RESEARCH TRIANGLE PARK, N.C. — If North Carolina Gov. Bev Perdue truly wants to spark the state’s faltering economy, she should insist the General Assembly adopt her ideas for a “Founder’s Credit” ASAP, as in "as soon as practical."

The new governor is under tremendous budgetary pressure as her term begins with a deficit estimated at more than $3 billion in the year that starts July 1. Tax increases rather than tax breaks are higher on most people’s agendas. However, Perdue sent a lightning bolt through the state’s investor and entrepreneurial communities last week when she said her budget would include an exemption on capital gains for founders when they exit (sell, merge, take public) their ventures.

Angels, venture firms and entrepreneurs, especially in the high-tech and biotech sectors, have lobbied hard for such legislation in recent years. As Richard Holcomb, the founder and chief executive officer at StrikeIron told LTW last week, he knows entrepreneurs who have moved out of state to escape N.C.’s taxes. Holcomb grew and sold two other ventures but, so far and luckily for the state, has chosen to stay home.

When Local Tech Wire sought comment from the three of the state’s top business organizations (NCTA, CED, NCBIO), entrepreneurs and investors, the reaction was quick – and stunningly positive. In the more than 15 years I have been writing about high-tech and life science in North Carolina, I have never received so much reaction so quickly. In fact, one organization CEO called me within seconds of receiving my e-mail inquiry. See LTW’s stories and .

The details of Perdue’s “Founder” plan are sketchy, but what follows is a proposal submitted by the N.C. BIO group:

Qualified business venture founders credit fact sheet

Issue

North Carolina’s economic success in the coming decades will depend in part on our ability to commercialize technologies developed in our university system and other public and private research institutions. Presently, a key impediment to such commercialization is the lack of seed and venture capital. Mechanisms for encouraging the availability of capital should be an integral part of our state’s economic development program.

Recommendation

North Carolina should adopt a capital gains tax exclusion for founders’ stock and angel investments.

Basing eligibility for such a “founders’ credit” on the state’s existing qualified business venture tax credit would effectively target the proposed incentive to investors in startup companies with disproportionate potential for rapid growth and high job creation.

Advantages

  • Improves availability of startup capital by encouraging individuals to invest in North Carolina startup companies
  • Encourages creation of companies that will attract follow-on investments – and subsequent taxable gains – from venture funds and public equity markets
  • Places more capital in the hands of experienced investors who have previously invested in successful startup companies
  • Encourages successful entrepreneurs to start and grow successive, innovation-based startup companies
  • Provides tax credits only for successful ventures; startups that do not succeed will not realize gains and will not receive tax benefits
  • Results in economic growth and job creation before credits are allowed
  • Minimal initial fiscal impact if eligibility is limited to investment after date of enactment

Credit structure

Eligibility for the proposed exclusion would be limited to investors and companies qualified under North Carolina’s existing qualified business venture (QBV) tax credit. In addition, the exclusion would be available only for investments made after the effective date of the proposed legislation. The exclusion would provide for recapture of QBV credits taken by investors at the time of their investment.

The exclusion would not be available for securities purchased in connection with certain redemptions after transactions substantially limiting risk of loss to the investor.

Fiscal and economic impact

Seed and other early stage investments in startup companies are in the range of $50,000 to $1,000,000. Typically these initial investments are followed by subsequent equity rounds funded by venture capitalists and public equity markets.

In 2008, startup companies in North Carolina attracted just over $564 million in funding from angel and venture investors. Since 1999, angel and venture-backed companies in North Carolina have attracted more than $7.6 billion in investments, excluding IPOs. The proposed legislation would make nearly all such follow-on investments ineligible for the proposed exclusion.

Therefore, although the fiscal impact of the proposed exclusion will be driven largely by small, early stage investments, the overall economic impact of the proposal will be driven by follow-on investments likely to be exponentially larger. Taxation of these cash flows may well result in additional state revenues that substantially offset, or even exceed, the fiscal impact of the proposed exclusion. Moreover, because follow-on equity investments will typically precede initial investors’ cash-outs, the state is likely to derive material revenue gains from the proposed exclusion even before negative fiscal impacts of the exclusion are realized.