Open Letter re: Supercharging Business Development in Alabama

I would humbly propose a vision. The vision is of a state in the heart of the Southeast that is an economic engine and a force in the global economy. That may sounds unachievable, but I firmly believe that it is within our grasp if Alabama can couple some measure of bold leadership with coordinated and efficient usage of current resources.

The strategic steps need to include solutions for two major bottlenecks in the high-growth company creation process by:

1. Increasing the number of investment ready high growth potential companies in Alabama; and
2. Encouraging investor participation in funding seed and growth stage high potential companies.

As a part of step one.

The state needs to use existing state resources to support the maturation process of quality high-growth potential companies.

Today, the Board of Alabama Launchpad is meeting to discuss the direction of that program and it is potentially a very important meeting in this business development process. Launchpad is a unique statewide organization that was established as a partnership among the state's research universities and the business community. The primary program run by Launchpad is an annual business plan competition that awards grants of $100,000; $50,000 and $25,000 for 1st through 3rd places respectively and it is a great starting point.

The reviewers and mentors already working with Launchpad are great entrepreneurial resources and their feedback is often worth significantly more than the prize money. However, Launchpad can be much more...

Ask almost any active angel investor or seed stage venture fund manager in any state and you will hear a lament about the typical sophistication and "readiness" of most startup businesses for outside capital. This is a huge bottleneck in the creation of high growth companies because regardless of the amount of capital available, it simply will not be effectively put to work if there are not proper risk/reward investment opportunities. Either the capital will under-perform or it will be put to work in other investments.

This is an opportunity Launchpad can grow to fill with a couple of steps:

1. Launchpad is expanded to include any innovative business, so that the entire state population can have the opportunity to participate.

2. A seed fund (or grant program) is associated to provide a stipend of $10,000-20,000 to the top 25 (approx. Phase 4) participants.

*this would be in addition to rather than replace the top 3 awards

3. Launchpad schedule is reworked to be a quarterly program rather than annual.

4. In exchange for receiving the seed funding, the top 25 participants agree to move company operations into the nearest business incubator for a three month program *(think TechStars on a state-wide basis).

Such program incubators could include:

5. During the three month program, mentors and advisors (many qualified candidates are already involved as judges) regularly meet with the participants in a combination of one-on-one company sessions, incubator-wide group sessions and program-wide webinars.

6. Following the end of the three month program all of the participants would come together for a graduation showcase of all the companies and the progress made by them during the term.


As a part of step two.

The state needs to implement a state tax credit that encourages increased investor participation with potential high-growth companies in Alabama at both the seed stage and growth stage.

Such a tax credit would be best if:

1. It is open to many industries and leaves the specific company and industry selection to the investing parties, so that profit motive may direct the investing activity without artificial manipulation.

2. It is targeted at seed stage investments (i.e. no previous 3rd party capital, less than 20 or so employees, less than $1 million investment, etc.)* because that is where the largest gap is located.

*the criteria need to be fully vetted to avoid unintended consequences

3. It is in the 20-40% range, so that the investor incentive is significant while not eliminating the need to properly evaluate prospective investments.

4. It is available for both direct investments into a target company as well as for investment into a qualified venture fund, so that those investors interested in participating, but without sufficient time, skill or interest may act through a qualified professional.

Conclusion

If both of these projects (Part 1 and 2) can be implemented, then Alabama could see the annual creation of 100 new investment ready high growth potential companies. If only 5% of those companies are able to achieve a successful exit, then Alabama could still be creating an annual addition of approx. $225 million* in new enterprise value to the state's economic base. Furthermore, those number would not include the economic effect of the other 95 companies and the "exiting" companies that choose to stay in Alabama and continue to grow, so the total economic effect could be many times the simple exit value.

*(5 companies annually multiplied by the $46 million median exit value in 2010 of venture backed companies...according to DJ VentureSource)

P.S. As always, take what you like and leave the rest.

IRS targets S corporation tax savings

The Wall Street Journal reports on a recent court case, David E. Watson P.C. v. U.S., in which the IRS took on an accountant-taxpayer for not paying himself enough salary as an employee of the subchapter S corporation he co-owned:

For Sub-S owners, this issue isn't going away. Last year it even turned up in legislation, when the House passed a provision that would have subjected all profits of shareholder/employees of personal-service firms—such as accounting, law and consulting firms—to payroll taxes. The measure died in the Senate, but the IRS would likely welcome its return. Cases like Mr. Watson's are expensive for the agency to litigate because each turns on individual circumstances.

Recent IRS statistics suggest why the agency might focus on Sub-S pay. Over the past decade and a half, when executive paychecks exploded, the salaries of Sub-S owners declined as a percentage of total income, from 52% in 1995 to 39% in 2007, according to the latest data available. (The remaining income is taxable to the owners as well, but doesn't incur payroll taxes.) During the same 12-year period, Sub-S income doubled, while salaries increased only 26%. The average pay for a Sub-S owner was recently was $38,400, according to Martin Sullivan, an expert with Tax Analysts, a nonprofit publisher near Washington.

Tom Ochsenschlager, former head of tax for the American Institute of CPAs, says pay and payroll tax issues are a frequent source of friction with clients: "Sometimes you have to take them to the woodshed and say, 'You need to report more income as pay for personal services."'

What is a fair ratio of profits to pay? There isn't one answer, experts say. A company with substantial capital or assets, such as a manufacturer, often is able to justify lower pay than one selling personal services like a law or accounting firm. Says Mr. Willens: "I would tell a client that for personal services, 70% would be the absolute floor and might not get the job done," he says.

Read more about S corporation tax savings.