As you read the words that form this opinion, know that we have a vested interest in the success of Minnesota’s technology entrepreneurs and the startup community at large. It’s formed with only the longest and strongest views in mind — extending beyond blind, blanket support in any form just for the sake of it. Not all support is created equal as some methods have unintended consequences, moral or practical trade-offs to consider.
The end of an era is here for Minnesota’s most popular corporate welfare program, at least the one that hits closest to home for so many of our readers and their business dealings.
The Angel Investor Tax Credit (AITC) was born in the spring of 2010 as a part of a broader bill among new laws pertaining to government sponsored economic development. The method used political means to influence the private business community by taking money from all of Minnesota tax payers and funneling it to a very select group of individuals known as accredited investors — defined as those who have a net worth of a million dollars plus or earn in excess of $200k/year.
The “credit” component equated to a 25% kickback on an investors tax return, up to $125k/year per person, on select startup investments made through the program. It was only available to the few at the expense of the many, and while accredited investors may not be within the top 1% statistically, they are surely among the top 10% of income earners across the state of Minnesota.
For those with strong beliefs one way or the other about trickle down economics, there could not be a more explicit example in action than the AITC premise: if the government stepped in to bend the tax laws in favor of the wealthy, then a broader ripple effect would occur for all.
With a 25% discount available on their dollars, the theory is investor risk would be reduced, potential IRR increased, and/or purchasing power extended. The intention here would be to stimulate their appetite for action, to push them past the tipping point by manipulating the math into their favor, to incentivize accredited investors to invest more money, more often.
As a hypothetical consequence, AITC certified startups could now position themselves as more attractive when pursuing investment or seeking that extra concession to close a deal. For these ventures, it was like going on sale by offering a discounted stake without having to actually pay for the price break since that kickback was indirectly covered by all the taxpayers, not the startups founders or shareholders themselves.
Recipients of this investment money (that they otherwise might not have) could then, in turn, spend their new/extra capital on resources such as hiring more employees to increase production and probability of success out there in the market.
For enabling this scenario to exist in the first place, the government gets what it wants: public relations and the impression of new job creation to expand the local tax base and revenues necessary to perpetuate its own business model.
And for the public, those not part of the technology industry, not entrepreneurs or investors, they indirectly get…the promise of a better future for Minnesota as a result.
Everyone wins, right?
Suddenly, Minnesota’s Department of Employment and Economic Development (DEED) became a intermediary at the table, party to an otherwise private transaction, picking winners and losers when determining which private companies and investors were qualified to participate in the scheme.
For seven years now, Minnesota’s tech investors and entrepreneurs generally embraced the government intervention as a solution to their free market challenges, touching many different Minnesota corporations, local and national investors over the years.
At the highest level, the welfare spanned 450 different companies and 2,000 unique investors with one hundred million dollars in credit kickbacks tallied up by the end of this year. It was said that investors came off the sidelines, new capital was deployed, startups got funded that otherwise wouldn’t have, companies stayed instead of leaving, and overall the directive was working as intended.
And some jobs were made: they key metric scored by AITC’s political advocates to subjectively judge efficacy was 1,168 related jobs when last reported at the end of 2016, which breaks down to a public cost of $77,637 per job.
The AITC will now be laid to rest at the end of 2017 based on a new and different law introduced by Minnesota’s political actors, one that does not legally permit DEED to take money from all classes and redistribute it to the highest in the name of innovation.
Welfare lobbyists mourn as this development disrupts their ability to continue receiving millions of free dollars, forcing them to step up or step aside for the savviest of investors, many of which never needed or accepted welfare in the first place. On the startup side, surely there will be pain in the process of accepting a new norm, one where the carrot must cultivated 100% by the entrepreneurs themselves, no more public support for their private profit pursuits.
Combined, the net effect will initially look like a reduction in the quantity of deals done and dollars invested, as far as Minnesota tech is concerned, considering that approximately 50% of the AITC transactions were Internet/hardware/software oriented. As more time passes, the market will adjust on its own and the best startups will naturally rise to the top, continuing to capture the necessary funding without crutches, as they have been doing all along.
In essence, pulling out the safety rug out from underneath will weed the weak while the strong will soar. It’s a future of quality over quantity, one where companies and their investors that prosper will be fortified to withstand the globally competitive marketplace in which they operate because they’ve earned it, not because it was propped up by political programs to appear larger than life.
This is exactly how business functions at the ground level where the product meets the market and pure Darwinism, like it or not.
The AITC existence only meant that the local market could continue along in its dysfunctional ways without facing the facts of what’s broken between startups and investors. Consider that investment — whether it comes from customer sales or investors — can either be found in abundance or in scarcity, and is always an effect, never the cause.
Money is a measurable byproduct of economic value creation, therefore a lack of value created in the market correlates closely to lack of sales and investor appetite, or vice versa, it never fails.
This happens all the time and is the way of the venture world where a deal stands on its own merits and is priced accordingly, or it doesn’t, and the failure rate is high at the tip of the startup spear because is bar is set by the market. When the market itself isn’t supporting the fundamental value proposition, via revenue — or investment capital in the case of AITC — that’s a warning sign that something isn’t right in the business model.
Greater alignment between these factors (product-market) now means that entrepreneurs will find out faster if their venture has what it takes to succeed in the real world, to create actual value, and offer sustainable employment opportunities that are derived naturally, not watered down government sponsored economic development. Real jobs come from strong companies that are proving their value based on true market demand from customers and capitalist investors, nothing less.
Built to last style entrepreneurship happens when companies are created using their own resources, not off the backs of the public sectors labors. Perhaps the most entrepreneurial environments by default actually have the least amount of government involvement — the two variables could be inversely related.
And perpetuating a business culture that is tied to the volatility of politicians and their antics, one that reinforces dependency, now that’s just unnecessarily risky. If so much of business is about reducing risk, then why would any entrepreneur or investor intentionally create a scenario whereby their prosperity is contingent upon the whims of politicians? Or an environment that becomes dependent upon having a long term, essentially permanent, welfare system that becomes status quo. The whole point of introducing a stimulus should be to one day stop it because whatever was off in the first place has been figured out and such subsidies are no long deemed necessary for the market to function.
No more AITC means no more political intermediaries, less time and energy spent lobbying, less rhetoric about ‘support for startups,’ which frees up time and space for becoming an active and/or better investor who doesn’t need tax credits to make a favorable return.
For those afraid of what happens next as the corporate welfare runs dry, consider what it means to support startups in a true entrepreneurial environment where deals price fairly, judged only by those with the knowledge to know and courage to participate.
A place where corporate life, death, and resurrection are naturally occurring phenomenon, just like nature itself. A thinning of the herd is about to occur as a new generation of makers, doers, creators — such capitalistic risk takers emerge.
The AITC’s demise is good for Minnesota tech because it brings out the best entrepreneurs and investors by forcing everyone around to adapt or perish, freely letting the tenets of capitalism decide who wins and loses, not the government. It’s good for Minnesota tech because it makes for an entrepreneurial community focused more on real value creation, not the pretense of it, nor one distracted by inflated job numbers. It’s good for Minnesota tech because it reduces dependency on bureaucrats, and brings the two parties together that matter the most to sort things out like the adults they are. It’s good for Minnesota tech because there are sufficient numbers of capable entrepreneurs and active investors to adequately represent this great state without welfare handouts in the mix.
Whether you agree or not with this opinion set forth, doesn’t change the circumstances that exist and isn’t really important relative to what’s next. There’s nothing else left now for everyone to do but be optimistic about a futureless AITC. What matters from this point on, is if and how Minnesota’s entrepreneurs and investors decide to evolve their attitudes and actions to meet this new reality.
Everyone has a choice, it’s one they can fully control, and the opportunities abound for those who choose open hearts and minds.
*Thank you to Jeff Nelson at DEED for his consistent and professional public service over the years.