Innovation and the Angel Tax Credit – NJ Tech Weekly

By Richard Kasmin, Chief Economist of NJEDA

(This article was republished from the NJEDA website with permission and originally appeared here. )

Innovation is an essential ingredient for economic growth. But what do we mean exactly when we talk about innovation? Basically, its economic evolution, the process of taking what has been discovered and applying that discovery to create better ways of using limited resources to get things done.

Innovation can take the form of a process or a product. For example, learning to use available technologies to produce things faster, cheaply or with lower energy consumption are types of innovation.

The creation of something as simple as a pencil was the product of countless innovations over hundreds of years. Think about what it takes to produce a pencil: the raw materials, the ability to bring these resources together and the labor and machinery needed to make a pencil. And it is to say the least to put the pencil on the market, where the value of the product is finally realized.

The big differences between the pencil and what we consider to be more modern examples of innovation can be measured on two dimensions: time and value. In terms of time, spoke of the past and the present. It is difficult, in 2020, to consider a pencil as the product of innovation. DNA engineering, on the other hand, is happening now, and it seems almost magical in terms of potential economic impact. In terms of value, different innovations have different economic impacts. The pencil has certainly created economic value, but compared to the potential benefits of DNA engineering in terms of health care, the economic benefits of a pencil seem small.

Many state policymakers understand the value of innovation in terms of economic growth and raising living standards, and they are implementing various policies to encourage innovation. Whatever the innovation, there is one thing they all have in common. Innovators and those who invest in innovators take risks. So, this is where policy makers usually focus their attention on how to mitigate the cost of risk taking to encourage investment in innovation.

The tax credit for angels
One of those policies that we have in New Jersey to encourage investment in innovation is the Angel Tax Credit. As the name suggests, The Angel Tax Credit offers tax credits to so-called angel investors against qualified investments in New Jersey technology and life science companies. It aims to improve access to finance for start-up companies engaged in technologies and life sciences. Additionally, assuming that the tax credit encourages investments that would not otherwise have taken place, it increases the size of the innovation economy and helps build a strong community. of angel investors.

Angel investors are a special breed of investor. More than funds, angel investors also tend to invest their time and expertise in the businesses they support. They finance start-up entrepreneurs and often serve as mentors or external directors of startups.

Research indicates that angel investors have significant positive effects on the companies in which they invest. As evidence, a study by the National Bureau of Economic Research showed that companies with high angel investor interest were more likely to succeed than companies with low angel interest (Figure 1). The researchers concluded, Companies that aroused high interest among angel investors were more likely to grow, issue patents, win new rounds of financing and successfully exit the start-up phase..

In 2020, the size of the tax credit will increase from 10% to 20% of qualified investments. In addition, an additional credit of 5% will be granted for investments in enterprises located in areas of opportunity and enterprises belonging to minorities or women.

Increasing the size of the tax credit makes sense. To understand the right size of incentive, one must consider the motive for investing in the first place. Angel investments are high risk investments, the investor invests in a business in its early stages of existence. During this period, companies are more likely to be engaged in research and development and likely have little or no income. So these companies don't have a clear market value, you can't really assess the economic value without generating income. So the value of these companies rests more on a bet for what it will be worth once their products hit the market. And many must be fine for all of this to happen.

So, these are generally very high risk investments where investors make a bet to, hopefully, generate multiples of their original investment. As such, a larger incentive is likely to be needed to change investment decisions, which are what incentives such as the Angel Tax Credit are supposed to do.

History of the Angel Tax Credit

Since the launch of the programs from 2013 to 2019, the NJEDA has approved approximately 1,400 applications for angel tax credit for nearly $ 600 million in investments in approximately 90 New Jersey-based companies. Regarding the sectoral destinations of these investments, 45% went to life science companies and 55% to technology companies (including 14% to clean technology companies).

The two graphs below show the flows of approved requests and investments divided into three sectoral destinations – clean technologies, life sciences and other technologies. Figure 2 shows the annual claims for the lifetime of the Angel Tax Credit program. Figure 3 illustrates the investment flows for which these tax credits have been applied. Focusing on the past four years, approved applications have averaged about 240 per year for an average of about $ 120 million in investments per year.

Figure 2 The number of requests per year

Figure 3 Investments supported by angel tax credits

The geography of venture capital and angel tax credits

A question we might ask is: where do we see the flow of venture capital in New Jersey and how representative is the geographic coverage of the state? To answer the first part of this question, we have mapped data from Crunchbase, a web platform that provides data on the locations of head offices that have received venture capital funding (from 2011 to present; hui). As the map below shows (Figure 4), there is evidence of what looks like a boot corridor, with hot spots around Jersey City and Princeton. There are a few concentrations of businesses along the shoreline and near Camden. When we examine the location of corporate headquarters for companies that have benefited from angel investors (Figure 5), we find similar hot spots in and around Jersey City, Newark, New Brunswick and Princeton. Most activities take place in the northern part of the state, north of 195. It may be useful to ask whether more can be done to extend the geographic coverage of the Angel Tax Credit by outside some of the current homes to try to expand the ecosystem venture capital.

Fig. 4 VC in New Jersey

Fig. 5 Headquarters of the tax credit for angels

Underrepresented communities

As noted earlier, the new iteration of the Angel Investor Tax Credit will grant bonuses for investments made in areas of opportunity or businesses owned by minorities or women. This begs the question: what evidence do we have from companies in these categories that need more attention?

According to a recent survey by DiversityVC and RateMyInvestor, nationwide, only 1% of corporate supported founders are black and less than 2% are Latinx. Clearly, black and Latin American populations do not have access to venture capital.

Women-owned businesses – businesses owned both exclusively or in partnership with men do not fare much better. In eleven years of data released by Pitchbook (2008-2019), women-owned businesses in New Jersey generated 176 transactions for $ 769 million in venture capital flows. The flow during this period represented around 13% of the transactions and 9% of the capital flows. It is clear that women are underrepresented in this corner of the economy.

Yet, as Figure 6 shows, the data shows that women-owned businesses in New Jersey are seeing an increasing share of the flow. If we look at the linear trend (shown on the dotted lines), since 2008 the share of transactions and flows in New Jersey going to businesses owned by women has increased by about one percentage point per year. In 2008, women-owned businesses accounted for about 7% of transactions and only 4% of the capital in New Jersey. In 2019, these shares increased to around 23% and 14% respectively.

Figure 6 Share of venture capital flows to women-owned businesses

In conclusion, policymakers focus on supporting the growth of innovation ecosystems for good reason, innovation is essential for economic growth and improving living standards. Given the risk commensurate with angel investment, the increase in the amount of the tax credit should encourage more investment and encourage the growth of New Jerseys' innovation ecosystem. . In addition, the evidence shows that businesses run by women and minorities have always faced difficulties in accessing capital, and that the tax credit for angel investors should focus on these populations.

For more information on the Economist’s Corner or to view the archive of publications from the Economist’s Corner, please visit www.njeda.com/economistcorner.

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