Fund proposed to aid high-tech growth here

By Sean Hao
Advertiser Staff Writer

Even supporters of Hawai'i's controversial high-tech tax credit program acknowledge one shortcoming of Act 221: It doesn't address local companies' need for second-stage venture capital.

Now state officials are considering creating a new tax-credit program that could help keep companies in Hawai'i by providing them the capital they need to grow.

"All we've had in place until now is 221 — one tool in the entire toolbox — so we overused that tool," said Ted Liu, director for the state Department of Business, Economic Development and Tourism.

"Having other tools in place, I think, is more efficient — you know the right tool for the right job."

The tool that Liu is considering is called a contingent tax-credit-backed fund. Pioneered by Oklahoma and now used by a handful of states, the program typically involves a state borrowing money, which is placed in a fund. Money is leveraged with private investment and placed with venture capital funds that invest in local companies with state oversight.

When investments are made, tax credits are created. But they don't have an immediate drain on the state's general fund, one of the criticized characteristics of Act 221. That's because the credits don't kick in until the fund is terminated, say, after a period of 10 years, and only then if the fund loses money, Liu said.

The tax credits essentially provide a guarantee on repayment of the state's loans.

"Even if we take a discount on what we consider to be historical returns, it would have to be a pretty disastrous situation that we don't get 3, 4, 5 percent return (on the fund) — especially if we have a very diversified portfolio."

Arkansas, Utah, Ohio and Iowa — in addition to Oklahoma — have contingent tax-credit-backed funds or are in the process of starting them, he added.

"We're not trying to stray off the reservation," Liu said. "We're trying to figure out what's been done before and whether or not those things might work within the context of Hawai'i."

Despite Act 221's unanticipated costs and concerns of abuse, its proponents contend it is succeeding in encouraging a high-tech entrepreneurial climate.

Still, Hawai'i companies will need to attract $138 million from venture capitalists outside the state during the next five years to meet their needs, according to an Enterprise Honolulu study.

Lacking local venture capital interest, some companies, such as networking equipment maker Firetide Inc., have shifted some Hawai'i employees to California.

But there is disagreement about the value of a venture fund backed by contingent tax credits.

Such an investment fund will never work in Hawai'i as long as Act 221 remains as it is, said Barry Weinman, managing director of Allegis Capital and a co-founder of HiBEAM, an organization of venture capitalists and others who have raised millions for its client companies.

Among the concerns about Act 221 is that it has been used to finance one-shot movie deals, resulted in tax-credit claims as large as four times the value of the original investment, and cost the state millions.

Weinman, a vocal critic of Act 221, said local venture capital funds can't attract investors as long as Act 221 provides such generous benefits.

"It starves VC funds from getting capital, because they can't compete," he said. "Capital is not being deployed to the better companies. It's being deployed to the better tax shelter."

Consensus on the need to change Act 221 before it expires at the end of next year appears to be building. The creation of a tax-credit-backed fund and a conversion to more return-driven tax incentives could be a part of the debate.

"With the contingent tax credit fund in place, I'm hoping ... that you don't then need to induce investors with a 300, 400 percent return on tax credits," Liu said. "This is not like 221. Nobody's investment is guaranteed to return 100 percent or 200 percent."

Although he is promoting the new venture fund, Liu made clear that he is still supporting Act 221.

Oklahoma has invested $27.3 million in its tax-credit-backed funds, which in turn have invested $89.9 million in Oklahoma companies, according to Robert Heard, president of the Oklahoma Capital Investment Board.

Since the program's inception in 1992, Oklahoma has not had to issue tax credits in order to repay its loan obligations.

Liu said the tax-credit-backed fund is among several capital-raising incentives being considered by the state. Another is tax credits to create closer ties between the University of Hawai'i and the private sector, with the aim of commercializing university research.

State Rep. Brian Schatz, chairman of the House committee on economic and business concerns, said the state needs to address the problem that Hawai'i companies have in attracting expansion capital.

However, he's concerned the state could be left with a hefty bill should such a tax-credit-backed fund lose money.

"We're taking a look at it, and I'm not averse to it in concept," he said. "What we have to look at is: How much is this going to cost?

"It's an incredibly ambitious proposal."

Reach Sean Hao at shao@honoluluadvertiser.com or 525-8093.