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CDFA Spotlight:
State Tax Credit Programs for Angel Investors
By Stan Provus |
Preface
This article discusses state tax credit programs for angel investors. At least nine states have turned to these programs as a way of stimulating seed capital investments for entrepreneurs.
Body
In an effort to encourage start-up financing, nine states have established tax credits for angel investors. Depending on the state, the credits range from 15% to 50% of the amount invested. Each state has unique provisions. Louisiana requires angels to demonstrate that at least half of the sales recorded by the businesses they funded come from out of state. Arizona prohibits investors who finance embryonic stem cell research. These programs have become more popular as a smaller share of institutional venture capital funds is invested at the seed stage—less than 2%. By far the largest source of funds for seed capital are angel investors.
The first tax credit for angels program was adopted by the Finance Authority of Maine, nearly 20 years ago. Stan Provus created this program, while serving as the CEO of the Finance Authority of Maine at that time. The program was initially created with $1 million of state tax credit authority, originally allocated to create a natural resources capital corporation. $1 million of tax credit authority was not sufficient to help capitalize a capital corporation that would make equity investments in natural resources companies. Therefore, the tax credit authority was redeployed to an angel program which has been very successful over the years and received additional allocations of tax credits from the Maine legislature.
The rest of this article presents summaries of programs in Maine and Arizona.
Maine Seed Capital Tax Credit Program
This program is designed to encourage equity and near equity investments in young business ventures, directly and through private venture capital funds. FAME may authorize State income tax credits to investors for up to 60% of the cash equity they provide to eligible Maine businesses. Investments may be used for fixed assets, research or working capital.
Eligibility:
- Businesses located in Maine
- Investors must own less than an aggregate of 50% of the business
- Principal owners and their immediate relatives are not eligible
- Annual gross sales of less than $3 million
- Business must either: 1) be a manufacturer; 2) provide goods or services with 60% of sales derived from outside the State or to out-of-state residents; 3) develop or apply advanced technologies; 4) bring significant permanent capital into the State
- Must be the professional, full-time activity of at least one of the principal owners
Basic Terms:
- Tax credits equal to 40% of the investment - 60% for investments made in businesses located in high unemployment areas (contact FAME for a current list of eligible areas)
- An investor may provide up to $500,000 per business
- Aggregate investment limit per business is $5 million for which tax credit may be received
- Investments must be at risk for 5 years
- Credits must be taken in increments of 25% (of the credit) per year for the 4 years following the investment. Credits used cannot exceed 50% of the total tax due by the investor for that taxable year before application of the tax credit. To the extent this limitation requires the taxpayer to take the credit over more than 4 years, unused credits may be carried forward no more then 15 years.
- For a more thorough description of the Program and any limitations thereon, refer to Chapter 307 of the FAME Rule.
Special rules for venture capital funds:
- Investors may provide up to $1,000,000 per venture capital fund in any consecutive 3-year period.
- Investors in any one venture capital fund cannot receive more than $5,000,000 in credits, but may invest more without credit.
- Investors in certain qualifying venture capital funds may receive one half of this credit (up to 20%) at the time of investment.
- The remaining amount of an investor's tax credit will be awarded when and if the venture capital fund invests sufficient monies in an eligible Maine business. Credits will be revoked if not substantiated within 3 years.
- Investment into venture capital funds must be at risk and principal may not be paid without FAME consent for 5 years. Dividends, royalties, interest, stock options or warrants and other forms of return, which are not in the nature of return of principal, are allowed.
Reporting Requirements:
Businesses receiving investments for which credits are issued, must file annual reports with information on the total investments received, number of employees and jobs created/retained, annual payroll and total sales revenue. Failure to file reports will result in ineligibility and possible revocation of credits issued in the reporting period (the prior year).
Fees:
- $250 per business (one time fee)
- $100 per investor, per investment
- $250 per venture capital fund
Arizona Angel Investor’s Tax Credit – SB 1335
Purpose – to expand early stage investment in Arizona’s small businesses.
Background - Small businesses comprise more than 80% of Arizona’s economy. Assisting small businesses as they grow, particularly those well positioned to create high wage jobs, is critical to Arizona’s economic growth.
A significant area of need for small businesses is access to “early-stage” equity capital when building their operations. This is so because they are too small to secure adequate financing through bank loans and other traditional sources of capital, or enter the stock market as a publicly traded company.
Private equity investments by individuals and specialized “angel” funds and venture capital firms can be used by small businesses to gain access to these resources. Yet, as the economy boomed in the latter half of the decade and “early stage” and “venture” capital investments soared nationwide, Arizona fell behind.
Arizona cannot afford to lose its knowledge-based small businesses to other states. The critical shortage of equity capital for new businesses in Arizona represents a serious shortcoming and, as a result, small, homegrown businesses face difficulties in expanding operations and taking new ideas, products and services to market.
Description of Program - A state tax credit is made available to investors who invest in early-stage “qualified small businesses.” The credit is 30% of the investment, increasing to 35% for investments in bioscience companies and companies located in rural Arizona. The credit may be offset against AZ taxable income in equal amounts over a 3-year period. The credits are not transferable.
A “qualified investment” must be an equity investment in a minimum amount of $25,000 per investment and each investor is limited to a maximum of $250,000 in investments in all qualified small businesses eligible for the credit per year. Credits are not available to persons who already hold 30% or more of the equity of a qualified small business.
A “qualified small business” must:
- Have at least a portion of its operations in Arizona;
- Have at least two full-time principal employees or full-time independent contractors in Arizona;
- Not have a principal business in retail, restaurants, real estate, professional services, personal services or health care services;
- Have total assets less than $2 million; and
- Have received not more than $2 million in investments eligible for the credit.
The total tax credits are capped at $20 million over a 5-year period with no general fund impact in fiscal year 2006. Credits will be available to investors on a first-come, first serve basis.
For more information, go to http://www.azleg.state.az.us/FormatDocument.asp?inDoc=/legtext/47leg/1r/summary/h.sb1335_05-16-05_astransmittedtogovernor.doc.htm&DocType=S.
This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.
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