leveraging private equity with government business incentive programs the following

7/28/2019 Leveraging Private Equity With Government Business Incentive Programs the Following

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Leveraging Private Equity With Government Business Incentive Programs

The following Article appeared in the July 2002 issue of American Venture MagazineBy: Michael Rambert, Esquire & Sidney Wigfall

The private equity markets for early-stage technology companies are a tough place. Traditionalventure capitalists ("VCs") are busy supporting their firms' existing portfolio companies withtheir available investment capital while writing-off their non-performing portfolio companies--and some VCs are even focused on saving themselves and their ability to raise their next venturefund given the substantial reductions in valuations that occurred along with the "bubbleexplosion". Corporate VCs are virtually no place to be found as they have focused their limitedresources on their core business lines with venture capital considered non-core, and angels havetaken a step back to the sidelines. The media has officially pronounced early-stage technologyventure capital dead. Thus, the question becomes: where can an early-stage technology companyturn for help? The government of course.

Were from the Government, and Were Here to Help YouOften when the term private equity is mentioned in the same sentence as government, mostprivate sector business people do a double-take. Mostly because they view equity investments interms of private sector venture capital, otherwise known as risk capital, and everyone knows thatthe government is generally risk averse. In actuality, the federal government, several stategovernments and certain sophisticated local governments are some of the most active players inbeing a source of risk capital for early-stage technology companies.

Federal Programs:There are numerous federal financial incentive programs that are designed to assist and supportearly-stage technology companies. Among the federal agencies that have such programs are theDepartment of Commerce, National Institutes of Health, National Science Foundation,Department of Defense, Department of Energy, Small Business Administration and many others,and several of these agencies participate in the Small Business Innovative Research Program(SBIR) and/or the Small Business Technology Transfer Program (STTR). Outlined below aretwo programs in which some of our clients have participated: the SBIR Program and SBAsSmall Business Investment Company Program.

Small Business Innovative Research (SBIR) ProgramThe SBIR Program provides approximately $1 billion annually to American small businesses forearly-stage research and development projects. There are at least ten federal agencies thatparticipate in the SBIR program. Each of the agencies allocates approximately 2.5% of theirmultimillion-dollar R& D budgets to the SBIR Program annually.

Many savvy private equity investors introduce their early-stage technology companies to theSBIR Program because it saves the investor money and time. The investor lets the federalgovernment use its money to research the viability of the technology. Thus the investor can comein when the company already has a researched and proven technology. The investor can then usemore of its funds for bringing the product to market, so that it can generate those highly valuedrevenues and hopefully significant profits.


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Small Business Investment Company (SBIC) ProgramThe Small Business Investment Company (SBIC) program was created in 1958 to help smallbusinesses meet long-term, patient capital needs not available through banks. Small companiesoften require equity financing in the critical $250,000 to $5 million range, not usually obtainablefrom private VC firms. SBICs help to bridge this capital gap. For [2000], there were

approximately [404] SBICs with over [$16 billion] under management nationwide. In [2000],approximately [$5.5 billion] was invested in [3,060] small businesses and, for [2001], nearly [$6billion] in SBIC investments is expected to be made.

State and Local Government Business Incentive Programs:State and local governments also invest in and loan substantial monies to early-stage companies.Each of the 50 states and some local governments has some form of economic developmentinitiatives. These initiatives are usually administered by a state economic development agency,whose sole purpose is to attract business to their respective state and localities with theinducement of business incentives. Due to the unprecedented growth in technology companiesduring the 1990s along with the establishment of technology centers such as Silicon Valley,

Bostons Route 128 Corridor, the Innovation Garden State (New Jersey) and Silicon Alley (inthe New York/New Jersey/Connecticut tri-state region), many states have also developedbusiness incentives for the exclusive attraction of technology companies (e.g., technology seedfund programs supported by millions of state-invested dollars).

Many small and start-up companies are often under the impression that government businessincentives are just for large established companies. In actuality most state business incentiveprograms are designed to assist small and start-up companies.

Types of Business IncentivesSome of the most sought after and more popular state-local business incentive programs aresummarized below.

Seed capital and technology funding programs have been developed by several states (includingNew Jersey, New York, Pennsylvania, Connecticut and Maryland) and New York City. Theseseed capital and technology funding programs are tailored exclusively to fit technology companygrowth patterns and financing needs.

Technology commercialization grants/loans and venture capital access are offered by severalstates and localities to companies that are converting new technologies to commercialization.They have recognized that technology is the new growth industry, despite the current economicclimate. For states/localities, this translates into increased jobs for its citizens and residents andincreased tax revenue for the state/city treasury. In addition, many states want to become knownas the next Silicon Valley, Route128 Corridor or Silicon Alley, or at minimum get their fareshare of technology companies to locate and grow in their backyards. The rationale is to attractyoung high growth companies early, and therefore several states offer research grants, start-upcapital and even venture capital funding access and introductions. Such financing can begarnered by companies operating in a stand-alone mode, companies in state or privateincubators, or companies partnering with the research and development divisions of universitiesand colleges.


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Low-interest loans and loan guarantees can make the difference between paying an interest rateof prime plus or even below prime. Many economic development authorities can alsosupplement a bank loan with direct low-interest financing or help to obtain the financing with aguarantee of the bank loan.

Private venture capital funds are often invested in by state governments. Many states havedetermined that it is a wise decision to diversify its portfolio of investments by investing inventure capital funds. These state entities investment motives go beyond that of your typicalinstitutional investor who merely wants a big return on its investment in the fund. States invest inprivate venture funds (usually SBICs because of the advantage of SBA leverage) because theywant to take advantage of the experience of the private venture fund managers, and hopefullyshare in the mangers success.

In return for the states investment in the private venture capital funds, the fund commits to makeinvestments in qualified early-stage companies located in these states. States such as New Jersey,New York, and Pennsylvania are each invested in several different private venture capital funds.

Business incubators/accelerators are being invested in and supported by many states interested indeveloping in-state high-growth companies and attracting young high-growth companies to theirrespective states. Such incubators may be privately managed or university/college-based, andmay offer location, technical and financial assistance to its company clients.

Location grants and loans are offered by states/localities to target certain geographic areas foreconomic development and business growth. If your company is located in one of these areas, oris willing to locate some facilities in one of these areas (commonly named EconomicDevelopment Zones, Empowerment Zones, Urban Enterprise Zones, etc.), your company canqualify for land write-downs, real estate tax abatements, low-interest loans and grants.

Business employment incentive programs and sustainable job grants are probably some of themore important programs to state officials since the goal in federal, state and local economicdevelopment is primarily job creation, especially in a slower or recessionary economicenvironment. These programs are generally in the form of grants to assist businesses that plan torelocate and/or to assist existing companies that plan to expand employment in the state. Theymay also include training grants to businesses that plan to expand employment in a state orlocality. The money for these grants usually comes from income taxes that are routinely withheldfrom employee checks, and companies can usually get up to 50-80% of these withheld fundsback.

Tax credits/breaks will usually be an option. Tax credits for job creation are typically available tocompanies that create or relocate jobs in the state, especially in designated economic/enterprisezones. Tax breaks usually come in the form of exemptions such as real estate tax abatements,deductions, credits, preferential calculations, or reduced rates that can lower the companys totaltax burden.


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Leveraging Private Equity

Most venture capital firms seek to leverage their investments by investing jointly with otherprivate equity investors (a consortium or syndication approach). This consortium of investors isreferred to as an investment group, and usually consists of one lead investor and a few followerinvestors. This team approach to investing allows these private equity investors to spread the risk

of their investments. In tough economic times, you tend to see more team investing, and, in thesetough times, private equity investors find it extremely beneficial to partner and utilize variousgovernment financial incentives to leverage their risk and cost of investment. In other words,savvy private equity investors seek to become partners with government. They accomplish thisby utilizing government financial business incentive programs to leverage their own privateequity money in a portfolio company.

Experienced venture capitalists and other private equity investors know the value of a dollarbecause more often than not some of the dollars that they are investing in companies are comingout of their own pockets. For this reason, VCs, especially those managing smaller funds, valuegovernment business incentives. Even beyond the federal governments SBIR/STTR and SBAs

SBIC matching funds, these VCs have become adept at leveraging the various state/localgovernment business incentive programs with their own money. For instance, many VCs willrefer a start-up technology company to the SBIR grant program in order to complete thecompany's product/ technology research and proof of concept.

The VC will also refer the same company to state government agencies for a productcommercialization grant. Once the product is ready to be sold on the market, then the VC willmake its own investment in the company. For every dollar the government invests in thecompany is a dollar saved by the VC. Which in the short term reduces such VC's risk exposureand in the long run will yield a greater return on investment for the firms investment. This ofcourse makes the VC happy, but it also makes the VCs institutional investors or limited partnershappy because it is also getting more bang for its buck.

Steps to Leveraging Private Equity:

1. First, determine what type of funding you need and for how long you will need it.2. Go to each governmental entity's business resources web site (whether federal, state, or

regional/local), and learn what each has to offer and determine whether the subjectcompany might qualify. [See attached table of contact information for selectedfederal/state governments.] It is recommended that you read the profiles (if available oraccessible) of companies that were successful in utilizing the various business incentives,to determine if there are any similarities to your own company. It is also recommendedthat you request literature on grants, technology loan programs, technologycommercialization programs, etc. from the federal government and the various stateswhere you are located or are considering locating your company.

3. Set up meetings with states economic development agencies, preferably the stateagencies that is most likely to understand your technology/business. They can explain theprograms you may qualify for and make introductions to other state agencies and thestates venture fund partners. They should also be able to put you in contact with their


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state's liaison to the federal government for assistance with federally supported businessincentives.

4. Be friendly and positive at the meeting. You are a small early-stage company, not GE.(Do not threaten to move your company to another state. This will definitely kill yourchances of getting the best deal.)

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Calculate the numbers and determine the time frame in which you need to get the dealdone. (State approval boards usually meet monthly.)6. Negotiate the deal.7. Be sure that you negotiate a deal that you can live with. (Do not over promise job

creation, expansion plans etc.) Some states are beginning to impose penalties oncompanies that do not meet their promised goals.

8. Pick up your business incentive check and get back to work on growing your early-stagetechnology company.

When structuring financing for a private equity deal, two of the most important considerationsare: cost of capital to the early-stage company and, if you are an investor, the opportunity costs

of utilizing that capital. Federal, state and local government business incentives can greatlyreduce the overall cost of capital for an early-stage technology company. It also places thatcompany in a better bargaining position when negotiating with potential investors. For privateequity players, these business incentives allow them to leverage their (usually expensive money)with low or no cost government funds. It also can result in the investor obtaining a greater returnon its investment.

Overall, government business incentives result in making the deal more attractive for both theinvestor and the early-stage technology company. They give both parties incentives to do thedeal.

leveraging private equity with government business incentive programs the following

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