Tuesday, February 3, 2009

The Story of ACT 221: Stimulating Hawaii’s high-tech industries

Hawaii’s innovative high-tech industries have built new energy systems and discovered inexpensive ways to create pure drinking water in remote areas. They’ve regenerated human tissue for cell therapy, produced electricity for the grid, and developed vaccines for emerging infectious diseases.

Part of a new global community providing 21st century solutions, they’re also luring renowned scientists to Hawaii, bringing accomplished young Island graduates back home to work and creating good jobs and tax-paying companies for the state.
Between 2002 and 2007, the high-tech industry pumped at least $1.4 billion into Hawaii’s economy in direct spending, creating a firm foundation to help the state move away from dependence on tourism and the U.S. military.

In a few short years the high-tech industry has grown from less than $1 billion of the state’s overall economy to an amount almost equal to the construction industry. Latest estimates peg tourism at $11 billion; construction at $3.5 billion; and high-tech close behind at $3 billion.

All of this is thanks, in part, to one of the nation’s most innovative stimulus programs for high-tech industry – a law commonly called Act 221 – that offers tax credits to investors willing to take an early risk on the state’s high-tech future.

Act 221 is aimed at encouraging high net worth individuals in Hawaii to invest in innovation in their own back yard, but it has also served to inspire outside investors to evaluate Hawaii companies as wise investments with good return and strategies in place to reduce risk.

Since the high-tech tax credit was first initiated in 1999 – then later expanded and amended – results have been impressive. The 177 qualified Hawaii high-tech companies that filed with the state under a new 2007 transparency law, received $1.2 billion in cash investments between 2002 and 2007. Over the same period, they spent $1.4 billion in the Hawaii economy. They’ve employed at least 4,500 people, with more than half of the 1,450 full-time jobs averaging pay above $60,000 annually. At the same time, the state has seen a welcome diversification into industries offering a “brain gain” with new opportunities encouraging more young people to consider innovative fields for themselves.

“The high-tech industry is very much a fresh dollars industry,” says Anton C. Krucky, who co-founded and is president and CEO of an innovative medical company called Tissue Genesis, which has grown in just a few years to become a $4 million-a-year enterprise with 29 employees.

“We brought some very bright people from the Islands home, and that has been very exciting,” he says. “I’m a big hit with parents,” he adds with a laugh.
Investors collected $295.6 million in tax credits from 1999 through 2006, but every one of those tax credit dollars attracted three more in outside investment for the state.

Those numbers don’t take into effect thousands of other subtle and less quantifiable benefits, including the trickle-down effect of a new industry as people spend money on additional goods and services, pay excise and income taxes, and inspire additional economic activity.

“When we were founded, Act 221 was an essential part of getting the business off the ground, and getting the financing we needed,” says Dustin Shindo, founder, president and CEO of Hoku Scientific, a renewable energy company. Hoku Scientific’s success has helped to fund other technology companies, assisted in drawing other research funding to Hawaii, and supported local businesses.

Without Act 221, says Shindo, Hoku wouldn’t have gotten going or been in Hawaii.

In a few short years the high-tech industry has grown from less than $1 billion of the state’s overall economy to an amount almost equal to the construction industry. One of the earliest success stories was Oceanit, begun back in the mid 1980s before the tax credit helped pull in venture capital. But even a company as diverse and substantial as Oceanit has doubled in size to 150 employees in the last seven years, says Ian Kitajima, director of marketing.

Kitajima is one of those lured back to Hawaii from an international career with high-tech companies. Trained at UH, he left the state for what he once thought were better opportunities on the Mainland, in Europe and in Asia. What brought him back was the realization of just how good high-tech had become here – and a recognition that Hawaii’s welcoming people are the best in the world.

“In all those years of running away – and seeing the world – I realized how special Hawaii is,” he says. “When I was in Finland (one of the world leaders in high-tech development due largely to government support), I would meet some of the best guys there and I would think ‘I know guys back in Hawaii that are as good….’ In going away I got to see the world’s best and realize our people are as good. Or better. And because I saw what Finland is doing, I said ‘We’ve got to get to that.’”

According to Kitajima, Hawaii legislative support of high-tech through Act 221 is already setting the state on a positive course.

“Act 221 has proven it’s an incredible vehicle to start companies, bring folks back from the Mainland, inject capital into Hawaii and bring in outside investment,” says Kitajima.

“When you’re trying to build a company, capital is a lifeline,” agrees Krucky, CEO of Tissue Genesis. “Act 221 has enabled companies to have the energy, willingness and hopefulness to get going.”

Krucky launched his company on the Mainland, then brought it to Hawaii. Because of his Native Hawaiian ancestry, coming back to live in the Islands – after spending much of his life away because of his father’s military career – was a dream. That’s also part of what resonates for him when the company hires new employees.

He remembers poignantly what some of those people have told him: ‘I couldn’t believe there was this kind of work going on in the islands’…‘I’m so happy I found you’…’One of my dreams was to come home and this is part of that dream…’”

The company has thrived and grown, partly because of a good business plan and contented employees and partly because of the high-tech tax credits and incentives provided by Act 221. The credits also provided the leverage to bring top scientists into the Tissue Genesis fold.

The credits themselves are less important to many Hawaii investors than the fact that they help to continually assure interest in Hawaii among outside investors, says Rob Robinson, founder and managing partner of Kolohala Ventures, which raises money both in and outside of Hawaii to invest in local high-tech businesses.

“For most individual investors in Hawaii, they’ve already got a lot of tax credits, and many no longer use tax credits,” says Robinson, who is also a Professor of Management at the Shidler College of Business at the University of Hawaii-Manoa.

“What concerns them is, ‘Will these companies be able to get additional capital when they need to grow?’ Without Act 221 there’s almost no way for these companies to raise additional money in Hawaii. They’ll either go out of business or be forced to leave the state. That would be the worst of all worlds. The companies we’ve already invested in and the tax credits we’ve already given would be for naught and we wouldn’t get any new companies. The consequences are pretty dire.”

Robinson said it’s important for the state to recognize that new economic sectors can’t be built in just a few years, and continuing support is a crucial element.

“It’s important to understand that it takes 20 to 25 years to build a new sector of the economy. It took 25 years to build high-tech in San Diego, for example. We’ve had Act 221 for seven years and we should absolutely renew it for another 10. Capital is a very delicate thing and you don’t want to create capital flight.”

Not every enterprise that benefits from the economic stimulus of Act 221 has succeeded. But many have – and are now drawing investment and interest far beyond what was initially spurred by the tax credit.

“You can’t just count jobs,” continues Krucky. “You have to count money swirl and economy creation, especially in life sciences. There are grants and contracts. These technology companies – they’re not companies that want to do business just in Hawaii, but to do it nationally and internationally, with their base in Hawaii. They have to do that to bring fresh dollars into Hawaii, and these companies are doing that.”

Shindo’s Hoku Scientific, for instance, is building a $390-million 67-acre polysilicon plant in Pocatello, Idaho, for producing the raw material used in manufacturing most solar panels, though the company’s corporate headquarters and operations remain in Hawaii.

“People think ‘If Hoku did that in Idaho, it’s not good for Hawaii.’ Not the case,” says Shindo. “The corporate office is here and the growth of the business outside the Islands has helped Hoku to develop its solar integration business in Hawaii,” he said, referring to the design, installation and servicing of photovoltaic systems.

In the highly competitive high-tech arena, Hawaii’s innovative economic stimulus program has given the state an advantage in facing challenges from other states trying to lure investment capital to innovative industries of their own.

“Outside investors wouldn’t invest in Hawaii deals if there wasn’t local skin in the game,” says Bill Spencer, co-founder and CEO of Hawaii Oceanic Technology and president of the Hawaii Venture Capital Association.

“When you’re an early stage company trying to get off the ground, the likelihood of getting money from traditional Mainland sources is very low. So one of the motivations behind Act 221 was we’ve got to do something to get our local high net worth investors to look at investment opportunities right here in our own back yard.”

As the country and the state face difficult economic times, Act 221 is being seen as an even more critical economic stimulus. Without a continuing infusion of venture capital, young companies could struggle to keep providing the jobs and growth that have already become an important piece of Hawaii’s economic pie.

In a January 2008 report assessing market opportunities in Hawaii for venture capital, the Hawaii Institute for Public Affairs noted that Hawaii is “broadly undercapitalized,” consistently ranking among the bottom 10 states in venture capital and small business loans, even though it ranks as the 15th best state for “young growing firms” and “surviving start-ups.”

David G. Watumull, president and CEO of Cardax Pharmaceuticals, which has also grown dramatically with support from Act 221, notes that high-tech now produces as much income as one of the major pieces of the tourist industry – ‘accommodations’ –dominated by the state’s vast array of hotels.

“The whole tech sector has been fueled by Act 221,” says Watumull. “And it’s significantly faster growing than anything for the visitor industry.”

For those companies, entrepreneurs and chief executives on the front lines of building new 21st century business models for the state, continuation of the tax credits is a crucial tool.

“When I joined Hawaii Biotech we had 10 employees and a $1 million budget,” says Watumull. “Now three companies have come out of that – with 70 to 75 employees and annual budgets that total around $30 million. The company probably would have gone out of business without Act 221. None of the three companies would have been around.”

As both the State administration and the State Legislature begin a new year of ideas to both sustain and stimulate the economy, potential changes are being considered to make Act 221 less generous to investors.

However, any potential changes could have a devastating effect both on the growth of high-tech companies in Hawaii and the overall economy itself, say business leaders.

“If Act 221 goes away, there’s not a big reason to stay in the state,” says John Bower, CEO of uBoost, which is helping hundreds of thousands of children across the country improve school performance with a wide variety of incentives and rewards.

“You’re going to see a mass exodus of all the more established companies,” said Bower. “They won’t have the strength or the leverage to say ‘I can’t go.’

“Why would any Act 221 company stay in Hawaii?” he asks. “What would the reason be? Why fight the battles, the resource issues? Why fight all the people who want to give you financing – but only if you move?”

Hawaii’s business sector has always faced an uphill battle to attract outside capital. Geographic isolation, a small workforce and limited land availability have served to dampen many bright ideas. But in the age of the Internet – and with a 25-year commitment by state government to building infrastructure – those obstacles began fading.

The Manoa Innovation Center, Pacific International Center for High Technology Research, Hawaii Technology Development Corporation, Mililani Tech Park, and the John A. Burns School of Medicine, all have helped support the state’s growing ability to diversify and spread beyond dependence on tourism and military spending. Act 221 was an enlightened next step in nurturing the seedlings of 21st century industries; biotech, solar energy, cutting-edge medical research, new fuels and dozens of innovative ideas that have often sprung from University of Hawaii research projects.

Industry executives worry about the impact of a retreat at this time.

“Putting something out there and then taking it back makes the business community leery about any government-led initiative,” says Bower. “Hawaii has always been in the bottom 10 percent of the states friendly to business. Things like that perpetuate the idea this is not a great state to do business in.”

Act 221 has turned around that perception. By offering a 100 percent tax credit, to be taken over several years, to investors who support bright young entrepreneurs, Hawaii has begun to gain a reputation as business-friendly.

“Without Act 221 we never would have been able to raise money to hire the software developers,” says Bower of uBoost. “There would have been no funding for this idea. And now we’re teamed up with Harvard. And Arne Duncan, the new (U.S.) Secretary of Education, uses it in Chicago.

“It’s something that wouldn’t be here without that funding. Nobody on the Mainland was willing to fund a Hawaii company. If you’re a Hawaii company with a good idea, they’ll fund you – if you move. But that’s the battle. We want to keep the jobs here. And have high-paying jobs for our kids. So we have to figure out how to seed and develop an industry and be willing to invest in it over the long term.”

Developing future industries is only one of the ways Act 221 has benefited the state. The social benefit is equally compelling. Act 221 creates hope – and job opportunities – for high school students who might otherwise feel forced to leave the state or work in less meaningful positions in the tourism industry. Simply put, Act 221 brings Hawaii people back home to work, raise families, purchase homes and contribute to the economy.

“What options have really existed in Hawaii for kids who go to college, get a degree, and want to return to Hawaii and live in the community where they were raised?” asks Robinson of Kolohala Ventures. “What we’ve seen is a huge exodus of the best and brightest going to the Mainland and living in economic exile because there aren’t the kinds of jobs in Hawaii using the skills they’ve acquired and offering a decent salary.

“But we live in an era now when a lot of wealth is being created by high technology. The average starting salary in Act 221 companies is $55,000 a year. Most of those jobs require people to have a degree. Without this kind of diversification there is no future for our kids. Or for our community. Tourism is a mature industry. It’s not going to create a lot of new jobs. And we know what kinds of jobs it creates – mostly low-paying, low skill jobs.”

In an island state where extended families provide much of the strength and cohesion for local communities, bringing bright young people back home for highly skilled jobs makes for contented employees and a congenial workforce. At Oceanit, for instance, some employees hit the waves for an hour of surfing before they settle in for a day’s work, while others even keep their surfboards in their office. Studies continually show that happy employees are productive workers.

Spencer, of Hawaii Oceanic Technology and the Hawaii Venture Capital Association, has tracked the growth of Hawaii’s high-tech industry and warns against allowing the tax credits to expire in 2010. Instead, says Spencer, the credits should be extended indefinitely to give the companies an even more solid foundation and investors confidence in the business environment.

“At least 80 percent and probably more are in these early stages of development where they haven’t hit their stride and aren’t ready for large Mainland funding,” he says. “If you kill the program now, you’re probably cutting off 4/5 of the companies that have started, cutting them off from getting more funding, completing their research and development, and positioning themselves to grow.” Just 38 out of 333 qualified high-tech businesses were profitable as of 2007, says Spencer. That means the rest are still in the research and development mode.

In fact, extending these credits could serve as a far greater stimulus to the state economy than other proposed plans, say business leaders. Watumull, for instance, believes Act 221 has far greater potential for stimulating the economy than Gov. Linda Lingle’s proposed construction stimulus package that calls for borrowing and spending about $1.86 billion. Once a construction job is completed, he points out, the job goes away.

“It’s not as good… It costs almost $100 million a year to finance,” said Watumull. “You will have some early economic activity, but you will pay for it for 30 years, far in excess of the economic activity generated.” By contrast, said Watumull, Act 221 provides “three times the economic activity vs. the cost.”

The state has tried direct investment of taxpayer dollars to stimulate the economy in the past, without great success. Back in the mid 1970s, as Big Island sugar plantations closed, the Kohala Task Force recommended pumping money directly into new industry. Those efforts were generally considered a failure. By contrast, Act 221 stimulates high net worth individuals to invest their own money in new ventures. That technique is proving successful based on the Dept. of Taxation data.

“What they’re really doing,” says Spencer, “is achieving the goal of bringing in outside investors.

What’s critical now, say local entrepreneurs, is to keep Hawaii ‘skin in the game.’ To move forward with state leaders believing in Hawaii products/services, Hawaii people, Hawaii potential.

“The reason I’m so passionate about the notion of a diversified economy,” says Spencer, “is that unlike tourism, where we’re dependent on the world coming to us, tech companies have the whole world as their marketplace. It’s a way to leverage our local talent, our local intellectual property. It’s a way to bring revenues into the state from outside of Hawaii rather than depending on people coming here and spending their money.

“But you’re not going to have entrepreneurs setting up shop in Hawaii unless there’s a source of capital. And you’re not going to have capital unless you have companies to invest in. You can have the best incubator in the world, but if there isn’t money to invest in it, there’s no glue to hold it all together.”

No comments: