What’s wrong with Act 221 in Hawaii (the state tax credit for investment in high tech)?

A. It’s a wonderful law, but most tax laws need to be refined. There are unintended consequences. I’ve been in the venture capital business since 1980, and every state at some point has tried to create a law like this. Every one of them has either gone away or been radically modified because people do try to take advantage of it. What it creates is an investment for tax purposes. The best companies don’t get funded. The best tax deal gets funded.

By:
David Butts
Honolulu Advertiser
Honolulu, HI
http://www.honoluluadvertiser.com in NASFV.org

Barry Weinman

Age: 64
Title: Managing director, co-founder.
Company: Allegis Capital, a $500 million Silicon Valley venture capital fund.
High school: Brooklyn Technical
College: B.A. from Clarkson College of Technology; master’s degree from University of Southern California/London School of Economics

• • •

Q. What’s wrong with Act 221 (the state tax credit for investment in high tech)?

A. It’s a wonderful law, but most tax laws need to be refined. There are unintended consequences. I’ve been in the venture capital business since 1980, and every state at some point has tried to create a law like this. Every one of them has either gone away or been radically modified because people do try to take advantage of it. What it creates is an investment for tax purposes. The best companies don’t get funded. The best tax deal gets funded.

What happens is you create mediocre companies … unless the tax law is defined in a way that puts limits on what you can get from a tax shelter standpoint. But the Hawai’i law has no limits.

Q. Why does Act 221 have the support of the Hawai’i Technology Trade Association, the Chamber of Commerce, Enterprise Honolulu and many Democratic legislators?

A. There are a number of people who represent those organizations who are very well meaning. They want to build a high-tech community in Hawai’i and they want to diversify the economy. I think what they are focused on is a fear that if the law is changed, nobody will know how it will be changed. They would rather have what they have than take a risk on some thing that is unknown.

The danger is … they have never been in a position — at least to my knowledge — of ever having to raise big venture funds. The biggest venture funds in Hawai’i are $30 million to $40 million. In Silicon Valley, we are a midsized fund. We have $509 million. In my own career, I’ve raised close to $2 billion. I know how hard it is.

The bad side of Act 221 is that it discourages the formation of a large pool of capital here. Why? Because most of the venture capital money in the United States — about 50 percent — comes from pension funds. They looked at Act 221 and say people are creating companies that are not necessarily great companies; they are good tax schemes. So why should we invest?

It’s a good law, but it needs fixing. Then we can go to the trusts and the endowments and the pensions and create a large pool of capital — $100 million. There will be enough now to support the better companies, not on their tax deals but on the quality of their companies — which is what the pension, trusts and the endowments want.

Q. What changes need to be made to Act 221?

A. There are three things that need to get done.

There is no other state that gives you as much as a 100 percent rebate, so if you invest a dollar you get a dollar back. In Hawai’i, there are deals where you can invest $1 and get $10 back. There is no cap. The cap should be at least at 200 percent and maybe less.

The second thing is that some companies form subsidiaries. You spin the computer department out and create a company, and now people can invest in that company and get a tax break. That’s not creating any new industries. It’s not creating any new jobs. It’s just transferring a division out to do the same thing they were doing before, and now you get a tax break. That’s shouldn’t be allowed.

The third thing that shouldn’t be allowed is called an escrow account. They raise the money but the money doesn’t actually go into the company. It sits in a limited partnership and instead of the company having use of the money, it’s dribbled into the company on a monthly basis.

So the company stays alive for a four- or five-year period, so they can get the five-year tax break independent of whether the company is a real company or not. There are a couple where they are just shells. One or two people.

Q. Who are the companies that are abusing Act 221?

A. That’s where it gets really tricky, because I’ve been warned about liability. I don’t come to Hawai’i to get in fights with individual people, so I would rather stay away from that.

Q. Who is making the most money off Act 221?

A. My personal opinion is that the lawyers and accountants who are structuring the deals. They can charge a lot of money for these deals because there are millions of dollars involved. I think they are also being shortsighted. If they create great companies, they will be with those companies for a very long period of time. Right now they are getting transaction fees, but they are not building long-term great companies. They are doing very well right now. In my own personal opinion, a number of them belong to some of the organizations that you mentioned and have absolutely a lot of influence in those organizations.

Q. Are they driving a lot of the support for Act 221?

A. I think so. I can’t prove that.

Q: What about Barry Weinman? What do you have to gain in this?

A. I’m in the period of my life where I’m getting ready to retire. I want to move to Hawai’i and I would like to see Hawai’i’s economy (grow). I’ve been very active in the community in Silicon Valley. People ask me to help them do this. I don’t need the money.

Q. But you are still in the game, aren’t you?

A. I like to be around entrepreneurs, and I like them to succeed. A lot of people have great ideas, work hard and really understand what they are doing, but they don’t know how to raise money because they have never had to do that.

Q. Why not make Hawai’i the restful place and leave the business in California?

A. Well, now you sound like my wife. I didn’t want to do this. What happened was Bill Richardson (general partner of local investing firm HMS Hawaii) is a personal friend. He asked if I would come over and meet David McClain, who is dean of the business school (also UH vice president for academic affairs), and he tried to talk me into helping the University of Hawai’i create an entrepreneur center. I said if we do that these guys will have to go to Silicon Valley to work. Why don’t we create some entrepreneurial companies.

Me, personally — what do I get out of it? Satisfaction. Most people don’t believe that.

The chief investment officer at ERS (the state Employees Retirement System) believes nothing I tell him because he says, "I just know that there is a hidden agenda here." I say, "OK, explain to me what it is."

He says, "I think it is world domination." So we kid about it a lot.

I say, "OK, the first step in world domination, we have to dominate Hawai’i." I guess that’s the noose I wear around my neck. I really just kind of fell into it. But then if you do it, you might as well do it right.

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