Hawaiʻi's Technology Community

It’s Back-to-Business for Hawaii Tech Companies!

Well, it’s official. The Governor did not veto the Legislature’s Bill 199, so Hawaii’s Investor Tax Credit for high technology companies has now been scaled back from a maximum of 200% to “only” 100% return of high tech investment through tax credits, and the credits will now be claimable at no more than 80% of State income tax liability per year. Actually, the scaling back of benefits was not so bad. Rather, it was the way the whole tax credit program has been conducted over the past 10 years, reinforcing the perception that Hawaii is not a good place to do business. There is plenty of blame to go around on all sides, from the tech industry’s resistance to disclosure of jobs created and companies benefitted or to timely compromise to help the State close its huge budget deficit, to the Administration’s fecklessness in administering the tax program and articulating its support of development of the tech sector. This whole charade is mandated to sunset in 18 months anyway. Hopefully, the next iteration will be better conceived, supported and executed.

So, what now? The national economy remains in recession, trillion-dollar federal budget deficits will continue to grow, and the State will see declining revenues and negative growth in its mainstay real estate and tourism industries for years to come. If there is any desire of investors to invest in technology companies in Hawaii, they will be tight-fisted and very choosy over fewer deals. So is our tech sector doomed to wither and die? Not necessarily. Even in Silicon Valley, the new wave of tech investment is toward smaller amounts in more focused companies. Hawaii tech companies can thrive using an alternative business model in which smaller amounts of capital, possibly leveraged with research grants, are used to validate technology and secure IP rights that can be licensed, pooled or sold to more established, national or global companies that have the size and economies of scale to commercialize the technology in their industries.

This is actually not a new thing in Hawaii. Most of our successful tech deals and investor exits over decades have followed this model, although not by calling it the “R and D business model”, and often only when facing bankruptcy or business default. For example, Verifone pioneered its credit card POS technology in Hawaii, but moved to California for manufacturing and sales growth, in effect exporting its IP rights in patented technology to the Mainland. Hawaii Biotech also ended up exporting its IP rights in tropical vaccines to an Australian pharma company while retaining only a research presence in Hawaii. Ad Tech sold its IP rights in broadband test equipment to Spirent, and Spirent now maintains a regional sales office here. Digital Island was acquired by U.K.’s Cable & Wireless essentially for its IP rights. BAE Systems bought STI’s patented hyperspectral imaging technology, and maintains a research office for its biomedical spinoff here. Almost all significant Hawaii tech deals have gone this route. That is why we continue to see good technologies developed in our university and DoD research labs, but no permanent manufacturing or product sales from the Islands.

In the alternative business model, the R and D company can secure IP rights in the form of copyright-protected software and media, patented invention rights, and/or licensable engineering know-how. It can monetize these IP rights by licensing, pooling or selling to established companies in the Mainland U.S. and globally. As a further option once its technology has been validated through licensing, it can seek the next stage of venture capital funding for spinning out a sublicensed company to commercialize the now-proven technology in local or regional markets.

The R and D business model can greatly reduce investor risk by focusing on technology validation and securing IP rights. This allows the constrained venture funding pool in Hawaii to fund more companies to develop more innovative technologies with the small amounts of venture capital available. The research activity also fits squarely within the qualifying guidelines for the 100% high tech investor tax credits in the next year and a half, which helps to reduce investor risk. So, far from doom and gloom, our R and D companies can now focus on their real business mission and hopefully thrive.

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Comment by Bill Dash on July 23, 2009 at 7:42am
Ken... I have listened to your company presentation. You look like a quality guy with a good idea. I didn't ask to invest because I didn't understand the business model and I don't like to invest in Act 221 companies in general because they usually have poor corporate governance and lack exit opportunities. I am surprised by your attitude that tax dodges are acceptable ethics for both investors and entrepreneurs. Most big ethics violations start with small lapses and tend to escalate over time.
Comment by Bruce M. Bird on July 21, 2009 at 9:45am
Hi, Ken. Your point about Act 221 having another 18 months to run anyway (and so the rules shouldn't have been tightened up before then) is a good one. Maybe any "Son of Act 221" legislation can address your concern.

I think that's what Leighton is trying to encourage here: to figure out how to "better conceive, support and execute" the next iteration of Act 221.
Comment by Ken Berkun on July 21, 2009 at 8:33am
My view is that Act 221 is not the best idea on the planet, but it is (was) the only game in town and it should have been played out. It is the changing of the rules in mid game that bothers me. You are correct that I should not have used the word "dodge" that is what happens when I write in a hurry. Nonetheless, that is exactly what Act 221 was - a productive tax dodge. As my father always said - don't get fooled by your own propaganda.
Comment by Bruce M. Bird on July 21, 2009 at 3:58am
Hi, Ken. You wrote: "Local high net worth individuals will find other less productive ways to dodge state taxes".

So, the next time there's a crowd of people and someone is carrying a sign with "Act 221: A More Productive Way For Local High Net Worth Individuals To Dodge State Taxes", that would make it a "pro-"Act 221 rally ?

If you view Act 221 as a "tax dodge", that hardly makes for a ringing endorsement of its merits. My sense is that many local high net worth investors would also take issue with being labeled -- at least by implication-- as "tax dodgers". (Possibly even more so if they moved to Hawaii from L.A. ...)

Just a suggestion, but the word "dodge" is a loaded one. It appeals to the "soak the rich/ wealth envy" crowd. I know from your posts that you aren't a member of this crowd, but it's like swinging red meat in front of an attack dog...

Not wishing to end this post on such a gory and disturbing note, here's another quote by Yogi Berra: "Little League baseball is a very good thing because it keeps the parents off the streets."
Comment by Ken Berkun on July 20, 2009 at 4:52pm
The advertiser just called, they said it is being considered for publication, which usually means they're running it.
Comment by Ken Berkun on July 20, 2009 at 4:20pm
well, here's what I wrote. And it's not for Choy, he'll believe what he chooses to believe, but he got a prominent piece of newspaper real estate and it's good to let the general public see our points. I just hope I represented them well. Usually if I write something quick I screw it up...

To the Editor,

Representative Isaac Choy’s editorial in the Monday Advertiser (“Scaled-back tax credits still allow sector to grow”) is an obvious attempt at self-promotion that completely misses the damage that SB 199 caused. Certainly it is true the Hawaii’s high tech tax credits remain generous. But once again Hawaii has changed the rules of the game in the middle - and this is what deters investment. You can not treat intelligent people like this – they look at this state and say to themselves “Why bother? First you kill the Superferry; then you build a light rail that does not go the airport, Waikiki or the University; then you pull the incentives for out of state investments right out from under us.”

Local high net worth individuals will find other less productive ways to dodge state taxes (the total benefit to the state will be far less the Rep. Choy would like you to believe).

Act 221 was not perfect, but it was effective. It had only one more year to play out which would have allowed a reasonable amount of time to carefully consider an improved version (there is no question that better reporting is required). Instead, as before, we have demonstrated to the rest of the country that Hawaii is not a state that you can trust in the long run.

Will the high tech industry survive? Sure, but this will certainly slow us down – not because of the money – because of the action.
Comment by Leighton K. Chong on July 20, 2009 at 3:54pm
Whose point of view did Rep. Choy miss? We all have points of view, and we all want to be right. There is no reply to Rep. Choy that would be other than a rehash of already well known positions. After 10 years of whipsawing, we should be looking for what we can agree on to achieve our objectives, which is supporting our tech companies in the best and most appropriate ways to succeed.
Comment by Bruce M. Bird on July 20, 2009 at 3:48pm
Hi, Daniel and Bill.

Daniel, thanks for the info. By the way, does your SaaS company operate by just licensing its software or by both licensing its software and selling ads? If the latter, is there any informal "rule of thumb" that you know of regarding the Department of Taxation's policy in this regard? Would a 50-50 split be O.K? 40-60? 20-80? Just wondering...

The last time I checked --about 2 years ago-- the Department of Taxation didn't "publish" its
comfort rulings involving Act 221. Like you wrote, some of this stuff isn't in the Act itself, so one has to rely on "administrative gloss" (which, of course, consists mostly of unpublished comfort rulings).

Hi, Bill. Well said! Leighton certainly deserves a lot of credit on the quality --and tone-- of his blog.

I think that Hawaii's Act 221 credit is still the most generous credit in the United States. I have to quibble a tiny bit, though, with your "zero financial risk" comment. There is some risk under current law when you take into account the time value of money and the increase in regular federal income tax relating to the "lost" state income tax deduction. One school of thought on this is that every investor should have at least some "skin in the game" (but that this hasn't always been the case under prior iterations of the law).

One other thing. In my opinion, most of the members of the tech community in Hawaii have a "can do" attitude and don't spend a lot of time walking around with one hand out seeking various tax incentives from the government. What strikes me as surprising, though, is that a few members of the high tech community think they have a "can do" attitude as they walk around with one hand out seeking various tax incentives from the government.
Comment by Ken Berkun on July 20, 2009 at 3:00pm
OK, I wrote a letter to the editor, gives me a chance to work off steam whether they publish it or not.
Comment by Ken Berkun on July 20, 2009 at 2:43pm
Did you see Rep. Isaac Choy's editorial in today's Advertiser? ( "Scaled-back tax credits still allow sector to grow". Silly pap. He misses the point that the issue is that the rules changed in mid-game and the tax savings won't materialize because investors will find another way to dodge taxes. Is anyone planning a letter to rebut his editorial?


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