Capital Investment Legislative Update

Capital Investment Legislative Update

Senate Bill 261 (as amended by Senate Sub. 2)

The Hamilton Consulting Group

November 17, 2003

© The Hamilton Consulting Group 2003

The following summary of SB 261 and its adopted amendment, Senate Substitute Amendment 2, was prepared by Secretary Nettles of Commerce and his office. The bill, as amended, passed the Senate on Friday, Nov. 14, 2003.

Introduced By:
Senators: Kanavas, Stepp, Leibham, Darling, Brown, Welch, Zien, Lassa and Roessler

Representatives: Nischke, McCormick, Ladwig, Musser, Montgomery, Towns, Owens, Lehman, Weber, Van Roy, Krawczyk, Olsen and Ott.

Credits for Investments in Qualified Businesses by Angel Investors

Background
SB 261 acknowledges the important role that angel investors play in developing new economy (high-tech, high-wage) companies. Unlike traditional venture capital, where funds are pooled and then invested by a professional fund manager, angel investments can be as simple as a single individual deciding to invest in a friend's company, or as complex as a network of angel investors that meet on a regular basis to evaluate multiple investment opportunities. However, notwithstanding the process selected, angel investment is best defined as an equity investment by a high net worth individual, or group of individuals, into a company at its earliest stage of development.

A close cousin to the "friends & family" type of financing that is typically used by start-up businesses, angel investment is characterized by its larger size ($100,000 - $500,000) and the fact that it is targeted toward companies whose asset base, human capital, and intellectual property is not conducive to traditional bank financing.

As the first tier of outside equity investment, angel investors play a crucial role in helping early stage companies achieve the type of research milestones that allow them to subsequently compete in the more traditional venture capital community. This bill is necessitated by the fact that Wisconsin's high net worth individuals have historically taken a very conservative approach to investing in start-up companies. The bill's fundamental goals are to encourage individuals to invest in emerging technology companies, create an atmosphere of entrepreneurial development throughout Wisconsin, and demonstrate the long-term financial benefit of investing in high-tech businesses.

Program Parameters
Total Allocation: $30 million in tax credits over a 10 year period;

Credit: Individual: 40% of the first $500,000 made by a single investor into a Qualified Business;

Aggregate: A single business would be limited to no more than $1 million of Qualified Investment;

A single investor could make investments in multiple Qualified Businesses.

Fiscal Impact: No more than $1.5 million in credits would be certified in each of the first two years of the program. Thereafter, credits of $3 million per year would be available.

Process: Qualified Businesses would apply to and be certified as being eligible by Commerce within 10 days of receipt of an application. A Certified Business would utilize its business plan to solicit investors in the private sector marketplace. A Certified Business would document to Commerce that it has received Qualified Investments on an individual (per investment) or aggregate basis (e.g., once it has raised the desired $200,000). Commerce would issue a Notice of Certification to both the Certified Business and Qualified Investor/s within 10 business days of receipt.

Deal Flow: Assumption: Average investment per Qualified Business of $250,000. Years One & Two: 15 new projects per year. Years Three - 11: 30 new projects per year;

Qualified Business: Minimum Qualifications: 1) Headquartered in Wis.; 2) 51 percent of employees in Wis.; 3) Average net income less than $5 million; 4) Net worth less than $10 million; 5) Has less than 100 employees; and 7) Has been in business for not more than seven years.

Ineligible activities include: 1) Professional services provided by accountants, attorney, physicians, hospitality, insurance, banking, lobbying, consulting or real estate; 2) retail trade, transportation and construction.

Eligible activities include: Manufacturing, agriculture, processing or assembling products that involve research and development that will result in the development of a new product or business process.

Qualified Investment: Investments made by an accredited investor.

Credits for Investments in Early Stage Seed Funds

Background
It is generally agreed that access to capital is a critical component of economic growth for new economy (high-tech, high-growth) companies. Unfortunately, this is an area where Wisconsin has historically underperformed. In fact, with a "capital under management" average of less than $8 per person, Wisconsin is significantly behind the national per capita average of $315. As such, any strategy designed to position Wisconsin as one of the leading 10 states for technology innovation must include initiatives designed to strengthen Wisconsin capital markets.

In retrospect, given the heightened level of risk associated with venture capital and the conservative nature of Wisconsin's investment community, the state's current position is understandable. However, if we are to move forward, we must embrace change.

To that end, a number of initiatives have been developed by the governor and legislature that are targeted toward specific segments of the capital market. These new programs include technology transfer and angel investment initiatives that are addressed elsewhere, as well initiatives specifically targeted toward the varying types of venture capital funds.

The program outlined below is targeted toward early- and seed-stage venture funds that make equity investments in businesses that are at the proof-of-concept or prototype development stage. Typically, these companies have not yet had commercial sales and they are just beginning to put together a management team. At this point in their lifecycle, the firms most likely have used funds from the founders, friends, family, federal R& D grants, or angel investors to cover operating costs.

It is at this point that the business is most at-risk. Unless it is able to attract outside investment from a professionally managed venture fund/s, its research and product development activity will end. In Wisconsin, this is also the area where there is the largest disparity between the needs of the business community and available capital. In fact, some of Wisconsin's venture capital funds do not invest any funds in early stage companies.

Therein lies the need to stimulate the development of early-stage seed funds in Wisconsin. Building upon an expanded angel investment network, these funds will play a crucial role in positioning new economy companies for long-term success.

Program Parameters
Total Allocation: $35 million in tax credits;

Credit: Individual: Institutional investors and accredited investors can receive a tax credit of up to 40 percent on funds invested in a Qualified Early Stage Seed Fund.

Fiscal Impact: No more than $1.5 million in credits would be certified in each of the first two years of the program. Thereafter, credits of $4 million per year would be available.

Fund Selection Process: Professional fund managers would submit applications in response to a Request for Proposal (RFP) prepared by Commerce. Commerce would certify fund managers based upon an analysis of specific criteria. Certified Fund Managers would utilize their business plan/offering memorandum to solicit private sector investment into the fund. Provided the fund is able to raise at least $10 million of private sector investment, it will be certified as a Qualified Early Stage Seed Fund. Once a Qualified Early Stage Seed Fund is capitalized, the fund manager will have the flexibility to make investments in early stage businesses without regard to geographic location. However, only investments in Qualified Wisconsin Businesses would be eligible for the 40 percent credit.

Certified Investment Process: Certified Fund Managers will submit information on a prospective investment. Within 10 days of receipt, Commerce will certify the business as a Qualified Wisconsin Businesses. The fund's subsequent investment into the Qualified Wisconsin Business will be eligible for a 40 percent tax credit. The maximum amount of Qualified Investment into any single business shall be limited to $2 million.

Deal Flow: Assumption: Average investment per Qualified Business of $1,000,000. Years One and Two: 4 - 5 new projects per year. Years Three - 11: 10 new projects per year

Note: The above estimates are conservative and assume the tax credits do not leverage additional investment. Commerce believes that it is reasonable to expect that the credits will leverage additional investment. For example, without leverage, the $35 million in tax credits will result in total fund size of $87.5 million ($35 million / .40). However, with a 1:1 leverage factor, the tax credits will result in total fund size of $175 million.

Eligible activities include: Manufacturing, agriculture, processing or assembling products that involves research and development that will result in the development of a new product or business process.

Qualified Fund Manager - Criteria

Managers education and experience
Size and number of funds previously managed
Type of funds previously managed
Success rate of funds previously managed
Projected funds leveraged