Several bills have been introduced into the Minnesota legislature which would provide investors an “Angel Investor Tax Credit” based upon their investment in certain types of Minnesota small businesses engaged in high technology or green manufacturing. The bills also permit indirect investment by taxpayers through a “Certified Angel Investment Network Fund.”
Prior legislatures and last year’s session have considered “angel investor” tax credits. These are intended to help spur investment in young businesses by granting the investors a bottom line tax credit. They would also help keep the Minnesota environment for entrepreneurs competitive with other states (such as Wisconsin) that have similar credits. Similar proposals have not passed in recent sessions but, despite tough budget issues, the prospects this year appear brighter. The governor specifically urged an angel investor credit in his State of the State Address, and committee hearings are ongoing regarding multiple pending bills.
The current proposals would focus the credit on businesses that use technical innovations, are engaged in research and development or technical activities, or are involved in specified environmental or similar activities. As expected, the credit would be available only to certain types of investors and only if the nature of their funding meets certain tests. The bills also include proposals to allow investments to be made through an “Angel Fund” (essentially allowing taxpayers to invest in an entity which would, in turn, invest in multiple qualified businesses, thereby providing taxpayers an opportunity for more diversity).
There are multiple bills that should be considered “live,” and they are changing daily. Click here for a “flow chart” showing the requirements as to qualification of the issuer and of the angel investor under one of those bills. This flow chart analyzes eligibility under S.F. 2307.1 This bill was chosen because it was the only pending bill already to a second engrossment. Other bills, just as “live” have similar, but not identical, requirements.
In light of budget issues, the proposed credit cannot be a “blank check,” but, instead, must be focused on businesses most likely to make investments with long-term benefit to the state, such as job growth. The pending bills would limit the eligibility for the credit based upon attributes of the issuer and of the taxpayer.
Although I might wish for a broader credit, I recognize “not this session.” The limitations that are imposed in the pending bill are clearly intended to focus use of the credit, and the cost to the state treasury, on investments in businesses that the legislature believes will best benefit the state economy and where the tax credit is most likely to affect the taxpayer/investor’s decision to invest.
I believe some improvements can be made which will not have serious financial impact. I would be curious to hear your comments.
- Don’t Limit to Accredited Investors. As proposed, investments can be made only by “accredited” investors. Accredited investors are generally individuals with high net worth or high net income or are certain institutional types of entities. “Accredited investor” is a concept existing under securities laws (Federal and state) designed to make it easier for private companies to raise private capital. In my view, this is a limitation that does not belong in this bill. Other valid methods exist which do not result in the issuer becoming a “public company” and without a trading market developing. For example, Minnesota, like most states, allows an offering to 35 or fewer non-accredited investors without the cost and complications of a public offering. There is no reason these investors (or more importantly, the issuers who only have access to non-accredited investors) should be denied access to the Angel Credit (this is not the “Archangel Credit”).
Example: Entrepreneurs sought investment to purchase a particle board device (a sizable capital investment) and to use it with corn stalks and similar materials. The resulting product, although weaker than traditional particle board, would have been oil absorbent and would have been used to absorb oil spills and leakage in manufacturing plants. This would have been an ideal target for this credit. Lack of access to accredited investors should not make this credit unavailable.
- “Bad boy” disqualification. Some enterprises face stiffer requirements under Federal and state securities laws because their principals fall within the definition of a “bad boy.” These categories are well defined and have existed for at least 25 years. They generally are persons who have previously been convicted or lost licenses in financial-related matters. As proposed, eligible issuers are not subject to this limitation. Imposing similar “bad boy” disqualifications, perhaps subject to waiver, would help ensure that the credit is allocated to legitimate businesses.
- Timetable and minimum amount of investment per taxpayer. The credit is available only if the issuer is certified as a “qualified small business” and if the taxpayer is certified as a “qualified taxpayer.” Application for both of these certifications must be made by November 1st of the year prior to the investment. (Angel funds are subject to similar requirements.) Once a proposed transaction is certified as eligible, the investment must be made within 60 days. This means that the credit will generally be available only if the angel investor and the qualified business are prepared to move very quickly.
This timetable works for investments by venture capitalists or “deep pocket” angel investors. It will not work well for businesses whose funding will come from multiple sources. At recent committee hearings on a similar bill, there were references by the legislators to businesses that “started in a garage” as benefitting from this bill. Businesses at this early stage will not benefit from this bill unless the entrepreneur has very quick access to multiple accredited investors. In my experience, many quality business do not.
Comment: There is a related timetable issue. There is an application deadline of November 1st of the prior year, both for the enterprise and for the investor. If the business does not have qualified investors waiting in the wings, it will likely not be able to obtain funding within the 60-day timetable and will lose its ability to take advantage of the credit.
Suggestion: allow the application and the certification to take place on a “rolling” basis. Applicants late in the year will still be at risk that all of the appropriated funds are gone but that might not be the case. This would be particularly true if the program is a success and a larger amount of funding exists in future years.
Example: A client developed a device that would eliminate the need for chlorine in swimming pools and hot tubs. The entrepreneurs did not have access to, or fell under the radar of, angel investors. They sought their funding by conducting a more traditional private placement. That private placement could not be completed in 60 days, although it was well on its way with nearly two-thirds of the funds committed. That business and the investors who had submitted subscriptions would have lost their ability to claim the credit.
- Limited Public Offering/Private Placement with Public Solicitation and without “Body Count.” Minnesota has a special “short-form” registration process called “SCOR” (Small Corporate Offering Registration) which essentially allows an issuer to raise funds in a private placement-like offering but permits public solicitation and eliminates the “body count” of most exemptions. This means that entrepreneurs whose access to accredited investors is limited could still benefit. (Consider the difference in access to capital and access to this credit if an invention is made by two persons, one living in a “wealthy suburb” and the other in a small town without many high net worth investors.)
The pending proposal (SF 2307) excludes publicly-held issuers from access to the Angel Credit, presumably because their investors will have liquidity in their investment. Although SCOR is technically a registration, a public trading market is highly unlikely to develop and any market that develops would be very “thin” and provide only very limited liquidity. The investor will be committed to a long-term investment.
SCOR is intended for very early stage companies and each issuer can raise only $1 million per year. This limitation will inherently limit the financial impact on the cost of expanding the credit to include these offerings.
Example: the company with the “chlorine-elimination” device, described above, would have been an ideal candidate for this form of offering. This strategy would have expanded the field of possible investors and reduced the disadvantage to these “garage inventors” of their limited access to accredited investors.
If SCOR offerings are eligible, the bill will also need revisions as to the calendar of qualification and fund-raising.
In addition to which entities and taxpayers are eligible (the flow chart), the legislature has numerous choices as to matters not addressed here. I will follow these with interest. Examples are:
- The amount of funding;
- The maximum amount of credit per business;
- The maximum amount of credit per taxpayer;
- The credit as a percentage of investment;
- Allocation of limited funds among multiple qualified businesses;
- Interaction with the taxpayer’s other taxes and credits;
- Permitted “carry forward” or “carry back” of the credits;
- Reporting obligations of the issuer;
- Reporting obligations of the taxpayer;
- Circumstances triggering disqualification of the issuer, the taxpayer, or the investment;
- The effect on already-taken credits of disqualification; and
- Numerous other policy issues.