Tax Incentives (Startups + Angels) = Job Creation 

As part of the Boston Region Entrepreneurship Week (BREW), Spencer Trask will be hosting a panel discussion on Friday, October 15 entitled: “Building a New Framework for Economic Sustainability through Entrepreneurship and Innovation.” The event’s focus will be on the critical roles job creation and community development play in stimulating the economy, at the local and national level. 

The principle of economic growth through job creation is a key driver for Spencer Trask. ·In today’s blog, our CEO Bill Clifford lays out the basics of economic sustainability through entrepreneurship and innovation.

According to the Kauffman Foundation, virtually all U.S. net job creation since 1980 have come from companies less than 5 years old.  Essentially, if we want to create jobs, we need to create new companies.

So the solution to unemployment in the US sounds simple: an entrepreneur develops a wonderful new business proposition, funding to start the company is identified and secured, the company is wildly successful, and hundreds of new jobs at all levels are created. The unemployment rolls are subsequently reduced, new tax revenues flow to local, state and federal coffers and the economy rebounds! This sounds like a fairy tale; if it were that easy, why isn’t it happening in any meaningful way today? The flaw in the process, and the biggest impediment in new venture creation, isn’t in the lack of new business ideas – there are literally thousands of entrepreneurs with viable business propositions searching high and low for the key ingredient needed for any new venture to get off the ground – it’s the seed capital!

This critical capital typically comes in many flavors – most likely from the entrepreneur’s savings account or from friends and family – but those resources are expired quickly, don’t bring any/much value-add, and come from non-traditional sources unaccustomed to a high risk profile.  For new venture creation to accelerate, entrepreneurs need access to a source of capital that is currently hard to identify, hard to target, and increasingly elusive – the Angel Investor. It’s this category of individual investor, not the big Venture Capital or Private Equity firms, that is the catalyst for new company formation.  In 2008 alone, angels invested about $50 billion in 54,000 new startups.

Sitting on an estimated $1.5 trillion in cash, individual investors certainly have the capital. What would be the economic/job impact if those Angels invested just 1% of that — $15 billion — of it over the next 24 months?  The answer to that question can be a critical ingredient in our nation’s economic sustainability.

So how do we find, educate and incent these Angels to part with their seed capital?   If we want more jobs, we need tax policy to coax this age-old source of capital out of hibernation.  Tax policy must entice the “investor-next-door” to back the “Edison-next-door.”

The recently passed the Small Business Jobs Act of 2010 extends a tax break stimulus on capital gains resulting from investments in early stage companies by reducing the taxes due on capital gains to 0% – but only for investments made by the end of this year.  This leaves both entrepreneurs and Angels with less than 3 months to find each other, complete some due diligence, negotiate terms and place the investment – a process that even savvy investors with deep pockets would consider a 3-6 month process at best. In 2011 these reduced tax rates will “sunset,” or revert to the rates in effect before 2003, which were generally 28% – hardly an incentive to redirect investable capital away from more predictable yields in bonds and dividend-paying equities into riskier seed funding of new ventures.

The provisions of the Small Business Jobs Act of 2010 will make for great campaign fodder and spin, but it will fail to move the needle toward angel investing.  Zero capital gains tax is a great concept – but this bill lacks the permanence needed to truly accelerate early stage investments by those with the inclination and financial resources to invest.

If America is serious about job creation as a key driver of the economy, this legislative initiative must have a longer life cycle – even to the point of becoming a permanent stimulus to job growth and the US economy – for example,  a tax rate of 0% to a threshold (e.g. $1 million in investor returns) with any returns over the threshold taxed at prevailing dividend rates.

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Incentives must be clear for individual investors and early stage companies.  And they must come at the local as well as national level.  Cities that want to spur their local economies must provide the right incentives to keep startups in the community.  The City of Boston is a clear example of this strategy in place.  Earlier this summer the city’s mayor Thomas Menino announced the Innovation District – a large tract of underdeveloped land in an area with clear opportunity for growth, a skilled and well educated local workforce, and the ideal location for producing innovative ideas, services and products – essentially an incubator for startups.

Coupled with tax incentive for startups and angel investors, this kind of community-centric catalyst for entrepreneurship and can serve as a solid base for the economic sustainability of the city.  And as a concept without borders, this idea could potentially spread across the globe.  Supporting entrepreneurs and early stage ventures while incentivizing angel investors can bring us back to a booming economy.

But here’s the next challenge: high potential early-stage investment opportunities are as elusive to the individual investor as investors are to startups.  Several questions have been raised from would-be angel investors:

• - Where do I go for a consistent stream of quality deals?
• - Who do I go to vet these deals?
• - What form or structure will my investments take?
• - What should I expect after I invest?  Additional request for capital? Transparency into the company’s performance?  Involvement in the company?
• - What kind of investor am I?

As a network of angels, c-level executives, entrepreneurs, and corporate investors, Spencer Trask brings highly vetted opportunities to individual investors and supports them through the investment process from beginning to end.  Members of our network invest for different reasons.  Some are excited about the world-changing potential of a startup’s innovative solution, others are driven by the potential for returns, while still others invest to extend their reach in a certain domain. Whatever the reason for investment, we recognize thatindividual investors backing new companies are the engine that drives job creation and innovation.  This is the key to real economic sustainability.