We recently put together a list of policy recommendations for the incoming administration that relate to helping small and medium sized technology businesses, and we’re looking for your feedback! Are these the right things to concentrate on? Did we leave something out? Read the recommendations below and then send your suggestions to mmoskal@actonline.org.
Stimulus Package for American Innovation and Entrepreneurship
Throughout American history, investments in research and development during economic downturns have provided the fuel for economic recoveries that followed. During the Great Depression, Du Pont’s research team invented Nylon and Douglas Aircraft developed the revolutionary DC-3. Hewlett Packard invented the pocket calculator during the recessions of the early seventies. During the economic slowdown of the late 1990s, Apple developed the iPod and iTunes and hundreds of successful, innovation-focused firms were created.
While history suggests the importance of investments in innovation during economic downturns, it is often counterintuitive for firms facing slowing sales, mounting debt, and limited opportunities for credit. The current credit crunch is making it particularly difficult for entrepreneurs to stay afloat, let alone keep investing in new research and development.
While it is often true that good ideas fund themselves, the current economic crisis is changing the normal rules. Startups and even more established small companies are unable to obtain capital to grow their businesses. Even worse, many companies are having a hard time staying afloat, and desperately need working capital to pay employees and sustain the business. Bank bailout money is not circulating fast enough to smaller businesses, and is itself not enough to feed the fire of entrepreneurship and innovation.
Now is the time for a comprehensive strategy to incentivize the continued formation, growth, and acquisition of startups in the IT industry. We believe a stimulus package should focus on three key things: access to capital; promoting research and development job creation; and more rapid and accessible technology transfer.
Rescuing Good Companies From the Credit Crunch – Unlike the early 1990’s, where workers that lost their jobs often started new companies, today’s economic crisis puts a squeeze on entrepreneurs and small businesses in a new and devastating way: the loss of access to credit and capital.
Right now, the best companies are having trouble getting the working capital they need to survive the next year and even the best ideas are struggling to find funding to get off the ground. Entrepreneurs and small businesses need ready access to funds for working capital to pay employees, and to continue hiring workers and innovating new products and services. Federal policy must incentivize the kind of investment that leads to the startup and growth of IT companies.
• “Payroll Points” for Financial Institutions that Disburse Loans to Startups and Small Businesses. Federal policy should create incentives for financial institutions to provide working capital loans to small businesses. The current bailout funds are not trickling-down from the big banks to the small businesses that need money the most. In order to drive banks to make these loans, Financial institutions should receive “payroll points”—a payment from the federal government to financial institutions that help companies maintain and expand their payroll. For each working capital loan of 30 days or more to a small business, a financial institution would receive a “payroll points” payment of two percent of the total loan amount. The payment would occur at the granting of the loan and would be paid out of existing bailout money. As a condition of accepting payments, banks would have to show that they have in-fact expanded their loans to a larger pool of applicants.
• Turn R&D Tax Credit Into a Small Business-Friendly American Job Creation Credit. As research has proven, the R&D tax credit is a direct subsidy toward the creation of high-paying American jobs focused on innovation. In today’s flat world, the R&D tax credit stimulates job creation by lowering the marginal cost of hiring research scientists in the United States. Small firms are the engines of innovation and job growth, but many are unable to take advantage of this credit because they have no current revenues and/or do not have a long enough corporate history. . The key to making the R&D Tax Credit work for startups is to make it refundable.
• Provide Start-up & Early-Stage Businesses Tax Relief. Businesses are typically volatile in their early stages, and tax benefits can help nurture their growth without a large impact on the federal budget. Yet tax relief would have significant benefits for job creation. On the margin, tax relief for early-stage companies provides greater incentives for their formation, resulting in more jobs. These changes would have relatively small budgetary impact:
- Exemption from Corporate Income Tax. Start-up companies should receive an exemption from corporate income tax in their first three years of operation.
- Capital Gains Exemption. Capital gains exemption should apply for stock held three years or more by founders, individuals and institutional investors, up to the first $5M gained.
- Encourage Mentors to Serve on Boards. Director stock compensation in early stage companies should be made tax-free for 5 years. This would create powerful incentives for experienced people to serve on the boards of young businesses and mentor entrepreneurs.
• Maintain capital gains tax treatment for carried partnership interests. Last year Congress introduced legislation (H.R. 2834, H.R. 3996) that would treat profit, or “carried”, interests as long-term capital gains. A carried interest is a fundamental aspect of capital investments in IT businesses. Investors contribute capital to a fund in exchange for limited partnership interests, which the fund invests with the intent to sell at a profit. The fund’s investment professional, as general partner, usually receives a management fee and a “carried” interest equal to a certain percentage of appreciation in the fund investments. Because profits are far from a sure thing, a carried interest is a risky investment. Taxing income on carried interests increases the required return from investing in companies. This means that more startups will not get the money they need to grow their business, or that investment funds will take a greater equity stake of the companies they invest and thereby leave less for the entrepreneurs themselves.
Provide Incentives to Create and Invest in New Startups – In addition to keeping the existing good companies afloat and growing, the administration should look for ways to promote the creation of new ideas and commercialization of new research.
• Tax-free Licensing of Intellectual Property for New Startups. Federal tax policy can help “prime the pump” for innovative new businesses—make the licensing of intellectual property tax-free. All licensing fees earned from patents and copyrights created in the U.S. would be exempted from federal income taxation. This exemption would be available to small businesses with no more than 150 employees and have been in existence for three years or less. This policy would create incentive for businesses to relocate their research and developments activities in the U.S., and would help keep America competitive with the rest of the world.
• Reform tax law to remove disincentives to corporate-sponsored university research. Current tax law penalizes universities that accept corporate research funds. Universities fear a loss of their tax-exempt status if they provide contributing corporations with flexible intellectual property licenses; reducing corporate access to university R&D. American companies are instead taking their research dollars overseas, where there are fewer restrictions. Congress eliminated this threat for government-sponsored funding. Corporate-sponsored funding should be treated similarly.
• Create a Quasi-Public Entity to Stimulate Innovation Through Enhanced Technology Transfer. The U.S. is a world leader in government-funded research, spending almost $20 billion on basic R&D. However, the utilization and commercialization of basic research is lacking, particularly from federally owned and operated national laboratories. This is a missed opportunity for the U.S. economy and American small business technology innovation. One answer is a Technology Commercialization Foundation to unlock the crown jewels of our federal research and better commercialize them. A technology commercialization foundation would assist universities in developing best practices and partnering small businesses with translatable research opportunities.
There will be critics that could oppose these policies. Large companies may view them as unfair, and may characterize the focus on small businesses as misguided. They may oppose using the set aside “bailout” money for small business projects. Other critics may oppose what they see as another bailout. However, a “bailout” this is not.
The above policies are packaged as an opportunity to address issues that are in some cases, long-standing and needing reform. Furthermore, it seems to only make sense that Federal policies should encourage bottom-up assistance in addition to a “trickle-down” bailout approach. A focus on stimulating access to capital, research and development, and technology transfer will result in broad economic benefits, creating more jobs and promoting innovation.