How Angel Investors can Reduce their Taxes with Tax Credits

Slowly but surely, our Federal and State Governments are recognizing that most new job creation comes from small to medium size companies.  As entrepreneurs launch their businesses, get funding to bring innovation to the market and grow into bigger companies, jobs are created.   Furthermore, they have realized that the primary source of capital to start and grow those businesses are private investors…not the local bank.  Therefore, to provide an incentive to the very wealthy to “give back” to their local economy by investing in local businesses, they provide a tax incentive. By putting their wealth back to work in providing capital to early stage companies, the investor receives tangible benefit in the form of a tax credit against earned income, but they also receive intangible benefits from knowing they have contributed to the creation of jobs and the delivery of innovative goods and services to the market place….ie Compassionate Capitalism.

The Compassionate Capitalist Broadcast covering this topic can be replayed by clicking this link:

http://www.blogtalkradio.com/karen-rands/2014/04/01/compassionate-capitalist-saving-taxes-as-an-angel-investor

This podcast reviewed the various options that investors have to reduce their tax basis by investing in companies that have not yet gone public.   Investing in companies with tax credits associated with them offers two wins…reduced paid in taxes during the term investment tax credit, and return on investment at the point of sale of the equity to a public market or another company.  Twenty-one (21) states now offer tax credits for angel investment.  The Angel Capital Association maintains a list with links for each state to learn what is available in that state.  http://www.angelcapitalassociation.org/public-policy/existing-state-policy/ .

The movie and gaming industry is also a big contributor to local economies.   States have implemented multiple programs to attract companies to produce movies and develop gaming software.  Forty-Four (44) states offer “production incentives” and twenty-eight (28) states offer tax credit incentives to investors in those endeavors.  http://en.wikipedia.org/wiki/Movie_production_incentives_in_the_United_States

For the most part, tax credits are applied against earned income.   If the investor doesn’t earn a “w2” income, the can still gain benefit by selling the credits.  A number of financial firms and legal firms exist to advise investors with tax credits and broker those credits for sale.   This is just one firm that offers good information about selling of tax credits. http://www.taxcreditsllc.com/

It is important to understand the options that are available to you to reduce your tax basis while diversifying your investment portfolio.   As you seek to increase your wealth, it is important to also protect that growth with a reduction in taxes whenever possible.  In most cases the states require paperwork to be filled out in advance by the company to eligible for tax credits.   Some industries may be excluded.   Therefore it is important to become familiar with the programs available in your state and as you look for companies to invest in, take the potential for tax credits into consideration when calculating the Internal Rate of Return (IRR).

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Are you an investor that is tired of the volatility and unpredictability of the stock market? Are you frustrated that you have little influence to affect the management or operation of that public company? Have you realized that the public stock market is actually pretty risky and the overall return on investment isn’t that great?  Then learning how to invest in private companies, purchasing shares in a company before it goes public, while the valuation is still low, could be the wealth creation strategy for you. Join the National Network of Angel Investors and sign up for the educational newsletter and free excerpts from the “Inside Secrets to Angel Investing”. http://NationalNetworkofAngelInvestors.com

How to Create Wealth through Angel Investing

Angels are the financial fuel of the economy. Before Venture Capitalists get involved, before banks will loan a company an unsecured note; Angel Investors provide the capital that fuels the entrepreneurial spirit and helps inventions become products and ideas become reality.  They take the greatest risk, but also have the potential to reap the greatest rewards.   The return on investment for an affluent person who invests in a company at the early stage can be as much as 10 or 20 x.   The original investors in Microsoft, Amazon, Google, and even traditional non-tech businesses like Home Depot all made huge returns.  The logic behind it is quite fundamental….buy low, sell high.  But unlike buying a public stock at say $1 a share and it going to $20 a share are rare.   When an investor buys a private company’s stock at an early stage of their development, the likelihood of that stock increasing to reflect the growth in value from a start up to a revenue producing profitable company is much more likely to go from $1 privately to $20 as a public offering.

I like to refer to Angel Investors as Compassionate Capitalists. “Compassionate” because they have figured out that even though they can lose all their money, by providing investment capital to an entrepreneur with passion and purpose to see his or her company succeed, they are providing a hand up, not a hand out, that will fuel the economy by creating jobs and potentially whole markets by bringing innovation to the market. “Capitalists” because they aren’t donating to a charity, they are investing in a risky venture that banks won’t loan to and venture capitalist won’t even look at, with the intent of creating a big return on their investment. High net worth men and women become angel investors to create great wealth, never with the intent to lose money.

Angels are wealthy individuals who provide seed capital and growth capital to companies in the start up and early stage of their company’s life cycle. Their capital can be offered in exchange for equity in the company or as some specialized form of debt facility. Investing in this stage of company is the most risky, but it can also be the most rewarding. Rewards come not just from the financial returns, but also from experiencing the purest form of capitalism…bringing value to the market by supplying a product or service to satisfy a market demand. There is a definite sense of pride and accomplishment from being able to say you were an early investor in a block buster like Microsoft or Starbucks, and surprisingly, there is little regret from the early stage investors in the near misses like WebVAN and PETS.com because they got their sizable returns when those companies went public. It was the investors that followed the advice of their stock broker or financial planner to invest when those companies went public that saw a decline in the value of their investment because they bought at “retail” hoping that the value would increase over time. Angel investors buy stock when the company is still private, and reap their rewards when the company then sells that stock to another buyer or to the public stock market. They learned early in life that profit is made when buying at wholesale and selling at retail. That is how it works for the wise angel investor.

Investing or buying Private Equity of early stage companies is one of the secrets the wealthy use to create more wealth. As Robert Kiyosaki wrote in his best seller book, Rich Dad’s Retire Young, Retire Rich on page 127:

“the rich invest in shares of a company when the company is still a private company”.

To become a successful angel investor, it is important that individuals learn how to identify and screen opportunities for early stage private equity investing. In the eBook Series “How to Be an Angel Investor”, investors are taught how to take what they know from investing in public stocks and real estate and apply to making investment decisions about private equity investments.  You can subscribe to free excerpts of those books by going to this web page:  How To Be an Angel Investor

A survey of active angel investors revealed a startling and little known fact.   Most angel investors learn how to be angel investors by losing their investments….learn by doing and losing!  Oops won’t do that again. Investors can take classes on real estate investment and stock market investment, but rarely is there a class on angel investment.  Some new investors are fortunate if they have a mentor that will lead the way or if they are near an angel group that they can join to provide an environment to identify, vet, and co-invest with.  Many more potential investors are not located in an area where there is an angel investor group or they don’t want to be tied down to the commitments of a group.   The Center for Venture Research of New Hampshire University found in their survey of angel groups, 66% of the angel investors that could invest, didn’t.   They were called “latent” investors.  Here they are, part of an angel group, with full intentions of making investments into early stage and start up companies, but don’t actually stroke the check.  Why? It doesn’t make any sense until you learn that they hesitate because they are unfamiliar with the process.  Buying a public stock is easy….just call your broker, or go online and point and click.  Buying private stock involves signing paperwork; not really sure what you actually bought; how to measure the growth in value; when do you get to sell; do you get a piece of paper like a stock certificate for your $30,000???? and so on.   Even though broker/dealers are the ones authorized to sell private stock, most don’t because their costs to the companies are prohibitive for a pre-revenue company, and they discourage their wealthy clients from making those types of investments because of the fear of the SEC slapping them with a “selling away” charge and yanking their license.   What is a millionaire to do?

The ebook series described above was written for this very purpose.   Years of research, volumes of information, and scores of books were summarized for the consumption of a millionaire wanting to learn how to be an angel investor.

Mitigating Risk for Private Investors

With the turmoil of the stock market and the advent of large blue chip companies failing and event real estate faltering….risk vs reward takes on a whole new meaning.   Private Equity Investing in early stage companies has long been considered the most risky of asset classes to put money into.   However, it has proven historically, even in the market collapse of the dot-com era, to be the investment class that produces the greatest return on investment.   Angel investors historically get better returns than even VCs or the big Private Equity Funds you hear so much about.   Why is that?

Angel Investors tend to get better returns because they invest when the company has the lowest valuation.   The stock they buy may be less then $1 a share, and yes although you can purchase stocks on OTC BB or even the regular exchanges at less than $1 a share, that is usually becuase of some decline in value.   Early stage companies that are currently valued at less than $1 a share have all the promise of massive increase in valuation.   If they are starting out at 50 cents a share, and then get purchased at a modest valuation years from now at $5 a share, that is 1000% gain, or even if they do what most regular public companies go public at greater than $10 a share…presto big return.   Enough to make up for the 3 or 4 that went belly up….that is the risk part of the reward.

So how can you mitigate risk when making an investment in private companies?   There are 4 key areas:

  1. Intellectual Property Protection – patents, copyrights, trademark, trade secrets
  2. Management Team/Advisers – experienced management from within or recruited from outside
  3. Insurance – key man insurance, errors & omissions, other corporate insurance
  4. Strategic Planning – what will they exactly do once they have their funds
  5. Sales Validation – do they have the sales team/strategy that can achieve the expected results
  6. Terms of Investment – small terms may have big impact on the angel investor down the road
  7. Market Validation / Competition – having sold something or having market validation in a pipeline, joint venture, or in improving on the competition go a long way to validating the opportunity

Listen to Karen’s Podcast on  Mitigating Risk for Investors Now!

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