New report on financing of high growth companies – and missed opportunity

Earlier this month, the National Advisory Council on Innovation and Entrepreneurship (NACIE) issued a report on Improving Access to Capital for High-Growth Companies. [NOTE: Formed in 2010 by Secretary Locke, the NACIE should not be confused with the recently established Innovation Advisory Board, mandated under the America COMPETES Reauthorization Act of 2010 or the President’s Council on Jobs and Competitiveness.]
The report calls for a number of steps including:

Recommendations for Early-Stage Access to Capital
1: Provide a 30% refundable tax credit on angel group investments of <$200,000 into small businesses.
2: Provide a 100% exclusion on capital gains tax to small business investments held for 5 years, with deferrals permitted for roll-over investments into other small business within 9-month periods.
3: Provide a 100% exclusion on corporate income tax for the first taxable year of profit, a 50% exclusion on following two years of profit, and tax deferral on exercise of NQ stock options in small businesses.
4: Reduce further the SBIR/STTR grant review process from the current 6-12 months to a 3-month timeframe.
5: Support the SBA's proposed Early Stage Innovation Fund and efforts to further reduce SBIC license processing times and interest rate burden. Recommend future SBIC eligibility consideration be given to emerging investment classes such as angel groups, micro-VCs, and VDOs.
Recommendations for Later-Stage Access to Capital
6: Maintain the capital gains tax rate at 15%.
7: Amend the Spitzer Decree to permit payment for analyst coverage through banking revenue, and mandate analyst coverage of IPO issuers for at least five years.
8: Amend Sarbanes-Oxley Act Section 404 to reduce compliance controls and external-audit frequency on smaller public companies.

However, it also represents a missed opportunity: the use of intellectual property as collateral for loans. The report focuses almost exclusively on on equity financing, with a nod of the head to the SBIR/STTR grants program. But there are opportunities on the debt side as well. As readers of this blog know, I have long advocated for the use of intellectual property (and some other intangible assets) as collateral in debt financing. The irony of this missed opportunity is clear when looking at the SBA announcement (as part of Start Up America) of the Fund. They note that “Early-stage companies face difficult challenges accessing capital, particularly those without the necessary assets or cash flow for traditional bank funding.” This statement is correct in one sense and completely off track in another. It is correct when it states that these companies don’t have assets that traditional bank funding would accept as collateral. It is completely wrong in its implication that the companies don’t have assets. These companies are often sitting on intangible assets that could be used in debt financing. The key is not necessarily to expand the equity route — but to change how the “traditional bank funding” treats these assets.
As I’ve argued for before, there are two action that SBA could take:
•  Develop SBA underwriting standards for IP. SBA should work with commercial lenders to develop standards for the use of intangible assets as collateral, similar to existing SBA underwriting standards. Allowing IP to be used as collateral will increase the amount of funds a company, such as one in the high-tech sector, would qualify for.
•  Create an IP-backed loan fund. Other nations have developed special programs to encourage IP-based finance. The U.S. should set up similar programs on a pilot basis, ideally run by the SBA to take advantage of its lending expertise. Technical support could be provided by the SBA’s Office of Technology, which already coordinates the Small Business Innovation Research (SBIR) program. The SBA technology office also works with the U.S. Commerce Department’s National Institute of Standards and Technology (NIST) on its Technology Innovation Program and has a hand in other federal science- and technology-related initiatives. Such a direct lending program would be a step beyond SBA’s current loan guarantee programs–direct lending is needed to jumpstart the process. Once the process of utilizing IP as collateral is fully established, the program could be converted to a loan guarantee structure.
These two action would begin to unlock the debt financing option for high-growth companies. It is an option the Commerce Department and its National Advisory Council on Innovation and Entrepreneurship should not ignore.


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