HB 2946 – The New and Improved Illinois Angel Investment Tax Credit Program

For those who don’t know, Illinois has had an “Angel Investment” program since 2012 where investors who invested in qualifying companies would receive a 25% tax credit against their Illinois income taxes. Sounds great in theory, but the types of companies that would be eligible for qualification under this program are severely limited. Not to mention the fact that the program itself expired, pursuant to its terms, as of December 31, 2016. Given the significant beneficial impact an angel investment tax program could have on Illinois business, I drafted a bill (HB 2946) which will both reinstate and improve the Illinois Angel Investment program. As the bill itself is written in legalese (my apologies for that), I felt a summary of the proposed bill and how it actually will work was in order.

THE PRIOR ANGEL INVESTMENT PROGRAM

The prior Angel Investment program was overseen by the Illinois Department of Commerce and Economic Opportunity (the “Department”) and governed by 35 ILCS 5/220 which expired on December 31, 2016. Under this program, a person investing in a “qualified new business venture” (i.e. a company that is approved and meets the requirements of the program, a “Qualified Company) would be eligible to receive a credit against their respective Illinois income tax equal to 25% of their investment (subject to a cap). So an investor who invested $1,000 in a Qualified Company would be eligible to receive a credit of $250 against their respective Illinois income tax. Sounds simple in theory but there were several limitations, including most significantly, who could become a Qualified Company.

Not just any company could become a Qualified Company under the prior program. In fact, it was quite limited. In addition to meeting “General Qualifications” (as discussed below), in order to become qualified, a company would need to be either:

“principally involved in innovation in any of the following: manufacturing; biotechnology; nanotechnology; communications; agricultural sciences; clean energy creation or storage technology; processing or assembling products, including medical devices, pharmaceuticals, computer software, computer hardware, semiconductors, other innovative technology products, or other products that are produced using manufacturing methods that are enabled by applying proprietary technology; or providing services that are enabled by applying proprietary technology;”

or

“undertaking pre-commercialization activity related to proprietary technology that includes conducting research, developing a new product or business process, or developing a service that is principally reliant on applying proprietary technology.”

Further, the company could NOT be principally engaged in:

Boil all that down and you get a credit program where really only companies involved in “innovative” technology, in a very limited number of industries, can qualify. As a result, the prior program was used overwhelmingly by larger companies and investors to fund separate R&D efforts, not to fund real Illinois job producing companies as was intended. As discussed below, there were several other limitations with respect to the prior program which even further limited its effectiveness.

THE NEW AND IMPROVED ANGEL INVESTMENT PROGRAM

Not only does HB 2946 reinstate the Angel Investment program for another 5 years (through 2022), it significantly expands and improves on the program’s usefulness. The intent of the included changes are two-fold: to incentivize investment in local companies (particularly job producing companies), and to better allow local Illinois investors to participate in both large and small deals here in Illinois. By accomplishing these goals we can substantially increase the number of available jobs here in Illinois and allow more Illinois resident investment dollars to remain here in the state.

While the language of the bill itself is admittedly dense, the concepts are relatively straight forward. Here are the highlights:

The Basics. Under the proposed bill, any person or entity that invests in a Qualified Company:

A. In a Type 1 Offering (as discussed below) will receive an Illinois income tax credit equal to 25% of the amount invested:

B. In a Type 2 Offering (as discussed below) will receive an Illinois income tax credit equal to 25% of the amount invested:

C. In a Type 3 Offering (as discussed below) will receive an Illinois income tax credit equal to 10% of the amount invested:

It should be noted that the above mentioned credits would be subject to certain investor level and aggregate cap amounts as well as certain other qualifying provisions as detailed below.

General Qualifications. Regardless of what “Type” of offering we are talking about, in order for a company to be considered a “Qualified Company” the company must satisfy the following “General Conditions”:

A.  The company must have its headquarters in Illinois;

B.  At least 51% of the employees employed by the company must be employed in Illinois;

C.  The company must have the potential for increasing jobs in Illinois, increasing capital investment in this state, or both, as determined by the Department;

D.  The company must not be principally engaged in real estate development (except for development projects anticipated to take more than 3 years to complete), insurance, banking, lending, lobbying, political consulting, or construction except for construction projects anticipated to take more than 3 years to complete or with respect to power production plants that derive energy from a renewable energy resource;

E.  The company must agree not to move its operations from Illinois for at least 3 years; and

F.  At the time it is first certified, the company:

(1) must have fewer than 100 employees;

(2) must have been in operation in Illinois for more than one year but not more than 10 years; and

(3) must have not received not more than: (i) $25 MM in aggregate investments (and not more than: (a) $4 MM in investments that qualify for a credit under a Type 1 Offering or a Type 2 Offering; and (b) $10 MM in investments that qualify for a credit under a Type 3 Offering).

The above qualifications are substantively similar to those under the prior program. For purposes of comparison, the new/modified language has been emphasized. It should also be noted that the proposed Section (D) above is significantly broader than under the prior program which was shown above.

Three Flavors of Credits. Under the new proposed program there will be 3 distinct types of investments that will be eligible for a tax credit. Here are the basics of each type:

  • Type 1 Offering (the Original)

Basically a Type 1 Offering refers to the same type of offering that was done under the prior program. Put another way, if a company/investor qualified under the prior program they would be able to qualify under the new proposed program and would receive the same 25% tax credit. The only change would be with respect to the new/modified General Qualifications noted above.

  • Type 2 Offering (Illinois Crowdfunding)

Essentially if a company meets the General Qualifications above, and they are using the new Illinois Crowdfunding Exemption (815 ILCS 5/4(T)) to raise money from investors, any person or entity that invests in the crowdfunding offering would be eligible to receive an Illinois income tax credit equal to 25% of the amount invested. By way of example, an investor who invests $1,000 in a Qualified Company through an Illinois crowdfunding offering would be eligible to receive a credit of $250 against their respective Illinois income tax.

For purposes of background, Illinois Crowdfunding Exemption allows Illinois companies to raise money by selling equity to (or borrowing money from) Illinois residents. The Illinois Crowdfunding Exemption was passed, unanimously by the Illinois house and senate I may add, in order to both help local businesses better find access to capital and to help Illinois residents support local business by investing in them.

In light of this, the intent of this new credit section should be simple to see. Allowing Illinois investors a tax credit under this program will significantly help incentivize them to invest in local companies by helping to minimize the downside risk of investment. Put another way, this new addition is intended to help ease the risk to investors who choose to invest in local businesses and keep their investment dollars local. These investors are doing Illinois a great service by supporting local businesses and should have the same access to tax credits as the larger companies funding R&D as under the prior program.

  • Type 3 Offering (The Side-Car Offering)

Now this part of the new program is actually something which has not been seen before. While the new Illinois crowdfunding law goes a long way toward democratizing private investment in Illinois, participation in the larger, more potentially lucrative deals, still remains limited exclusively to larger individual and intuitional investors, PE and VC firms. The intent here is to incentivize these larger/ institutional investors to open up a portion of these larger Illinois-based deals to local investors.

Under the proposed bill, a larger/institutional level that makes an investment in a company that otherwise would not be eligible for accredit under one of the two Types above, may still be eligible for a 10% tax credit IF the fund raising company ALSO conducts an Illinois crowdfunding offering. Now there is nothing in the proposed bill that would require both the larger/institutional level offering and the Illinois crowdfunding offering to have the same terms (other than with respect to access to financial information). As a result, the larger investors would be able to conduct basically the same types of offerings they conduct today and still qualify for the credit as long as they opened up a piece to smaller investors.

The practicality of the above credit might be easier seen in an example. Let’s assume a company (we’ll call them “Company A”), who meets all of the General Qualifications above, is receiving $5 Million in financing from a large financing group like the Pritzker Group in exchange for a controlling interest, preferred distribution rights, etc. Let’s further assume that Pritzker’s investment would not otherwise qualify for a credit under one of the other above Types of offerings. Under the proposed bill, the Pritzker Group could make the same investment, and would be eligible to receive a 10% tax credit (= to $500k), so long as Company A also conducted an Illinois crowdfunding offering which would allow smaller Illinois investors to get involved. In this example the equity sold as part of the side Illinois crowdfunding offering could carry a lesser profit percentage, be completely non-voting, etc. so as not to interfere with the interests of the Pritzker Group. The result, as you can see in this example, is that under the proposed bill the Pritzker Group would be able to make the exact same investment in Company A that they would make today except now they would be eligible to receive a tax credit in connection with that investment AND smaller Illinois investors would actually be given a chance to participate. Put another way, not only will the Pritzker Group get an investment tax credit and local Company A get more investment dollars, but Illinois residents will have the chance to participate in the deal and potentially earn significant returns which will ultimately be redistributed within the state.  If that isn’t a win-win-win I certainly don’t know what is.

Other Beneficial Modifications.

  • Increased Cap.

Under the prior program the total amount of tax credits allowed in any given year was capped at $10 MM. As the total amount of credits was more than used up each year, the proposed bill expands the annual cap to $20 MM.

  • Quarterly Allocation.

Previously the annual cap amount was not allocated through a given year which would lead to a surge in applications for credits at the beginning of each year. Further, the cap would typically run out somewhere around July/August of each year leaving companies looking for funding in the later portion of the year out of luck. To alleviate these issues, under the proposed bill, the $20M cap would be allocated quarterly (subject to certain discretion of the Department as to %s) with any unused portion of the cap automatically carrying over to the next quarter.

  • Investment Types.

Under the prior program, only a direct “equity” investment, or “Simple Agreement for Future Equity” (SAFE Agreement) were permitted forms of investment. Convertible debt, which is the overwhelmingly preferred choice of investment vehicles for angel investors, was not permitted. The proposed bill would specifically allow for the use of convertible debt as well as warrants, options and the like.

  • Transferability of Credits.

Credits received under the prior program were non-transferrable. This may not seem like a big deal, but there has been significant research showing that allowing credits like these to be transferrable significantly increases the attractiveness of the investment. This may do little for the individual investor but transferability of a tax credit can significantly influence larger and institutional investors. Take for example a Silicon Valley investor who is considering investing in an Illinois-based tech company. If the tax credit is not transferrable (as under the prior program) it would do nothing to incentivize this investor as they most likely would not have Illinois income to offset the credit against. However, if the credit was transferrable (as under the proposed bill), and the same Silicon Valley investor could sell the credit for .50 on the $1 or something like that to an Illinois PE/VC firm, it could significantly increase the attractiveness of the investment. This is why states like Indiana, and many of the states who currently have an angel tax credit program (or something similar), have been amending, or pushing to amend, their programs to make the respective credits transferable.

  • Better Investor Protections.

For whatever reason, under the prior program, in the event a Qualified Company left Illinois within 3 years the investors who received a credit would be required to pay back that credit. The proposed bill shifts that obligation to the company rather than the investor. Put another way, under proposed bill, if a Qualified Company left Illinois within 3 years the company, and not the investors, would be responsible for repaying the total amount of credits previously taken by investors. Not only will this better protect investors, but it will act to significantly deter the companies from leaving the state after they have received their money.

WHAT’S NEXT?

The Illinois Angel Investment program has the potential to significantly increase investment in Illinois businesses. The prior program didn’t go far enough in supporting actual job producing entities in the state. Under the prior program, the available credits were used primarily to fund “innovative” R&D companies where the Illinois job potential, even if significant, could be far in the future. Funding these endeavors is all well and good and should be supported but not the exclusion of funding companies that have the potential to create real-time jobs here in the state. HB 2946 will ensure that credits will still be available for “innovative” companies as they previously were while still opening up the program to other companies that have the potential for generating, or otherwise keeping, more money in the state. This type of job creation and local investment is exactly what the Illinois Angel Investment program was always intended to do.

With the help of the Illinois Small Business Advocacy Council (SBAC) and Representative Carol Sente, HB 2946 was submitted to, and is making its way through, the Illinois house of representative. Currently it has four additional co-sponsors (Rep. Elgie R. Sims, Jr., Rep. Emanuel, Rep. Chris Welch and Rep. Margo McDermed). That being said, we need as much support as we can get so I implore you to reach out to your local representative and ask them to support HB 2946.

It should also be noted that there are currently 2 additional bills seeking to reinstate the Illinois Angel Investment program; HB 0162 (submitted by Rep. Michael J. Madigan) and SB 1622 (submitted by Sen. Daniel Biss). As these bills do not offer the significant improvements to the program outlined above, we are hoping to get Rep. Madigan and Sen. Biss to support HB 2946.

THE NITTY GRITTY:

For those that are interested, here are some of the specific provisions of HB 2946 (Disclaimer: reading may cause drowsiness, nausea or general annoyance):

A.  Type 1 Credit. An investor (other than a “Related member” as defined below) will receive a tax credit equal to 25% of the aggregate amount of equity investments made in a Type 1 Offering.

B.  Type 2 Credit. An investor (other than a “Related member”) will receive a tax credit equal to 25% of the aggregate amount of equity investments made in a Type 2 Offering, so long as the subject Illinois crowdfunding offering:

(1) has been publicly offered for sale solely to residents of Illinois;

(2) must reserve at least 25% of the offered investment interests for sale to non-accredited investors (whether or not the same are resultantly sold to such investors);

(3) must be held open for sale for a period of at least 5 months (or until fully funded, if sooner); and

(4) must be conducted in compliance with the new Illinois Crowdfunding Exemption (815 ILCS 5/4(T)) and all other applicable law.

B.  Type 3 Credit. An investor (other than a “Related member”) will receive a tax credit equal to 10% of the aggregate amount of equity investments made in a Type 3 Offering, so long as:

(1) The Type 3 Offering is made in conjunction with, within 1 month from the commencement of, and as part of a single plan of financing which includes, a Type 2 Offering (i.e. an Illinois crowdfunding offering);

(2) The aggregate amount of available investment interests being sold as part of the Type 3 offering does not exceed 10 x the aggregate amount of investment interests being sold in the related Type 2 Offering (e.g. if the total amount of investments in the related Type 2 Offering is limited to $1 MM, the total amount of investments under the Type 3 Offering cannot exceed $10MM);

(3) The rights, with respect to distributions and payments only, of the available investment interests being sold as part of the Type 3 Offering are equal, or junior, in terms of priority to the respective rights of the investment interests being sold in the related Type 2 Offering; and

(4) The Type 3 Offering is conducted in compliance with all applicable law.

C.   Limitations. 

(1)   Annual Investor Limitations: The total credit allowable for any one taxpayer in a given tax year will not exceed $1 MM.

(2)   Annual Aggregate Limitation. The aggregate amount of credits allowable in any given tax year will not exceed $20 MM. The allocation of these credits among Qualified Companies in any given year will be made by the Department based on approved applications.

(3)   Allocation. The $20 MM annual aggregate cap will be allocated by the Department, on a per calendar quarter basis and prior to the commencement of each calendar year, in such proportion as determined by the Department, provided that: (a) the amount initially allocated by the Department for any one calendar quarter will not exceed 35% of the total allowable amount; and (b) any portion of the allocated allowable amount remaining unused as of the end of any of the first 3 calendar quarters of a given calendar year will be rolled into, and added to, the total allocated amount for the next available calendar quarter.

E.  Qualifying Investments. The credit will be allowable for qualifying investments made in taxable years beginning after December 31, 2016 and ending on or before December 31, 2021. Qualifying investments will include:

(1) an equity interest in the Qualified Company (without regard to the class, seniority position, or distribution/dividend, voting or other rights, of such equity interest);

(2) any agreement for the future receipt of equity interests of the Qualified Company upon the occurrence of a defined future event or events (including any agreement for future equity or convertible debt issued by the qualified small business entity) so long as such agreement provides for a definitive method (including calculation, timing and amounts) for converting the value of the same into equity interests of the Qualified Company; and

(3) any combination of the above.

E.  Related Members. An investor will not be eligible to receive a credit if, with respect to the subject Qualified Company, the investor is any one or more of the following (Note: these have not been changed from the prior program).

(1) An individual, if the individual and the members of the individual’s family (as defined in Section 318 of the Internal Revenue Code) own directly, indirectly, beneficially, or constructively, in the aggregate, at least 50% of the value of the outstanding profits, capital, stock, or other ownership interest in the subject Qualified Company.

(2) A partnership, estate, or trust and any partner or beneficiary, if the partnership, estate, or trust and its partners or beneficiaries own directly, indirectly, beneficially, or constructively, in the aggregate, at least 50% of the profits, capital, stock, or other ownership interest in the subject Qualified Company.

(3)  A corporation, and any party related to the corporation in a manner that would require an attribution of stock from the corporation under the attribution rules of Section 318 of the Internal Revenue Code, if the subject Qualified Company and any other related member own, in the aggregate, directly, indirectly, beneficially, or constructively, at least 50% of the value of the corporation’s outstanding stock.

(4) A corporation and any party related to that corporation in a manner that would require an attribution of stock from the corporation to the party or from the party to the corporation under the attribution rules of Section 318 of the Internal Revenue Code, if the corporation and all such related parties own, in the aggregate, at least 50% of the profits, capital, stock, or other ownership interest in the subject Qualified Company.

(5) A person to or from whom there is attribution of stock ownership in accordance with Section 1563(e) of the Internal Revenue Code, except that for purposes of determining whether a person is a related member under this paragraph, “20%” shall be substituted for “5%” whenever “5%” appears in Section 1563(e) of the Internal Revenue Code.

About Anthony Zeoli

Anthony Zeoli is an experienced transactional attorney with a national practice. Specializing in the areas of securities, commercial finance, real estate and general corporate law, his clients range from individuals and small privately held businesses to multi-million dollar entities. Mr. Zeoli is also an industry-recognized crowdfunding, peer-to-peer (P2P) lending and JOBS Act expert and is currently an active board member and Secretary of the CfPA (Crowdfunding Professional Association) and an active member of CFIRA (Crowdfund Intermediary Regulatory Advocates). Most recently he drafted Illinois House Bill 3420, a bill which provides for an intrastate crowdfunding exemption in Illinois and which was unanimously approved by the Illinois’ house and Senate. Anthony is also currently actively involved with the entrepreneurship program at the University of Illinois at Chicago as both a mentor and a student advisor and is an active advisory board member of the New York Distance Learning Association (NYDLA).
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