Dear Reader

Business Development is a complex topic. In such case the questions raised are more important than potential answers. Therefore, this blog will focus on presenting questions. There will be answers, full or partial, to be supplamented by links presented when relevant. The answers from my experience will be clearer once the questions are clearer.

While this is not a discussion forum, readers are invited to comment, and the comments will help determine the topics and current issues to be explained in the future.


Thursday, April 28, 2011

A heaven for Angels

Under the new fiscal law for 2011-2012 the Israeli parliament approve measures to encourage Angels to invest in High-Tech companies. The law basically recognizes an investment in a High-Tech as an expense over three years.
That law would appear to be a wonderful solution to the need to get more funds invested in High-Tech companies, especially for starting companies in that sector. The law actually holds more than meet the eye at first glance. In this post I will try and point out some interesting side effects that the law holds.
In the first place since the benefit recognizes the investment as an expense it allows a capital investment to be deducted from income in the annual personal profit and loss statement. The idea behind the benefit is that in many cases the angel’s investment is either turned into a loss after a few years (as most start-ups requiring angels to invest do), or that it bears some profit in the long term, and at that time the profit is deducted from the original investment.
High-Tech investment has been reduced since the 2008 global financial crisis. The need for investment in the High-Tech start-up section, is evident (IVA data) . By the benefit offered this investment has advantage (at least in postponing the tax) over other financial investment even for people not considering Angel Investment on regular basis. The law places some restrictions on the investment and the management of the firm in order for the benefit to be acknowledged:
• The firm must use at least 75% of the sum invested by the single investor for R&D purposes,
• 75% of the investment is spent in Israel.
• The year of investment and the following year the firm income cannot be more than 50% on the firm’s R&D expenses.
• Until the year in which the firm’s R&D expanses reached 75% of the investment the R&D expanses should be at least 70% of the total firm expanses.
The law discusses a personal investment of up to 5 million NIS. If we want to have a look at the first point above, we can see that the way it is phrased in the law makes it advantageous to have the investment in the firm done by several angels and not a single one. This requires an example;
A firm requires an investment of 1 million. It finds an angel to invest the whole sum. That means that according to the regulations above, the firm now needs to spend at least 750,000 on R&D, most of it in Israel, and until that is done the R&D expanses should make at least70% of the total firm expenses.
Alternatively 10 angels invest the 1 million paying 100,000 each. Meaning that the firm now has to spend at least 75,000 in R&D and only until they do that they other obligation regarding the firm expenses is in place. Of course these conditions are easier to meet.
Based on the example above it would seem that there are two major changes to the way Angels investments were regarded in the past. Angel’s clubs have an advantage under the law as they reduce the risk of an investment losing its eligibility during the benefit time since the more angels there are the easier it is for the firm to meet the terms.
More than that, if in the past once an entrepreneur found his Angel he would not like to share, but under the law, sharing would actually have a benefit for the entrepreneurs and the angels. So if you have an angel and you friend have another it would be best for them to invest each half in each of you. Everyone gains.
The law would be more interesting if the limit on income being no more than 50% of overall R&D expenses would not pose a most difficult restriction. The restriction exists for the first two years on investment. However, if the firm should have a marketing breakthrough and generate revenues more than 50% of its R&D expenses the benefit would be lost. This creates a conflict of interest between the Angels and the Firm’s directors. The angels want the revues for the first two years to be low and the directors have an obligation to increase the revenues and thus the firm’s value.
The point is further complicated as the law states that the tax reduction should be the main motive for investment, that is a bit complicated to explain when coming to ask for the tax exemption- recognition of the investment as expense.
Will the angels be able to overcome the difficulties and benefit from the advantage? Will former non-angels decide to make such investments due to the attractive benefit? And most important, will the law help increase the overall investment in High-tech companies in spite of the current financial situation?

Sunday, April 10, 2011

Portugal Bail-out request from the EU

The Portuguese Government has asked for the EU for assistance when it realized that borrowing was becoming unsustainable (NYTimes). That Portugal needs to be bailed out is evident, and in fact that step has been anticipated for some time now. Earlier in the year there were some hopes that China may be able to help Portugal, but it would seem that this was not enough. Portugal of course is not alone in its current crisis. Last May 80 Billion Euros were approved for Greece by the EU with additional 30 Billion Euro from the international monetary fund. In November Ireland had 85 billion approved for its own bailout. The exact amount to bailout Portugal is estimated between 75 billion Euros and 110 billion Euros – with 80 Billion Euros approved for three years. The crisis in Portugal is complex in the fact that the prime minister resigned last week (country going to general election in June after an election in January this year), a record high rate of un-employment and an economy that according to the national bank is going to contract this year. In Ireland the interest was kept high for the bailout as the government refused to raise its corporate tax percentage. What will be the price for this help in Portugal? This request for help constitutes a clear admittance of failure to navigate the national economy towards a safe haven. For those who had hopes that the government will save them, find them work, protect their interests and make the economy grow, that dream is over. It is now up to the Council of finance ministries to show that the eurozone can protect the unified monetary unit. As some experts argue the bailout deal offered by the EU is a heavy burden for many years and assures low economic growth rates and slow recovery. It is claimed that the poor are helping bailout the assisting banks – paying in future taxes and reduced economic growth to save the banks (external banks mostly) from losses at this point. There are two questions that are normally asked in such events: 1. How did this happen (sometimes phrased as "who is to blame?") 2. What can now be done to get out of this mess As an outsider, the first question holds no interest whatsoever, and therefore I would rather focus on the second question. This can be viewed as Portugal's finest hour. This is the time for the individuals in the country to get up and take action. It is well that the EU will probably assist in bailing out, but it is up to the people – more than the government, to see that the situation turns out for the good in the end. This should not be a narrow escape, but rather a step towards a much brighter future. When asked on several occasions: What is the secret behind Israeli Innovation? I used to answer: "the background of No-Alternative". The Portuguese people need to realize that one cannot expect others to bail it out, and that it is up to them to find ways, each one in his / her small way. This is the time to come up and: 1. On individual level take responsibility for one owns economic situation, without expecting others to provide for you. If you do not have a job thinks of ways to create jobs. Start your own business; cooperate with others who may be able to help and to be helped. 2. On national level – use the funds that will be coming in once the debt are being paid, and divert as much as can be towards the creation of tools that will allow anyone following number 1 above to do so. Use this opportunity to foster innovation and entrepreneurship. To create opportunities for small businesses to survive and grow. Create monetary tools, legal environment and general attitude that encourage such actions – via education, approach etc. 3. On international level – assure that the work the local citizens do, is not wasted on paying back loans at extortionist rates with internal prices of increased taxation leading to reduced growth. Demand to see the threatening inflation that requires higher interest rates – you are foreseeing a retracting economy, where is the inflation? To all that think that these are just slogans, or that this cannot be done, please look at Israel as an example. Insolated on the other side of the Mediterranean Sea, Israel managed to create opportunities for venture capital, for start-ups and technology parks, to increase the rate of technology transfer to industry and more. In the late 1980's Israel was not much different than Portugal (except for the crisis) is today. It was much worse, it had just come out from a huge inflation, had problems exporting its goods (mainly agro production) and had no venture capital, no technology incubators no start-up support mechanisms. It did have a good education system – and no other choice. Today, Portugal can benefit from its EU connection and learn from other EU best practices per each tool it chooses to develop. In a way the relative small size of Portugal is its main advantage. It is easier to make big changes in a smaller country than in a big one. It is up to its people, its real treasure, to show their true metal.