Kansas audit questions management of state’s angel-investor business incentive

2021 Legislature has option of clipping wings of $6M program

David Toland, secretary of the Kansas Department of Commerce, and Gov. Laura Kelly have concentrated the past two years on internal reviews of economic development programs, including the angel investor tax credit that drew attention of legislative auditors. (Sherman Smith/Kansas Reflector)

TOPEKA — The Kansas Department of Commerce declined to claw back $340,000 in income tax credits from three start-up companies that left the state before expiration of a 10-year angel investor agreement.

It appears the state agency didn’t like the stay-in-Kansas limitation and would appreciate lawmakers slashing it to five years.

The Kansas Legislature’s auditors also discovered this angel-investor program initiated in 2004 and hailed by advocates as an engine of economic development served companies in just eight Kansas counties from 2015 to 2018, with Johnson County scoring two-thirds of $51 million drawn to these fledgling businesses. Early stage investors working with the state during those four years pocketed $20 million in income tax credits, but auditors found participating companies didn’t survive as long as nonparticipants. Of more statistical significance, participating companies generated one job every two years from 2009 to 2019. Nonparticipating companies in an audit control group added one job annually.

Defining success of this risky business endeavor is subjective because the Legislature has never established in law metrics for evaluating the business tax break.

The 2021 Legislature will be asked to decide on renewing or abandoning the program relying on $6 million annually in state tax dollars to inject capital into companies working to market innovative products or services. The previous renewal bill signed in 2016 by Gov. Sam Brownback featured a five-year sunset. The administration of Gov. Laura Kelly is committed to amending and continuing the program for angel investors.

“As one of the few programs in our state focused on innovative entrepreneurship, we must continue to support this crucial program,” said David Toland, secretary of commerce for the past two years and the state’s lieutenant governor as of Monday.

 

Likes the cease fire

Kelly said she long ago directed the commerce department to launch a review of all the state’s business incentive programs with the goal of improving return on investment, but the COVID-19 interfered with the 2020 legislative session and portions of the reorganization.

Commerce was working to make state economic development investments of greater benefit and expressed pleasure in the agency's involvement in a record $2.5 billion in capital investment projects in 2020. (Sherman Smith/Kansas Reflector)
Gov. Laura Kelly said the Kansas Department of Commerce was working to make state economic development investments of greater benefit and expressed pleasure in the agency’s involvement in a record $2.5 billion in capital investment projects in 2020. (Sherman Smith/Kansas Reflector)

The commerce department was able, the governor said, to usher through a state record $2.5 billion in capital investment during 2020. The department last year closed on 131 development projects that created or sustained nearly 14,000 jobs — despite the pandemic.

The previous year’s total for capital investment in Kansas projects involving the commerce department was closer to $1.3 billion, officials said. The agency has tracked data for about 35 years.

“It’s important that we do not let the events of the last year be exclusively defined by hardship,” Kelly said. “Due to good public policymaking and fiscally responsible decisions my administration has made from day one, our state has been able to weather the worst of COVID and protect the foundation that will keep Kansas on the path forward.”

The Democratic governor said during a Kansas Reflector podcast interview that she was jubilant a cease fire was negotiated with Missouri officials to lower the frequency of cross-border raids leveraged with taxpayer-financed incentives from both states.

Some companies had notoriously exploited programs in both states by moving periodically from one location to another — a maneuver that didn’t add to the two-state job total or generate real business expansion.

“We were just wasting money,” Kelly said. “We were taking incentive money that we had and moving somebody across the river. We really changed all that.”

 

Angel skeptics

The audit of Kansas’ angel-investor program was the first in a series of examinations of economic development initiatives ordered by the Legislature. These were sought by lawmakers skeptical about these taxpayer-backed investments in terms of job expansion and product development. In round two of the auditing, the state’s popular STAR bond program will be analyzed.

Information technology, medical and pharmaceutical companies have been the most frequent recipients of angel investments in Kansas. The state makes $6 million available for tax credits each year. Companies eligible for investment funding must have 80% of business operations and 60% of employees in the state. Qualified businesses must be less than five years old and have less than $5 million in annual revenue.

An angel investor can earn up to $50,000 in state tax credits per company and no more than $250,000 per year in total tax credits. Each credit is equivalent to 50% of the cash investment in a start-up company.

Sen. Julia Lynn, a Johnson County Republican who didn’t run for re-election in 2020, said she wasn’t clear what the angel program had done for the economy since created more than 15 years ago.

“The data needs to show that it is working,” she said. “We want the innovators, obviously, to be successful in Kansas. We also want them to stay here.”

Auditors looked at 181 Kansas businesses that received angel investments from 2009-2019. For comparison sake, a control group of 65 companies was created by the audit team. Control companies were found to have a better survival rate after three and five years, the audit said. Among participating companies, 39% were in business after three years and 28% after five years. The control group’s survival numbers: 53% after three years and 38% after five years.

Rep. Kristey Williams, a Augusta Republican, said job growth statistics for the angel investor program should be explored by the Legislature as it considered renewal. There is interest in a core question: Is net gain of 212 jobs over the decade from 2009 to 2019 worth millions of dollars in tax breaks to angel investors?

 

Eight of 105 counties

Auditors reported the angel investors put $51.5 million into Kansas businesses from 2015 to 2018 and consequently earned $20.2 million in state income tax breaks. One way to look at it was Kansas surrendered $1 of tax income for every $2.50 invested in these businesses.

Andy Brienzo, who works with the auditing arm of the Legislature, said 78 start-ups received funding in those four years from 716 investors. Forty-eight of the businesses were in Johnson County, and those firms landed $32.6 million in angel investment cash. There were 27 businesses scattered among Sedgwick, Wyandotte and Douglas counties that accepted $17.1 million from angel investors. Four counties — Cowley, McPherson, Riley and Shawnee — each had one business in the program and the total investment there was $1.7 million.

Brienzo said it was “statistically significant” that participating businesses created jobs at about half the pace of nonparticipants.

“This is really geared to high-risk companies,” said David Soffer, the commerce department’s legislative and policy director. “Some of them are going to succeed. A lot of them are not. That’s understood.”

Sen. Richard Hilderbrand, a Galena Republican, questioned the decision by the commerce department to not penalize three participating businesses that left Kansas more quickly than statute allowed under the program. He was told the department was weighing the possibility of seeking reimbursement from one company, but it was unlikely reimbursements could be obtained from the other two.

The auditors recommended the Legislature consider shortening the 10-year retention requirement. In addition, auditors suggested legislators and the governor clarify the investor tax credit program’s goals by setting benchmark measurements of success.