ISLAND VOICES
Act 221 debate misses point

By Barry Weinman
Managing director of Allegis Capital and a co-founder of HiBEAM

The current debate on Act 221 and The Advertiser editorial of May 18 fail to consider the major issue that Act 221 affects: long-term capital formation. Without a significant pool of risk and venture capital, Hawai'i will not be able to diversify its economy and build a high-tech community.

The current Act 221 tax-credit debate revolves around budget consequences, high-tech job creation, incentives for companies to re-locate to Hawai'i, and offsetting of Hawai'i's business regulations, taxes and disincentives. Politicians disagree on who is the more supportive of high tech — those who want to keep the law intact or those who want to clean up the abuses in the law.

These are interesting and debatable questions, but they pale by comparison to what should be the central question. Act 221, even as currently structured, will only provide seed and first-round funding to start-ups. Where will the follow-on capital come from?

In order to build a successful and sustainable high-tech community, Hawai'i must figure out how to provide a large and stable capital pool, so that when local companies are ready for expansion capital, they can raise a portion of that locally. If a significant capital pool — $75 million to $100 million — is not developed soon, these young start-ups will be starved for capital or will have to relocate to be near their future investors. All of the Act 221 and angel dollars invested in the last two years will either be lost or significantly washed out if there is no capital pool for local follow-on investments.

As a Silicon Valley venture capitalist, I always ask companies that come to us for the next round of funding, "How much are your local investors, those who know you best, putting into this round?" Local investors must invest in each of the three to six rounds needed to grow significant companies. After all, why should we in California invest when the start-up's own community doesn't think it's a good investment?

During the last two years, pension funds, trusts, endowments and corporations — the lifeline for significant pools of venture capital — have been educating themselves on how venture capital and private equity can improve their investment performance. This education process is essential for the capital-formation process. Professional investors are adverse to investing in asset classes they do not understand.

Act 221, with its obvious abuses, plays into the hands of trustees who are cautious. They view venture capital as risky and hard to understand. They must have absolute confidence in the ethics and transparency of venture fund managers and entrepreneurs. Even supporters usually quietly admit that Act 221 encourages sham tax transactions, and some unscrupulous people have brokered transactions that have little or no economic value. Many of these trustees are now sitting on the sidelines. The two-year education progress will soon be wasted.

Without the participation of Hawai'i's major institutions in investing in Hawai'i start-ups, I believe the unintended consequences of not correcting the flaws in Act 221 very soon will result in:

• Quality start-ups that will be starved for their next round of capital and will either fail or move to the Mainland to be close to their investors.
• Hawai'i's reputation being marginalized and viewed as being home to tax shelters and unethical business brokers.
• The government will soon tire of the tax losses with little or no lasting gain of quality jobs or economic diversification and will sunset the act.

The Hawai'i high-tech community should have confidence that the Legislature will be responsible and will make reasonable modifications to Act 221. Closing the tax loopholes will encourage professional investors to have confidence in the ethics of local venture funds and entrepreneurs.