TOPEKA — The Kansas Department of Commerce is seeking to revamp and expand a program that allows for angel investors in high-risk companies to receive state tax credits to soften their financial risk.
Gov. Laura Kelly’s administration wants to update the sunsetting Kansas Angel Investors Tax Credit statute, citing the need to stay competitive for companies and jobs within the Midwest and mitigate the outward migration of college graduates from the state.
“It’s telling people, look, Kansas wants your business here,” said Rep. Stephen Owens, a Hesston Republican and the sponsor of the bill. “We want you to start here, we want you to take your risks here in Kansas. We don’t want you to leave.”
The new bill would extend the program by five years, incrementally increase the amount of money allocated to the program from $6 million to $8 million per year, and increase the amount of money each investor could receive through the tax credits.
Crucially, the bill would also cut the amount of time most of the businesses must stay in Kansas after receiving the tax credit from 10 years to five years.
The 2021 Legislature will be asked to decide on renewing or abandoning the program, which currently relies on $6 million annually in state tax dollars to inject capital into companies. The previous renewal bill signed in 2016 by Gov. Sam Brownback featured a five-year sunset.
The program works by having businesses apply for the tax credit, and the Department of Commerce said each business that applies in the first round typically gets up to $150,000 in those tax credits that they can then distribute to investors. If there is additional money left, eligible businesses can return for an additional round of tax credits.
Qualified businesses must be less than five years old and have less than $5 million in annual revenue. Currently, 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.
The new bill would increase that to allow investors to earn up to $100,000 in state tax credits per company and up to $350,000 per year. Commerce said this update was needed because there are also income and net worth requirements for investors, meaning the amount of eligible investors in the state is limited, and this would give them the opportunity to invest in more companies through the program.
The House Commerce, Labor and Economic Development Committee heard testimony on the bill from the Commerce department and supporters of the tax credit earlier last week.
Owens said he worked with the Commerce department during the offseason on improving this program and supported the efforts to update and grow it. As an entrepreneur, he said, he is familiar with the challenges faced by those starting a business. He noted that the angel investment is usually the first round of funding, and therefore the riskiest.
“We look at these economic incentives, and my first instinct is to cringe at them,” Owens said. “Then my second instinct is to say, ‘OK, well, what if we don’t play the game?’ I can tell you what happens in Kansas because I’ve been involved in these circles for many years. They go to Kansas City, Missouri, and Oklahoma City, and they go to Dallas. Because that’s where the resources are.”
Audit finds issues
The program hasn’t been without its challenges.
An audit presented to the committee and released last week noted the law as written does not include any way to effectively measure the success of the program, whether that’s jobs created or return on investment through economic growth of the company.
The audit found that at least three companies from the program were no longer in Kansas, but the law’s clawback mechanism — which would force the company to return the tax credit money if they left the state before 10 years — had not been used, effectively giving the businesses taxpayer money despite no longer adhering to the program.
The Kansas Legislature’s auditors also discovered this 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.
The changes the Commerce department is requesting in the new bill do not include any form of measuring the success of the program as recommended by the audit.
David Soffer, legislative and policy director for the Commerce department, said the current administration can’t speak to what happened before 2018 with the program. The agency now is committed to making the program more user friendly for businesses, but also ensuring they follow the standards set forth in the program, he said.
Soffer said of the three companies the audit found to have left the state, two are beyond the time limit to use the clawback mechanism. Commerce is currently investigating the third.
“I can’t speak for the previous secretaries. I don’t know why they chose to do the things that they did,” Soffer said. “I can tell you that since Secretary (David) Toland has been in office, clawbacks have been a priority. If a company is not following the rules, we do need to claw back. That’s a fact. That’s why we want to change it down to five years. We want to make sure they have a fair standard, but if they don’t meet the standard they need to give the money back to the taxpayer. That’s perfectly right.”
The one exception to the shortened time limit would be bioscience companies. Unlike other companies that qualify for the tax credit within five years of founding, all bioscience companies would have 10 years after founding to qualify for the program, but would be required to stay in Kansas for 10 years after receiving the tax credit. Soffer said the reason for this exception is straightforward: They need more time because bioscience companies have to apply for the yearslong U.S. Food and Drug Administration approval process.
Advocates of the bill said it can be challenging to measure the success rate of the program, because these are often the types of companies that wouldn’t get outside funding, and therefore are more inherently risky than other startups.
“If you’re a company that has easy access to capital, for the most part you’re not coming to the Kansas Department of Commerce, because we ask for a good amount of information about your business and then we hold you to those standards with the potential that we may take the money if you don’t follow it,” Soffer said.
Soffer said in 2019 the department and the program manager for the program had started instituting site visits before COVID-19 to ensure that the businesses were located in Kansas. The department plans to resume those visits when it’s safe to do so.
The requested changes, Soffer said, bring the program more in line with the realities of modern startups. The department requested a shorter timeframe for most businesses in the program because it is common for startups to sell in the first 10 years, which could move the business out of Kansas but wouldn’t necessarily be a bad thing.
Soffer used EyeVerify, a biometric software company, as an example of the promise of the program. The company is now based in Kansas City, Missouri, but its success is felt in Kansas. When the company sold to Alibaba for $100 million in 2016, the founder became an angel investor in Kansas, he said.
“If we’re going to get our economy closer to where the global economy is heading, It’s these high risk companies that are producing the most growth when successful,” Soffer said.