A Tax Cut for Angels
A Special Report by Adam Bluestein and Amy Barrett
How states such as Ohio, Wisconsin, and Minnesota give angel investors (and start-ups) a break.
Raising capital is a challenge under any circumstances, especially in a tough economic climate. But try doing it in a place like Ohio, which lacks the investing infrastructure of Silicon Valley or Boston. Brad Beasecker, CEO of Traycer Diagnostic Systems in Columbus, has spent much of the past eight months seeking funds for his medical and materials imaging start-up. He has done pretty well: He is in the process of closing a $1 million round of angel funding from 15 investors.
Beasecker has a lot of confidence in his company. But he also knows that much of his good fortune is thanks to an Ohio program that lets angels deduct 25 percent of an investment in a start-up company. Over the past 12 months in Ohio, 58 companies have received angel investments that qualified for the state's 25 percent tax credit. "There was a dearth of [early-stage] capital in the state," says Lisa Patt-McDaniel, director of the Ohio Department of Development. "I wouldn't say that capital is now robust, but it is more available."
In Beasecker's case, many of his 15 investors cited the credit as helping to sway their decision. "The investment has to stand on its own," he says. "But these are still difficult times, and people have a lot of investment alternatives. I think having the tax credit can push someone over the edge and make it an easier decision to say yes." Beasecker says he plans to use the funds to develop his technology and add staff.
A number of states, including Wisconsin and Minnesota, offer tax credits to angels; Michigan's legislature is considering such a program. More states should follow their lead. And so should the federal government. In the U.K., for instance, angel investors are eligible for a 20 percent tax credit for investing in start-ups. A May 2009 survey of U.K. angels found that 24 percent of investments in new businesses would not have been made without the credit.
As it happens, the U.S. federal tax code provides for a 50 percent to 75 percent reduction in capital gains taxes for investments in small businesses. The problem is that the tax break is so overloaded with requirements that it's almost useless. One of the biggest problems is that businesses targeted for investment must be C corporations, even though most start-ups are registered as limited liability corporations. The tax break "isn't widely used, because there are so many technical requirements that can't be met," says Scott Jones, a Boston-based partner at the law firm Proskauer. That should be fixed.
Bottom Line We will let an actual angel investor, Stephen Spinelli, co-founder of Jiffy Lube, sum things up: "If I get an immediate tax credit, I get an immediate return. I know I would increase my investing if there was a tax credit."