A drug development company in the Madison area that raised $8 million in financing from angel and venture investors, some of it from outside Wisconsin, received an unhappy surprise from state government when it learned it would be taxed on the capital raised.
That’s not a tax on earned revenue from sales of products – the young company is still pursuing federal regulatory approval for its drugs, which have yet to hit the market – but a tax on the capital raised from investors itself.
“The company is on a very tight budget,” said John Neis, managing director of Venture Investors LLC, a lead Wisconsin investor. “They were shocked to learn they were starting out $24,000 behind budget as soon as they closed on the financing.”
Wisconsin is perhaps the only state that taxes private investments in so-called “foreign corporations,” which are C Corporations most often registered in the state of Delaware. Many U.S. companies incorporate in The First State: Nearly two-thirds of all Fortune 500 companies are incorporated in Delaware and three-quarters of all initial public offerings in the United States involve Delaware companies.
Companies don’t do so to dodge taxes at home, as state tax laws in Wisconsin and elsewhere largely boil down to a test of where the company physically does business, hires workers and makes sales.
Rather, they do so because Delaware’s incorporation process is modern and efficient. Politicians of both parties in Delaware understand the importance of keeping the state’s corporate law up to date, and Delaware courts are renowned for their expertise and expedited dockets.
As a result, many startup companies in Wisconsin are – or, should be if they expect to get professional financing – C Corporations. Like similar companies in other states, many of Wisconsin’s homegrown “C Corps” are incorporated in Delaware.
With angel and venture capital investment dollars scarce for many young companies, the question arises: Why is Wisconsin virtually alone in taxing capital raised by those companies?
“I know of no other state that taxes the capital raised at the time of investment like this,” said Neis, an early stage investor for nearly 30 years. “It is always a shock to investors from outside the state that are investing in the state for the first time.”
That’s why some members of the Legislature want to repeal Wisconsin’s investment tax on companies that are registered out of state, even though their roots, offices and workers are here.
“C-Corps have no issue with paying taxes on earned income, but capital from investors is difficult to come by for Wisconsin startup companies,” said Rep. Mike Kuglitsch (R-New Berlin). “Our position is that these companies are doing business in Wisconsin; their staff is in Wisconsin and the vast majority of – if not all – of their dollars raised from investors are spent in Wisconsin.”
If enacted, this idea would help Wisconsin’s early stage economy produce more companies and jobs. Here are other examples of Wisconsin policy initiatives that have received national attention:
- In its annual report on trends in tech-based development, the State Science and Technology Institute cited Wisconsin and New York as two recent examples of creative approaches to capital development. This was due to the Legislature’s overwhelmingly support for a “fund-of-funds” that will begin with a $25 million state investment and attract matching private dollars.
- That same report by SSTI cited Wisconsin’s decision to amend state securities laws to permit equity crowdfunding. In other states where similar laws are already in effect, there are signs of increased economic activity.
- It also highlighted the Wisconsin Economic Development Corp.’s $300,000 investment in the BrightStar Wisconsin Foundation, which is beginning to invest in Wisconsin companies. In mid-February, WEDC and the UW System announced creation of a $2 million fund to help transfer technology from other system campuses.
- The latest Halo Report by the Angel Capital Association cited a Madison angel network, Wisconsin Investment Partners, as one of the nation’s most active in the third quarter of 2013. Milwaukee’s Golden Angels Network was called out in another Halo report as one of the top groups in the nation for dollars invested per deal.
- In a recent report on Colorado’s efforts to create a statewide angel network, Xconomy cited the experience of the Wisconsin Angel Network and the overall success of Wisconsin’s investor tax credits program.
If Wisconsin wants to build a truly competitive capital market, eliminating archaic barriers to investment would help. Ending Wisconsin’s tax on investments in so-called “foreign corporations” would signal to investors everywhere that Wisconsin understands what it takes to build young companies.
Tom Still is president of the Wisconsin Technology Council.
