Friday, October 10, 2008

How I See It

Focus needed on state tax incentive for angel funding

Massachusetts lags behind many other states in offering an incentive for angel investing in young tech companies and startups. Small businesses, as many know, are the engine that drives the economy in Massachusetts. It is estimated there are more than 250,000 angel investors in the United States today that have invested more than $27 billion in startups over the years. More than nine formal angel groups are now operating in Massachusetts alone, up from just three or four a few years ago. We have a great opportunity to stimulate jobs and advance great innovative products with our young work force and bursting college scene, but we do not have proper state tax incentives to inspire angels to fund these companies.

On the federal tax side, there are several incentives afforded to investors. One of the most beneficial ones allows investors to eliminate up to 50 percent of the gain on a sale of qualifying startup stock in a new investment. If an early investor puts money into a startup that is set up as a “C” corporation and the entity has assets with a value of less than $50 million — and if the investor holds the stock for more than five years, 50 percent of the gain can be excluded. However, here in Massachusetts there is no such type of tax incentives for angels.

Massachusetts is one of the most technologically advanced states and serves what is a very unique entrepreneurial setting. Today, the only real tax advantage for the young Massachusetts corporation is the research and development credit. This credit, which usually allows the company (not the investors) a potential tax credit of 25 percent (but usually 10 percent) of qualified incremental research and development expenses, is not far reaching and generally does not help the young startup that usually has losses that do not allow it to use these credits early on. In 2003, the Associated Industries of Massachusetts published a paper that concluded that eliminating “the research credit would lead to lower employment and income in Massachusetts.” Even this minor credit has obviously had a positive impact on our Massachusetts economy.

Now let’s compare our state to the state of Hawaii, which offers angel investors a dollar-for-dollar tax credit for funds invested with a $2 million cap per business per year and no total cap. Or compare Massachusetts to the state of Wisconsin, which allows a 25 percent credit for funds invested and has a $125,000 cap per investment in tax credits. More than 15 states today offer some type of investor incentive for taking the risk.

 Earlier this year, the National Governors Association published a paper called “State Strategies to Promote Angel Investment for Economic Growth.” While the paper could not definitively conclude on the specific benefits various states have seen, it did conclude that the “benefits of supporting and encouraging angel investment can be great.”

The Massachusetts Legislature needs to invest in the future of the state and young entrepreneurs. We see every day in our tech practice group new, exciting technologies and ideas and entrepreneurs that are fully engaged in their young venture. Helping these innovative people raise money by offering incentives to angel investors will only encourage more ideas and others to get involved. There is a large funding gap that exists for the small business, as VCs usually do not fund very early stage companies. The angel investor is the one who has stepped up.

Massachusetts should be leading the way to encourage these incentives across the nation, not lagging behind states like Ohio or Wisconsin. It is time to make sure the Legislature continues to ensure our vibrant economy keeps growing and thriving.

Jeffrey D. Solomon is a partner at the accounting and business consulting firm of Levine, Katz, Nannis & Solomon PC. He heads its emerging business technology practice group and can be reached at jsolomon@lknscpa.com.