow" for returns in the high double digits?)  Another reason for this change is that the venture capital community has gradually (and understandably) moved its focus "upstream" to companies whose sale or IPO is in sight or, at least, just across the horizon.  VCs' investments in the earliest stage businesses have also become focused (again, understandably) on those businesses with potential for the highest returns (read this "grand slam not just homerun"). 

Fortunately, the Minnesota legislature recently adopted, and the governor signed into law, an "Angel Tax Credit" designed to encourage equity investment in early stage "innovative" businesses.  The law also allows pools of investors ("Qualified Funds") to make such investments.  Total credits available are $11 million in 2010 and $12 million in each of the next 4 years (equal to $44 million then $48 million of investment). 

Here is a brief summary of key provisions:

• The credit is equal to 25% of the amount of the investor's cash investment in equity of the company pursuant to a SCOR offering (Small Corporate Offering Registration) or in a private placement (but only pursuant to specified exemptions from registration).
• The company must be a "Qualified Small Business Issuer" meeting requirements as to nature of its business (engaged in innovation in specific fields listed in the statute), employees (25 or fewer with at least 51% in Minnesota), use of proprietary or licensed patents or technology, maximum years in business, limited prior equity funding, and "bad boy" limitations.
• To earn the credit, Angel Investors must invest at least $10,000 and there are limitations related to the investor's income from the company. Investors in a "Qualified Fund" which is a "pass-through" entity (S corporation, partnership, LLC, etc.) can receive the credit for the fund's investment of at least $30,000.
• The credits are allocated on a "first come" basis, there are annual and total limitations, and there are requirements as to advance certification of angels, funds and companies and as to timing of investment. If the company does not continue to meet requirements as to its business, location of employees and amount of payroll for five years, the company must repay the credit (100% at first, nothing in the sixth year). Angels are not required to repay the credits they receive.

Even with its numerous limitations and requirements, the Angel Tax Credit will be a powerful incentive for investment in early-stage, technology-based businesses and should help increase the equity capital available for these companies.  Although I might wish for a less-restricted, more broadly available credit, the Legislature and the Governor are to be commended for adopting this credit, particularly in light of the significant budget problems the state is facing.  Let's put it to good use.