Thursday, July 16, 2009

It’s Back-to-Business for Hawaii Tech Companies!

Well, it’s official. The Governor did not veto the Legislature’s Bill 199, so Hawaii’s Investor Tax Credit for investments in high technology companies has now been scaled back from an allowed multiple up to 200% to “only” 100% return of state tax credits to Hawaii investors, and the credits will now be claimable at no more than 80% of State income tax liability per year. Actually, the scaling back of benefits was not so bad. Rather, it was the way the whole tax credit program has been conducted over the past 10 years, reinforcing the perception that Hawaii is not a good place to do business. There is plenty of blame to go around on all sides, from the tech industry’s resistance to disclosure of jobs created and companies benefitted or to timely compromise to help the State close its huge budget deficit, to the Administration’s fecklessness in administering the tax program and articulating its support of development of the tech sector. This whole charade is mandated to sunset in 18 months anyway. Hopefully, the next iteration will be better conceived, supported and executed.

So, what now? The national economy remains in recession, trillion-dollar federal budget deficits will continue to grow, and the State will see declining revenues and negative growth in its mainstay real estate and tourism industries for years to come. If there is any desire of investors to invest in technology companies in Hawaii, they will be tight-fisted and very choosy over fewer deals. So is our tech sector doomed to wither and die? Not necessarily. Even in Silicon Valley, the new wave of tech investment is toward smaller amounts in more focused companies. Hawaii tech companies can thrive using an alternative business model in which smaller amounts of capital, possibly leveraged with research grants, are used to validate technology and secure IP rights that can be licensed, pooled or sold to more established, national or global companies that have the size and economies of scale to commercialize the technology in their industries.

This is actually not a new thing in Hawaii. Most of our successful tech deals and investor exits over decades have followed this model, although not by calling it the “R and D business model”, and often only when facing bankruptcy or business default. For example, Verifone pioneered its credit card POS technology in Hawaii, but moved to California for manufacturing and sales growth, in effect exporting its IP rights in patented technology to the Mainland. Hawaii Biotech also ended up exporting its IP rights in tropical vaccines to an Australian pharma company while retaining only a research presence in Hawaii. Ad Tech essentially sold its IP rights in broadband test equipment to Spirent, and Spirent now maintains a regional sales office here. Digital Island was acquired by U.K.’s Cable & Wireless essentially for its IP rights. BAE Systems bought STI’s patented hyperspectral imaging technology, and maintains a research office for its biomedical spinoff here. Almost all significant Hawaii tech deals have gone this route. That is why we continue to see good technologies developed in our university and DoD research labs, but no permanent manufacturing or product sales from the Islands.

In the alternative business model, the R and D company can secure IP rights in the form of copyright-protected software and media, patented invention rights, and/or licensable engineering know-how. It can monetize these IP rights by licensing, pooling or selling to established companies in the Mainland U.S. and globally. As a further option once its technology has been validated through licensing, it can seek the next stage of venture capital funding for spinning out a sublicensed company to commercialize the now-proven technology in local or regional markets.

The R and D business model can greatly reduce investor risk by focusing on technology validation and securing IP rights. This allows the constrained venture funding pool in Hawaii to fund more companies to develop more innovative technologies with the small amounts of venture capital available. The research activity also fits squarely within the qualifying guidelines for the 100% high tech investor tax credits in the next year and a half, which will help to reduce investor risk. So, far from gloom and doom, our R and D companies can now focus on their real business mission and hopefully thrive.