For startup companies in Connecticut, it’s no secret that trying to find seed funding in the state is a challenge. Investors remain skittish about injecting cash in a state many perceive as business unfriendly, while venture funding in general has moved upstream.
But all that could be changing.
Angel investors looking to inject capital in Connecticut companies say a new tax credit passed by the state legislature earlier this year could be a game changer.
It’s already making a difference for some companies like Stamford-based Xlerant Inc., a software development firm that has created a product similar to TurboTax, but for budgeting.
The company is in the process of raising $1.25 million in bridge funds to add to its staff. It is one of eight Connecticut startups that have qualified for the angel investor program, which began July 1. That means investors interested in injecting cash into the company would be eligible for a tax break.
As a result, Xlerant is likely to close on a deal soon, said Will Wilcoxson, the company’s CEO.
“We are going to raise more money than we would normally be able to because of the tax credit,” Wilcoxson said. “That will allow us to do more in terms of growth.”
The tax credit also changes the game for an angel investor, often a wealthy individual who invests in a startup company.
Angel funding has become increasingly popular — and important — in recent years, especially after the dot-com bust scared venture capitalists away from early-stage deals, creating a major funding gap for startups.
But angel investing is also a highly risky business proposition and most involved in it, don’t do it to make a living.
“We discourage members who don’t have tolerance for risk,” said Joe DeMartino, president of the Angel Investor Forum. “If you need to think about investing $15,000 to $25,000 in a deal, this is not the thing you want to be doing.”
The Angel Investor Forum is a group of about 55 private investors residing in Connecticut and New York who invest in early-stage companies. Of the approximate four deals they do each year, only about a third have historically been done with Connecticut companies. The rest of the money is injected into startups outside the state including in Boston and New York.
Connecticut recently launched a new program that allows angel investors to take a credit against their income tax for certain investments made in bioscience, advanced materials, information technology, and emerging technology businesses.
Investments must be at least $100,000 and the income tax credit equals 25 percent of the cash investment, up to a maximum credit of $250,000.
The state has allocated $6 million for the program over the next few years and then $3 million a year until 2019.
DeMartino, a retired software entrepreneur who lives in Glastonbury, said the new tax credit will likely make him a more aggressive investor in Connecticut.
The AIF receives about 350 applications a year, but the group is strict with its criteria. It doesn’t invest in lifestyle businesses and focuses on consumer products, life sciences, technology, mobile, and internet companies. AIF looks for companies that have a sustainable business plan and the ability to grow quickly — which positions the company for an exit in three to five years.
Of the 350 applications, about 150 are legitimate business propositions, but they will only invite about 30 companies to pitch their business plan.
Typically, AIF will invest in four or more companies a year. Each deal usually involves at least six members investing about $25,000 each.
“With the tax credits on the table, I’m going to tilt toward Connecticut,” DeMartino said. “I think it will definitely boost interest in Connecticut-based deals.”
But the credit program has as much to do with changing the perception of Connecticut’s business climate as it does with satisfying wealthy investors.
Capital is the lifeblood of growing small businesses, especially startups. The more capital a state can attract the greater potential for job growth. And Connecticut is in desperate need of jobs.
Peter Longo, president and executive director of Connecticut Innovations, the state’s technology investing and innovation arm, said about 20 states offer tax credit programs for angel investors. Connecticut’s program is key to gaining leverage in the increasingly competitive environment.
“I think this sort of levels the playing field with other states,” Longo said. “Connecticut has a great deal of wealth and a pretty high concentration of accredited investors so this gives us the opportunity to keep more of that money in the state.”
The credit should also help CI, which is running the program, leverage more of its own dollars with private funds. CI has invested $152 million in Connecticut companies from 1995 through 2008.
Longo said CI will also be able to play a matching role and build tighter relationships with the angel community.
But of course the legislation does have some drawbacks, DeMartino warned. It requires a minimum $100,000 investment, something that is not typical of an angel investor who traditionally injects about $25,000 in a single deal.
That is going to require groups of investors, like the AIF, to change the way they do business in order to capitalize on the new credit. Instead of investing in Connecticut companies on an individual basis, AIF members will likely form a limited liability company and pool their investment so it qualifies for that $100,000 benchmark.
“It’s a little more costly, but we’ve done it before,” DeMartino said.
Regardless, the new tax credit program is spreading some optimism.
Wilcoxson, of Xlerant, said his company will use its bridge funding to grow while it waits to raise its next round of funds in 2011. That’s when the company will be testing the venture capital market by trying to raise $3 million to $5 million.
“There need to be more incentives like this for venture firms to invest in early-stage companies,” Wilcoxson said.
Greg Bordonaro writes the Financial Sense column every other week. Reach him at gbordonaro@HartfordBusiness.com.
