Delaware Seeks to Incentivize Start-Up Technology Companies to Headquarter in the First State
The State of Delaware has long been an attractive home for businesses. A stable political system, accomplished judiciary and tested business laws combine for a business-friendly environment. Intending to build on this reputation, Governor John Carney signed the Angel Investor Job Creation and Innovation Act on May 24, 2018. The act offers tax credits to investors in a technology start-up company that locates its headquarters and the majority of its employees in Delaware, with the goal being to spur economic development in the technology sector. Although well-intended, the act’s barriers to participation and limited benefits are likely to throttle its effectiveness.
Investors and businesses seeking the tax credit afforded by the act must file an annual application to the Director of Small Business, Development, and Tourism in order to be “qualified” in advance of making the subject investment. The application fee is up to $500 for businesses and individual investors and up to $1500 for investment funds. Once the qualifications are obtained, the investor can receive a tax credit worth up to 25% of its investment in the business. If the credit exceeds the amount of tax due, the excess credit is received as a tax refund. Individuals must invest a minimum of $10,000 per year, whereas the annual minimum investment for funds is $30,000.
To be a qualified under the act, businesses must:
- be a legal entity qualified to do business and headquartered in Delaware;
- have fewer than 25 employees, at least 51% of whom are employed within Delaware, and 51% of its total compensation paid be for work provided within Delaware;
- have not previously received private equity investments of more than $4 million;
- have not issued securities traded on a public exchange;
- have not been in business longer than 10 years or 20 years where certain FDA approvals are required; and
- be engaged or committed to engage in innovation within Delaware by researching, developing, producing, or using proprietary technology to add value to a product, process or service in a “qualified high technology field” (listed in the act), particularly in the fields of agriculture, manufacturing, environmental science, or transportation.
Funds seeking qualification under the act must by organized as a pass-through entity and have a minimum of three separate investors, at least three of whom must be individuals separately qualified under the act. Significantly, officers, principals and individuals owning, holding or controlling 20% or more voting power, together with their respective family members, are expressly excluded from benefitting under the act.
There is an annual aggregate credit limit of $250,000 for spouses filing jointly, or $125,000 for individuals utilizing any other filing status. This annual limit is cumulative of individual investments and as an investor in a qualified fund. The director is also limited to approving no greater than $5 million in annual credits, no more than $500,000 of which can be approved for investments in a single qualifying business.
An investor must maintain its investment in the qualified business for a minimum of 180 days. Additionally, the investor must maintain its investment in the qualified business for at least three years, or else be subject to repayment of all or a portion of the credit. This three-year holding period does not apply where, prior to the expiration of the three-year period:
- the qualified business becomes worthless or liquidates and dissolves after the initial 180 day holding period;
- 80% or more of the assets owned or the equity issued by the qualified business is sold to an unrelated third party;
- the qualified business’ common stock begins trading on a public exchange; or
- the qualified investor dies.
The act imposes one-year and three-year reporting requirements upon the qualified business and qualified investors. The form of the reports is yet to be established by the director. But, the act indicates that the reports will confirm continuing qualification eligibility and identify when an investor divests its interest in the qualified business.
Despite best intentions, the act is unlikely to convince a meaningful body of technology companies to relocate, conduct their operations and employ a majority of their personnel within Delaware. Even if it is does attract such businesses, it is somewhat questionable whether the companies would stay in Delaware for the long term as they grow and no longer qualify for the credit absent other developments to attract and incentivize high tech talent to remain in the region. First, the act targets relatively small enterprises. Although better than nothing, such operations are not likely to significantly benefit the local economy in the near term. Second, the standards for qualifying to benefit from the act are overly restrictive. By example, shutting out founders and their family members from the act overlooks that early funding of small technology start-ups most often comes from these sources. Lastly, the annual cumulative and per-company caps on credits available under the act can limit its attractiveness to many investors and potentially restrict its benefits to only a few companies.
If you have questions or would like additional information, please contact Marc Casarino (email@example.com; 302.467.4520) Lori Smith (firstname.lastname@example.org; 212.714.3075) or another member of the Corporate and Securities Group.