Policy: How the Innovation Fund Tax Credit impacts Iowa

Iowa Innovation Fund Tax Credit Illustration by Jess Lynk

After being created in 2011 the Iowa Innovation Fund Tax credit sat for two years before it was used.

But in 2013, Des Moines-based Next Level Ventures became the first fund to be certified as an “Innovation Fund”. Five years later, it is the only certified fund.

And it wouldn’t exist without the Innovation Fund Tax Credit.

“The tax credit was essential in getting investors excited about looking at investing in a fund that focuses solely on Iowa-innovated companies,” said Craig Ibsen, Managing Principal at Next Level Ventures.

The credit intends to strengthen Iowa-based venture capital and encourage investments in early-stage companies in Iowa. In order to receive the credit, investments must be made through a certified innovation fund.

Seven years after the creation of the Innovation Fund Tax Credit, the Iowa Department of Revenue released a report looking into the impact this tax credit has had on the state.

As of now, the report was “inconclusive” as to whether or not this credit changed the number of investments within Iowa, but the report did state that some “metrics showed that states with a credit did have a more favorable climate for startup growth.” It also noted that it may be too early to tell the impact that these credits have.

The Certification Process

In order to become certified, the Iowa Economic Development Authority requires a potential fund to show that they will invest in “innovative businesses with a high growth potential” and must obtain a minimum of $15 million in investment commitments before it can start investing in companies.

The Investment Company Act of 1940—a federal act—also limits the number of investors to a fund. According to the act, companies with more than 100 investors are subject to regulation and requirements that most venture capital firms have trouble meeting.

Evolving tax credit

When the credit was created in 2011, taxpayers who invested in these funds were required to wait three years after investing to receive their tax credit and the initial credit was to be 20 percent of the investment.

In the first two years of the credit, no funds were certified, so no awards were given out. But in 2013, the legislature adjusted the credit.

“They made two important changes that made it more attractive to investors,” Ibsen said.

The legislature increased the tax credit from 20 to 25 percent and eliminated the delay in claiming the credit. That same year, Next Level Ventures became an approved fund.

Ibsen said they had their fund up and running six months after they were certified.

Complications

The combination of these two requirements has left some funds unable to become certified.

Recently, a seed venture fund, River Glen Ventures Partners, said they were not able to materialize as an innovation fund.

“We couldn’t get enough individual investors, there are constraints you can only have 100 investors in these partnerships,” fund founder Matt Busick said. “So if you raise $25 million in 100 slots, the average investment needs to be $250,000. And there’s just not that many angels willing to invest that in a single fund that is constrained to investing just in Iowa.”

Because certification has proved more difficult for some, the tax incentive program has never reached its full potential. Capped at $8 million, the most awarded year, 2015, ended at $2.8 million.

Progress on the Innovation Fund Tax Credit

Even though the fund distributed only a part of tax credit awards, Scott Hoekman, another principal at Next Level Ventures, argues that this credit has had an influence on the growth of startups in Iowa.

According to the report released by Iowa Department of Revenue, the 230 full-time employees at companies in Next Level Ventures’ portfolio had wages 86.6 percent higher than the state average. Next Level Ventures’ seven companies (at the time of the report) had a 69.1 percent employment growth.  From right before Next Level Ventures’ invested in the seven companies in their portfolio until May of 2017, these companies grew from 42 employees to 136 employees.

These stats showcase the growth that Next Level Ventures provides for each company in its profile. The innovation fund has helped these companies expand.

Next Level Ventures, today, has nine companies in its portfolio including Dwolla, Igor and WebCare Health. They have invested around $20 million of the $40 million they have raised so far.

“These nine companies have grown quite considerably, which is pretty exciting because the ultimate gains from that $20 million or so investment has turned into a lot of sales growth number one and number two about 100 new jobs,” Hoekman said. “The jobs that are created through the tax credit program and our investment has created companies that are growing quickly and are creating jobs here in Iowa. Without those tax credits, Next Level Ventures would not exist and those investments would not have taken place.”

Hoekman also explained that through this tax credit, Next Level Ventures is able to help make Iowa companies appealing to investors outside of state. Hoekman says that they have brought in investors from organizations in New York, Colorado and California.

“They likely wouldn’t have come to Iowa to do those investments if it wasn’t for the fact that we are leading the ground in Iowa ourselves because that has made them more excited to come here to have a partner inside the state to help out with the portfolio management of the companies that they are co-investing alongside Next Level Ventures,” Hoekman explained.

Although the Iowa Department of Revenue’s report was uncertain the influence of the credit at this time, Next Level Ventures see this fund as valuable to the growth of innovation in Iowa.

“We believe that the innovation and angel tax credits are essential tools in helping build and grow our own high tech companies right here in Iowa,” Ibsen said. “But with a $40 million fund focused solely on Iowa, there is a lot of work to do, but … in the last four years, Iowa has moved up in rankings and will continue to do so.”

Jess Lynk is a reporter for Clay & Milk and a senior at Drake University