News & Insights

As we celebrate South Carolina angel investing tax credit transfer season (among other things), we found this report on the SC Dept of Revenue’s website here (under Publications / Reports / Additional Reports) about who applied for the credit in 2021. We thought you might enjoy reviewing it with us. The maximum $5M of credits were awarded in 2021. (We noted that here, when the award letters revealed a 30% credit, indicating $5.78M of valid credit applications.) These data tell us (I think for the first time) where those awardees came from, and raises a few interesting questions. South Carolina Most credits were awarded to people in South Carolina – $3.37M, or 67% of the total awards. Not a great surprise: South Carolinians are naturally the most likely to be making angel investments in South Carolina companies. Maybe surprising, though, is Greenville County’s total dominance here. Over half (58%) of the credits to South Carolina locations, or 39% of all the awards, were in Greenville. Charleston was a distant second at 14% overall, and Columbia (Richland and Lexington counties combined) only just over 2%. Does that reflect a more vibrant tech community in Greenville? More knowledgeable angel investors? Another possible explanation is more “wholesale” applicants in Greenville, which we have thought in the past used up large amounts of credits – but the average award in Greenville ($43k) is lower than in Charleston ($70k), so that does not seem to be it. Whatever the reason for Greenville’s lead, it is not a small difference! Not South Carolina Equally interesting (at least to us) is the location of non-SC investors. First, it’s surprising how few credits went to direct neighbors – just 4% from North Carolina and essentially nothing (0.3%) from Georgia. Apparently, it remains difficult to attract investors up or down I-85! Second, Virginia posts an impressive showing, and especially the coast – almost 12% of the total awards, and over 1/3 of all out-of-state investors. Could that be because there’s an excellent angel group there (and a VentureSouth group)? Or because Virginia has an angel tax credit of its own so people are more familiar? Third, New England (MA, CT, NH, NY) has more awards at 8% than the southeast (excluding SC, so NC, GA, FL, TN). Areas with well-established early stage investing ecosystems create investors that become more willing to invest anywhere – if you give them compelling investment opportunities and structures. Or perhaps simply everyone from New England is moving to South Carolina… And lastly, notably absent are credits to any west coast locations. California usually dominates angel investing and venture capital statistics, but not in this report! Are west coast investors simply not willing to look this far afield for early stage investments? Maybe this data illuminates academic studies like this one on the importance and use of angel tax credits. Whatever the reason, it’s their loss! Just one more thing One last interesting note is how many applications were denied. Of the 138 applications sent in, only 123 were approved – meaning more than 10% of applications people thought would get a credit ultimately did not. Given the challenges on paperwork timing, this is a lower rejection rate than I would have guessed – but still disappointing if you’re part of the 10%. Make sure the company is properly qualified before you invest. And if you are applying for a credit on investments made in 2022, make sure your applications are submitted before the end of the year! More guide here. Happy Thanksgiving and Happy Investing.

It’s that time of year again: South Carolina angel investor tax credit (SCAITC) award letter time!! For the last couple of years we have shared data on the amounts of the SC angel investor tax credits being awarded. You can see the original posts from April 2020 and the follow up from last year explaining the angel investor tax credits. Here is the 2021 awards update based on letters received this week. For 2021, applicants received a tax credit of 30.3% of their investment amount. As we explained in the prior series, this means that people are receiving a tax credit of 30.3%, rather than the 35% that they would receive if the $5M cap on credits awarded was not being hit. An updated table of “proration factors” for the last few years is shown in this table, with the inferred total amount of tax credit applications, and therefore the total implied investment amount, for each year. 2021 is added in green.  In 2021, the proration factor is 0.86486, meaning approximately $5.8M of applications were made, and therefore around $16.5M of qualified investments into eligible South Carolina startups were completed. This is “down” considerably from 2020 (with the proration factor quite a lot higher) as applications and investing activity were lower by nearly 40%. In 2020 the claimed credits fell a little as the pandemic hit; this year the impact of a global pandemic and economic shutdowns in response was much greater, reducing levels down to the lowest since 2018. On the positive side, this is the third year in a row that the $5M of credits was fully awarded, and for investors this year the good news is they are getting more credit (30%) per dollar of investment than in recent years. But the fall in activity this year overall is interesting.  Was it from the shift in the application system mid-way through the year? Will it change as denied applicants appeal? Was it that angels simply invested less in South Carolina last year? (This was not the case with VentureSouth; our investment into the state increased by 33% in 2021 over 2020. South Carolina’s share of our overall invested capital also rose from 27% to 35% over the same period.) Or directed their investments to later stage, larger companies, or otherwise ineligible deals? (For VentureSouth, our SCAITC-qualifying investment total also rose from 2021 to 2020, by 15%.) It’s hard to know to why the fall, but it raises some questions…

An overlooked attraction of angel investing, compared to most other asset classes, are the fun tax rules around gains and losses on early stage investing. Sounds odd, but it’s true. As we discussed in our guide to angel taxes, the gains from angel investing are often tax free – thanks to the Dabo of the tax code. Following a lucrative 2021 for VentureSouth members, we have spent much of the last few weeks explaining to investors the tax consequences of their exits. We thought it might be useful to share a case study on a recent exit, as it covers the range of tax implications described in the guide. VentureSouth members made five investments in a company, as follows:priced preferred equity seed round in 2015a small purchase of common stock from a departing cofounder in 2017a convertible note in 2017; this note converted into the next round of equity in August 2018priced preferred equity Series A-1 round in 2018, and a further priced preferred equity Series A-2 round in 2029…and exited when a purchaser acquired our shares in 2021. Sounds complicated, but this is a typical journey for an early-stage investor. Each of these rounds is an interesting angel investing tax scenario, so let’s take them one by one. 1) Priced equity held more than 5 years We’ll start with the best. This first round was an investment in Qualified Small Business Stock (“QSBS”), as a a C-Corp running a real business with less than $50M in assets. This is the “base case,” a typical angel investment in a southeastern deal. As QSBS stock held for over five years, gains on this stock are exempt from capital gains taxes. (There are, of course, some limitations, like a max gain of 10x or $10M. There are also more…creative… methods (“stacking”, “packing”, and of course “peanut buttering” discussed here), which do not really apply to angel investors but make for interesting reading.) So the gains on this investment were tax free for our members. Not only was this the best pre-tax return (earliest money in, at the lowest price, so the largest gain); the returns are entirely tax free. What more could you ask for? 2) A purchase of founder’s common stock The next round was a similarly strong pre-tax return, but had a less favorable tax impact. QSBS only applies to newly-issued shares in a company. If you buy existing shares – as in this case where common stock shares held by a founder were purchased in a “secondary transaction,” or more generally, like when you buy shares in a public company – QSBS does not apply. QSBS is designed to encourage new investment. While active and liquid secondary markets make investing more appealing – it’s more palatable to buy stock (and found companies) if you can sell that stock one day – QSBS is focused on rewarding new funding of startup companies, and so is limited to newly-issued shares. Even without the benefits of QSBS, though, this is still fairly appealing as a long-term capital gain taxed at capital gain tax rates. 3) Later priced equity rounds held for less than five years Let’s disrupt the timeline by next tackling #4, the two recent priced equity rounds. Both these investments were QSBS: still a C-Corp with less than $50M in assets, still operating, selling newly-issued shares. So you might think QSBS / Section 1202 / Dabo applies. Unfortunately (from a tax perspective), this was, fortunately (from an IRR perspective), a quick win, with capital deployed and returned within five years. That means the stock was not held long enough to get the Section 1202 exemption. The good news, though, is that these proceeds are eligible for “rollover” under Section 1045 of the tax code. If the proceeds are redeployed into new QSBS within 60 days, no capital gains tax is due on the gains. Investors then face the decision: do we bank the proceeds (and pay long-term capital gains tax on the gain); or do we “roll the dice again” by reinvesting the proceeds into one or more (sensibly: more) QSBS companies? Letting tax treatment determine your investing has the tail wagging the dog, but recognizing the net, post-tax returns is a critical part of investing successfully. 4) The convertible note round The most complicated round of all is the convertible note round in the middle. If you’re familiar with VentureSouth’s soapbox, you know we are generally not fans of convertible notes. One reasons is taxes. The original investment in the convertible note was not into stock of a C-Corp, so QSBS doesn’t apply. The QSBS “clock” only starts when the note converts – which in this case was several months later, which is typical. There are other complications too. How much of the “gain” here was from the accrued interest on the convertible note (taxable as interest?)? How much came at the conversion event? How much should each be taxed? This is a bit beyond the scope of this post, but let’s just say the tax treatment might be murkier on notes than on priced equity. As one hypothetical, notice that if the exit had been in January 2022, a priced round in December 2016 would have been capital gains tax free under Section 1202, but a convertible note at the same time (but that converted in June 2017) would not. (It would have been Section 1045 rolloverable based on the date of conversion, which is good, but it ties up capital for more than six years total to get the treatment you might have received after five. Not so ideal. And no guarantee that the rolled-over money would not be written off!) Not a bad outcome, of course, but one tangible example of where equity would’ve been better (post taxes) and simpler than a note. To sum up: One company, five rounds, four different tax treatments. Fun stuff we hope you agree! We think VentureSouth members benefit from having access to early stage, QSBS-eligible deals; from a steady supply of Section 1045 rollover-eligible companies so eligible proceeds can be reinvested within 60 days; and a full-time team who love explaining the tax implications of investing before and after the investment. Perhaps you will join us for the next one! PS – Section 1045 in action! As an interesting aside, some of our members invested into this company using proceeds from a successful exit of another VentureSouth portfolio company. The prior exit was from a QSBS company held less than five years, and so the proceeds from that exit were eligible for rollover under Section 1045. The successful investors took those proceeds, redeployed them into Company A, and made a further multiple of gain on them. First company was held for two years; second held for three; added together they passed the five years required for QSBS to apply – so all the gains became capital gains tax free. This is Section 1045 working exactly as advertised!  Double win.

Last April we ran a series of posts about the South Carolina angel investor tax credits.The tax credit award letters for 2020 have just been released, and so here is a quick update on the 2020 awards, the proration factor for the year, and what this might tell us.For 2020, applicants received a tax credit of 18.86% of their investment amount. As we explained in the prior series, this means that people are receiving a tax credit of 18.86%, rather than the 35% that they would receive if the $5M cap on credits awarded was not being hit.An updated table of “proration factors” for the last few years is shown in the table below, with the inferred total amount of tax credit applications, and therefore the total implied investment amount, for each year.In 2020, the proration factor is 0.53898, meaning approximately $9.3M of applications were made, and therefore around $27M of investments into eligible South Carolina startups were completed.This is “down” from 2019 – with the proration factor slightly higher, and the applications and investing activity down 14%. Given a global pandemic and epic economic dislocation, this is a fairly minimal fall – with more qualifying investing activity than that long-ago “dark age” of…2017.Naturally, it’s a little disappointing for investors to be getting less of the credit than expected. But as last year, from the wider perspective of South Carolina’s early-stage companies, entrepreneurs, and ecosystem, it’s good news. An impressive, and resilient, amount of investing activity into startups in South Carolina.

The skeptic from the first post in this series was arguably given useful supporting evidence in August when several prestigious professors published an NBER working paper called Investor Tax Credits And Entrepreneurship: Evidence from US States. (Downloadable from here: http://www.nber.org/papers/w27751.)This paper has two key propositions:Angel investor tax credits increase the number of angel investors and angel investments.But this increased activity has no impact on measures of entrepreneurship like job creation.This paper was a serious piece of scholarship, and so deserves a thorough review and detailed reply. For now, we’ll simply pass along their conclusions:The first proposition is that angel investor tax credits increase angel investing. The effect is not trivial: tax credits lead to 18.5% more angel investments (p.14); they lead to 31% more individual angel investors (p.1); and they lead to increases in number of angel investments, angel-backed firms, and unique angels in ranges of 27.6-32.3% (p.15). It’s also these are not just the same old investors just cutting a few more checks: “the programs induce entry of new angel investors” (p.15). Tax credits do exactly what (some of) their proponents aim at: increasing the number of angel investors.The second major proposition is that this increased angel investing activity has no impact on entrepreneurship. As the paper states: “We find that the policies have no significant effect on a plethora of entrepreneurial activity metrics, including young-firm employment, job creation, startup entry, successful exits, and patenting.” (p.2).Yikes. Go on: “Across a broad array of outcomes, we consistently find that an insignificant and economically small impact of the policy.” (p.19) and “Overall, we do not find evidence that angel tax credits significantly impact state-level entrepreneurial activity.”Yikes again. So what’s going on here?On the face of it, this seems like a pretty unlikely proposition: the whole point of angel investing is to help fledgling companies grow. As practitioners in the space that make angel investments and closely monitor the portfolio companies, including their employment levels, we can attest that in our experience the South Carolina angel credit is leading to more investments in more companies and to more jobs. One day we will try to reconcile this paper with our experience.

In August 2020, the SC Department of Revenue updated how individuals applied for the South Carolina angel investor tax credit.All the rules about qualified businesses, qualified investors, and the application deadlines are the same. Even the form TC-56A remains the same. What has changed is that the application has to be done through MyDORWAY now.The first step is to set up an account on MyDORWAY. To get set up on the platform, you will need some combination (depending on whether you are applying as an individual or an entity) of your tax ID number (FEIN, SSN, or South Carolina ID number), a “file number”, and one of these items: Last Payment Amount, Last Refund Amount, Line 1 from the Last Return, or a Letter ID (a number displayed on all SCDOR correspondence). If you don’t have any of these – for example, because you are not a SC taxpayer and this is the first application you have made – you had better call the Department of Revenue. The DoR is responsive, especially the Tax Tech team.Once you are in MyDORWAY, the DoR provides a useful tutorial on applying using this new application. It’s fairly straightforward. Make sure to keep a copy of your confirmation number!Lastly, make sure to get a receipt as confirmation that the application has been received. If you don’t have one, double check the application was received before the end of the year!

During 2018-2020, we conducted a survey through our website about angel investors in South Carolina. It wasn’t an exhaustive scientific study with robust statistically-validated outcomes! It was, though, we think, useful data containing interesting results about attitudes to the angel investor tax credit. Of the investor respondents:84% indicated that the angel tax credit was a “deciding” or “significant” factor when deciding to invest in a given company.64% indicated that the cap on the credit was a “significant” or “moderate” concern, because the cap leads to a lower amount of credit and therefore has less influence on the investment decision.On average, investors indicated they invested 2-3x as much in companies eligible for the credit vs companies not eligible for the credit. These were investors focused on South Carolina: they collectively made 209 angel investments, of which 123 (nearly 60%) were in South Carolina; angel investors generally invest close to home. Making people more willing to invest in local companies is the point of the credit, and seems to be working.Our survey was consistent with another conducted in North Carolina in 2020 by the SBTDC. This survey (which you can read more about here) was completed by 79 respondents covering 21 angel groups across North Carolina.The situation in North Carolina is a little different: its angel investor credit, the NC Qualified Business Venture (QBT) Tax Credit, began in 1989 but was removed in 2013. The survey found:Removal of the credit had a negative impact on investing activity (fewer deals, less capital) and on investing in North Carolina specifically (with more focus outside of the state).A new credit would lead to more investing, with 69% of respondents saying they would invest more, including in higher risk companies and in more North Carolina-based companies.Admittedly these are small samples of respondents and not stringently controlled scientific testing. Nonetheless, it is encouraging to see others reaching similar conclusions to VentureSouth – that these kinds of credits are helpful to stimulate local angel investing and entrepreneurial development.

As you know, at VentureSouth we are fans of the South Carolina angel investor tax credit. Over the course of 2020, we have learned more about the credit, its renewal, its use, and its impact, and so we wanted to share some of these learnings through a few additional posts.Why now?Late in each year, we like to remind anyone that owns a South Carolina angel investor tax credit that the “transfer window” is now open at its widest. This is because buyers can use the purchased credit on their tax returns for the year in which they purchased the credit – so the buyer could use a credit purchased today (November 2020) on her 2020 tax return, which will be filed in the next few months, and is a quicker payoff than for purchases made in January.So, if you have any credits for sale, now’s the time! But the window is closing soon.OK, pitch over. To start this series, here are some questions from a skeptic!***1) The angel investor tax credit renewal process.Back in June, we celebrated when the credit was extended for another five years. Passage of the renewal was uncertain, right up until it was passed! Legislative process is not our area of expertise, but during the process a number of questions were posed about the credit and its impact, and so we thought it would be interesting to record those questions, and our responses, here. (All are edited slightly for clarity.)1 – Some of the lobbying material says the credit needs reauthorization or the companies may not survive. Who are “these companies” specifically?The Secretary of State provides a listing of Qualified Businesses. Many early stage companies are structured to require outside private capital, sometimes over several rounds, before they reach a sustainable cash flow position. This is precarious position even before the revenue shortfalls many companies are facing from the pandemic. We can only attest to the companies VentureSouth supports directly, but there are several SC-based companies in our portfolio that would likely not survive without additional angel investment.2 – Of the total amount invested that qualified for the tax credit since 2013, what percentage was invested in companies that have not survived?At VentureSouth, we do not know the outcomes for all the approved companies or companies that received investment that received a credit, because we are only involved in a fraction and there is not currently a mechanism to capture that data. We would expect a non-trivial failure rate, as startups are inherently risky and over half are expected to fail. The angel investment incentive gives more of them a better chance to survive the “valley of death” before they have sustainable cash flow. 3 – Compared to the total amount invested that qualified for the tax credit, how many angel investor dollars were invested that did NOT qualify or did not even apply for the tax credit?There is no current mechanism to capture that data, so we do not have a way to report that broadly. We can however report that roughly one third of VentureSouth investments in South Carolina since 2013 have been in companies that qualified for the credit.   4 – What evidence is there that angel investments would happen anyway without this tax credit? Angel investors drop millions into new, innovative, risky startups in exchange for ownership and in hopes of scoring an outrageous profit—not a tax credit.While it is true that angels invest in risky startups in exchange for equity in hopes of significant returns, the track record of those “outrageous profits” is limited in South Carolina (unlike venture hotbeds elsewhere). This makes it more difficult to get outside angels who use the “outrageous profits” target to invest here.However, not all angels invest under that thesis. Angels that invest outside of venture hotbeds, including VentureSouth members, are generally not aiming at the “life-changing” results. Those are nice, but actually strong returns are possible just from build a diversified portfolio of companies that go fairly well. In that investment scenario, the tax credit provides a meaningful marginal incentive to invest.Whatever the investment strategy, young companies that grow fast create nearly all net job growth – so we need that risk capital available from individual investors to give those companies a chance to survive and ultimately thrive.  While many startups will ultimately fail, the potential for strong returns helps investors to take the risk – and the angel tax credit mitigates the risk. As for data, a survey of angel investors in South Carolina found that 84% indicated the angel tax credit was a significant or deciding factor in their investment decision and on average, investors indicated they invested 2 3x as much in companies eligible for the credit vs companies not eligible for the credit. 5 – If this tax credit does indeed work as well as you say and is so necessary in revitalizing our economy, why the $5m cap? Shouldn’t we in that case double down and remove the cap?We would agree that the cap should be raised based on the evidence of effectiveness to date, but for now we simply want to make sure the bill is extended.  6 – Per the fiscal impact statement, the bill doesn’t directly benefit startups. It benefits investors who invest, not startups which receive investment.The fiscal impact statement considers the “cost” to the budget, but ignores all of the benefits of the credit.The credit itself is for the investors taking the risk of investment, and so yes they benefit from a tax credit initially. Some of that benefit is “recaptured” (i.e. surrendered by the investor) if the investment produces a significant positive return.The benefit of the credit, though, is much wider than just to the investor. First the startups most certainly benefit from the capital provided by the investors, as they would otherwise not have the funding needed to sustain or grow their business. Second, the people employed by the jobs created and sustained by the recipient companies benefit; the accompanying payroll taxes and downstream sales taxes generated by those salaries benefit the local economy (and the tax base) in many ways.7 – Tech entrepreneurs are frequently encouraged to take as little angel investor money as they can and to put it off as long as they can to avoid diluting their ownership, so I’m skeptical that they will turn to angel investors rather than banks or government when they need capital due to the economic situation.Certainly entrepreneurs attempt to raise as little dilutive capital as is needed to make their company successful. However, banks do not lend to startups – especially technology driven ones with little in the way of tangible assets – because there are no consistent cash flows or collateral. And especially they cannot lend to founders who do not have personal collateral to support personal guarantees. Government grant programs for most startups are very limited and not applicable for most companies.Angel investors therefore fill a very significant gap in the “valley of death” for entrepreneurs. No-one forces entrepreneurs to take angel funding, but VentureSouth sees a constant stream of entrepreneurs seeking angel investment. In a market like South Carolina with limited venture capital, those entrepreneurs have very limited access to forms of risk capital to help them get started and grow.

June has been busy at VentureSouth so blogging has been light, but we hate to leave gaps between posts about taxes so here’s a second to follow the renewal of the South Carolina angel investor tax credit earlier this month.As you hopefully know, several tax deadlines were extended – notably tax day moving from April 15th to July 15th – in response to the pandemic. But you may not know that the Section 1045 rollover window was lengthened too.What does that mean and why does it matter?First, back in our posts about angel investment tax issues, especially this one about Section 1045, we explained how you can defer (and eventually eliminate) capital gains from successful angel investment if you “rollover” proceeds into other investments. You have 60 days from the exit to make a rollover, so finding a suitable deal at the right time can be hard. (Unless you’re a member of an angel group with reliable deal flow, of course.)The COVID rule change extended the rollover period. If your investment reached a successful exit in February or March, the roll-over deadline should have been in April or May. After the extension, the deadline for rollovers was pushed out to July 15 (or later if the 60-day window would be later anyway).So if you were an investor in any recent angel deal exit and just realized you could avoid capital gains by doing a Section 1045 rollover:Go discuss with your tax advisor now!Find an interesting deal to roll proceeds into. Give us a call: we have plenty of open rounds under review. The tax savings will surely more than cover your VentureSouth membership!Takeaway:Taxpayers have until July 15, 2020 to complete the Section 1045 rollover if the 60-day deadline was on or after April 1 and before July 15.Don’t have any relevant deals? Give us a call, we know some people.

Originally passed in 2013, The High Growth Small Business Job Creation Act, affectionately known as the South Carolina Angel Tax Credit, gave investors a state income tax credit of up to 35% of the amount they invested in eligible SC-based companies. The tax credit was a huge success, resulting in over 290 South Carolina companies attracting more than $100 million of qualified investments, which ultimately helped created or sustain more than 1,200 high-paying jobs. Unfortunately, the tax credit’s original sunset date of Dec. 31, 2019 came and went without an extension. VentureSouth, along with many other organizations who understand the importance of supporting our burgeoning entrepreneurship ecosystem, worked closely with our state’s leaders to convey how important this tax credit is to our state. We are thrilled to announce that on May 26, Governor McMaster signed into law the extension of the South Carolina Angel Tax Credit, allowing residents and non-residents to receive an income tax credit for investing in high-growth, high-impact South Carolina startups for the next six years! This is a huge win for South Carolina and could not have come at a more important time as our state’s entrepreneurs are battling new market challenges brought on by the coronavirus epidemic. Many people and organizations worked hard to get this done, but we wanted to express our sincere gratitude to Jason Zacher, Senior VP of Business Advocacy for the Greenville Chamber, and the team of Sunnie Harmon and John DeWorken of SUNNIE & DeWORKEN. Their collective understanding of the tax credit’s importance played a critical role in navigating the process and gaining the bipartisan support needed to pass this highly impactful legislation. Finally, we especially would like to thank the people listed below. The proactive leadership these legislators exhibited epitomized what it means to be a public servant, especially in trying times. Our state’s entrepreneurs owe a significant amount of gratitude for their instrumental role in getting this across the finish line. ·     Representative G. Murrell Smith, Jr.·     Representative Bruce Bannister·     Senator J. Thomas McElveen, III ·     Senator Ronnie W. Cromer