Hawaiʻi's Technology Community
A New Model for Venture Capital Investment in Tech Companies in Hawaii
It is time that we put on our thinking caps and create a new model for venture capital investment more suited to our real circumstances in Hawaii. I advocate three major changes to the Hawaii venture capital model for tech companies:
1. Allow Act 221 to sunset, and implement the Act 215 State Private Investment Fund (SPIF) to be funded with up to $38 million in state tax credits that can be used to guarantee secured interest-bearing notes issued to lenders.
2. Have the SPIF act as a “fund-of-funds” to sector-focused tech investment firms required to raise 3:1 private equity funds to match SPIF investment, thereby multiplying by 4X the total investment pool available to invest in promising tech companies.
3. Encourage tech investment firms in Hawaii to shift away from the Silicon Valley model which has proved unworkable in Hawaii and toward the alternative R and D company model of direct monetization by tech transfer which plays to our strengths.
Given what we have learned from the Act 221 experience and the realities of the Hawaii business environment that our tech companies work within, we should consider this new model for venture capital investment in tech companies in Hawaii. Funding an SPIF revolving fund under Act 215 through secured loans paying an annual yield guaranteed by state tax credits opens the pool for tech investment to larger and more mainstream sources of capital, such as banks, insurance companies, real estate companies, and annuity funds. Using the SPIF vehicle as a “fund of funds” would leverage larger private investment funds and provide a more effective use of state tax credits. Targeting SPIF investments into a number of funds each focused on a promising tech sector would concentrate domain expertise, spread risk, cover more innovation, provide more knowledgeable vetting of potential deals, and enable sharing of industry-specific management expertise with portfolio companies. Finally, instead of pursuing a Silicon Valley model that has not worked in Hawaii, we can reorient tech investment into R and D companies that require lower amounts of capital, have lower business and market risk, have quicker, more achievable exits, and can provide comparable rates of returns for investors.
To read my complete blog article, go to:
Hawaii Technology Blog
1. Allow Act 221 to sunset, and implement the Act 215 State Private Investment Fund (SPIF) to be funded with up to $38 million in state tax credits that can be used to guarantee secured interest-bearing notes issued to lenders.
2. Have the SPIF act as a “fund-of-funds” to sector-focused tech investment firms required to raise 3:1 private equity funds to match SPIF investment, thereby multiplying by 4X the total investment pool available to invest in promising tech companies.
3. Encourage tech investment firms in Hawaii to shift away from the Silicon Valley model which has proved unworkable in Hawaii and toward the alternative R and D company model of direct monetization by tech transfer which plays to our strengths.
Given what we have learned from the Act 221 experience and the realities of the Hawaii business environment that our tech companies work within, we should consider this new model for venture capital investment in tech companies in Hawaii. Funding an SPIF revolving fund under Act 215 through secured loans paying an annual yield guaranteed by state tax credits opens the pool for tech investment to larger and more mainstream sources of capital, such as banks, insurance companies, real estate companies, and annuity funds. Using the SPIF vehicle as a “fund of funds” would leverage larger private investment funds and provide a more effective use of state tax credits. Targeting SPIF investments into a number of funds each focused on a promising tech sector would concentrate domain expertise, spread risk, cover more innovation, provide more knowledgeable vetting of potential deals, and enable sharing of industry-specific management expertise with portfolio companies. Finally, instead of pursuing a Silicon Valley model that has not worked in Hawaii, we can reorient tech investment into R and D companies that require lower amounts of capital, have lower business and market risk, have quicker, more achievable exits, and can provide comparable rates of returns for investors.
To read my complete blog article, go to:
Hawaii Technology Blog
Views: 335
Comment
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Comment by Alex Salkever on September 5, 2009 at 6:39pm
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Leighton, one thing I wanted to add. I spend a lot of time on the Mainland talking to VCs, entrepreneurs and others. And I am continually amazed how few of them know about the interesting things going on in Hawaii science R&D even if it is in their area of immediate expertise. I wonder if half of the problem is not a lack of funding but a lack of visibility -- that we wouldn't even need state incentives or anything like that if money on the Mainland and abroad understood the quality of the science and the opportunity.
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Comment by Bruce M. Bird on September 5, 2009 at 9:44am
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Hi, Leighton. Great post! Would your plan involve state tax incentives and, if so, how would you structure them?
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Comment by Leighton K. Chong on September 5, 2009 at 6:39am
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OK, here is a quick sketch of a SWOT analysis for the discussion in my blog article:
Strategic Use: Orient SWOT to Objective
Objective: Foster the growth of tech companies in Hawaii for economic development, diversification, and skilled job creation and education for next generation.
Strengths:
S1: University research funding in HI, #18 of states on per capita basis
DoD research funding in HI, #5 of states on per capita basis
Expat techies want to live and work in Hawaii for lifestyle & environment
S2: Location midway proximity between West Coast U.S. & Asia (12 time zones)
S3: Disproportionately large numbers of tech grads seeking employment in HI
Weaknesses:
W1: Business infrastructure based on agriculture, tourism, and real estate; few companies in manufacturing, distribution, global marketing & sales vs. Mainland
W2: Venture capital pool is small; insufficient to fund HI companies for global sales
W3: Geographical remoteness from Mainland U.S. = added costs of doing business
W4: Lack of efficient transportation & product distribution infrastructure
W5: High school, university grad skills levels below Mainland U.S. & Asia
Opportunities:
O1: Capitalize on high levels per capita of tech research in HI via R&D companies; reduce business infrastructure requirement for HI tech companies by focusing on R&D
O2: Reduce venture capital required for HI tech companies by focusing on R&D
O3: Tech transfer of HI R&D to Mainland & Asia product distrib & sales companies; geographical remoteness and lack of infrastructure not an issue
O4: Tech transfer of HI R&D to Mainland & Asia product distrib & sales companies; lack of efficient transportation & product distribution infrastructure not an issue
O5: High school and university grad skills levels will benefit from partnering with Mainland & Asia global companies
Threats:
T1: U.S. recession will continue: response - reduced VC requirements and outsourced R&D make HI more attractive to Mainland companies
T2: HI has little access to do tech transfer deals with Mainland companies: response -- HSDC fund-of-funds can attract Mainland VCs and companies to invest in HI tech deals
T3: HI has little capability to enforce technology (IP) rights of HI R&D companies: response – investor-based enforcement entities on Mainland are growing in number & wins for small companies
T4: U.S. Patent Office is mired in delays & issuing fewer patents, Patent Reform bill seeking to undercut patent enforcement: response – U.S. Admin, Commerce Dept., and new USPTO Director are committed to improving U.S. patent system
T5: U.S. & Asia companies can outperform HI R&D: response – HI has unique tech assets in renewable energy, Defense dual use, biotech, and aquaculture that are unlikely to be replicated elsewhere
Conclusions:
C1: Is objective attainable: response - tech transfer model will increase HI capacity to grow tech companies thru R&D better than existing global exponential sales growth model
C2: Is objective sustainable: response – success of HI R&D companies in tech transfer deals will set stage for ongoing exchange with U.S. & Asia companies, and create 2nd stage of HI spinoffs in proximate markets
C3: Is proposed model best for HI: response – it plays to our strengths, avoids problems with the existing global exponential sales growth model, and can be implemented within existing laws and HI business processes
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Comment by Peter Kay on September 3, 2009 at 10:45pm
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I think a SWOT-like analysis on what would work here is an excellent idea.
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Hi, Peter. Hi, Leighton.
Peter wrote: “What has worked at other states and why?”
Many states take a targeted approach when growing or attracting certain businesses, industries, and/or activities. Some of it is housed in secrecy, but a lot of it is basic, common sense.
The first question is usually "What type of business/activity do we want to grow/attract?"
Leighton has blogged elsewhere that "The Time is Right to Locate a Regional Patent Examining Office in Hawaii". So, let's take his idea and run with it.
Is this the type of business/activity that Hawaii would like to attract? Is there a need for a regional patent office? Is one eventually going to be located somewhere in the U.S.? Would a regional patent office in Hawaii result in relatively high-paying tech and/or professional jobs located in Hawaii? Would a regional patent office in Hawaii increase its tech reputation? My sense is that the answer to all of these questions is "Yes". So, maybe this is something that Hawaii's representatives might want to look at and consider supporting.
Some states use SWOT analysis. It can help a state identify its "blind spots" and other perceived weaknesses. For example, if I'm a decision-maker sitting up in Washington, why would I want to house a federal regional patent office in a state that currently ranks somewhere around #47 or #48 in Internet access ? Maybe state tax incentives should be used to develop better --and cheaper-- high speed access in Hawaii. Or, maybe there's a way to address the issue of Internet access without using state tax incentives. Or, in the context of the decision to be made, maybe it's more of an issue of perception than reality.
On a separate note, Leighton, your idea about a hybrid R&D company model is an intriguing one. It has many positive qualities.
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In reply to Peter's questions, I proposed the R and D company model as more suitable to Hawaii's unique business environment than tech company models that have been used in other states, esp. the exponential sales growth model in Silicon Valley. The R and D company model is analogous to the corporate Independent Business Unit (IBM's) model used by major companies in which non-core technologies are spun out to "friendly" (former employee) startup companies to develop into viable marketable products, with possible re-acquisition by the parent company as an exit option. Other examples include Bell Labs spinout companies and the IdeaLabs (Bill Gross) incubator model. In the U.S. pharma industry, the majority of new drugs and biomedical innovations are acquired from outside boutique firms. My understanding also is that Singapore has invested in targeted biotech R and D incubators for tech transfer to Chinese pharma and biomedical companies. These are some analogous tech transfer examples, although I don't know of any state that has specifically targeted use of this model.
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Thanks for your insightful comments, Wayne. In the R and D company model, the Hawaii tech company must navigate technical risk to come up with a profitable, marketable product (backed by solid IP rights) that it can convince an established already-market-present company to sell or license. This is the same mode as Pipeline Micro seeking to license its heat sink technology to companies like Panasonic et al to commercialize globally. By seeking a tech transfer exit, the R and D company avoids the pitfalls of a business plan based on trying to bring the product to market itself and achieve exponential growth in sales from scratch in a short time, an exercise which requires a lot of venture capital backing and is fraught with huge business risk (mgmt team, execution) and market risk (competition, timeliness). The R and D model seeking a tech transfer exit plays to our strengths in Hawaii, since we have great research assets that can be spun out from UH, DoD contractors, and web companies, then productized with smarts, persistence, and a bit of venture capital. If our Hawaii tech companies do their work efficiently and offer the real value of technology rights to a profitable, marketable product for licensing or acquistion, I believe they have as good a chance if not better of achieving success as compared to the Silicon value model, but with a lot less venture capital required and by avoiding business and market risks that they are not funded or suited to handle.
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Leighton, congrats to you for posting something like this. As a founder in a 221 company, I was of course in favor of the 221-like tax credits. But now that it's over, it's time to move on. The question for the high tech now is where do we go from here?
IMO we all need to have the collective courage to ask hard questions and follow the facts wherever they may lead. One stubborn question I've not been able to get an answer to is: "How well have Hawaii's investors fared sans tax credits when compared to commensurate investors on the mainland?"
So far, no answer.
More questions I would love to engage:
“What has worked at other states and why?”
“Which of the successful models should we replicate and why?”
“What do we need to do in order to replicate the model we have chosen?”
Hopefully we can all engage in a respectful, thoughtful dialog on this vital topic.
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To read my complete blog article, go to:
http://HawaiiTechnology.BlogSpot.com/
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