A state lawmaker wants to restore an angel investment tax credit in Michigan as a way to create a larger pool of prospective investors in startup companies.
Citing a lack of available capital for new companies at their earliest stages, Rep. Jeff Farrington is working to introduce legislation for a 20-percent credit against the state’s personal income tax for qualified angel investments.
“We have a gap. It’s up to us to fill it,” said Farrington, a term-limited Republican from Macomb County who chairs the House Tax Policy Committee. “This is all about job creation. Job creation starts with someone willing to invest their time, their money, their efforts and their energy and their expertise.”
Farrington aims to introduce bills in July and hold a committee hearing on the legislation in September.
While he’s fully aware of the budget problems that large, uncapped tax credits are causing the state as companies cash them in years later, Farrington would cap an angel investment credit at a cumulative $6 million. The cap would limit financial exposure for the state and create a self-imposed end to any angel investment credit, forcing the Legislature to either renew it, make changes to allow it to work better, or simply let it expire without any action.
“Maybe that takes a year, maybe it takes two years, maybe it’s five years. The point is when you hit that $6 million cap, the program’s done unless the Legislature goes, ‘This seemed to work. Let’s put more money into it,’” Farrington said. “If it’s working, it’ll come back. If it’s not working, people will either tweak it or they’ll say, ‘You know what, it didn’t work … move on to the next thing that may work better.’”
Michigan’s previous angel investment credit of 25 percent on the personal income tax went away in 2011 as part of a broad rewrite of the state’s business tax code that eliminated most credits.
Nationwide, more than half of states either have a similar program or are considering a tax credit to coax high net worth individuals to become angel investors. Some of the existing credits are higher, up to 50 percent, and some are lower than what Farrington intends to propose.
“You might see that it takes off and we go, ‘You know what, studies show that 25 percent or 35 percent or 50 percent is better and it’ll bring in whatever,’” Farrington said. “This is a good starting point based on information we got from a lot of other states.”
Under Farrington’s planned legislation, angel investors could get a maximum nonrefundable credit of up to $200,000 per qualified investment that they could carry forward over five years.
Angel investors could receive a credit on investments in a company that’s in the early stage of development, headquartered in Michigan, has a pre-investment valuation of less than $10 million, employs fewer than 100 full-time equivalent workers, and has been in existence less than five years. The legislation would exclude retail businesses from the program.
The proposed legislation comes as angel investing in Michigan has been on a steady growth trajectory for years.
Michigan ended 2015 with 10 angel investing groups that last year put $16 million into startup and early-stage companies. Those groups had about 300 active angel investors, a 59-percent increase from five years earlier, according to an annual research report published by the Michigan Venture Capital Association. The 128 Michigan-based startup companies that are backed with angel funds represent a 42-percent increase over five years ago.
Even with that growth, startup and early-stage capital remains hard to come by, say proponents of restoring an angel investment credit.
“Despite some good progress toward increasing access to capital for early-stage companies, there’s still a very big challenge in getting those very first sets of dollars that won’t come from the venture capitalists,” said Stephen Rapundalo, CEO of the Ann Arbor-based life sciences trade group MichBio. “So anything that encourages or incentivizes high net worth individuals to invest in our companies is good. It’s good for the economy and results in them putting money back in, time and time again, because they’re getting something out of it.”
Rapundalo cites a recent biennial report from the Bio Industry Organization, or BIO, that highlighted growth from 2012 to 2014 in the life sciences industry, a key sector for existing angel investors. In Michigan, the sector grew 5.7 percent during the two-year period to 44,277 jobs and the number of companies involved in life sciences increased 4.1 percent to 1,833.
That growth occurred in the period immediately following the elimination of the angel investment credit and a state research and development tax credit.
“The question is if we had some of those things, which would make us more competitive, would the growth have been even better?” said Rapundalo, who also advocates for restoration of an R&D tax credit in Michigan.
“It’s a great competitive tool to have,” he said. “When we had it, we were one of the first states to have it, and now many others have since put their own in place.”
FILLING A GAP
The gap in early-stage capital stems in part from venture capital funds moving upstream in recent years and putting their money into companies that are further along in their development, said Kevin McCurren, executive director at Grand Valley State University’s Richard M. and Helen DeVos Center for Entrepreneurship & Innovation.
Private and public sector investments over more than a decade are largely credited with spurring strong venture capital growth in Michigan. McCurren believes the state needs to restore an angel investment credit that’s part of a broader initiative to boost early-stage investing as well.
“We’ve lost a lot of the early-stage investments,” McCurren said, citing as an example the move by Start Garden LLC in Grand Rapids to focus on supporting existing portfolio companies rather than making new early-stage investments.
“Angel groups have formed to support the communities. Now we need the state to support the angel groups and the development of angel groups and close that (gap in) early-stage investment capital,” he said. “It’s very difficult to form an angel group because of the heavy cost of investment and administration and the ongoing management of the group.”
EFFICACY IN QUESTION
Despite states’ greater use of tax credits to spur angel investments, many experts have persistently questioned whether the incentives work as intended.
One study in 2013, published in the Small Business Institute Journal and conducted by researchers at the University of Arkansas at Little Rock, concluded that angel investment tax credits do “influence state level entrepreneurial activity,” although the report noted the result is preliminary and the issue requires more study.
“This is important because lawmakers continually debate the benefits of these programs in light of the cost in lost tax revenue,” researchers wrote in the study. “While more research is needed in this area, this preliminary study suggests that the angel tax credits do provide an incentive to increase early stage investment in high growth potential new ventures, which should in turn lead to the creation of higher paying knowledge-based jobs and ultimately an increase in tax revenue.”
A 2008 report by the National Governors Association concluded that “the benefits of supporting and encouraging angel investment can be great.” The association did suggest that states that want to boost angel investing could offer incentives such as tax credits or matching loans or grants.
“However, if tax credits are to be implemented, there are several principles that states can incorporate from other states’ experiences. Additional monitoring and evaluation will be needed in the field of angel investment to better determine the effectiveness of financial tools,” according to a report from the National Governors Association.
States should also look at efforts such as greater investor education and fostering social networks between angel groups, the group noted.
LOWERING THE RISK
McCurren cites U.S. Census Bureau data showing that Michigan had 98,000 people with a net worth of $3 million or more, some of whom could become angel investors.
Both he and Farrington acknowledge that a tax credit is more apt to bring investors into the field if they are already considering it. A tax credit would reduce the risk and generate some form of return for an angel investor over the period of years until his or her investment produces an exit.
“It doesn’t really cause you to make an investment, but it does make you feel better about the investment. It lowers the risk,” said McCurren, who is also an angel investor. “And remember, you constantly have to fill the angel pool” as investors move on or retire.
Farrington expects some opposition to his proposal, including from within his own party from people who are against tax credits based on ideological reasons.
Part of his rationale in wanting to restore an angel investment tax credit is that investors are going to invest their money anyway. Offering a tax credit can encourage them to keep their investments in Michigan, especially if they are already considering it.
“There are people who are on the fence,” he said. “All of a sudden (if) you have a 20-percent kicker on it, those that are on the fence, they’re in the game.”