By Scott Meacham
It’s a good thing when state leaders recognize the strategic importance of innovation in job and wealth creation. It’s also a good thing when a state considers legislation to help address capital gaps. Oklahoma’s Technology Business Finance Program (TBFP) Seed Fund is a nationally recognized best practices example of legislated early stage capital that has stood a 20-plus year test of time.
Tax credits are another financial tool that states have attempted to use with varying success to stimulate early-stage investment in startups. The concept behind tax credits is that they will help investors offset a portion of the investment risk and thereby create more capital for startup companies.
Over the last 20 years, more than half the states, have experimented with tax credits as a way to stimulate investment capital in early stage deals. So, unlike 20 years ago when Oklahoma was trailblazing with TBFP, there is considerable data and real-world experience from other states to help a legislature considering an investment tax credit make better decisions based on what other states have tried.
State investment tax credits have ranged from 10 to 100 percent, typically applied to technology businesses often based on qualified research from the state that is providing the credit. Credits may include carry-forward provisions to off-set future tax liability. Some credits are transferable. Certain industries, for example real estate or finance, may be excluded.
An innovation economy grows when investors perform rigorous due diligence and challenge the assumptions, goals and plans of entrepreneurs seeking the highest quality startups — companies that have market-validated business plans, a track record of achieving growth milestones, and management teams focused on building a business with long-term potential for acquisition or exit.
Tax credits, however structured, should not be so lucrative that an investor would be attracted to invest in a startup company primarily for the tax benefit. Overly generous credits in the short run might attract more capital to early stage deals; however, the downside is that poorly constructed tax credits can undercut market discipline and cost a state much more in the long run than any passing short-term gains it might realize.
Tax credits and other tax write-offs, like most decisions, especially in economic policy, usually cut both ways. There is much to learn from Hawaii and other states that have already been down the path of utilizing tax policy to stimulate early stage investment. The bigger the tax credit or deduction, the greater the opportunity for unintended consequences. Public disclosures and comprehensive metrics with strict and highly transparent reporting requirements can prevent what Hawaii calls “opportunistic manipulation.”
When early stage equity markets “behave,” angels and venture capitalists are attracted to businesses with the potential to solve huge problems and disrupt markets. Investors reserve capital for follow-on investments as the company attains milestones of growth and sustainability. They provide mentoring, advice, and board of directors participation.
State initiatives that leverage this infrastructure to expand Oklahoma’s pipeline of investable companies will accelerate our state’s innovation economy, creating high-paying jobs and life changing products and services. Oklahoma’s problem with a low level of startup investment is not really a capital problem but a low deal flow problem. Good deals get funded and bad deals do not. That is the way healthy startup ecosystems function.
Scott Meacham is president and CEO of i2E Inc., a nonprofit corporation that mentors many of the state’s technology-based startup companies. i2E receives state appropriations from the Oklahoma Center for the Advancement of Science and Technology. Contact Meacham at i2E_Comments@i2E.org