Misguided Nebraska Senators question angel tax credit benefit due to business risk

The legislative debate over the Nebraska Angel tax credit is instructive for Alabama because we will probably have some of these same issues raised when the (hopefully soon to be introduced) Alabama angel tax credit is debated.

Nebraska Senators question 'Angel' tax benefit - Omaha.com

Lincoln Sen. Danielle Conrad, who led a legislative study last year on how to improve the “economic ecosystem” for entrepreneurs, said Nebraska has done well attracting larger businesses but needs to be just as aggressive helping innovators capitalize on a good idea or a new invention.

But Schuyler Sen. Chris Langemeier questioned whether the state should spend $3 million on such tax benefits when it is cutting spending elsewhere.

He called LB 389 “a slot machine.” Research shows that up to 75 percent of such projects fail.

“I’m not against this. I just don’t think today is the day to make this investment,” said Langemeier, who drafted an amendment to kill the bill.

Senator Langmeier is probably a very smart and hardworking individual, but his comments are laughable.  There are no doubt risks for the success of an angel investor tax credit, but the good Senator is missing them.  Calling an angel tax credit proposal a "slot machine" simply because many small businesses eventually fail completely misses the point...and the point IS that 25% of them succeed (by his statistics).  Of those succeeding, some are also going to succeed in a large way and that is exactly what makes the entire process profitable for entrepreneurs, investors and the State.   If the Senator's reasoning were followed then no one should ever start a new business.

Nonetheless, to a certain extent he is exactly right, because the law of large numbers is critical to angel investing just as in casinos*...only he has the parties wrong because in an angel tax credit the State is playing the role of casino, not player.  *(meaning, like individual bets, it takes investment in a lot of individual companies to normalize the overall portfolio return) In fact, based on some table napkin math, the State stands to create a tremendous capital multiplier by increasing the creation of high growth startups (see prior posts).   The only real limitation on the upside is the State's ability to keep supplying potential investors with high quality candidate companies able to appropriately use investment capital and that is a risk worth talking about and trying to mitigate, but that is for another post.

Organized for success...

Many new (and even some experienced) entrepreneurs seem to struggle with the dizzying array of business entity choices and their various combinations. To name a few there are: proprietorships, partnerships, limited partnerships, LLPs, LLCs, Trusts, Corporations and S-corporations. Each entity has its place and time, but for high growth potential businesses I will choose a corporation almost every time. The reason is mainly tied to tradition and corporate governance.

"Tradition" you say...why in the world would that be a big deal? Well, the reason is rooted in a desire to maximize available resources and standard corporations have been the traditional entity of choice for high growth entities for a long time. That has resulted in most of the resources being created with a heavy Corporation bias and that bias runs the gamut from internet articles to professional expertise.

Corporate governance is the other reason and it is probably the biggest. By corporate governance, I mean the structure of how the entity develops, authorizes/makes decisions and holds people accountable.

Corporations have three main levels of authority to get these things done: (1) Board of Directors ("Board"), (2) Shareholders and (3) Officers. The basic process flow is: Shareholders elect the Board; the Board approves strategies and major decisions, including hiring/salaries of Officers; and Officers suggest strategies and actions to the Board for approval, then work to implement. As payment for their respective parts Shareholders receive profits, Officers (and employees) receive salaries and Board member compensation varies, but they typically receive a stipend of some kind.

By having the Board to focus on overall strategy and wade in on major decisions the company can ensure that planning is occurring (i.e. "doing the right things") while Officers focus on the day to day activities (i.e. "doing things right"). Meanwhile, Shareholders hold everyone else accountable for the end results.

This division of labor is critical in a high growth entity because, without the checks and balances, the high volume of necessary work makes it very easy for the favorite activities of the founders to take dominance to the detriment of other necessary activities. The typical result....Chaos and frustration reign.

In very small companies (startups or otherwise) maintaining a proper division of labor is complicated as well, which can be double trouble for a high growth startup. Small companies by definition don't have a lot of people involved, so it is easy not to properly maintain the division of labor because there aren't actually different people performing each function. When small size is combined with entities that do not legally require such a division of labor it is easy to understand why it may never occur at all and in companies where planning, implementation and accountability are not all treated with due respect (which can certainly happen in a corporation too) the results are going to be sub optimal.

So the net-net is that I usually recommend corporations for high growth potential companies, but I would always recommend that companies think hard about what structures are in place to address planning, implementation and accountability regardless of the entity choice.

2011 EDD Employer Payroll Tax Changes

The EDD has announced additional online services for small business, as well as highlighting other 2011 payroll tax changes.