This post originally appeared on Entrepreneur.com - #StartingABusiness
State tax credits are a great incentive for both founders and funders to connect in the best and the worst of times.
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If you’re an angel investor or interested in becoming one, tax credits are popping up across the country, stimulating a form of trickle-down economics that actually works. By funding startups of all kinds, people are choosing to invest their earnings in high risk/high reward companies, placing their own bets instead of letting the government do it for them.
And why wouldn’t they be thinking about angel investing, when many of their friends are already in? The amount of capital invested in seed and angel rounds last year rose 44 percent year over year, and the overall number of angel and seed deals spiked by 30 percent. As angel investments rise, states and investors alike are paying attention.
Making Credits Work
As an example of how these credits work, take Iowa’s Angel Investor Tax Credit. Iowa set aside $2 million per fiscal year that will end up back in investors’s pockets. For individuals, they can get a check for up to $100,000, and for businesses, it’s up to $500,000 — all for investing in companies that meet the state’s tax credit criteria.
The state is essentially bankrolling 25 percent of an angel investor’s commitment. The biggest factor keeping those with the capital from making angel investments, and taking advantage of the tax reduction, is risk. Fear of risk keeps trillions of dollars in no- or low-yield assets locked on sidelines, not helping anyone. It’s a lose-lose scenario for the investor and for GDP growth. But the state of Iowa and others are making these investments much less risky, as half of the downside is protected via state and federal credits and write-offs.
Related: Getting Started With Angel Investing
Connecticut also just increased the budget for similar tax credits to $5 million. Since the state began this program in 2010, more than 200 companies have received qualifying angel investments, with $18.9 million in credits going back into investors’s bank accounts over that time.
See, Click, Fix and Device42 are two recent examples where the investors earned above-market returns from an exit, along with cashback from the state. These are good examples where capital was unlocked and deployed into the riskiest earliest asset class, creating jobs and investment returns that benefit everyone in the economy. This is how trickle-down actually works.
Breaking Out of Silicon Valley
One qualifier you’ll find with every one of these credits is the investment has to be made in a company with local roots. That means if you live in Louisiana and you want to get Louisiana’s version of the angel investor tax credit, your money will stay close to home. And it’s not just the jobs that these startup investments create; there are the industries that support them, such as the accelerators, co-working spaces and coffee shops where founders and their employees gather. This is the stuff that economic-development is made of, and it becomes possible when an investor knows with certainty they’ll be getting back a good chunk of their investment even if the company fails (between the state tax credit and the federal government deduction for losses, the guaranteed minimum return is ~50 percent).
Giving Ideas a Fighting Chance
What state or city wouldn’t want to be home to the next Airbnb? As we’ve seen with the “rise of the rest” trend, big ideas happen everywhere. The question is whether the dreamers and the company makers are matched with the capital they need to emerge into large fast-growing companies in their home region. The truth is that the vast majority of good ideas never actually make it to market. Investor tax credits unlock local capital to keep the best and boldest from going elsewhere or worse, never having their shot.
Recession-Proofing Your Economy
There’s been plenty of recent news pondering whether we’re headed for an economic downturn, yet another period when trickle-down can work. Angel tax credits can help to prepare and protect economies when a recession does happen, so people keep investing when times turn tough, instead of pulling back and retrenching. It can keep the momentum going — new companies, new jobs, and economic growth, even when overall the signals aren’t bullish. As Warren Buffett said, “Be greedy when others are fearful.” Let’s not forget that even as we were barely clawing our way out of the worst recession of our lifetimes in 2009, Amazon happily spent more than $1 billion to acquire Zappos.
The key is to ensure the relationships between angels and their local innovation ecosystems and founders are strong now, in good times. State tax credits that put money back into the pocket of the investor are a great incentive for both founders and funders to meet and work together in the best and the worst of times.
Matthew McCooe is CEO of venture-capital firm Connecticut Innovations.