Are Hawaii's Tech Tax Credit Worth the Cost?

Comment

Comment by Bill Spencer on February 15, 2009 at 4:23pm

Yes, Howard did a good job. Finally a journalist that hasn't been fooled by urban myths and half truths, just looking for dirt. Mucho Mahalo Howard!

Comment by aaron kagawa on February 15, 2009 at 2:50pm

nice article by Howard Dicus about the tax credits: The truth about Act 221

Comment by Daniel Leuck on January 11, 2009 at 1:56pm

Wearing the moderator hat: Lets keep to well reasoned discourse and avoid ad hominem arguments. I don't think there are any malicious or stupid people participating in this thread, just differing views. This is a debate amongst well intentioned and intelligent people (I know most of you), which is a great thing. We should never be afraid to pose questions about important issues such as Act 221 or the recruiting challenges in our state.

As the person who started the "Finding & Retaining Talent" thread: I'm obviously excited about our growing tech sector and the people in this community. We highlight a local world class techie every month on our front page. I was simply stating that often start-ups need specific skill sets that are hard to find in Hawaii, most likely because of our size. I base this statement on the nearly ten years of experience I have running and working for technology start ups in this state (four with Ikayzo after returning from Japan) and the experiences of my fellow entrepreneurs. During this time I have screened thousands of resumes and interviewed hundreds of individuals locally and abroad.

There are different types of start ups. Some are research oriented and can work with smart people straight out of academia. Others are incubated by larger organizations or have some other source of money that provides a runway during which intelligent people can learn the necessary skills. In many cases smaller start-ups without a lot of cash need to get people involved that can work with specific technology stacks from day one. In Hawaii this can be a challenge. This isn't a dig. Its a fact, but possibly one that can be ameliorated through the determination of our community.

The intention of my post was to encourage discussion of how to retain more of our local talent and attract additional talent from the mainland and abroad. That is part of the reason we started TechHui.

Comment by John on January 11, 2009 at 11:17am

Hi Jianshi, Thanks for joining the discussion.

No one is suggesting that Hawaii developers are talentless. No one believes that there are no developers in Hawaii with talent. Unfortunately, this seems to be the underlying assumption behind your and Aaron's criticism of the thread.

Why do you suggest that there is 'no backing' and that the comments are from 'people who have very limited technical knowledge'? For instance, I assume you have read both Dan and Laurence's comments on the talent thread.

The general point being made is about the relative technical depth of Hawaii compared to other technology centers and how that can affect the success of technology startups here.

If you (or others) have personal experiences comparing UH to top West Coast or Ivy League universities, feel free to share. If you (or others) have personal experiences comparing mainland startups to Hawaii startups, feel free to share.

You may be right but it's hard to discern unless you provide a substantive response detailing your case. I hope you choose to share for the benefit of the community reading this thread.

Comment by jianshi on January 11, 2009 at 10:35am

Hello everyone. I work with Aaron and I am a developer and (hopefully) an example of talent here in Hawaii. I sense negativity as well. Here's my suggestion. Negative general assumptions about the "talent" here have no backing. Takes one to know one. I won't go into detail about this thread but, I've heard so many complaints and comments from people who have very limited technical knowledge. But there's no hate involved in this. We need to move forward and think about how to make working here more appealing. I think it's already appealing. But somehow we messed that up? We need to figure out what happened.

Comment by John on January 10, 2009 at 7:06am

Hi Aaron,

I appreciate you joining the conversation despite your belief that it is unproductive and negative. At the very least, your contribution should provide perspective and support to the many readers who I am sure agree with you.

First, I do not believe people in Hawaii's tech industry are talentless. My point is whether we have sufficient people of sufficient talent to compete globally against other startups.

To use a analogy: Lots of people excel at high school sports, many people are top-tier college athletes, very very few people make the pros.

Just because a person cannot make the pros does not mean they are talentless. There are many many people with lots of talent but not sufficient talent to make professional sports.

While I honestly think you have misred me as saying Hawaii tech industry is talentless, I do apologize and want to make it clear that I do not think the industry is talentless.


While this conversation is certainly critical, I think it actually makes it more productive. When building strategy, one needs to be clear about the fundamental assumptions behind it. I do not think you can get that clarity without asking hard questions.

In a startup, you are continuously faced with "Is my product good enough compared to my competitors? Do I need to add features, change target markets, adjust pricing, etc?"

The point is to critically and carefully understand relative positioning. I am applying this question to how Hawaii relates to other markets its startups compete against.

There are a number of people and a lot of evidence that Hawaii has a relative talent disadvantage to other markets. Maybe we are wrong but I would encourage you to educate us specifically on how 'awesome' Hawaii's engineers, on average, are to their international peers in startups.


Finally, I actually support greater focus and spending on local education and UH (as I have previously mentioned in this thread). I think this is a much more efficient and direct way to improve Hawaii's technology position. I think the State would definitely benefit from more engineer driven startups that are lower cost and lower risk profile.

Thanks for responding and I look forward to talking with you in the future.

Comment by aaron kagawa on January 10, 2009 at 12:45am

I've been trying to stay away from this conversation, because I don't particularly think its that productive and has a far too negative tone. But, I decided to chime in because of this comment:
As a whole, in software/IT, I don't think the local talent compares with the level of global competition a startup has to face. (This is the same point Guy Kawasaki essentially made.) Because of the talent deficiency, funding such companies is almost inherently a high/bad risk. Money is a very inefficient way to compensate for talent. Using state funds to subsidize this is very likely to be wasteful.

Here are a few comments:
(1) did i miss the state wide talent evaluation survey that allowed you to make this claim. perhaps people should stick recounting their own experiences and refrain from making broad claims. besides i really don't think the talent thread you keep pointing to had very much careful and analytical examination of talent. i know a lot of these software and IT people that you are calling talent deficient and i think thats very wrong and inappropriate. perhaps all the talented people are avoiding you. or perhaps its the senior management, entrepreneurs, and executives that aren't getting the job done. i'm being sarcastic, but i think my statement is just as plausible.
(2) i actually think Guy Kawasaki is a little mistaken in his comments. we do have awesome professors and students in the College of Engineering (he actually is forgetting about the Department of Information and Computer Science where most of the software and technology graduates comes from). but, the problem is that the startup industry is too small of an industry for them to target to transition into. i recently had a conversation with a professor that said we want to grow the startup mentality in his students. perhaps Guy should visit the College of Engineering and Dept of Information and Computer Science and help build and transition the "supply".

anyway, say what you want about the actual tax credit program, the facts, the reports, the investors, or even the companies. but stop calling the people in hawaii's tech industry talentless.

Comment by Bill Spencer on January 9, 2009 at 9:53pm

Thank you John for your thoughtful remarks and help understanding your background and experience. I appreciate your perspective and appreciate your kind remarks.

I will look forward to reviewing the talent thread.

Ultimately I'm a champion of diversifying our economy with tech I believe our entrepreneurs and the talent available can achieve that objective. We once lost our best and brightest to the mainland but that is starting to change. We have great talent on the ground, in the pipeline and can evolve our new talent if we stay committed.

Comment by John on January 9, 2009 at 8:59pm

Hi Bill,

I appreciate the feedback and think you nicely articulated the benefits.

For background information, I ran product management for a Kleiner Perkins funded startup and operations for a local 221 startup as well as a number of other senior management roles where I was involved in raising equity, developing strategy, etc. Currently, I run a bootstrapped startup where I am profitable after 9 months. I have already had two unsolicited acquisition offers for my startup. Also, I conduct analysis on investments and M&As for VCs and bankers (within my field).

That being said, I do not know if this meets your criteria. I will offer some feedback in the hope that other readers can benefit from the exchange.


ROI Even if Startups Do Not Do Well

I agree with you that 221 investors do care, that risk is not eliminated and that they are "looking for a better than average return on investment."

The specific problem I see is that 221 makes it significantly easier for investors to achieve better than average return on investment even if the company does not do well.

For local investors, their ROI is a sum of tax credits + exit valuation (where normally it is simply the exit valuation). Even if we accept that credits are only worth 70 cents on the dollar, startups can have far poorer exits and the investors can still achieve a better than average return on investments.

For mainland investors, the 'bonus equity' plays a similar role in reducing the size of the exit valuation needed to achieve a better than average return.

A significant part of the risk has been shifted to the state. Such a separation of risk and reward encourages waste, excessive risk and moral hazard. This is not my original position. It is a well establish position among global VCs and economists.


The Local Situation

I would encourage you to read the "talent" thread. That discussion seems to be at odds with the public position the HVCA has on Hawaii having great technological talent.

I am not sure what you consider very talented but in our thread we carefully and analytically examined what we considered talented and how we compare talent.

As a whole, in software/IT, I don't think the local talent compares with the level of global competition a startup has to face. (This is the same point Guy Kawasaki essentially made.) Because of the talent deficiency, funding such companies is almost inherently a high/bad risk. Money is a very inefficient way to compensate for talent. Using state funds to subsidize this is very likely to be wasteful.

- That's just my opinion.
- I don't think it applies to all local companies.
- I really do hope local companies succeed.
- I am happy to do my part to help.
- Last but not least, I certainly respect and appreciate all of Bill's efforts to champion technology entrepreunership.

Comment by Bill Spencer on January 9, 2009 at 6:15pm

Sorry John, but this just isn't so. Your ideas and argument here are fundamentally flawed. I do not know anything about your background and do not in any way mean to discredit you, but I suspect based on your comments that you have neither invested in a start-up nor raised private equity for a company before. Consequently your analysis lacks the benefit of experience. I apologize if I am wrong about this presumption.

John says, "221/215 encourages risky behavior because investors and executives have little downside but lots of upside. In other words, it encourages startups to take bad risks.
The executive risk is low because they get good compensation packages and easy money subsidized by the state. The investors risk is very low because they get the tax credits.

Even for mainaland investors, when you get more company for less money, the company can do worse and an investor can still be ok.

For instance, let's say a startup struggles and eventually is sold for only 60% of the capital invested. Normally, investors would take a loss. With 221/215, because they are getting more company for less money, the investor may actually make money even if the company is sold for less than the capital invested. The local investor is profitbale off the tax credits and the mainland investor,via the 2-to-1 mechanism, makes money because they got extra equity via the credit exchange."

It is not easy to raise money, even with the tax incentive. In Silicon Valley ithas been said the only8 out of 1000 business plans submitted get funded with the expectation that maybe two of those 8 will hit home runs. Companies have to have a high degree of good governance when OPM is invested. Board's are composed of shareholders who would never allow excessive compensation or bad risk taking. This is not EASY MONEY that people dump into a company and walk away from even when tax incentives are involved. You could argue that some of the movie deals like Lost were tax incentive driven, but for every qualified high tech business started by Hawaii entrepreneurs, I cannot think of one that fits your bad risk characterization.

Yes, the tax credit helps with downside risk, but it does not ameliorate that risk. The net effect of the dollar for dollar credits is only about $.70 on the dollar because it is spread out over five years and you cannot deduct state income tax on your federal return. Even if the company goes belly up after five years, the investor loses the real money they put in and maybe more importantly the use of that money for some other purpose.

Check your math on the non-tax advantaged investor scenario you paint. The market gives a non-tax advantaged investor 25% equity in exchange for their credits, so if a company get's acquired for 60% of the post money valuation and that non-tax advantaged investor has put in $80,000, swaps their credit for $20,000 so get's $100,000 in equity, they by no means end up ahead and have still lost the use of their $80,000.

This is not an easy money, no risk proposition by any means. All companies that take on investors are using other people's money and those other people invest because they are either founders, family, fools and friends, or they are serious investors looking for a better than average return on investment. That is why for example, Hawaii Angels require members to be "qualified investors".

Speaking of Angles, I have been on the board of directors since its inception February 2002. More than 1,200 business plans have been submitted for board review, 250 companies have presented to the members, and about 40 companies have been funded, mostly QHTB's. None of those companies have failed and I assure you that they operate with good governance and none of the moral hazard and bad risk taking you surmise.

I have not followed the "talent" thread so cannot comment on that other than to say the successful entrepreneurs I know are very talented and do not exhibit the risk taking behaviour you propose. Anyone who runs a start-up or invests in one knows that it is all about mitigating risks, not taking risks.

Finally, regarding the report, it was the actual conclusions that were manipulated by the Governor's staff and not the conclusions held by the Tax Department.

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