As the “startup fever” sweeps the country, investing in startups has hit an all-time high. In 2014, venture capital investments reached $48 billion — the highest level in over a decade.

But while the investment industry is alive and well in the U.S., some question if the same can be said for North Dakota. Critics point to restricting tax credit policy and risk-adverse leadership as a hindrance to entrepreneurial growth throughout the state.

Currently, North Dakota offers a variety of ways for entrepreneurs to access both public and private capital.

The first are tax credit incentives. Angel funds, or groups of private investors who pool money together to make large investments, receive tax credits on up to 45 percent of each investment. Seed capital investors, who are often company founders’ or friends and family raising initial funds, receive tax credits for up to $3.5 million.

The North Dakota Development Fund and the Regional Rural Revolving Loan Fund are another access point. They exist to finance primary sector businesses through the state, funded by tax payers dollars and allocated by the legislature.

There are also a variety of finance programs, such as the Growth Initiative Fund which is run by the Greater Fargo-Moorhead Economic Development Center and aims to support “projects targeted at the emerging sectors.”

However, there are aspects to these existing programs that some see as a barrier to both investors and entrepreneurs.

Low incentives = low investments

David Batcheller, President and COO of electronics manufacturer Appareo Systems, voiced his concerns about investment in North Dakota at the Mayor’s Summit in September. He pointed to other parts of the country as an example of what healthy investments look like.

In Austin, TX, he said, total funding from investors reached $993M in 2014. In Minnesota, venture capitalists invested almost $203 million in 2014, in companies 5 years old or younger, according to research firm PitchBook.

But in North Dakota, Batcheller said, the numbers are sorely lacking. According to MoneyTree’s state-by-state analysis, venture capitalists in North Dakota invested a total of $7.5 million in 2014. For 2015, the only listed amount is a $50,000 venture capital investment.

Batcheller sees the tax credit programs for angel fund investments and seed capital investments as restricting, and a major reason why investors may not want to invest higher amounts.

“Although both [angel fund and seed capital] programs are good on the surface, they have significant flaws that prevent the type of deal flow and investment required to have a vibrant startup and mid-stage company environment,” he said.

The 45 percent tax credit on angel fund investments is “okay,” Batcheller said. However, he said, it only allows you to take out a maximum of $45,000 per year. This means for an investor to take full tax credit advantages, they are limited to $100,000 per year.

Additionally, the current program has a lifetime limit of $500,000 per investor – married couples count as one person – or about $1.1 million of investments. Investments are also only eligible on companies with annual revenues up to $10 million.

The seed capital investment program also has limiting factors, Batcheller said. The $3.5 million cap on annual tax credits means that all investors can only claim a total of $3.5 million per year. This means anything over the $7.7 million of total investment in the state under the program would not be eligible for tax credits.

For Batcheller, these are serious red flags.

“Although both of these programs are positive, they do not incent nearly the type of volume of investment we need to see to attract startups and encourage investments in the state for homegrown companies,” Batcheller said. “They also provide no incentives to entrepreneurs investing in their own endeavors. If we want to create an environment of growth in technology and advanced manufacturing companies we need to encourage more investing and investing at higher levels ($1 million+).”

A lack of statewide leadership

Batcheller is not the only one who sees a problem.

James Burgum is the co-founder of Arthur Ventures, the sole active venture capital firm in North Dakota. Although Burgum doesn’t see a huge problem with tax credit policies, he does see a lack of statewide leadership in funding entrepreneurial endeavors.

“Right now we have one active venture capital firm — Arthur Ventures. We need a dozen. We need two dozen angel funds,” Burgum said, noting that right now there are no active angel funds in the state. “We need to have a lot more investment in and around the startup economy if this is something we are serious about.”

Burgum also sits on the board of the North Dakota Development Fund. The Fund was started in 1991 to help fund primary sector businesses and create more jobs. Yet while the Fund has been very successful in creating jobs, Burgum questions whether job creation is an appropriate metric for success.

“That’s a good metric downstream but it’s just too hard short term,” he said. “You’re planting seeds and many of those seeds will not grow. They evolve over time. Hopefully those turn into a big success story, which overpowers anything you could ever do…but it’s so far down the road.”

Instead, he encourages the Development Fund and others like it to stop measuring success by the job creation metric, and start measuring by how much capital is aggregated.

“If the state pursued the capital angle, you’d see more deals getting done. More velocity. The pipeline around startups would be good,” Burgum said.

Dean Reese, CEO of the North Dakota Development Fund, said he was unsure as to why the job metric was still being used.

“Today we have more jobs than people, but we still use that guideline,” Reese said.

Nevertheless, Reese said he felt good about the work the Development Fund was doing for the entrepreneurial ecosystem. From 2013-2014, they invested $4.1M in 22 primary sector and childcare businesses, according to their annual report. Seven of those businesses were startups, Reese said, including mobile app developer Myriad Mobile and biocomposite manufacturer C2Renew.

“I’d love to do more (startups),” Reese said. “It just depends on where they’re at. We look to invest once the product has been made, been tested, and it’s certified. The gap is in the early stage, because that’s where the most risk is.”

The Risk Factor

Shying away from risk is another piece to the problem, according to Ahron Walter, chief financial officer at Appareo Systems. He sees a particular lack of risk-taking with the Growth Initiative Fund.

“The Fund is sitting on $4 (million) to 6 million which sits in a bank,” he said. “Nobody knows what to do with it or wants to take risks with it. They like having that money in the bank but they don’t do much with it.”

On the other hand, The North Dakota Development Fund is on the right track, Walter said. Burgum expressed similar thoughts, saying that the Development Fund “has good intentions, although it is pretty conservative.”

Reese acknowledges that at times, risks can and should be taken. He encourages more entrepreneurs to reach out to him about accessing funds. But while the money may be there, Reese said that there are limitations to spending money on risky ventures – particularly when using taxpayers’ dollars.

“Are we a full risk fund? No. But we do have a 17.4% loss rate. We haven’t always been successful,” he said. “But I think if that number were higher the legislature wouldn’t like that and probably would have shut us down.”

While some argue that North Dakota culture is naturally risk-adverse, Burgum disagrees. Rather, he said, it’s a lack of risk-taking in leadership that leads to risk-adverse investing.

“We need a culture that supports risk-taking. We’re getting better and better that when someone fails they aren’t tarred and feathered,” Burgum said. “I don’t think the culture is too risk-adverse. At the end of the day, North Dakota’s DNA is built on farmers. There are no bigger risk takers than farmers. I actually think it’s just lack of leadership on a statewide level to coordinate a concerted effort.”

Coordinating a concerted effort

Whose responsibility is it, then, to lead a concerted effort towards funding entrepreneurial activity? Reese points it back towards angel funds and private investors.

“Is there a need for it, yes. You have to find the people to fund it [startups],” he said. “To count on the public’s tax payers dollars, that’s difficult to ask…You just need someone who has a big checkbook.”

Reese also said that if someone would be willing to privately raise money, something like $3 million, and take that to the Governor, a public-private “buck for a buck ” partnership could be possible.

“If somebody wanted to take on that challenge, and get it to a Senator or representative, they could present it. It could happen,” he said.

Burgum also looks to other states’ funding models to see how North Dakota can better allocate the money it has. He points to Michigan as a prime example. They use a fund-to-fund model, Burgum said, in which the state gives about $100M to a diversified portfolio of fund managers who can then get the money integrated throughout the state – whether through venture capital firms, angel funds, or private equity funds.

“This creates an industry around investment that North Dakota should be looking hard at,” he said.

In the end, they each agree that change will only happen once someone is willing to take initiative. Who that someone is, however, remains to be seen.

“How did Silicon Valley start?” Appareo’s Walter asked. “It wasn’t because somebody woke up one day. It was the confluence of a lot of money from the Bay Area and universities invested in technology and forward thinking, and then a lot of people making it a reality.”

For North Dakota, it’s just a matter of getting the ball rolling, Burgum said.

“The broad will is there – we just haven’t been able to push the ball forward,” he said. “It’s going to take a concerted community buy-in.”

 

Feature photo by J Alan Paul Photography for Fargo Monthly.