Model Bill Aims to Fill Hawaii Capital Fund Void

Months of behind-the-scenes planning have gone into the new capital formation bill scheduled to be unveiled later this month in the 2004 legislative session.

By:
Terrence Sing
Pacific Business News

http://www.nasvf.org/web/allpress.nsf/pages/8248

Based on a model pioneered in Oklahoma, business leaders and state officials believe it could help fill a capital void here beyond the seed funding normally raised through Act 221, the state’s high-tech tax-credit law.

That void is estimated to be $233 million over the next five years, $95 million of which is expected to be raised locally if existing startup and emerging companies remain here, according to a 2003 study commissioned by private economic development group Enterprise Honolulu.

The fund could help diversify the state’s economy through increased venture capital investments in new or expanding companies that would in turn create more and higher-paying jobs.

There appears to be broad support among industry associations and economic development groups for the Oklahoma model, but, for political reasons, few have been willing to go on record to describe the plan in detail.

A coalition of private industry groups, including the Hawaii Venture Capital Association, Hawaii Technology Trade Association, Enterprise Honolulu and various stakeholders here plan to formally introduce the capital formation bill, which they are calling the State Private Investment Fund, at a State Capitol briefing on Jan. 29.

Gov. Linda Lingle’s administration has declined to discuss details of upcoming legislation until it submits its legislative package on Jan. 26.

Details of the capital formation bill, which has the support of both the House and Senate economic development committees, are still being finalized, said Ann Chung, executive director of the Hawaii Technology Trade Association.

"I know the administration supports the concept, which came from private industry," she said. "I don’t know if it’s going to be in the administration’s package."

A number of different drafts have been circulating, said Sen. Carol Fukunaga, chairwoman of the Senate Economic Development Committee.

"We just have to wait and see what emerges during session," said Fukunaga, who declined to comment further until the bill is introduced.

Industry insiders are waiting to see if the administration will hold Act 221 hostage, requiring liberally construed language be removed and the research and development credit adjusted, in order for the capital formation bill to be adopted. Last year, House and Senate Democrats fended off the administration’s repeated attempts to change the law.

But talks of a deal being cut behind the scenes between Act 221 advocates, who don’t want to see the law sunset in 2005, and the administration, have been circulating.

"These are really separate issues," said Enterprise Honolulu Chairman Mike Fitzgerald. "The Oklahoma model is a separate fund that would deal with second- and third-stage financing, not just for high-tech companies, but for any business. It’s just a capital fund."

The only relation between Act 221 and the Oklahoma model is that there may be some political tradeoff, he said.

Ted Liu, director of the state Department of Business, Economic Development and Tourism, has sought a consensus in the business community on Act 221. At his urging, over the past two months, the Hawaii Business Roundtable and Economic Development Alliance of Hawaii met with stakeholders to determine their position on Act 221. According to one industry source — who asked not to be identified — the idea was to report back to Liu.

"The strategy was to bring in respectable people like [retired] Adm. Bob Kihune [chairman of the Economic Development Alliance] and Mitch D’Olier [chairman of the Hawaii Business Roundtable] who were not involved in the debate, were well respected and perceived to be objective," the source said.

While various drafts of internal memos summarizing their mostly positive findings have been circulated, they have not been released officially. However, PBN has obtained a draft approved by neighbor island economic development boards (see accompanying story).

Another source, who also asked not to be identified, said there was a belief among those who participated in the discussions that the administration had already made up its mind about Act 221.

Though Liu commented on a story that ran in PBN’s Jan. 2 edition discussing the Oklahoma model and Act 221, he declined further comment on this or any other legislative matters until the administration introduces its legislative package.

Stakeholders have been trying to reach an agreement on amending Act 221 in order to get the law extended beyond 2005, Fitzgerald said.

"We’d be willing to make some exceptions on our position in lieu of an extension of five to 10 years," he said.

How the Special Private Investment Fund would work

The Special Private Investment Fund, which is based on a working Oklahoma model, would be managed by the Hawaii Strategic Development Corp., a state entity that is in effect a cash-poor fund of funds.

In theory, the capital formation bill would create a $100 million fund that could be matched with another $100 million from participating fund managers. It’s still not clear whether the money would be funneled through a single or several fund of funds on its way to venture funds that would in turn invest in high-growth companies.

The Hawaii Strategic Development Corp. would borrow from banks to create the fund with state tax credits as a guarantee to large institutional investors. If the return on investment fell below the guaranteed rate of return, tax credits would be sold to contingent "tax credit purchasers" to make up for the shortfall. Such tax credit purchasers could be the banks themselves, insurance companies or other companies or high-net-worth individuals with large tax bills.

"Banks are not in the business of investing in venture capital," said Tareq Hoque, a former Wall Street investment banker and founder of Hawaii wireless high-tech startup Firetide. "They are going to invest in it with the guarantees of state tax credits to protect their investment."

Hoque’s hands-on experience in the world of high-stakes venture investing has led to a more realistic view of the deal-making process.

"My experience from Wall Street is the more people and parties involved in any transaction, the harder it becomes to pull off," he said. "The Oklahoma model involves a large number of players. You have to have large institutions invest the money through loans, people or institutions to buy the contingent tax credits, venture capitalists who can properly invest the money in local startups and companies that can effectively take the money and make good investment decisions."

Ann Chung, executive director of the Hawaii Technology Trade Association, is confident the Oklahoma model could solve the state’s long-term capital needs without draining state coffers.

"The coalition scoured the different mechanisms used by other states that worked," she said. "We didn’t want to start something completely new. Oklahoma has been using this model for 12 years and not one dime has come out of the state to subsidize it."

The coalition believes very strongly Act 221 and the Oklahoma model can coexist, she said.

"Act 221 can support the startup companies and the Special Investment Fund will take care of second- and third-stage funding," Chung said.

Hoque also believes both laws can coexist.

"I don’t think they are mutually exclusive," he said. "The real issue on Act 221 hasn’t been its effectiveness, but the overall cost of it and alleged abuses."

Exactly what ratio of tax credits will be doled out by the proposed Special Private Investment Fund is still unclear.

"If I’m going to buy a tax credit, I’m not going to buy it dollar for dollar," Hoque said. "You are going to want a sweetheart deal."

It’s going to take a commitment from local banks and other large capital sources for the Oklahoma model to succeed, he said.

"I think the Oklahoma model is helpful," Hoque said. "I don’t think it’s the silver bullet. It’s one part of an overall technology policy."

Business community reacts to Act 221

A series of draft memos has been circulating in the business community to gather a consensus on Act 221. The following is a portion of a draft obtained by PBN and approved by the neighbor island economic development boards.

They found Act 221 has a positive impact on high-tech investment in Hawaii, but that uncertainty about it has caused harm.

The following points are, for the most part, consistent with other drafts that have been circulated by other business groups, but not officially released.

Changes to Act 221 would be acceptable if the following criteria were met:

1) Prospective only — transitional rules will allow grandfathering of existing investments, including follow-on funding of previous investments under original law.

2) Ten-year extension of the statute through Dec. 31, 2015.

3) Acceptance by the administration and Legislature so that the Tax Department would again begin issuing comfort letters on a timely basis. Provide a time limit for responses to letter rulings and settlement of refund claims.

4) Continue to permit investors in qualified high-technology businesses to privately negotiate and allocate among themselves their investment tax credits as they deem appropriate, on a case-by-case basis, unrestricted by the state.

5) Escrows and similar restrictions on funds should continue to be subject to private negotiations among investors and the qualified high-technology businesses they invest in.

6) Research and development credit should be limited to qualified high-tech businesses and to situations where high-tech jobs are created, maintained or preserved in Hawaii.

7) The use of Act 221 for one-shot films being produced in Hawaii would be prohibited.

8) Existing comfort letters will not be limited by future changes, except as may apply to the entire act.