Prepared for the January 2016 - Business Resources · January 2016 . Finance Program Study Table of Contents ... • Robert Hannon, Executive Director, Anne Arundel County Economic

Maryland Economic Development Finance Program Study

Prepared for the

Maryland Economic Development Corporation

January 2016

Finance Program Study

Table of Contents Acknowledgements ___________________________________________________________ iv

Executive Summary ___________________________________________________________ v

Introduction _________________________________________________________________ 1

Chapter 1: Summary of Recommendations _________________________________________ 4

Improve Competitiveness with Other States ____________________________________________ 6

Align Program Design with Program Goals ______________________________________________ 7

Program-specific Recommendations __________________________________________________ 11

Operational “Tweaks” for Better Customer Service ______________________________________ 12

Chapter 2: Overview of National Economic and Incentive Trends ______________________ 13

Economic Conditions Overview ______________________________________________________ 13

State Business Incentives Trends _____________________________________________________ 17

Chapter 3: Place-based Tax Credit Programs ______________________________________ 21

Enterprise Zone Tax Credit __________________________________________________________ 21

One Maryland Tax Credit ___________________________________________________________ 26

Regional Institution Strategic Enterprise (RISE) Zone Tax Credit Program ____________________ 30

Cross-Cutting Issues and Conclusions _________________________________________________ 31

Chapter 4: Investment Tax Credit Programs _______________________________________ 33

Biotechnology Investment Incentive Tax Credit (BIITC) ___________________________________ 33

Cybersecurity Investment Incentive Tax Credit (CIITC) ____________________________________ 39

State Experiences with Angel Tax Credits ______________________________________________ 41

Overall Findings __________________________________________________________________ 45

Policy Design and Administrative Recommendations for Improvement ______________________ 51

Chapter 5: Incentive Programs Targeted to Attraction of Significant Employers __________ 54

Maryland Economic Development Assistance Authority and Fund __________________________ 54

Economic Development Opportunities Program Fund (Sunny Day) _________________________ 56

Policy and Administrative Options for Improvement _____________________________________ 63

Chapter 6: Small Business Lending and Investment _________________________________ 67

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Maryland Small Business Development Financing Authority Lending and Investing Programs ____ 67

MSBDFA Findings _________________________________________________________________ 83

MSBDFA Recommendations ________________________________________________________ 83

Small, Minority- and Women-owned Business Account – VLT Fund _________________________ 85

VLT Findings _____________________________________________________________________ 92

VLT Program Recommendations _____________________________________________________ 93

Chapter 7: Credit Enhancement, Loan Guarantees and Bond Financing _________________ 94

Maryland Industrial Development Financing Authority Program Overview ___________________ 94

Preliminary Findings ______________________________________________________________ 106

Policy and Administrative Options for Improvement ____________________________________ 107

Chapter 8: Credits and Funding for Workforce and Job Creation _____________________ 111

Partnership for Workforce Quality (PWQ) ____________________________________________ 111

Maryland Job Creation Tax Credit ___________________________________________________ 118

Findings for Workforce Training and Job Creation Tax Credits ____________________________ 127

Policy and Administrative Options for Improvement ____________________________________ 127

Appendix 1. Characteristics of Place-based Programs in Selected Other States __________ 131

Appendix 2. State Angel Tax Credit Programs ____________________________________ 135

Appendix 3: Capital Access Market Need ________________________________________ 142

About the CREC Team ________________________________________________________ 144

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Acknowledgements The CREC team is pleased to thank the Steering Committee assembled to advise this project for their attention, support and suggestions that greatly improved the final product. The members of the Steering Committee were:

• Robert Brennan, Executive Director, Maryland Economic Development Corporation • Ronald Causey, CEO, SC&H • Gregory Cole, Senior Director, Office of Finance Programs, Maryland Department of

Commerce • John Genakos, Assistant Director for Development and Information Technology,

Maryland Economic Development Corporation • R. Michael Gill, Secretary, Maryland Department of Commerce • David Gillece, Regional Managing Principal, Cassidy Turley • Robert Hannon, Executive Director, Anne Arundel County Economic Development

Corporation • Steve Pennington, Managing Director Business & Industry Sector Development at

Maryland Department of Commerce • Robert Rosenbaum, President and Executive Director, Technology Development

Corporation of Maryland (TEDCO) • Stanley Tucker, President and Chief Executive Officer and co-founder of Meridian

Management Group, Inc., and Executive Director of the Maryland Small Business Development Financing Authority (MSBDFA)

• Tom Sadowski, President and CEO, Economic Alliance of Greater Baltimore In addition, Department of Commerce staff were extremely generous with their time and shared their experiences with the various programs, including:

• Tim Doyle, Manager, Central, Southern and Capital Region, Office of Finance Programs • Darla Garrett, Manager of Administration, Office of Finance Programs • Emiko Kawagoshi, Tax Specialist, Office of Finance Programs • Jayson Knott, Senior Director, Office of Business Development • Stacy Kubofcik, Tax Specialist, Office of Finance Programs • Nancy McCrea, Research and Information Director • Ursula Powidzki, Special Assistant to the Secretary • Roger Venezia, Director, Operations, Division of Business and Industry Sector

Development • Mark Vulcan, Manager, Tax Programs, Office of Finance Programs

Thanks also to Rachel Ryan, MEDCO, for her assistance with logistics.

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http://www.cassidyturley.com/


Executive Summary The Maryland Department of Commerce asked the Maryland Economic Development Corporation (MEDCO) to seek “pragmatic, substantive and detailed guidance in updating and improving State financial programs that aim to retain and attract businesses to Maryland,” with an eye towards understanding how economic trends and client expectations should be impacting the programs. In addition, Commerce requested that Maryland’s programs be benchmarked against national trends. The Center for Regional Economic Competitiveness (CREC) provided context for and analysis to support recommendations for the various programs, building upon existing in-house analysis and evaluations. The specific programs studied represent a subset of all Maryland incentives and they are grouped into the following six categories:

• Tax credit programs, “place-based”, focused on lowering real estate and operating costs: o Enterprise Zones o One Maryland Tax Credit Program o Regional Institution Strategic Enterprise (RISE) Zone program

• Tax credit programs, investment: o Biotechnology Investment Incentive Tax Credit o Cybersecurity Investment Incentive Tax Credit o Proposed angel investment tax credit

• Incentive programs targeted to attraction or retention of significant employers: o Maryland Economic Development Assistance Authority and Fund (MEDAAF) o Economic Development Opportunities Program Fund (Sunny Day)

• Small business lending and investment: o Maryland Small Business Development Financing Authority (MSBDFA) o Small, Minority- and Women-owned Business Account – Video Lottery Terminal

Fund (VLT) • Credit enhancement/loan guarantees/bond financing for small and mid-sized firms:

o Maryland Industrial Development Financing Authority (MIDFA) • Credits and funding for workforce, job creation

o Job Creation Tax Credit o Partnership for Workforce Quality (PWQ)

The twelve existing incentives noted above represent only a fraction of Maryland’s 72 incentive and financing programs in statute (in 2015). Maryland’s overall portfolio of programs is managed not only by the Department of Commerce, but also with the help of other agencies such as the Technology Development Corporation (TEDCO), the Department of Housing and Community Development (DHCD), Maryland Energy Administration (MEA), and the Comptroller of Maryland. Among the 50 states, Maryland has one of the largest number of incentive programs. Combined, these programs seek to address a very broad array of goals. This large number of incentive programs is funded by a relatively modest (compared to other states) v


investment in economic development. By spreading limited resources so thin, many existing programs are small and underfunded. Even when they are implemented effectively, these programs often have very limited resources, diminishing their ability to have a significant impact on the state’s economic development outcomes. In our assessment, we distinguish financing programs from incentive programs. Financing programs are designed to provide up-front cash to a business that may need it but ultimately is expected to repay the loan. These debt and equity programs are designed to help businesses that are unable to access private markets without some form of credit enhancement, collateral support, or subsidy. By comparison, incentives provide a public subsidy designed to encourage a company or project to locate or expand in a community that may be competing with a community outside the state or to encourage a company to make an investment when it might not otherwise do so. These subsidies are provided not so much because the company 'needs' it, but because the community needs the public benefits that would be derived locally from the company’s investment. Over the past several decades, Maryland has shifted from using direct business financing with grant and loan programs toward a greater use of tax incentives, especially tax credits. More than half of Maryland’s active incentive programs offer some kind of tax-related benefit. By comparison, state tax incentives represent less than half of all business incentive programs used by other states. Approximately a third of Maryland’s programs provide direct business financing, while about 15 percent offer “indirect” business financing. The emphasis of Maryland’s current portfolio of incentives and financing programs is on tax burden reduction and capital access or formation, with a smaller number of programs addressing business operations improvements. Compared to other states, Maryland’s program portfolio places a stronger emphasis on addressing tax burden reduction and technology and product development. Taken together, the twelve programs seek to fulfill a number of goals set through a succession of administrations and legislatures:

1. To strengthen Maryland’s existing businesses by providing access to loans and related sources of capital to accelerate their growth;

2. To specifically support targeted industries, such as biotechnology and cybersecurity, where the state has a demonstrated leadership position;

3. To attract significant employers to Maryland; 4. To support the economies of distressed communities in the state, whether they are in

rural counties or in urban settings; 5. To encourage Maryland companies to invest in their workforce; and 6. To assist minority- and women-owned businesses throughout the state in accessing

capital to grow their businesses.

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These goals are similar to those espoused by other states. However, states do differ as to which industry clusters they target based on each state’s respective strengths and assets. Furthermore, some states place more emphasis on supporting existing businesses and growing new ones, while other states underscore the attraction of new enterprises as their predominant economic development goal. The support of minority- and women-owned businesses, as well as supporting distressed communities are roles often delegated to the regional and local levels through community development corporations; workforce and job training is also often organized regionally through local Workforce Investment Boards. By virtue of its geography, Maryland is caught between these two paradigms. Compared to the Southern states that have significant attraction programs, Maryland falls short both in budget and programmatic content. When compared to the Northeastern states, including Pennsylvania, Maryland falls short in its commitment to workforce training and the support of existing businesses, both in specific clusters and in manufacturing. That being said, many of the twelve programs are working well, demonstrating good results, and meeting the goals set for them. Some of the programs, such as the Biotechnology Industry Investment Tax Credit and the Maryland Small Business Development Financing Authority’s minority lending programs were pioneering when they were started. In most cases, there are some design changes that could better align the program with its goals and mission. In some cases, we have also identified operational “tweaks” that can be made, sometimes administratively, that would improve the marketing and/or ease of use of the incentive by its target customer. Our recommendations focus on several key objectives:

• Help Maryland compete for major corporate relocations or expansions; • Improve Maryland’s ability to support disadvantaged regions, businesses and

entrepreneurs; • Streamline the management of current programs to make them more efficient to

administer; and • Increase Maryland’s business “friendliness” by improving business access to programs

and services. Overarching the programmatic recommendations detailed in the following chapters are three new ideas that cut across multiple programs and incentives.

1. If Maryland wants to compete for major corporate relocations or expansions, we strongly recommend restructuring MEDAAF as a strategic fund with greater flexibility. Existing discretionary funding is contingent on significant capital investment, which may or may not be accompanied immediately by job growth. Re-structuring to enhance flexibility also provides an opportunity for Maryland to re-brand these discretionary incentives as more responsive to market needs.

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2. To improve the State’s overall competitiveness and more effectively support distressed regions, add a tiered approach to recognize greater barriers for certain areas in attracting private investment. These tiers would apply consistently to a wide variety of tax credit incentives, making them easier to understand and navigate. The tiers would assign all parts of the state into categories, based on characteristics tied to geography, economic distress, or some other indicator. Maryland would use the tiers to structure benefits so that the most disadvantaged would access the most generous benefits. This may also involve retiring or consolidating some legacy tax credit programs to reduce confusion and increase transparency.

3. Develop a holistic approach to expand capital access to a diverse mix of businesses by adjusting the design of finance programs to leverage limited state resources with private capital. Proactively coordinate available pools of public funds targeted toward small business and economic development financing into a more cohesive capital access and formation strategy targeted to the needs of underserved businesses.

The CREC team’s assignment was to review twelve existing Maryland business tax credit, grant, and loan programs designed to promote economic development in the state. As Maryland deliberates about what overarching reforms might be desirable, the team also had recommendations related to those existing programs that would help make them operationally stronger should the state reaffirm them. For most of the twelve incentives or financing programs studied, CREC suggests some structural changes that could be made that would improve either their efficacy or reduce barriers for companies that are eligible for the incentives. More specifics are provided in the chapters that describe these programs in detail. Some of these are:

• Biotechnology Industry Investment Tax Credit: Eliminate the maximum age criteria related to eligibility for investments and replace it with a lifetime cap on credits per company.

• Cybersecurity Industry Investment Tax Credit: Same change. Also, make the credit accrue to the investor, not the company, as the current statute incentivizes cyber companies to move to neighboring states where their investors would be rewarded for investing.

• MEDAAF Capability One: Increase funding capacity and adapt Capability One to allow conditional loans or performance grants (as in Capability Two) while maintaining or broadening project eligibility by location and sector to enable maximum flexibility in the state’s decision-making.

• MIDFA: Convene a group of experienced lenders to review the existing MIDFA Loan Guarantee Program and to recommend changes to make it more appealing to the banking community.

Lastly, we have identified some operational changes that could be made administratively to improve the delivery of these programs, in most cases making them more efficient in their use of staff time as well. This list is not exhaustive, but rather is illustrative.

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• Biotechnology Industry Investment Tax Credit and Cybersecurity Industry Investment Tax Credit: Ensure that there is a separate and distinct step that allows a firm to be certified as a Qualified Maryland Biotechnology or Cybersecurity Company before they go out to raise capital.

• MEDAAF: Re-structure MEDAAF as a strategic fund by introducing greater flexibility in shifting funds across capabilities, create focus for the program by limiting the purpose of its incentive grants or loans, and market the various capabilities through their respective communities of interest.

• Job Creation Tax Credit: Simplify the verification of created jobs. The current requirement to have a CPA certify the jobs is expensive and not necessarily better than potential alternatives such as using the existing Unemployment Insurance reporting mechanisms.

• MIDFA: Actively market the MIDFA Loan Guarantee. Consultations with lenders and state banking associations should be ongoing to support continued program use by identifying the evolving needs of lenders.

The twelve programs are generally working well when they are fully funded, and are meeting the goals and objectives set by the General Assembly when they were introduced. The changes recommended reflect a policy window for improvement of the incentives overall created by the coincidence of a new Administration, an interested General Assembly, and the oversight of the public through activities such as the Augustine Commission.

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Introduction U.S. job gains have outstripped those of Maryland since 2013, with current Maryland employment standing 3 percent above the 2005 level compared to 5 percent higher for the U.S. Going forward, the nation’s monthly payroll gains are expected to remain above 200,000 throughout 2016 and beyond. Job growth in Maryland is forecasted to be slower than for the U.S. as a whole. So whereas Maryland has recovered from the recession when comparing job figures – future employment growth is expected to trail that of the U.S. Maryland has a reputation as a place with a business climate that is challenging. Yet, as the home of several top ranked universities and numerous federal laboratories, the state is best known as a mid-Atlantic powerhouse in science and technology. Economic development responsibilities are spread across a variety of agencies and organizations, notably the Department of Commerce (formerly the Department of Business and Economic Development) and the Technology Development Corporation (TEDCO). These and other agencies manage a large number of incentive programs. Maryland has a total of 72 active programs in 2014. Incentive programs are defined as state-administered programs designed to influence business investment behaviors. The responsibility for administering these incentive programs is spread across 13 different state agencies. The primary agencies responsible for administering incentive programs are the Department of Commerce, Department of Housing and Community Development (DHCD), Maryland Energy Administration (MEA), and the Comptroller of Maryland. The Comptroller exclusively administers tax incentives (primarily exemptions and offsets of business-related expenses), while Commerce and other state agencies administer a mix of tax (primarily credits) and non-tax programs. At the same time, the actual amount of overall economic development program spending per business establishment in the state is lower than the average in most other states. Economic development tax expenditures are particularly modest despite the large number of incentives offered. Thus, Maryland is not as generous with its incentives as other states, yet has spread these investments across many more programs. This suggests the state recognizes the diversity in goals that economic development can have, but it also may be interpreted as a lack of adequate focus on key priorities. Over the past couple of decades, the state has moved from a focus on providing funds for direct grant and loan programs that provide capital to businesses directly toward a greater emphasis on using tax incentives, especially tax credits, to influence business investments for job creation. These changes have come about largely through the actions of the Maryland General Assembly, rather than through a planned economic development strategy. This is not unusual as many states sought to increase economic development during the Great Recession without increasing the budgeted costs for these programs.

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Today, more than half of Maryland’s active incentive programs offer some kind of tax-related benefit. By comparison, tax incentives represent 45 percent of all state business incentive programs in the United States. Approximately a third of the state’s programs provide direct business financing, while about 15 percent offer indirect business financing. Maryland utilizes a variety of initiatives for tracking the outcomes of these investments in economic development programs, including Maryland Finance Tracker, Managing for Results, Maryland StateStat, and the Tax Credit Evaluation Committee. Even so, the state is continuously exploring new methods for effectively evaluating how well its incentive programs accomplish the state’s economic development priorities. For instance, Maryland participated in an initiative of the Pew Charitable Trust and Center for Regional Economic Competitiveness (CREC) that worked with six states during 2014 and 2015 to understand how each has been measuring its investment in incentives, and how the measurement effort can be improved. Maryland continues to seek ways to build on the results of its collaboration with other states during the Pew/CREC initiative, including this study. Governor Larry Hogan’s new Administration has added urgency to the desire to better understand the effectiveness of the state’s incentive programs. In addition, the legislatively appointed Maryland Economic Development and Business Climate Commission, headed by Norman Augustine (the Augustine Commission), issued a report in February 2015 that contained a number of observations and recommendations for improving Maryland’s economic situation. While the number and range of Maryland’s incentives was noted in the report, its most pointed comments referred to the perceived business unfriendliness of Maryland government:

Most often cited was a culture among State and local governments that might be summarized as, “We are here to assure that you comply with the rules,” rather than “We are here to help you grow your business and create jobs while complying with the rules.” . . . Ironically, most of the complaints were not directed at the rules themselves, but rather at what was perceived to be an arbitrary, irrational, and time-insensitive manner in which the rules were too often being interpreted and implemented.”

The Department of Commerce is interested in learning how to improve its incentive programs, but it operates in an environment that makes this challenging. Not only do many critical programs operate in other agencies, but also many initiatives emerge from the General Assembly, making a coordinated evaluation and strategy difficult. At the same time, Maryland’s economy is doing quite well, led by its strong innovation sectors whose success is masking greater difficulties in some other fundamentals. However, Commerce recognizes that Maryland has a lot of incentive programs, that they are often too small, too restricted, or no longer relevant to today’s economy. Therefore, Commerce asked the Maryland Economic Development Corporation (MEDCO) to seek “pragmatic, substantive and detailed guidance in updating and improving State financial programs that aim to retain and attract businesses to Maryland,” with an eye towards

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understanding how economic trends and client expectations should be impacting the programs. In addition, Commerce requested a benchmarking of Maryland’s programs against national trends. CREC’s role is to provide context and analysis to support recommendations for the various programs, building upon the existing in-house analysis and evaluation. The specific programs represent a subset of all Maryland incentives and they are grouped into the following six categories:

• Tax credit programs, “place-based”, focused on lowering real estate and operating costs: o Enterprise Zones o One Maryland Tax Credit Program o Regional Institution Strategic Enterprise (RISE) Zone program

• Tax credit programs, investment: o Biotechnology Investment Incentive Tax Credit o Cybersecurity Investment Incentive Tax Credit o Proposed angel investment tax credit

• Incentive programs targeted to attraction or retention of significant employers: o Maryland Economic Development Assistance Authority and Fund (MEDAAF) o Economic Development Opportunities Program Fund (Sunny Day)

• Small business lending and investment: o Maryland Small Business Development Financing Authority (MSBDFA) o Small, Minority- and Women-owned Business Account – Video Lottery Terminal

Fund (VLT) • Credit enhancement/loan guarantees/bond financing for small and mid-sized firms:

o Maryland Industrial Development Financing Authority (MIDFA) • Credits and funding for workforce, job creation

o Job Creation Tax Credit o Partnership for Workforce Quality (PWQ)

The Center for Regional Economic Competitiveness (CREC) assembled a national team of experts in economic development, incentives and evaluation, including its staff and Senior Research Fellows, to provide MEDCO and Commerce with a detailed assessment of its financing incentive programs, and to develop recommendations for increasing their effectiveness, flexibility and efficiency. The report is organized with a Summary of Recommendations that pulls together the individual program recommendations and recognizes the relationships among and between them (Chapter 1). Next is an overview of existing economic conditions as well as national and state trends in economic development funding and incentive programs (Chapter 2). Following are six reports organized by category listed above, including findings and recommendations for each program reviewed (Chapters 3-8).

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Chapter 1: Summary of Recommendations In framing recommendations from this analysis, it is important to acknowledge up front that economic development has multiple goals and assistance to business in the form of loans typically have a different purpose than do incentives. Financing programs are distinct because they are designed to provide up-front cash to a business that may need it but ultimately is expected to repay the liability. These debt and equity programs are designed to help businesses that are unable to access private capital markets without some form of credit enhancement, collateral support, or subsidy. By comparison, incentives are distinct because they provide a public subsidy designed to encourage a company or project to locate or expand in a community that may be competing with another community outside the state or to encourage a company to investment that might not otherwise do so. These subsidies are provided not so much because the company 'needs' it, but because the community needs the public benefits that would be derived locally from the company’s investment. The twelve incentive and financing programs reviewed comprise only a small number of the total programs available through the Maryland Department of Commerce and other related agencies to support existing Maryland businesses and entrepreneurs and to attract new enterprises to the state. Taken together, they seek to fulfill a number of goals set through a succession of administrations and legislatures:

1. To strengthen Maryland’s existing businesses by providing access to loans and related sources of capital to accelerate their growth;

2. To specifically support targeted industries, such as biotechnology and cybersecurity, where the state has a demonstrated leadership position;

3. To attract significant employers to Maryland; 4. To support the economies of distressed communities in the state, whether they are in

rural counties or in urban settings; 5. To encourage Maryland companies to invest in their workforce; and 6. To assist minority- and women-owned businesses throughout the state to access capital

to grow their businesses. These goals are similar to those espoused by other states. However, states target different clusters, depending upon their strengths and assets. Some states have placed more emphasis on supporting existing businesses and growing new ones, while other states have the attraction of new enterprises as their predominant economic development goal. The support of minority- and women-owned businesses, as well as supporting distressed communities are roles often delegated to the regional and local levels through community development corporations; workforce and job training is also often organized regionally through local Workforce Investment Boards. By virtue of its geography, Maryland is caught between these two paradigms. Compared to the Southern states that have significant attraction programs, Maryland falls short both in budget

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and programmatic content. When compared to the Northeastern states, including Pennsylvania, Maryland falls short in its commitment to workforce training and the support of existing businesses, both in specific clusters and in manufacturing. That being said, many of the twelve programs are working well, demonstrating good results, and meeting the goals set for them. In most cases there are some design changes that could better align the program with its goals and mission. In some cases, we have also identified operational “tweaks” that can be made, sometimes administratively, that would improve the marketing and/or ease of use of the incentive by its target customer. The major challenge these programs face is that Maryland has too many, and they are insufficiently resourced to achieve all of the goals set out for them. Maryland must set its sights on a singular vision and focus its investments to achieve demonstrable success. Our recommendations focus on several key objectives:

• Help Maryland compete for major corporate relocations or expansions; • Improve Maryland’s ability to support disadvantaged regions, businesses and

entrepreneurs; • Streamline the management of current programs to make them more efficient to

administer, while broadening their impact; and • Increase Maryland’s business “friendliness” by improving businesses’ ease of access to

the programs and services.

The recommendations below focus on three new ideas that cut across multiple programs and incentives.

1. If Maryland wants to compete for major corporate relocations or expansions, we strongly recommend restructuring MEDAAF as a strategic fund with greater flexibility. Existing discretionary funding is contingent on significant capital investment, which may or may not be accompanied immediately by job growth. Re-structuring to enhance flexibility also provides an opportunity for Maryland to re-brand these discretionary incentives as more responsive to market needs.

2. To improve the State’s overall competitiveness and more effectively support distressed regions, add a tiered approach to recognize greater barriers for certain areas in attracting private investment. These tiers would apply consistently to a wide variety of tax credit incentives, making them easier to understand and navigate. The tiers would assign all parts of the state into categories, based on characteristics tied to geography, economic distress, or some other indicator. Maryland would use the tiers to structure benefits so that the most disadvantaged would access the most generous benefits. This may also involve retiring or consolidating some legacy tax credit programs to reduce confusion and increase transparency.

3. Develop a holistic approach to expand capital access to a diverse mix of businesses by adjusting the design of finance programs to leverage limited state resources with private

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capital. Proactively coordinate available pools of public funds targeted toward small business and economic development financing into a more cohesive capital access and formation strategy targeted to the needs of underserved businesses.

These ideas and others that focus on single incentives are discussed below.

Improve Competitiveness with Other States Flexibility is the name of the game in deploying state incentives. In most recent cases of large corporate relocations or new facility openings, the winning location relied on a generous—and very flexible—incentive package, a mix of multiple benefits specifically customized to meet the corporate client’s needs, usually spread across several years. These benefits might include infrastructure or site-related investments, workforce training, tax breaks, and grants, which are drawn from a variety of state and local incentive programs and services. For instance, the 2012 decision by Baxter International to build a $1 billion bio-manufacturing plant in Atlanta, creating 1,500 jobs, was leveraged by an investment from Georgia’s $78.5 million deal closing fund. This enabled the state to commit to building a $14 million workforce training facility just for the company. Georgia’s total investment package for Baxter totaled $210 million. Tesla’s 2014 announcement that they would build a new 6,500 employee battery factory in Reno, Nevada, was motivated in part by a $1.3 billion incentive package that included sales and property tax abatements, $120 million in transferable tax credits, and $12,500 per job (for 600 jobs) as well as discounted electricity rates. At present, the state of Maryland lacks the tools and capacity to compete for large projects of this scale and scope. Its current level of benefits is often too small and inflexible. At the same time, Maryland lacks the capacity to support key needs, especially related to workforce. Most importantly, Maryland’s large set of programs, each with its own rules and procedures, makes Maryland’s incentive offerings appear more bureaucratic and “unfriendly” than those offered in other states. A single, flexible program would be more competitive. To begin to be competitive in these arenas, Maryland should:

1. Restructure and rebrand MEDAAF as a strategic fund to provide increased flexibility to meet the needs of major employers who are considering a move to Maryland or to retain a significant existing company.

2. Devote a considerably larger portion of its incentive funds to workforce development and training, particularly through a customized job-training program in partnership with the Maryland Community College System.

3. Empower Commerce to package various incentives together into a single contract with performance milestones, reporting requirements and clawbacks to present to potential opportunities.

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4. Create a general angel investor tax credit in order to be competitive with the 26 other states that have them. While the two existing programs (BIITC and CIITC) are leading the nation, the restriction to just two sectors misses many opportunities today and in the future as technology evolves.

Align Program Design with Program Goals Many of the twelve programs we reviewed are operating fairly well. However, some program design changes could greatly increase the impact that these programs could be having on Maryland companies.

Increase Access to Programs by Simplifying and Unifying Eligibility Criteria A crosscutting recommendation is to rethink eligibility criteria for programs as disparate as Enterprise Zones, One Maryland, MEDAAF, PWQ, and JCTC. We recommend that Maryland consider a uniform tiered system of eligibility where more distressed communities can offer higher benefits to companies. These tiers should be consistent across all the programs, which would greatly simplify the administration and marketing of the incentives. We recommend the alignment of guidelines for jobs created or investments made with a tiered structure so that they are realistic for the situation. States and localities have used a variety of ways to “rank” or “score” communities in relation to their incentive programs. In most cases, the scoring systems are used to provide increased or “better” benefits to firms that locate or expand in a community of “special interest.” States define this special interest in several ways:

Economic Distress Economic distress metrics are the most frequently used tool for ranking communities. Indeed, nearly all states that have tiered systems use distress measures and all enterprise zone programs are based on these metrics as well. A wide range of distress measures can be used. These include household poverty rates, unemployment rates, per capita income, or the number of residents with incomes below the poverty line. A related issue concerns how best to “rank” communities. In some cases, programs use a threshold measure (e.g. poverty rates at 150% of state average) and provide added benefits to all locations that meet that threshold. In other states, benefits are based on specific rankings. For example, both Georgia and North Carolina rank their 40 least developed counties as Tier 1 and thus worthy of the most generous incentive benefits.

Performance Based Tiers Nebraska is one of the few states that use a very formalized tier structure based on the performance of a specific project. This structure ties incentives to the number of new jobs created or the amount of new capital investment linked to a project. For example, the state’s “Super Tier 6” is reserved for projects that provide 75 new jobs and $10 million in new investment or 50 new jobs and $109 million in new investment. These projects are eligible for the following benefits:

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• Refund of all sales tax on project capital purchases, • 10% job credit on new employee compensation • 15% investment credit, and • Personal property tax exemption for all personal property at the project for up to 10

years.

The provision of added benefits for larger project impacts is of course not unusual, but Nebraska is one of the few states to adopt a very formalized system for specifying these benefits in advance.

Special Interest Zones Some states have set up zones based on issues of special interest or concern. For example, Georgia provides maximum incentive benefits for its Military Zones, locations at or near the state’s many military bases. Programs like Start-Up New York or Pennsylvania’s Keystone Innovation Zones also operate on a similar premise, providing added benefits for communities located near college campuses. This is one way to incorporate RISE into a broader system of tiers.

Rural Focused Benefits For many states, their definitions of economic distress are sufficient to allow for the provision of added benefits or incentives in rural counties. Others also have their own definitions for qualifying rural counties. These are typically based on population and of course vary based on the unique characteristics of each state. Some examples include:

• Florida (Counties with fewer than 75,000 residents) • Washington (Counties of less than 250 sq. miles or with population densities below

100 persons per sq. mile) • North Carolina (Population density below 250 per sq. mile) • Virginia—its health and community development programs use a definition

developed by researcher Andrew Isserman who defined rural counties as those with a population density of less than 500 people/square mile, and 90 percent of the county population is in a rural area or the county has no urban area with population of 10,000 or more.

Align Maryland Small Business Financing Programs to Increase Impact Maryland is currently offering financing support to its businesses that is focused on small and minority-owned businesses (MSBDFA) and certain geographies (VLT) through direct loan programs. MIDFA’s approach of credit enhancements and bond financing is different, but it suffers from low utilization and limited staff. All of the financing programs wish to have greater marketing reach, but the funding available for marketing activities or even for overhead to cover loan origination, underwriting and portfolio management varies significantly. Taken together, the state has a total portfolio of $37.2 million in 216 loans originated by MSBDFA and VLT, averaging $172,000 each. MIDFA’s recent activity has averaged 13 transactions a year, leveraging $88 million in private capital. 8


These numbers need to be placed in aggregate against the state’s business demographics. Of the approximately 528,000 businesses in the state, a substantial portion of Maryland firms are owned by blacks (19.3%), Hispanics (4.9%) and women (32.6%).1 Over ninety-seven percent are small and around 100,000 are small businesses with employees.2 Of those with employees, 74% have less than 10 employees.3 There is significant evidence that minority- and women-owned businesses continue to face difficulties accessing capital. A recent study confirms “women and minority business owners’ fears of being declined for a loan were not necessarily unwarranted. In particular, in term of loan application outcomes, even after controlling for such factors as industry, credit score, legal form, and human capital, minority owners of young firms were significantly less likely to have their loan applications approved than were similar white business owners.” Therefore, women and minority business owners are less likely to apply for a loan and instead rely on other forms of financing to start businesses.4 The need is great, much greater than Maryland’s current approach can address effectively without more fully engaging private capital markets. To date, Maryland has been one of the most progressive states in the nation in using direct loans to address this issue. This approach helps a small number of firms each year access capital for business investments that would no doubt have been declined by lenders. Maryland has learned a great deal from these loan programs over the past three decades, but the policy question for 2016 is whether there are other ways to scale up these efforts and leverage greater impact to improve capital access to small, minority- and women-owned businesses. While this current approach was innovative and groundbreaking in the 1990s, changing economic and demographic circumstances suggest that a re-evaluation of this policy is in order. The increasingly larger numbers of businesses in these categories is in and of itself a reason to ask this question, as fielding a separate direct publicly funded loan program of appropriate scale seems unrealistic. Maryland’s total investment in small business and economic development lending represents an important potential pool of capital, but several organizations implement these programs independently and with little guidance from policy leaders about strategic goals. The programs may still be suitable, but they need to operate in greater concert. One option to consider for improving this coordination is to consolidate the existing pools of capital into a single flexible program with an organization staffed by persons with commercial lending experience and that has, established relationships with banks and CDFIs and a public mission. Even if Maryland does not want to pool the funds, it is vital that the state develop a cohesive strategy on how best to use its limited resources.

1 US Census 2007 Economic Census. 2 Small Business Administration. 3 The Kauffman Index: Main Street Entrepreneurship State Trends, 2015. www.kauffman.org. 4 Robb, Alicia. 2013. “Access to Capital Among Young Firms, Minority-owned Firms, Women-owned Firms, and High-tech Firms.” https://www.sba.gov/sites/default/files/files/rs403tot(2).pdf.

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To align the state’s various business financing programs, Maryland needs to examine how best to use those limited resources to leverage private capital more effectively in addressing the lending needs of so many Maryland firms that are young and especially those that are minority- or woman-owned. Given that these businesses now comprise a substantial share of businesses in the state’s economy, there is a growing need to help re-shape the way the private sector views these companies. Maryland must tap MIDFA, MSBDFA, VLT, and any other resources to engage with the private sector lending community more directly in ways that help encourage lenders to provide capital to underserved businesses. In doing so, they will gain much needed experience in working with these firms and in demonstrating that small, minority- and women-owned businesses can be good credit risks and sources of profit for private lenders. Direct loan programs are valuable tools, but they cannot achieve sufficient scale to make the kinds of changes in the private marketplace to which Maryland should aspire. This suggests that Maryland should explore a policy alternative to direct loans that incentivizes existing private capital, whether in national or regional banks, community banks, credit unions, or Community Development Financing Institutions (CDFIs), to better serve currently underserved segments of the population, namely young, minority-owned and women-owned businesses. Other states are learning much about how to increase their leverage of private capital. We draw on experience from other states resulting from the US Treasury’s State Small Business Credit Initiative (SSBCI) Program where a substantial portion of lending programs are helping underserved businesses. Using a variety of credit enhancement tools, the SSBCI funds allocated to 47 states and the District of Columbia have resulted in more than $5 of private lending for each dollar of SSBCI funds invested. Of $632 million in SSBCI capital expended since 2011 for lending programs across the U.S., Treasury and its state partners have leveraged $3.3 billion in private loans.5 Furthermore, 34 percent of the funds were made available to companies located in low- and moderate-income communities; one-third of the loans to companies 3 years old or less; 87% to companies with fewer than 100 employees; and nearly one-quarter to companies located in rural communities. Several lessons learned from the SSBCI program are also relevant here.6 Through analysis of the program, we learn that strong state leadership facilitated rapid deployment of capital. Participation with the Governor’s office encouraged integration of these loan programs into the state’s “multi-faceted economic development strategies.” This lesson from SSBCI nationally contrasts with the highly decentralized financing strategy that currently exists in Maryland.

5 CREC analysis of U.S. Department of Treasury SSBCI transaction data for the period January 2011-December 2014. 6 All findings are from CREC. 2014. “Filling the Small Business Lending Gap: Lessons from the US Treasury’s State Small Business Credit Initiative (SSBCI) Loan Programs.”.https://www.treasury.gov/resouce-center/sb-programs/Documents/CREC%20January%202014%20FINAL.pdf.

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Another lesson was that programs that solve a clearly identified borrower credit issue were popular with banks, suggesting that this may be a way to address challenges with minority- and women-owned businesses. In other words, providing loan participation, collateral support, and even leveraged guarantees may increase the likelihood that private sector lenders will provide loans to underserved businesses. Finally, quasi-public agencies and private contractors were found to be the most effective at deploying loan funds rapidly because they usually have staff with commercial lending experience and pre-existing lender relationships. Similarly, an assessment of SSBCI lending found that states working with mission-driven private lenders had the greatest success in reaching underserved borrowers. And, this partnership approach puts the loan origination apparatus into the hands of private and nonprofit partners located in underserved communities, where it is most effective. Paired with statewide outreach to underserved businesses and providing education about how to work with local capital sources, these program approaches could provide deeper penetration into the potential pool of borrowers than a standalone direct loan program. Therefore, we see the opportunity for Maryland to build on its progressive history in promoting capital access to small and underserved businesses and re-evaluate its approach to financing programs. This would potentially involve shifting Maryland programs from making direct loans to using credit enhancement techniques that incentivize the private sector to make loans to targeted business communities. This revised approach may gain greater interest from the private sector if the existing pools of capital are better coordinated through a leadership group or perhaps even consolidated into a single organization that employs staff with commercial lending experience and that has, established relationships with banks and CDFIs and a public mission. Sixteen states operate quasi-public agencies that manage their overall lending programs, often in partnership with public, nonprofit, and for-profit implementing partners. Examples include the Arkansas Development Finance Authority, Connecticut Development Authority, Indiana Economic Development Corporation, Finance Authority of Maine, Michigan Economic Development Corporation, New Hampshire Business Finance Authority, New Jersey Economic Development Authority, Vermont Economic Development Authority, and West Virginia Jobs Investment Trust. Ultimately, the goal of this proposal is to provide an organizational infrastructure that support public policies aimed at providing access to capital and the organizations charged with implementing MSBDFA, MIDFA, and VLT so that these efforts can reach a larger number and a more diverse mix of businesses. These ideas and others that focus on single incentives are discussed below.

Program-specific Recommendations In addition, we have some program-specific recommendations. More specifics are provided in the chapters that describe these programs in detail. Some of these are:

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• Biotechnology Industry Investment Tax Credit: Eliminate the maximum age criteria related to eligibility for investments and replace it with a lifetime cap on credits per company.

• Cybersecurity Industry Investment Tax Credit: Same change. Also, make the credit accrue to the investor, not the company, as the current statute incentivizes cyber companies to move to neighboring states where their investors would be rewarded for investing.

• MEDAAF Capability One: Increase funding capacity and adapt Capability One to allow conditional loans or performance grants (as in Capability Two) while easing up-front restrictions on location and industry eligibility to enable maximum flexibility in program use for desirable major projects.

• MIDFA: Convene a group of experienced lenders to review the existing MIDFA Loan Guarantee Program and to recommend changes to make it more appealing to the banking community.

Operational “Tweaks” for Better Customer Service The major challenge facing Maryland’s efforts is that that are too many and they are insufficiently resourced. Maryland must set its sights on a singular vision and focus its investments to achieve demonstrable success. However, CREC’s charge was specifically to examine the twelve incentive programs. In summary, there are some design changes that could better align the program with its goals and mission. In addition, we also offer operational “tweaks” that can be made, sometimes administratively, that would improve the delivery of these programs, in most cases making them more efficient in their use of staff time as well. This list is not exhaustive, but rather is illustrative.

• Biotechnology Industry Investment Tax Credit and Cybersecurity Industry Investment Tax Credit: Ensure that there is a separate and distinct step that allows a firm to be certified as a Qualified Maryland Biotechnology or Cybersecurity Company before they go out to raise capital.

• MEDAAF: Re-structure MEDAAF as a strategic fund by introducing greater flexibility in shifting funds across capabilities, create focus for the program by limiting the purpose of its incentive grants or loans, and market the various capabilities through their respective communities of interest.

• Job Creation Tax Credit: Simplify the verification of created jobs. The current requirement to have a CPA certify the jobs is expensive and not necessarily better than potential alternatives such as using the existing Unemployment Insurance reporting mechanisms.

• MIDFA: Actively market the MIDFA Loan Guarantee. Consultations with lenders and state banking associations should be on-going to identify the evolving needs of lenders to support continued program utilization.

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Chapter 2: Overview of National Economic and Incentive Trends State finance programs operate within the economic conditions of their state, regional and national economies. For this reason, we are including an overview of economic conditions present as of this writing. In addition, we include trends in economic and business incentives overall, to place Maryland’s programs in context.

Economic Conditions Overview The U.S. economy has been in the midst of a sustained, though modest, economic recovery since the financial crisis and Great Recession of 2008 and 2009. Most economists monitor gross domestic product (GDP) more closely because it is a more comprehensive measure of the economy's performance than jobs. GDP represents the value of the goods and services produced across the economy. As Figure 2-1 depicts, despite the erratic quarterly GDP pattern, demand from U.S. consumers, businesses and governments remains solid, as does demand for U.S.-produced goods and services, both domestically and from abroad. Consumers, in fact, are spending at a pace not seen since before the Great Recession. Despite recent volatility in the stock market, economists expect the sustained growth of the U.S. economy to extend into 2016, with a steadily improving job market helping to fuel this optimism. In fact, the U.S. economy is currently on track to return to full employment by mid-2016 and this should encourage faster wage growth and more spending as well. The steady stream of mostly positive economic news through the latter half of 2015 led economists to believe 2016 will see a continued steady growth of the U.S. economy, at a projected 2.5% pace, and for most states as well. Unless the current market volatility continues unabated, it is also expected that the Federal Reserve will shift away from their decade-long policy on quantitative easing and continue the

Figure 2-1: U.S. Real Gross Domestic Product, 2011-2016

Source: U.S. Department of Commerce Bureau of Economic Analysis and Bloomberg

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process of raising interest rates that started in December 2015 into 2016. The potential downside risks to this otherwise optimistic outlook for the economy include a more serious economic slowdown in China and regions heavily dependent on revenues from oil production as long as energy prices remain low.

Employment For state officials and policymakers, and the public at large, offering a plethora of good job opportunities to the citizens of Maryland is the most visible sign of an effective economic development policy the most carefully watched measure of economic health is the monthly jobs reports. After losing more than 7 million jobs between 2008 and 2010, the national economy has since rebounded, adding 13.5 million jobs from the recession’s nadir and surpassing 2007 peak national employment in early 2014. In the most recent U.S. jobs report, December 2015 payroll gains surged to 295,000 and the unemployment rate remained at 5%. The three-month average for payroll growth stood at 187,000, more than enough to keep pace with the growing national workforce. Service industries led the gains, but the gains were broad-based across industries. Both the nation and Maryland suffered job declines during the Great Recession, although the state’s job loss was less severe. Maryland has been growing in its number of jobs as well and the state’s most recent unemployment rate was 5.2% in November 2015, slightly above the national rate of 5.0%. Those job losses were also regained earlier in Maryland than nationally, as shown in Figure 2-2. Since 2013, however, U.S. jobs gains have outstripped those of Maryland. Current Maryland employment stands 3 percent above the 2005 level compared to 5 percent higher for the U.S. Job growth in Maryland is forecasted to occur at a slower pace than for the U.S. as a whole.

Figure 2-2. Job Growth Trends for Maryland and the U.S., 2005-2025

Source: CREC review of U.S. Department of Labor Bureau of Labor Statistics and EMSI data

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Economic Share “Economic share” measures the percentage of a state's economy that is accounted for by an individual county. Specifically, economic share is measured as the average percentage of the state's employment, population and personal income occurring in a particular county. The map in Figure 2-3 illustrates Maryland counties and their contribution to the overall state’s economy, based on employment, population, and income. Montgomery (19.0%) and Baltimore (14.0%) together tally nearly one-third of Maryland’s total economy. Prince George's (13.0%); Baltimore City (11.0%); and Anne Arundel (10.0%) account for another one-third the state’s economy. Measuring changes to economic share over time is particularly useful to help identify where, geographically, new economic development activities are most clearly taking place. From 2005 to 2014, the county contributions to the state’s economy have not changed significantly, yet there have been some shifts in Maryland’s economic composition during the period. Counties with significant gains in economic share over the last decade include Howard, St. Mary’s, Anne Arundel, and Harford. This is indicative, then, of where new capital investments and jobs have been advancing recently.

What Companies Say They Want As the state continues to seek policies and to provide business incentives to help maintain the growth of Maryland’s economy, it is important to understand what companies say they want when making important capital investment and job creation decisions. As shown in Figure 2-4, corporate decision makers most often cite highway accessibility as a critical factor for locating a

Figure 2-3. Economic Share by County, 2014

Source: CREC calculation using U.S. Department of Commerce, Bureau of Economic Analysis, U.S. Census Bureau, and U.S. Bureau of Labor Statistics data

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new facility. Nearly 9 of 10 company heads rate this as a top business site selection factor. Construction costs, land, crime, suitable buildings, skilled workers, and labor costs also weigh heavily as factors for 8 in 10 business owners. State and local incentives rank 14th on the list. In any given year, only a finite number of new facilities bringing job opportunities will take place. Of the possible few hundred new business sites annually, roughly 8% will be located in states in the Mid-Atlantic. With these facilities, 54% of companies indicate incentives are of great importance when making these final location decisions. Thirty-eight percent (38%) of business looking for a new location say that incentives are now more important now than in the past as an influence on site decisions. Given the limited number of opportunities, and importance given to business incentives by the companies themselves, it is imperative that a state be both efficient and effective with the mix and use of incentives. It is also important to recognize the role incentives play within the broader context of site selection factors, and that a state must work efficiently and effectively on all of the critical factors listed.

What Does the Future Hold? Besides competing for the business of today, a state needs to position itself to capitalize on the new innovations that will fuel the great industries of tomorrow. This means recognizing and being an early entrant in seeding new innovations and emerging industries. Disruptive technologies are innovations that help create new markets and value networks, and eventually disturb existing markets and value networks (over a few years or decades), displacing earlier technologies. Figure 2-5 highlights twelve disruptive technologies that are expected to create trillions in new revenues annually and many thousands of new jobs. Additionally, growth in the fields of cybersecurity, biotechnology, and unmanned aerial vehicles continues to advance by leaps and bounds.

Figure 2-4. Top Business Site Selection Factors

Source: Area Development Corporate Survey, 2015

1. Highway accessibility 88.3%2. Occupancy or construction costs 87.9%3. Available land 85.7%4. Low crime rate 84.4%5. Available buildings 82.2%6. Available skilled labor 82.1% 7. Labor costs 81.6%8. Right-to-work state 77.9%9. Proximity to major markets 77.1%10. Energy availability and costs 76.8%11. Corporate tax rate 75.6%12. Ratings of public schools 75.3%13. Healthcare facilities 74.2%14. State and local incentives 73.2%15. Expedited or “fast-track” permitting 71.0%

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The U.S. rose to economic prominence in the 20th century by connecting invention, manufacturing, and widespread deployment of new technologies (e.g., electrification). This connection has weakened in recent years as other countries have come to outstrip us in the manufacture and deployment of new game-changing technologies (e.g., green energy). Being a state on the forefront of disruptive “game changer” technologies offers the potential for economic growth and new industry cluster development – and the prosperity that goes along with it.

State Business Incentives Trends CREC, manages the Council for Community and Economic Research (C2ER) and maintains the State Business Incentives Database. The Database provides a national inventory of state business incentive programs with almost 2,000 programs from all U.S. states and territories, functioning as both a reference guide for currently active programs and a tool for cross-state comparisons of incentive program portfolios.7 Business incentives are defined by C2ER as “programs designed to influence business investment behaviors.” Since the new millennium, the overall number of state incentive

7 For a more detailed description of the C2ER State Business incentives database is provided see www.stateincentives.org

Figure 2-5. Top Disruptive Technologies, predicted by 2025

Source: McKinsey Global Institute

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programs targeted to businesses has more than doubled, from less than one thousand in 1999 to nearly two thousand today. (See Figure 2-6.)

Number of Incentive Programs Maryland has 72 active programs. The responsibility for administering these programs is spread across 13 different state agencies. The primary agencies responsible for administering incentive programs are the Department of Commerce (formerly DBED), Department of Housing and Community Development (DHCD), Maryland Energy Administration (MEA), and Comptroller of Maryland. The Comptroller exclusively administers tax incentives (primarily exemptions and offsets of business-related expenses), while Commerce and other state agencies administer a mix of tax (primarily credits) and non-tax programs. Based on recent data, Maryland and Oklahoma have the largest number of business incentive programs (see Figure 2-7). Both states have over 65 programs on the books. North Dakota, Wisconsin, New York, Virginia, and South Carolina also have high numbers -- above 50 for each. Nevada, Wyoming and South Dakota have very few state business incentive programs.

Figure 2-6. Total Number of State Business Incentive Programs, 1999-2015

Source: C2ER State Business Incentives Database

Figure 2-7. Total Number of Business Incentive Programs by States and Territories, 2015


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Incentive Program Types States design their incentive programs to influence business behaviors through tax incentives as well as through non-tax programs such as grants, loans, business assistance, and other investment vehicles. These incentives help businesses address one or more needs, such as capital access, workforce preparation, technology transfer, site facility improvements, and so forth. Nationwide, non-tax incentives represent 56% of programs and tax incentives 44%. (See Figure 2-8.)

More than half of Maryland’s active incentive programs offer some kind of tax-related benefit. Approximately a third of the state’s programs provide direct business financing, while about 15 percent offer indirect business financing. Over the past several decades, Maryland has moved from a focus on direct business financing with grant and loan programs toward a greater emphasis on using tax incentives, especially tax credits, to promote economic development.

Incentive Program Goals Nationwide, many incentive programs seek to address the business need of capital access or formation, followed by tax burden reduction. As shown in Figure 2-9, over half of the currently active programs seek to fulfill these two needs. States also use incentives to help businesses train their workforce, locate and develop sites, build infrastructure necessary to their operations, research and develop new products and production processes, and improve their business management and marketing. The emphasis of Maryland’s current portfolio of incentives is on tax burden reduction and capital access or formation, with a smaller number of programs addressing business operations

Figure 2-8. State Business Incentives by Program Type, 2015


0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0%

Collateral SupportTax deduction

Tax deferralInsurance

Tax abatementPreferential rate

Tax refund or rebateLoan guarantee

OtherEquity investment

Loan/Loan ParticipationGrant

Tax exemptionTax credit

Programs Offering Benefit as Percentage of Total Programs

% of MD Program Total

% of US Program Total

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improvements. Compared to other states, Maryland’s program portfolio places a stronger emphasis on addressing tax burden reduction and technology and product development.

Recent Trends Following the “Great Recession” of 2007-2009, states enacted almost 100 new incentive programs in 2011. Many of the new programs were intended to address small business capital access issues, largely as a result of the inception of the U.S. Department of Treasury’s State Small Business Credit Initiative (SSBCI). Enacted as a response to the tightening of credit available to small businesses SSBCI program allocates federal funding to states (that will ultimately be converted to state funds) to support state-designed loan participation, collateral support, capital access, loan guarantee and venture capital programs. In addition, several states recently created new “jobs tax credits” tied to reducing taxes for employers that retained or created jobs. Other states initiated technology transfer, angel investor, microloan and venture capital programs, as well as efforts to better coordinate business technology transfer activities with state university resources. States also increasingly attempted to target their incentives to specific industry sectors that they were trying to develop or attract to the state. However, after the proliferation of new state business incentives in 2011, states dramatically curtailed their creation of new incentives over the next few years, creating a combined total of just 123 net new incentive programs over the following four years. Given tight operating budgets, states have begun stringently evaluating the effectiveness of their current incentive portfolios. It is therefore likely that in upcoming years, states will continue to scrutinize the value of their business incentive programs, especially those that cannot demonstrate an adequate return on investment, while also experimenting with new approaches for getting the most value from the entire business incentive portfolio.

Figure 2-9. Total Number of Programs by Business Need, 2015


0.0% 10.0% 20.0% 30.0% 40.0%

Professional networkingMarketing & sales assistanceInfrastructure Improvement

Business managementFacility/site location

OtherWorkforce prep or developmentProduct & process improvement

Tax/Regulatory burden reductionCapital access or formation

Tech & product development

Programs Meeting Each Business Need as Percentage of Total

% of MD Program Total

% of US Program Total

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Chapter 3: Place-based Tax Credit Programs This chapter assesses Maryland’s place-based tax credit programs: the Enterprise Zone (EZ) Tax Credit, the One Maryland Tax Credit, and the Regional Institution Strategic Enterprise (RISE) Enterprise Zone program. Each program is briefly reviewed below. The RISE program is new and has not yet begun operations, and the EZ and One Maryland credits have been the subject of extensive review in recent years. For this reason, our analysis does not provide an extensive assessment of past impacts. Instead it focuses on issues related to program design and operations. A review of other states’ place-based programs is included in Appendix 1.

Enterprise Zone Tax Credit

Program Background Maryland operates one of the US’s oldest state enterprise zone (EZ) programs; dating back to the inception of the state’s enterprise zone tax credit in 1982. At present, 28 designated zones exist in 13 counties and Baltimore City. The program is designed to “focus local and State resources on the encouragement of economic growth in economically distressed areas and employment of the chronically unemployed in the State.”8 Businesses located or moving into an enterprise zone are eligible for both property and income tax credits. The property tax credit, which may last for up to ten years, is applied to the tax imposed on 80% of the original assessment for the first five years. The credit then gradually decreases over the last five years. The income tax credit is a one-time credit for new hires, providing $1,000 for a regular employee, and $3,000 for an economically disadvantaged employee. The enterprise zone tax credit is administered at the local level by zone administrators, with oversight and regulatory review provided by Commerce and the Department of Labor, Licensing, and Regulation (DLLR). In addition, the state Comptroller’s office and the state Department of Assessments and Taxation (SDAT) also play a role in assessing the EZ program’s income tax and property tax credit provisions. The day-to-day administration of the program occurs at the local level, typically by city or county officials. Unlike many other Commerce programs, the EZ program operates as a collaboration between local jurisdictions and multiple state agencies.

Results/Impacts to Date The EZ tax credit program is one of Maryland’s most heavily utilized programs. In FY 2015, it was estimated that the program would provide $28.8 million in property tax credits.9 The program remains quite popular at the local level and is widely viewed as one of the most important incentives to stimulate new investment in distressed neighborhoods.

8 From the statute at http://www.dsd.state.md.us/comar/SubtitleSearch.aspx?search=24.05.01. 9 http://business.maryland.gov/Documents/ProgramReport/EnterpriseZonesAnnualReport2012.pdf

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While the EZ property tax credits are regularly used, few localities and employers have taken advantage of the EZ income tax credits. According to the recent Department of Legislative Services (DLS) program evaluation, income tax credits now account for only 4% of the total statewide EZ program costs. Over the last decade, total annual EZ income tax credits have ranged from $400,000 up to $1.6 million. Limited use of the EZ income tax credits appears to stem from several factors. First, some firms claim that the benefit is too small, particularly in cases where it applies to non-disadvantaged workers. Second, some observers contend that the certification process for economically disadvantaged workers is too complex and burdensome. In practice, the process is fairly straightforward, but Maryland still remains one of the few states that require such formal approvals of economically disadvantaged status. Maryland’s EZ income tax benefits are slightly smaller than those found in other states, but these differences are relatively small. Typical EZ income tax benefits in other states may reach as high as $3000-$4000 per employee. Maryland’s benefit in the case of an economically disadvantaged employee ($3,000) does fall within this range even if its general benefit ($1,000 per employee) falls below that level. Many observers contend that limited use of the income tax credit stems from the requirement that DLLR certify a new employee’s disadvantaged status. While the certification process is straightforward, this step requires some paperwork from the employer and the affected employee, who receives no direct personal benefit from this credit. Maryland does not have a regular schedule in place for reviewing or updating zone designations to ensure that the program is being utilized and that the designated zones do meet established criteria for economic distress. This type of updating is not permitted under current statutes. However, Maryland’s EZ programs have been subject to a number of evaluations, most recently as part of the work of the Legislature’s Tax Credit Evaluation Committee.10 This widely publicized assessment included a number of criticisms of the program’s administration and data collection processes and also claimed that EZ credits were not having sufficient impact on the hiring of economically disadvantaged workers based in distressed neighborhoods. In response, Commerce has expressed an interest in considering changes to the current program, some of which will be discussed below.

Lessons from Other States There is an extensive and diverse research literature assessing the efficacy of enterprise zone programs.11 These studies present mixed results that can be difficult to summarize in a simple

10 Maryland Department of Legislative Services Office of Policy Analysis, Evaluation of the Enterprise Zone Tax Credit, November 2013. Hereafter referred to as 2013 DLS EZ Evaluation. 11 See, for example, David Neumark and Helen Simpson. 2014. “Place-Based Policies,” NBER Working Paper No. 20049; Andrew Sisson with Chris Brown, “Do Enterprise Zones Work? An Ideoplis Working Paper, February 2011; see Ian Pulsipher, “Evaluating Enterprise Zones,” National Conference on State Legislatures Issue Brief, February 2008; Alan H. Peters and Peter S. Fisher, State Enterprise Zone Programs: Have They Worked? (Kalamazoo, MI: W.E. Upjohn Institute for Employment Research, 2002).

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manner, but we can offer some general conclusions. The research literature finds that, in the right conditions, enterprise zone programs can and do help stimulate investment and create new jobs in distressed communities. However, their ability to offer new employment opportunities to the most disadvantaged residents of these communities has proved more limited. Beyond this general finding, the literature also offers several guidelines on program management and design. They include the following:

1. Enterprise zone impacts have been less significant in areas facing the highest levels of economic distress, and have proved more effective in areas facing fewer structural challenges.12 It is likely that, in many cases, zone incentives are insufficient to compensate for other structural and economic barriers facing high poverty communities.

2. Effective incentives must be sufficiently large to overcome the zone’s structural disadvantages and be closely aligned with program goals. For example, the use of property tax incentives, as in Maryland, may actually stimulate greater capital investments as opposed to investments in labor that create new jobs. Incentives directly tied to new hiring, such as job training subsidies, may prove more effective in spurring new job creation.

3. Enterprise zones cannot succeed in a vacuum. Thus, it is important to link zone benefits to other policy tools, such as job training subsidies and credits.

When compared to other states, Maryland’s enterprise zone tax credits have a few unique features. First, Maryland jurisdictions use the property tax credit at a much higher rate than in other states where tax credits are directly tied to new job creation. A 2004 Florida study of state zone programs found that 67% of states used employer income tax credits, and 61% used a job creation or wage credit. Meanwhile, 46% of states tied property tax reductions to their zone programs.13 Second, Maryland’s threshold for receiving benefits—the creation of one full time job in the zone--is fairly low. Not all zones use this threshold. Baltimore City, the state’s largest zone, does not utilize job creation or capital investment requirements, and many other large zones follow this pattern. A number of other EZs in Maryland do have minimum performance requirements. Many other states use higher thresholds before zone benefits commence. This may include a higher number of new jobs or higher levels of new investment. Maryland does not set statewide thresholds to receive benefits. Instead, it relies on local jurisdictions to develop these standards.

12 Don Hirasuna and Joel Michael, “Enterprise Zones: A Review of the Economic Theory and Empirical Evidence,” Minnesota House of Representatives Research Department Policy Brief, January 2005. 13 Florida Legislature, Office of Program Policy Analysis and Government Accountability, “Florida’s Enterprise Zone Program is Similar to those of Other States,” OPPAGA Information Brief (No. 04-24), March 2004.

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Most jurisdictions have developed standards that focus on the number of new jobs, job quality, or other factors. As noted above, several of the largest EZ programs, such as the City of Baltimore and Prince George’s County, have not developed their own performance thresholds. Maryland is also one of the few states that require certification of an individual worker’s disadvantaged status in order to receive income tax benefits. Nearly every other state simply certifies a geographical location or includes criteria to assess the quality of newly created jobs. Third, unlike Maryland, many states limit zone benefits to certain industries, such as manufacturing, or provide special or expanded benefits in targeted sectors. The Maryland EZ benefit is available to all firms, regardless of industry or business activity. Fourth, Maryland does not link EZ benefits to other programs. Many other states opt to link EZ credits to other forms of assistance. In particular, linkages to workforce training or other business development assistance are common. In addition, the provision of direct employment services, via projects like Jobs-Plus, also appear to be helpful in moving disadvantaged residents into full-time employment.14 Finally, Maryland’s EZ income tax benefits, which can range from $1000 to $3000 for economically disadvantaged workers, are fairly small when compared to many other states. In Louisiana, the state provides a one-time $2500 tax credit along with a 4% rebate on sales and use taxes, among other benefits. Virginia provides job grants (of up to $4000), and in New Jersey, firms receive a mix of sales tax exemptions, along with benefits tied to property taxes, new capital investment, and unemployment insurance payments.

Findings To summarize, we have seven findings related to the EZ tax credit.

1. Maryland’s EZ tax credit program is one of the few incentives available to Maryland’s local governments, and remains a very popular tool for stimulating new real estate development within designated zones.

2. There is a significant installed base of projects that relied on or continue to rely on the EZ incentives.

3. There is no regular schedule in place for reviewing or updating zone designations to ensure that the program is being utilized and that the designated zones do meet established criteria for economic distress. This type of updating is not permitted under current statutes.

4. Maryland is among a small number of US states that does not impose an overall cap on the statewide or even local use of enterprise zone credits. Nearly every other state invokes an annual cap on total credits along with caps on the value of credits that can be

14 For a discussion, see David Neumark and Helen Simpson. 2014. “Place-Based Policies,” NBER Working Paper No. 20049, pp. 45-46.

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used for a single project or company. Examples of overall statewide program caps include Connecticut ($25 million) and Pennsylvania’s Keystone Innovation Zone credits.

5. While the EZ property tax credits are regularly used, few localities and employers have taken advantage of the EZ income tax credits.

6. At present, there are no state-level rules that establish minimum job creation or capital investment standards or which require that incentivized projects focus on a target industry or have linkages to a wider economic development strategy.

7. There are few linkages between EZ incentives and other state incentive, business, and workforce development programs. In contrast, this is common practice in neighboring states, such New Jersey and Pennsylvania, where supported projects may also have expedited access, or other preferential treatment, to additional state and local supports.

Potential Next Steps: Policy Options In an effort to modernize its enterprise zone tax credit and to improve its effectiveness, Maryland could consider the following potential revisions to its enterprise zone tax credit programs.

• Re-designate existing enterprise zones Many critics of Maryland’s EZ tax credit program have focused their concerns on recent expansions of local enterprise zones, arguing that limits should be placed on zone expansions or new zone designations. Many states in the midst of similar reassessments of their zone programs, and a few, such as California and Kentucky, have opted to eliminate their zone programs. Elimination of the EZ program may generate concerns among local leaders that view it as one of the few incentives available to Maryland’s local governments. Furthermore, this move would generate great uncertainty and instability around projects that were or are relying upon the EZ incentives. It would also eliminate a major tool that has proved effective in terms of stimulating new real estate development within designated zones. Should state leaders decide to retain the enterprise zone program, then efforts will be needed to improve their design and impact. An interim step would involve development of a regular schedule for reviewing and updating zone designations to ensure that the program is being utilized and that the designated zones do meet established criteria for economic distress. Additional provisions to “sunset” underused zones might also be appropriate. This tightening of zone definitions could help improve program targeting and focus resources on zones facing the highest levels of economic distress. While this change might serve to rationalize current zone designations, it would also bring additional instability and uncertainty to the program.

• Institute program spending caps Maryland might consider imposing an overall cap on EZ benefits as a means to better manage the fiscal impact of this program. This move could also help address growing concerns of program critics who bemoan recent increases in the value of state enterprise zone property tax reimbursements. This shift would instill greater fiscal discipline to the program, but it could also

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place tight limits on program use, particularly in Baltimore City, which has seen the largest increase in the use of these credits.

• Redesign the income tax credits Maryland might stimulate greater use of the income tax credit if it eliminated the need for third-party certifications and instead asked employers and zone administrators to certify a new employee’s economic status. A number of alternative criteria could be employed including household income, previous employment experience (or lack thereof), or simply the residence location of the new employee.

• Revise program criteria In addition to reconsidering zone designations, Commerce could also consider other criteria related to how communities and projects quality for EZ credits. Creation of new state guidelines in this area might improve program operations in some communities that have not opted to develop their own local performance standards.15 Most localities have created these local zone standards, but several of the larger EZ credit users, such as the City of Baltimore and Prince George’s County, do not use their own local standards.

• Link to other programs A final consideration involves linking EZ incentives to other state incentive, business, and workforce development programs. This is common practice in neighboring states, such New Jersey and Pennsylvania, where supported projects may also have expedited access, or other preferential treatment, to additional state and local supports. Given the importance and challenges around job creation for disadvantaged workers, Commerce might consider developing expanded partnerships that provide job training and other workforce services to EZ residents and companies.

One Maryland Tax Credit

Program Background The One Maryland Tax Credit program, created in 1999, serves as one of the state’s primary incentives for supporting development in distressed communities. Businesses that invest in a “qualified distressed county” and create at least 25 full-time jobs may be eligible for up to $5.5 million in state income tax credits. In addition to income tax credits, firms may also use credits to help cover expenses related to start-up costs such as land acquisition, construction or equipment purchases. Credits can be carried forward for up to 14 years and are refundable. The tax credit is currently available for use in six counties and Baltimore City. It is, as noted in a recent program audit, “a high value, low utilization” credit.16 One Maryland credits can provide a sizable benefit for firms, but the benefits are typically focused for use in high-value and high-visibility projects. Economic development officials operating in rural counties have noted that the current One Maryland incentive threshold—the creation of at least 25 new jobs---has limited the applicability of this benefit for many new projects in their service areas.

15 For a review of current local standards, see DLR EZ report, pp. 85-87. 16 Maryland Department of Legislative Services Office of Policy Analysis, Evaluation of the One Maryland Economic Development Tax Credit, October 2013. Hereafter referred to as 2013 DLS One MD Report, p. 5.

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The One Maryland Tax Credit program is considered by many observers to be a very “high impact” incentive. Commerce and local economic development officials point to the One Maryland credit as one of their most important and most frequently used incentive tools.

Results/Impacts to Date In FY2014, Commerce authorized four companies as eligible for One Maryland credits. Together, these four firms created 168 new jobs with a payroll of $12.2 million.17 Since its inception in 2001, the One Maryland program has typically certified around five projects per year, with tax credits valued at an annual average of $15-18 million. To date, Commerce has certified nearly $200 million in One Maryland tax credits related to a total of 54 projects.18 However, only one-third of these credits have been claimed. While these credits may still be claimed in the future, the full extent of the potential unclaimed tax credit pipeline remains uncertain. Because current law prohibits Commerce from accessing taxpayer data, the Department cannot assess the full fiscal impact of these credits. Concern over these uncertain fiscal projections was the primary focus of the 2013 program evaluation sponsored by the Tax Credit Evaluation Committee.19 That review also recommended that Maryland simplify and make the One Maryland credit easier to administer. Finally, the report recommended annual caps for the credit and better targeting to focus on larger impact economic development projects.

Lessons from Other States This section examines the experience of other states in three areas of particular importance to the use and impact of the One Maryland Credit:

• Targeting Economic Distress • Administering Incentives and Credits • Managing Fiscal Impact

Targeting Economic Distress The use of special incentives for distressed regions, like those offered through the One Maryland tax credit, is fairly typical of incentive programs in other states and most states use distress measures (e.g. higher than average poverty or unemployment or lower per capita incomes) similar to those deployed in Maryland. States support new investment in distressed regions via multiple approaches. Some states opt for a system of “tiering” regions or counties in which a ranking or scoring system is used to provide an objective assessment of current or chronic levels of economic distress. Georgia uses this approach and ranks counties on annually based on their economic performance.20 The

17 MD Jobs Development Act Report, FY 2014, p. 11 18 DLS One MD Report, October 2013. P. 13 19 Ibid. 20 For the latest rankings, see http://www.dca.state.ga.us/economic/taxcredits/programs/documents/Current_JTC_Rankings.pdf

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Georgia Jobs Tax Credit and other states are either more generous or performance thresholds are lower in areas with higher levels of economic distress. Arkansas, Mississippi and South Carolina also target incentives based on a region’s economic distress levels. For the past two decades, North Carolina has used a tier approach to assign counties to one of three levels, with Tier 1 counties showing the highest levels of distress.21 A county’s tier level is used to determine eligibility for various state programs (including some not directly related to economic development) and to provide the most disadvantaged counties with access to certain incentives. In a report released in December 2015, a Joint Legislative Committee report to the North Carolina legislature recommended doing away with the state’s current tier system formula because it distorted economic distress rankings, especially because all low-population counties were included in the most-distressed categories and because distressed sub-county areas in more prosperous counties were not eligible for higher levels of assistance. 22 Other states opt to rank projects—and incentive packages—based on the nature of the project and its benefits. Nebraska may have the most advanced system in place.23 The Nebraska Advantage Act uses six different tiers that link incentives to differing levels of performance and local impact. Finally, many other states use enterprise zone designations as their primary means to target distressed communities. In some states, such as Utah, these zones are the primary vehicle for addressing high poverty communities. Many others, like Maryland and Georgia, operate both enterprise zone programs and other incentives targeted to distressed areas. While the One Maryland credit was not exclusively designed to focus on rural areas, many of the One Maryland zones are located in less densely populated parts of the state. A number of other states use place-based tax credits targeted to rural areas. These include: Colorado, Florida, Kansas, Mississippi, New Mexico, Tennessee, Utah and Washington. Some states, such as Utah, have opted to focus their enterprise zone programs on rural areas. In others, rural regions have lowered eligibility standards to qualify for credits. For example, Nebraska requires lower job creation thresholds for projects located in rural areas and Tennessee provides an enhanced tax credit for qualified projects in rural areas.

Administering Incentives and Credits The recent DLS review of One Maryland raised many concerns about the complexity of the program, arguing that the credit is “complex to claim and difficult to administer.”24 These complexities stem from two aspects of the credit: (1) the bifurcation of the credit between

21 https://www.nccommerce.com/research-publications/incentive-reports/county-tier-designations. The number of tiers used in North Carolina has changed from an initial five to the current three tiers as a way to simplify its use across a variety of programs. 22 North Carolina Joint Legislative Program Evaluation Oversight Committee “North Carolina Should Discontinue the Economic Development Tiers System and Reexamine Strategies to Assist Communities with Chronic Economic Distress.” Report Number 2015-11, December 14, 2015. 23 http://neded.org/business/tax-incentives 24 DLS Report, p. 47.

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https://www.nccommerce.com/research-publications/incentive-reports/county-tier-designations


support for project costs and start-up costs, and (2) the linkage of the credit to the project’s—as opposed to the business’—income tax liability. This project tax credit can create great complexity for employers who must do separate calculations to determine a project’s income tax liability.

Managing Fiscal Impact Assessing the future fiscal impact of the One Maryland credit has proved quite challenging. Commerce certifies businesses and projects for the One Maryland tax credit, but final approval and issuance of the credit is managed by the state Comptroller’s Office. Because of confidentiality rules and other factors, state officials have an incomplete projection of the future fiscal impact of unclaimed tax credits. Numerous states have developed procedures to allow the sharing of information between economic development agencies and tax/budget review offices. This issue was a primary focus of the Pew Trusts/CREC Business Incentives Initiative that included a team from Maryland. Indiana, Oklahoma, and Tennessee have all developed processes and procedures that allow for the tracking of tax credit information without compromising the confidentiality of tax and business records.

Findings Our review of One Maryland finds:

1. The use of special incentives or tax credits to support economically distressed regions makes sense and is common practice across the U.S. Similar programs should continue in Maryland. Maryland’s current definitions of what constitutes a distressed region make sense, and its incentive programs do target key areas of interest to employers. However, the large number of programs serving similar purposes and similar communities creates some confusion and some potential for overlap and duplication.

2. As currently configured, the One Maryland tax credit is overly complex, particularly with its focus on the distinction between start-up and project costs, and the linkage of the credit to the project’s tax liability.

3. State officials, especially those in Commerce, need better access to information on how One Maryland credits are eventually utilized. This requires close collaboration with the Comptroller’s office to develop procedures for sharing information in a safe and confidential manner.

Potential Next Steps: Policy Options As Commerce reviews the One Maryland program and other tax credits, it should consider the following potential reform options.

• Review Programs Targeting Economic Distress

As we will discuss below, Commerce might consider undertaking a deeper review of these programs with an eye toward potential streamlining and consolidation.

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• Simplify the One Maryland Tax Credit

Commerce staff should work with the Legislature to streamline the current One Maryland credit by merging the project and start-up costs parts of the credit and by directly linking the credit to the business’ tax liability. The credit should remain tied to payroll withholding of new positions that are created as part of the incentivized project.

• Enhance Capacities to Assess Fiscal Impacts

Commerce staff members have begun outreach to staff within the Comptroller’s office, and these discussions should be expedited.

Regional Institution Strategic Enterprise (RISE) Zone Tax Credit Program

Program Background The Regional Institution Strategic Enterprise (RISE) Zone Tax Credit program is a new initiative approved by the Maryland Legislature in 2015. The program seeks to help communities gain access to resources and assets from neighboring higher education institutions and other federally backed research centers. It is part of a wider national movement to support innovation districts, areas of clustered innovation and entrepreneurship assets that are viewed as key drivers of new business starts and innovative activities. RISE Zones must be located near “qualified institutions,” such as university campuses, that intend to make significant new investments to support economic development. Working with qualified institutions, local governments can designate RISE Zones where new and growing businesses will be eligible for real property tax credits and income tax credits related to capital investment and job creation. These benefits are similar to those provided in other state place-based tax credit programs.

Results/Impacts to Date Because the program is new, no investments have been made to date. Commerce staff is now reviewing initial applications by potential “qualified institutions.” After this review is completed, the process of applying for potential RISE Zone status will commence.

Lessons from Other States Most states make significant investments, via direct funds and tax credits, to support the development of local innovation clusters. However, very few states have place-based tax credit programs solely devoted to support the creation or growth of innovation districts. Both Washington and Pennsylvania operate state-backed innovation zones. Washington’s Innovation Partnership Zone program does not include tax credits or extensive financial support. Instead, designated zones (normally focused on a leading cluster) receive specialized technical assistance and marketing support. Pennsylvania’s Keystone Innovation Zones (KIZ) program does provide tax credits for growing businesses that operate within a KIZ. The program is

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subject to a statewide cap of $25 million. In 2014, the program provided more than $17 million in tax credits to 227 companies.25 New Jersey has designated three Edison Innovation Zones (in Camden, Newark, and New Brunswick) that are located near university campus centers.26 Technology and life sciences firms operating in these zones have access to a number of state support programs. Edison Zone incentives include the capacity to sell net operating losses and expanded access to other state incentives. The Start-Up New York program may be the closest analog to RISE. Begun in 2014 to great fanfare, Start-Up New York provides generous tax incentives to firms that start and grow in zones located near college and university campuses across New York. At present, 95% of the state’s colleges and universities are participating in the program.27 In its first year of operations, the program approved support for 54 companies. To date, these firms have created only 76 jobs, but they have projected to create more than 2,000 new jobs over the next five years. Start-up New York provides significantly more generous incentives than found in the RISE Zone program. In fact, many firms may qualify to operate tax free for up to ten years thanks to exemptions from state income tax, property tax, and sales taxes.

Findings Because the RISE program is in the inception stages, it is too soon to assess its impacts and effectiveness. Some observers have questioned whether a specialized innovation zone credit is needed, or could instead be accommodated via other existing programs. While we cannot present a final assessment on this question, it would indeed be possible to develop special criteria within other place-based incentive programs that could accommodate the special issues and concerns raised via the RISE proposal. Indeed, this has been the practice in most other states where university innovation districts are supported through general incentive programs or via special technology, innovation or entrepreneurship strategies.

Cross-Cutting Issues and Conclusions A review of Maryland’s place-based tax credit programs yields some important general conclusions. The programs are typically well managed and address issues of concern to new or growing employers. The credits have been used in an effective manner, and, in most cases, their impacts are tracked and shared with policy makers and concerned citizens. In fact, Maryland is a national leader in its efforts to evaluate and track the impacts of its tax credit and other economic development programs. While these programs are well managed, they all operate in a somewhat confusing mix of programs and initiatives. Within these three place-based programs, there is some overlap in the types of benefits provided and in the geographic locations being served. Moreover, many

25http://community.newpa.com/download/programs_and_funding/keystone_innovation_zone/kiz_tax_credit_annual_reports/KIZ-Tax-Credit-Annual-Report-2014.pdf 26 http://www.state.nj.us/scitech/university/izones/ 27 http://esd.ny.gov/Reports/2014_STARTUPNY_REPORT.pdf

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businesses tap into multiple programs and receive benefits from several different initiatives. By itself, the use of multiple programs is not necessarily a problem area—especially when employers tap into complementary programs such as job training assistance and tax credits that support the hiring of disadvantaged workers. But, if programs are serving the same (or similar) purposes, there may be a heightened potential for duplication. In an effort to streamline program management and improve program operations, Commerce should consider an extended review of these programs with a focus on potential benefits of tax credit consolidation. In particular, Commerce might consider development of a tiering or ranking system that categorizes localities based on levels of economic distress or other factors, such as urban vs. rural locations. This geographical ranking system could be combined with other factors such as targeted industries, the size of projects, specialized issues or impacts, etc.. Incentive offerings and other program supports could then be linked to each tier in the system. This new consolidated system could likely accommodate many, if not all, of the current definitions used to identify enterprise zones, One Maryland zones, and RISE zones.

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Chapter 4: Investment Tax Credit Programs

Biotechnology Investment Incentive Tax Credit (BIITC) The Maryland Biotechnology Investment Incentive Tax Credit (BIITC) (Code of Maryland, Article: Tax – General, § 10-725) was enacted in 1995, became effective in 1999, and was substantially revised in 2010. In the statute, biotechnology is defined as “research, development or commercialization of innovative and proprietary technology that comprises, interacts with or analyzes biological material including bimolecular DNA, RNA, or protein), cells, tissues, or organs.” A Qualified Maryland Biotechnology Company (QMBC) is a for-profit biotechnology company headquartered in Maryland that is not a sole proprietorship. The company must have less than 50 employees, be in business less than 10 years (except longer in some cases), privately held, and in good standing in the state. Qualified investors, individuals or entities that make an investment of cash or equivalents in exchange for stock, a partnership or membership interest or equity in a QMBC may receive a tax credit against their income tax in the year that the investment is made, equal to 50 percent of their investment, which must be greater than $25,000. The maximum credit is $250,000 per year per investor. The credit is refundable if the qualified investor does not have a tax liability in Maryland or if the credit is greater than the liability. The maximum credit associated with any single company is limited to 15 percent of the total appropriation in that year. There is a recapture provision if the investor sells or disposes of his/her shares or if the company cease operations. If these events occur in the same year as the investment, the credit must be repaid 100 percent. In the first year following the investment, the repayment is 67% of the credit, and 33 percent the second year. The statute itself does not describe the rationale for the credit. However, the BioMaryland 2020 strategic plan, prepared by the Maryland Life Sciences Advisory Board makes the case that the state has had a long-standing focus on the life sciences and biosciences. This is true because of Maryland’s assets in the sector, including the NIH and USDA, and the research assets at Johns Hopkins and other campuses. The life sciences in general are characterized by rapid growth and higher-than-average wages, and therefore would appear to be a targeted sector for Maryland. The generous size of the tax credit is associated with the high risk associated with biotechnology, arising from the uncertainties in the science itself, and the lengthy discovery and regulatory processes. According to PhRMA, the Pharmaceutical Research and Manufacturers of America, “On average, it takes at least ten years for a new medicine to complete the journey from initial discovery to the marketplace, with clinical trials alone taking six to seven years on

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average. The average cost to research and develop each successful drug is estimated to be $2.6 billion.”28

History of the BIITC in Maryland Since 2006, the BIITC has benefited 81 Qualified Maryland Biotechnology Companies (QMBC)s for a total tax credit amount of $66 million, with an additional $72 million invested. Figure 4-1 shows the experience of the program since 2006.

The geographic distribution of the QMBCs is statistically the same as the distribution of life sciences companies in Maryland, as shown in Figure 4-2. Of the QMBCs that received the investments enabled by the tax credit, there are several that received the benefit in more than one year. The number of companies and the number of years they received the benefit is shown in Figure 4-3. The average number of years that a company participated in the program is 1.85.

28 http://www.phrma.org/sites/default/files/pdf/rd_brochure_022307.pdf

Figure 4-1. BIITC History 2006-2014 2006 2007 2008 2009 2010 2011 2012 2013 2014

Appropriation ($000s)

$6,000 $6,000 $6,000 $6,000 $6,000 $8,000 $8,000 $10,000 $10,000

Applications 221 235 170 160 250 300 178 plus 17 from

prior year

242 plus 1 from prior year

220 plus 21 from wait list

Initial Tax Credit Certificates

181 203 140 131 193 194 183 182 186

Percent in MD 81.8% 64.5% 50% 51.9% 46.6% 38.7% 43.7% 52.2% 44.1% Initial Tax Credits Awarded ($000s)

$6,812 $7,735.6 $7,092.8 $7,631 $11,348.5 $11,570 $11,743 $13,336 $18,208

Rescissions ($000s)

$772.5 $1,200 $552.1 $1,850 $2,511.3 $2,689.3 $2,160 $3,477 $2,922

Reduced Amounts

($000s)

$87.5 $290.5 $263.5 $231.9 $1,067.3 $7,418.7 $1,150 $798.6 $1,584.9

Pending on Dec 31

0 0 0 $1,384 $1,520.1 $356.8 $1,035 $137.5 $3,029.8

Final Tax Credit Certificates

($000s) on Dec 31

$5,952 $6,245.2 $6,277.1 $4,665.3 $6,249.7 $7,775 $7,397 $8,923 $9,671

QMBCs that received Capital

as of Dec 31

20 21 18 13 19 18 22 23 25

Source: Maryland Department of Commerce

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The investors that received benefits are both in-state and out of state. In the last four years (2012-November 2015), a total of 651 investors have received credits. Two hundred and seventy-five (42%) were from Maryland, 365 from out of state (56%) and 11 (2%) were international investors.29

29 Innovation Policyworks analysis of data provided by the Department of Commerce.

Figure 4-2. Geographic Distribution of QMBCs and Life Sciences Companies by Maryland region, 2007-2013

Source: Source: Maryland Department of Commerce, annual BIITC reports, and LifeSciences Maryland, Jobs Analysis and Economic Impact Report 2011.

0%

10%

20%

30%

40%

50%

60%

70%

21 36 1 4

Baltimore region Capital Region Eastern Shore All OtherQMBCs Life Sciences Firms

Figure 4-3. Companies Receiving Multiple Years of Benefits from BIITC

Source: Innovation Policyworks analysis of Commerce data.

0

2

4

6

8

10

12

14

16

2 3 4 5 6 7 8 9

Number of QMBCs

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The amounts raised using the BIITC have also varied. Figure 4-4 shows the distribution of QMBCs by amount of tax credits issued to investors. This chart shows that 50 percent of the QMBCs have raised less than $500,000 that is eligible for the tax credit, but 20 percent of the QMBCs have raised in excess of $1 million.

One of the companies that have received BIITC for 8 of the program’s 9 years, Sequella, Inc., of Rockville, MD, is currently a clinical stage company that is developing a number of anti-infectives, including one for tuberculosis. This company has consistently raised monies since the mid-2000s, and is continuing to raise funds characterized on their website as “mezzanine.” They are clearly a later stage company, whose most recent raise of over $367 million puts their valuation over $10 billion. Another long-time user of the BIITC, 20/20 Gene Systems, also of Rockville, MD, is engaged in proteomics, developing and commercializing innovative and proprietary diagnostic tests, including for lung cancer and the detection of biological toxins. This latter capability is currently being commercialized. BioMarker Strategies, another Rockville, MD company, also has used the program 8 of 9 years. This company has developed the proprietary SnapPath® Cancer Diagnostics System for predictive tests to guide targeted drug development and treatment selection for patients with

Figure 4-4. Distribution of QMBCs by Amount of Tax Credits Issued to Investors, FY2007-2013


0

2

4

6

8

10

12

14Number of QMBCs

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solid tumor malignancies. The number of new companies participating in the program each year appears to be related to the amount of funds available, with a surge after each increase in the appropriation (see Figure 4-5).

There appear to be some actions on the part of potential QMBCs and investors brought about by the scarcity of these credits. QMBCs and their investors file their applications as close to the annual due date as possible: 92 out of 249 applications filed in 2014, for instance, applied within thirty days of June 1, 2014, and all but seven were filed in the first six months. In addition, QMBCs and their potential investors request tax credit amounts that exceed what was actually invested, in order to hedge their bets. Of the investments that actually received credits, the amounts invested were $2.6 million (ten percent) lower than originally projected. Overall, requests that were rescinded, rejected or incomplete, constituted 45 percent of the total investments proposed. Figure 4-6 summarizes the results of an annual survey of the QMBCs that receive the benefit of the BIITC. Not all QMBCs reported, and not all answered all the questions, but these data do show that the expectation that the QMBCs would pay higher wages has been met, and that these companies continue to add new employees, add new equipment, and attract additional capital and grants, as you would expect from growing firms.

Figure 4-5. Number of New QMBCs and BIITC Appropriation Levels, 2006-2014


0

2

4

6

8

10

12

14

16

18

2006 2007 2008 2009 2010 2011 2012 2013 2014

Number of New QMBCs Appropriation $ millions

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Biotechnology Trends in Maryland How has Maryland biotechnology employment changed since the BIITC was enacted? How does this compare with what’s going on in neighboring states? Battelle’s 2012 look at the biosciences nationally30 shows that Maryland’s bioscience sector is “sizeable and highly concentrated” with employment at 33,257 in 2010 and a location quotient (LQ)31 of 1.2, up 8.3 percent since 2001, but down 1.2 percent since 2007. Maryland’s LQ for biosciences overall was 1.07 in 2006, with 1,028 establishments and 25,453 employees.32 The strongest life sciences sub-sector in Maryland is Research, Testing and Medical Laboratories, with a LQ of 2.2, and 964 establishments employing 18,336. This compares favorably with neighboring states with strong biotechnology sectors. The Battelle 2012 data are shown in Figure 4-7. Note that during the same time period, 2001-2010, national biosciences employment grew at 6.4%, lower than Maryland’s growth of 8.3%. According to BioMaryland,33 one-third of all job growth in Maryland since 2002 has been in life sciences, roughly one-half of that has been in biopharmaceuticals and one-half in research tools, medical diagnostics and medical devices. In 2010, the average life sciences salary in Maryland was $91,100, well above Maryland’s average wage of $41,611. Biotechnology’s impact on Maryland’s economy is significant, at 6 percent of GDP.

30 Battelle/BIO. 2012. State Bioscience Industry Development. https://www.bio.org/sites/default/files/v3battelle-bio_2012_industry_development.pdf 31 A location quotient is a measure of the intensity of a particular sector in a place. A LQ of 1 means that the sector is equally represented in the place, compared to the US average. A LQ over 1 means that the sector is more prevalent in a place than in the US overall. 32 Battelle Technology Partnership Practice. 2009. “Maryland Life Sciences Strategic Plan: The Current Competitive Position.” http://marylandbiocenter.org/Bioscience%20of%20Maryland/Documents/BioMaryland%202020%20-%20Current%20Competitive%20Position%20(Battelle).pdf 33 http://www.bio.maryland.gov/Facts_and_Maps/Pages/general-profile.aspx

Figure 4-6. Annual Survey of QMBCs 2009 2010 2011 2012 2013 2014

Number of QMBCs that responded 20 13 14 15 22 23 Average salary $76,785 $86,057 $88,273 $88,000 $84,800 $94,683

Employees in Maryland 224 109 134 142 185 162 New MD employees 66 17 21 33 26 25.5

New employees per QMBC reporting 3.3 1.7 1.5 4.1 2.6 2.1 New equipment purchased ($000s) $865 $158 $594 $297 $338.4 $530.9

Additional venture capital leveraged ($000s)

$10,900 $14,500 n/a $20,500 $3,000 $5,750

Additional non venture capital raised ($000s)

$18,150 $1,900 $3,200 $6,540 $6,760 $12,670

New grants awarded ($000s) $36,100 $65,000 $34,000 $57,000 $94,500 $59,000

Source: Commerce Annual Reports

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Cybersecurity Investment Incentive Tax Credit (CIITC) The Cybersecurity Investment Incentive Tax Credit (CIITC) (Code of Maryland, Article: Tax – General, § 10-733) became effective January 1, 2014 and will be in effect until June 30, 2019. A cybersecurity company is defined as a for-profit entity, except for a sole proprietorship, that is in the business of developing “innovative proprietary cybersecurity products or goods intended to detect or prevent activity intended to results in unauthorized access to, exfiltration of, manipulation or impairment to the integrity, confidence or availability of an information system or data.” Like the BIITC, a qualifying investor must make an investment greater than $25,000 for stock or equity, and own less than 25 percent of the company. The credit is for 33 percent of the investment, not to exceed $250,000. No single company may get more than 15 percent of the total appropriation, which was $2 million the first year, and has been expanded to $3 million in FY14 and $4 million in FY15. Unlike the BIITC and all other angel tax credits, the CIITC accrues to the company, not to the investor. The Qualified Maryland Cybersecurity Company (QMCC) must be headquartered and operate in Maryland, in business for less than five years, have aggregate capitalization of at least $100,000, own or license proprietary technology, have less than 50 employees, be privately owned, and in good standing with the state of Maryland, including being current on all taxes and not in default. In January 2015, the Department of Commerce issued its first (and only to date) report on the cybersecurity credit. Despite high expectations, only 25 applications were received for the credit in its first year. Twenty initial tax certificates were issued, four were rescinded, three rejected and two were pending at the time of the report. Of the $1,525,725 initial credits issued, $466,500 was rescinded, and $34,650 less was invested than originally planned for a total of $1,024,575 final credits issued. This amount is roughly one-half of the total available. Only three companies received credits: Riskive, dba Zero Fox, Luminal, a company that moved to Frederick from WV, and Integrata.

Figure 4-7. Biosciences Employment Trends in Selected States

State Employment, 2010 Location Quotient, 2010

Change in Employment, 2001-2010

Change in Employment, 2007-2010

Maryland 33,257 1.2 8.3 percent -1.2 percent New Jersey 91,167 1.94 -7.5 percent -7.8 percent

North Carolina 62,386 1.34 23.5 percent 1.0 percent Pennsylvania 81,796 1.15 -4.9 percent -6.9 percent

Virginia 26,127 0.61 11.4 percent 2.6 percent Source: Battelle/BIO. 2012. State Bioscience Industry Development. https://www.bio.org/sites/default/files/v3battelle-bio_2012_industry_development.pdf

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To put this in perspective, in 2014 the Maryland Department of Commerce conducted a survey of the cyber industry in the state. The study found that 12.8 percent of all information technology companies in the state were active in cybersecurity, an estimated 1224 establishments employing 10,051 workers. Ninety-two percent were headquartered in Maryland, and 50 percent had less than 10 employees. However, 84 percent of the cyber companies had been in business more than five years, and only 15 percent hold patents. This suggests that the total universe of companies in Maryland that could possibly qualify for the credits is only 25 companies.34 The rationale for an angel investment tax credit aimed at cybersecurity companies is that Maryland sees itself at the “epicenter” of cybersecurity because of the location of so many key federal agencies and military installations in the state that are concerned with data and information security, including NSA, NIST, DISA and IARPA. In addition, strengths in cyber research exist at Johns Hopkins University, University of Maryland Baltimore County and College Park, and Morgan State University. Finally, there is a significant concentration of information technology jobs in the state.35 There is no question that cybersecurity is hugely important. The World Economic Forum said, “If cyber resilience is a potential risk to growth and competitiveness, it is also an enabler. Countries and companies that invest in and develop cyber capabilities to instill trust in customers, citizens and investors will have a competitive edge in this digital era.”36 The Forum goes on to state that the market opportunity is to embed security into the lifecycle of products and communications. Applications include secure communications, using big data to identify “insider” risks, a “genetic” approach to malware, software-defined firewalls, security as a service, network instrumentation, and embedded SCADA (supervisory control and data acquisition). CB Insights, looking at recent venture capital data, says that cybersecurity is “red hot.” Investors have put $4.6 billion into cybersecurity startups in the last two years. In 2Q15, 47 cybersecurity deals yielded $704 million in investment. The investors read like the Who’s Who of venture capital, including Intel, Kleiner Perkins, Andreessen Horowitz, Accel Partners, Bessemer, Google, NEA and Sequoia. Specific data for cybersecurity investments in Maryland companies are not available.

34 Calculated as 1,224 establishments times 16% (in business less than five years) = 195 establishments. Ninety-one percent have less than fifty employees = 178 companies. Ninety-two percent are based in Maryland: 178 times 0.92 = 164. Of these, only 15 percent own patents: 164 times 0.15 = 25. 35 Maryland Department of Business and Economic Development. 2014. “CyberMaryland: Epicenter of Information Security and Innovation.” http://business.maryland.gov/Documents/ResearchDocument/CybermarylandReport.pdf 36 World Economic Forum. January 2014. “Risk and responsibility in a hyper-connected world,” in collaboration with McKinsey.

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State Experiences with Angel Tax Credits The BIITC and CIITC are forms of angel investor tax credits, focused on single sectors. Therefore, in order to assess these credits, we have looked at the use of all angel tax credits, whether for a single sector or more general.

Angel Investors Angel investors are individuals and groups that make investments in the form of debt or equity, from their own funds, to a private business owned and operated by someone else who is neither a friend nor a family member. This distinguishes angel investors from professional venture capitalists who manage funds invested by others and make investments with the goal of achieving a return on investment for their investors. And, it differentiates angels from a friend or family members whose investments are often made to support the entrepreneur. The data about angel investors is spotty, with some general statistics available, but little national or state data on transactions. Therefore, assessing the impact of angel investment tax credits is challenging. However, the Angel Capital Association (ACA) data shows that angel investors fund the majority of startups. It is estimated by the ACA that there were 298,000 angel investors in 2013 that invested about $24.3 billion in 71,000 deals: 32,000 seed stage and 29,000 early stage. In 2013, venture capitalists invested $29.6 billion in only 4050 deals, of which only 120 were seed stage and 1,375 early stage.37 The Center for Venture Research at the University of New Hampshire, the source of the only reliable angel funding data, reports that in 2014, the average investment was $328,500, yielding 19.2 percent return on investment for the angels, and creating 3.6 jobs on the average per investment.38 Similarly, Shane (2005) conducted focus groups that revealed that angel investors desire to achieve 10 times return in 3-7 years, with an average investment of $250,000 to gain convertible preferred stock, and exit through an initial public offering (IPO) or acquisition.39

State Angel Investment Tax Credits A major challenge in accessing the effectiveness of angel investment tax credits is that state programs vary widely on their specifics, including in areas of eligibility, funding levels, available credits per investment and per year, and whether or not the credits are refundable or transferable. This is demonstrated in the table in Appendix 2.40 Currently, 26 states have 38 programs that are some version of angel or venture capital investment tax credits. Only Arizona has a biotechnology-only program like Maryland’s,

37 http://www.angelcapitalassociation.org/dataDocuments/Resources/ACA-AngelBackground2014.pdf 38 Sahl, Jeffrey. 2015. “The Angel Investor Market in 2014: A Market Correction in Deal Size,” Center for Venture Research. http://www.paulcollege.unh.edu/cvr. 39 Shane, Scott. 2005. “Angel Investing: A Report Prepared for the Federal Reserve Banks of Atlanta, Cleveland, Kansas City, Philadelphia and Richmond. “ 40 All data about other state programs comes from the State Business Incentives Database maintained by CREC, and sourced from the websites of the participating states. http://www.stateincentives.org

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although it has reached its statutory cap and has not been extended. The Arizona program allows credit for 35% of the investment, with an annual cap of $500,000 per company and $2 million lifetime per company. Across the 26 states, the credits allowed are generally 25-35 percent, except one state at 45 percent (Minnesota) and four states at 50 percent: Kansas, Kentucky, Maine and Maryland.

Eligibility All the states, including Maryland, have eligibility standards for qualified businesses that can receive benefits and for qualified investors. The qualified investor standards are consistent across the states, often referring to the federal Securities Act of 1933 for being an “accredited investor.” Qualified company definitions are similar to Maryland’s in that they require the company to be headquartered in their state, have a minimum number of employees in the state, and be in good standing in the state (pay their taxes, etc.). In addition, sixteen states have a maximum number of employees or age of company or both, aiming to focus the angel tax credit on young and small companies. The age maximums are generally 5-10 years, with the upper limit for bioscience companies. The employment maximums are often 20-25 (5 states), 50 (3 states), 100 (3 states) and one at 225. There are several approaches to the question of eligible sectors. Some states (IL, NM, GA, SC) specifically identify sectors that are primarily local and indicate that they are not eligible. Common industries excluded from eligibility are: Retail, Wholesale Trade, Finance and Insurance, Real Estate related, Accommodation and Food Service, Government. However, there are emerging innovations in many of these sectors that could end up be transformative, such as Airbnb for accommodations. A few states use generic language: (ME) “a manufacturer or a value-added natural resource enterprise; must provide a product or service that is sold or rendered, or is projected to be sold or rendered, predominantly outside of the State; must be engaged in the development or application of advanced technologies”; (MN) “rely on innovation, research or development of new products and processes for growth.”; and (NM) “high technology research or manufacturing.” In all of these cases, the Department has to rule on each application separately, and then makes a determination. This is both time-consuming and potentially opens the Department up to appeals and unhappy companies. Quite a few states list sectors (CO, CT, IL, NJ, GA, SC) with their Commerce Department-equivalent left to sort out the definitions. The specific definitions are not in statute. This approach has two downsides. One, it leave the Department in the role of arbiter and two, it can be time-consuming. The benefit is that the credits are used in sectors that the state is presumably focusing on, so there is a positive effect on the growth of those sectors. In many cases, however, the sector list is so broad as to accommodate almost any company.

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Being silent on the issue of sectors is also common. Nine states (AR, IO, KS, KY, LA, NE, ND, OH, PA) do not address the issue of sectors. One rationale for this approach is that sophisticated investors will be doing significant due diligence before investing in these companies. Furthermore, the characteristics of companies suitable for equity investing are also the characteristics of companies that the state would like to support; they have a unique and defendable innovation, they have a strong team and an approach to the market. A second reason is that technologies and markets are changing faster than government regulations, so a state stands the chance of missing out on a particular company if it does not align with pre-defined sectors, even if it ends up growing big. A good Maryland example is Under Armour. Built on a technology platform, this company’s investors would not have earned a tax credit in Maryland. The company is now doing $4 billion a year.

Transferability and Refundability Transferability means that the recipient of a tax credit can transfer its ownership to another taxpayer. Usually, this is done through a market transaction, and allows the recipient to monetize the credit immediately. The value of transferability is that recipients without a tax nexus in a state, or without a tax liability, can gain value from the credit. Transferability is common among tax credits such as New Market Tax Credits, Low Income Housing Tax Credits and Historic Preservation Tax Credits where the monetization actually contributes to the financing structure of a particular project. Refundability refers to the practice of allowing a taxpayer with a tax credit to gain a refund from the state if their tax credit exceeds their tax liability, especially if they do not normally pay taxes in a state. The value of this in an angel investment situation is that it gives the tax credit value to investors who are not residents of the state. If a state does not have a large number of angel investors or venture investors, then refundability can entice out-of-state investors to invest in local businesses. Only 5 of the 38 programs allows transferability (Arkansas, Iowa, Kansas, South Carolina and Wisconsin) and the same number allow refundability (Maine, Maryland, Nebraska, New Jersey and Ohio). All of these states except Maryland are well outside the regions with abundant venture capital.

Limits on Annual and Total Amounts Claimed per Company Twenty-three of the 26 states have limits on the annual amounts that a company may claim. The average is $1.365 million, but nine only allow $50,000 per year, with several states with annual limits in the multi-millions. The average lifetime maximum for a company to claim across the 11 states with this provision is $1.47 million.

Evaluations of State Angel Investment Tax Credits There are three credible and recent evaluations of state angel investment tax credits, one an overall assessment, and two focused on specific states: Iowa and Minnesota. Since the objective of angel investment tax credits is to increase early stage investment in high-growth potential new ventures, leading to higher paying knowledge-based jobs and increased

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tax revenue, Bell et al. looked at the linkage between the tax credits and entrepreneurial activity. They found that in 2012, 32 states had implemented some form of angel investment tax credits and 29 states had program that were still in operation. They found that “of the 29 states that implemented an angel investment tax credit program between 1997 and 2011, 22 (75%) display an increase in entrepreneurial activity within the first two years of the program.” Eight of the states implemented the tax credit during an economic downturn, but still saw an increase in entrepreneurial activity, as measured by the Kaufmann Index of Entrepreneurial Activity.41 Another recent study was conducted by the Iowa Department of Revenue. They performed a matched study looking at 52 companies. Of these, 28 got investments with angel investment tax credits, and the remaining received investments without tax credits. The study found that 70 percent of the companies were still in business, with those receiving the tax credits exhibiting slightly higher survival rates. Significantly, the 28 companies that received investments employed almost 200 people, 36 more than if they had not been in the program. However, the authors of this study note their small sample size, and cannot say statistically that the results are significant.42 Also in 2014, Minnesota’s Department of Revenue commissioned a study done by Economic Development Research Group with Karl F. Seidman Consulting Services to evaluate the Minnesota Angel Tax Credit Programs.43 This comprehensive study had a unique element: it included a survey of the investors who claimed the credit, and whose behavior was the target of the program. The authors found that, among the qualified investors who made an investment:

• 48% would not have made the investment without the angel tax credit • 34% would have made a smaller investment without the angel tax credit • 18% would have made the same investment

Further, the authors found that Minnesota expended $34.2 million from 2010-2012 in angel tax credits, yielding a total of $71.7 million in new investments in Minnesota companies. In addition, the study documented $34.9 million in new leveraged financing. Therefore, for each $1.00 in angel tax credit, there was $1.09 in new angel investment and $1.02 in leveraged investment. The companies reported 98 direct jobs at the end of three years, with $243.1 million in sales. Other important findings were that 68% reported that the angel tax credit program increased their awareness of investment opportunities in the Twin Cities metro area, and 52 percent had increased awareness of new technologies.

41 Bell, Joseph R., Wilbanks, James E., and Hendon, John R. 2013. “Examining the Effectiveness of State Funded Angel Investor Tax Credits: Initial Empirical Analysis.” Small Business Institute Journal. 9 (2): 23-28. 42 Iowa Department of Revenue, 2014. “Iowa’s Venture Capital Tax Credits, Tax Credits Program Evaluation Study.” https://tax.iowa.gov/sites/files/idr/Venture%20Capital%20Evaluation%20Study.pdf 43 Economic Development Research Group, “Evaluating the Minnesota Angel Tax Credit Program: 2010-2012.” http://www.revenue.state.mn.us/research_stats/research_reports/2014/evaluation_of_the_mn_angel_tax_credit_program.pdf

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A caution, however, was that 80 percent of the qualified investors surveyed were new to angel investing, and 42 percent were “insiders,” that is related to the company’s founders, employees or affiliated companies. The study concluded, “From a state budget standpoint, most of the program’s benefits will occur after its first three years, while most of the costs occurred during its first three years. It is estimated that the program will not pay for itself within ten years. . . But the 2010-2012 economic and fiscal impacts of the angel tax credit program are noticeably higher than would likely have occurred had the state used the same resources to increase the research and development (R&D) tax credit or reduce the corporate tax rate.”

Best Practices of Angel or Seed Capital Investment Tax Credits

• All states have some cap on a company’s lifetime benefit. About 30 percent of the states have a dollar maximum; 10 have a limit on the age of a participating company; 13 have revenue caps. Some have more than one of these limits.

• Benefits accrue to investors except in the case of the CIITC. • The discretion of staff to make distinctions about who is qualified and who is not is generally

limited. While it’s not uncommon for staff to decide whether a firm fits inside a certain sector specific, it is rare for staff to judge the quality of the business plan or investment. The structure of these programs is such that qualified investors make these decisions. However, it is best if staff decides in advance who is a qualified company before investments are sought.

• Average percentage of the credits is 25-35%, but this covers a broad range of technologies and industries. Several states use 50%, like Maryland’s BIITC.

• Surveying both companies and investors for results will enable a program to fully understand its results.

• Transferability is somewhat limited, as is refundability, except in states that desire to entice investors from outside the state or where there is not a large investor community (that already had a tax nexus).

• It is important to have the ability to clawback tax credits if company leaves state, goes out of business, or if investor withdraws their investment.

Overall Findings

Are Investment Tax Credits an Effective Way of Supporting Emerging Companies in Raising Capital? The rationale for investment tax credits in general is that they lower the effective rate of risk for a particular investment, thus making the proposed investment more attractive than a similar opportunity without a tax credit. Companies that are raising capital from angels and seed and early stage funds are generally extremely supportive of these investment tax credits, as they believe that it makes their fund-raising easier. In Maryland, the biotechnology community, both as individuals and through associations like the Biotechnology Association of MD (BioMD), continues to endorse the BIITC.

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The BioMaryland2020 Strategic Plan specifically calls for an expansion of the tax credit to increase early stage investment in Maryland biotechnology companies. Furthermore, nationally, the Biotechnology Association (BIO) has put angel investor tax credits on its agenda with an eye toward a federal-level credit. It is not obvious whether the companies that earn investment tax credits for their investors would have received the investments without programs like BIITC. The only direct evidence is the Minnesota evaluation that surveyed investors. Those investors asserted that the tax credit played a big part in their decision to invest. However, these investors were also largely first-time investors, and many had “insider” relationships with the companies they invested in, so the tax credit may not be as important to “arms-length,” experienced angel investors. On the other hand, anecdotal data from Maine where the Seed Capital Investment Credit was suspended for a year due to reaching its statutory limit suggests that the credits can influence when investments are made. Companies reported that investments across the state dropped precipitously during the period when no credits were available, and jumped back up when the credits were reinstated. Maine Angels, the local angel investment group, is now one of the ten most active investment groups in the country, despite being in a region that has relatively low deal flow. One could argue that if the BIITC is so high and generous, then it should be making a difference in Maryland’s share of venture capital investments. Venture capital is historically extremely concentrated in the Bay Area of California, New York City, and the Boston area, with the rest of the country sharing a very small percentage of the total. We looked at Maryland’s share of total venture capital investments compared to neighboring states. Figures 4-8 and 4-9 show that the percentage share of total venture capital dollars and deals for Maryland is not significantly different than these neighboring states, despite the introduction of the BIITC in 1999. On the other hand, all of the neighboring states have some angel tax credit program, so they may be required just to stay even. Unfortunately, we do not have access to data about angel financing in Maryland, or biotechnology financing in the state alone. A countervailing fact, however, is that the total BIITC and CIITC credits are extremely small in the context of a venture capital market that exceeded $43 billion in 2014.

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Figure 4-8. Venture Capital Investment Dollars per State and for Biotechnology, 1985-2014 as a Percent of All U.S. Venture Capital Investment Dollars

Source: 2015 National Venture Capital Association Yearbook, http://nvca.org/research/stats-studies/.

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Figure 4-9. Total Venture Capital Deals, by Selected States, and in Biotechnology, 1985-2014 as a Percent of All U.S. Venture Capital Transactions

Source: 2015 National Venture Capital Association Yearbook, http://nvca.org/research/stats-studies/.

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What About Other Incentives for Biotechnology? One interesting and unique incentive is New Jersey’s Technology Business Tax Certificate Transfer Program that enables technology and biotechnology businesses in the state to “sell” their Net Operating Losses (NOL) and unused research and development tax credits for at least eighty percent of their value to an unaffiliated, profitable NJ taxpayer. This incentive was conceived of in 1995 and has been on the books since 1999. It was substantially amended in 2010. The total appropriation for the program has been $60 million most years, and the maximum for a company is $15 million in total. The main benefit of the credit is that it is non-dilutive, and so doesn’t affect the ownership levels of the founders or other investors. Since 1999, 500 companies have participated for a total of $820 million. Last year, 44 companies received a total of $54 million, averaging $1.2 million each. Eligibility is determined by the NJ Economic Development Authority (NJEDA) and the NJ Division of Taxation determines the value of the tax benefits. To be approved, a company must demonstrate that its primary business is “the provision of a scientific process, product or service and the applicant owns, has filed for or has a license to use protected, proprietary intellectual property.” In addition, there is a provision that the company be headquartered in NJ and have less than 225 fulltime employees in the US and some in NJ. If the company is less than 3 years old, it only needs to have 1 fulltime employee in the state, which increases to 5 employees until after its 5th year, when it should have 10 employees in NJ. A 2010 evaluation performed by the New Jersey Institute of Technology for the NJEDA44 found that the program was especially good for NJ biotechnology companies because of their need for patient capital to fund lengthy discovery and approval cycles. The evaluation concluded that the NOL program helps young biotechnology companies create and maintain high wage, high quality jobs in NJ, but it also concluded that non-biotech and technology companies did not demonstrate the same effect. The study showed 30-60% job growth for biotech companies for the five years studied, but negative job growth for all five years for technology companies. The question is whether this incentive is more or less effective than an angel tax credit. One answer comes from a survey of NJ biotechnology companies done in 2010 by Ernst & Young for BioNJ, a trade association. This survey found that despite a 50 percent increase in biotechnology jobs in the state from 2007-2010 (from 10,000 to 15,000), early stage funding was still consistently reported as an impediment. BioNJ subsequently proposed a 25% angel tax credit in addition to the NOL program.

44http://nj.gov/transparency/reports/pdf/NJ%20Technology%20Business%20Tax%20Certificate%20Transfer%20Program%5B1%5D.pdf

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It appears that the NOL program does provide cash to fund some operations, but also that the requirements are so strict and (according to NJIT) often subjective, so that around 30 percent of all applications are regularly disapproved. Unlike the angel tax credit, the NOL program does not incentivize investors to provide capital to these companies, so it appears that the incentives work best in tandem, rather than replace each other.

Are the Tax Credit Programs Providing Benefits to the Intended Customer? The definition of the “intended customer” is somewhat ambiguous since both the BIITC and CIITC statutes are silent on the ultimate goal of their respective programs. While the technology pre-requisites of each program are well spelled out, the important question of whether or not the “intended customer” is only a young, seed stage company is not that clear. This is because the study of entrepreneurs has repeatedly demonstrated the difference between stage of company and age. This challenge is even more pronounced in biotechnology because of the extremely long product development cycles. A company could be over ten years old, but still be in product development. There is the real possibility that an information technology company that has been in business for many years could develop a new product or service in the cybersecurity space. The BIITC program, as shown earlier, appears to be supporting a wide range of Maryland biotechnology companies, with the geographic distribution consistent with the distribution of life sciences companies in the state. A total of 82 companies have been able to raise funding using the BIITC, and only 20 percent have taken advantage of the program for many years. This seems consistent with the idea that not all companies that seek financing have the appropriate products, business model or management to gain investors’ support. Therefore, few very large number of biotechnology companies in the state would be expected to be able to obtain the financing needed to trigger the credits. The quality of the biotechnology companies that have received the support is demonstrated by the additional capital and grants leveraged, and the progress they are making towards commercialization of their products. It has been suggested that the age limitation in the BIITC program is inappropriate, and leaves out QMBCs that may have started their product development at a later age, or for whom the regulatory process has been extremely long. In this way, the BIITC may not be providing benefits to all the intended customers. A maximum total lifetime credit limit per QMBC would appear to be a more equitable way to cap the use of the program, and allow more credits to be available to others. For the CIITC, on the other hand, the extreme limitations on eligibility combined with the unusual provision that the credits accrue to the company, not the investor, suggest that this credit has missed the mark. Here too, the age limitation appears to be arbitrary, and not related to the real experience of companies seeking equity financing to support new product development. And, the requirement that the company have licensed and/or proprietary technology is un-necessarily limiting, especially as many information technologies are not patentable. Lastly, requiring that the credits to accrue to the company ignores the dynamic that

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investment tax credits are built on—the desire to lower the effective risk to investors. Sophisticated investors in cybertechnology companies are likely to suggest that the companies move to states where the investors can take advantage of “vanilla” angel investment tax credit that have percentages comparable to the CIITC. A third question is whether or not the “intended customers” are only those entrepreneurs in biotechnology or cybersecurity. Clearly, Maryland is interested in innovation and entrepreneurship generally, and with new technology spaces being developed every day, the limited focus on these two sectors with these tax credits may be too narrow. So, while the state may wish to keep its signature programs in biotechnology and cybersecurity, it may wish to also consider a broad angel tax credit that does not require Commerce to undertake so much decision-making with regards to eligibility.

Summary

• The BIITC has helped 82 Maryland Biotechnology companies raise capital, and these companies have, in the aggregate, gone on to raise additional capital, both equity and debt, and gain new grants for research and development. In total, the leverage of the $66 million BIITC is (through 2014): an additional $72 million invested, with almost $55 million in follow-on venture capital, $49 million in non-venture capital equity, and $345.6 million in grants. This is a 7.9:1 leverage ratio.

• The 82 QMBCs that have raised funds and whose investors have taken the credit are geographically dispersed in a pattern similar to the dispersion of life sciences companies in the state.

• Roughly 20 percent of the QMBCs have received investments whose corresponding tax credits exceed $1 million, and 8 percent have received credits in more than five years. The average product development cycle for biotechnology companies is more than ten years.

• Maryland is one of only two states with an angel tax credit focused exclusively on biotechnology companies, and in general, the BIITC is quite generous, both in its credit limit (50%) and in its transferability. However, all of the states that allow transferability or refundability are “flyover states” that desire to attract capital from outside the state. Because transferability is in the statute, Maryland has attracted capital from 376 investors from out-of-state and international, equal to 58% of the credits.

• Maryland’s approach is consistent with other states that limit qualifying companies to those that are younger, have fewer employees, and are in specific segments. However, this approach is not universal, as other states let the market decide which companies have the best growth potential, and instead broaden participation by putting annual and lifetime limited on tax credits claimed.

• The few studies of angel tax credits suggest that there is a positive correlation with entrepreneurial activity, and that the decisions of individual investors are influenced by the availability of the credits. A positive attribute of the MN study was that they surveyed the investors, as well as the companies.

• The overall impact on the distribution of venture capital investments appears minimal, but data on angel investments and biotechnology angel investment by state is not available to enable a more detailed analysis.

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• The CIITC is a unique tax credit, both because of the sector involved, and because the credit goes to the company, not the investor. The number of companies in the state that are eligible for the CIITC is quite small, and the requirements may be too tight to accomplish the policy goals. The number of companies taking advantage of the program is very small, especially when compared with the BIITC. In addition, the limitation that the credit goes to the company, not the investor, may actually be a disincentive.

• The BIITC and CIITC do not support other innovative entrepreneurs in the state who may be engaged in commercializing other high-risk technologies and require equity financing. To the extent that the emerging technology landscape is constantly evolving, the choice by other states to have a general credit as opposed to a single sector credit is more flexible over time. On the other hand, having a tight sector focus can be a good thing if in fact there are demonstrable competitive advantages, such as there are in Maryland in both biotechnology and cybersecurity.

Policy Design and Administrative Recommendations for Improvement

Amend Biotechnology Investment Incentive Tax Credit The Biotechnology Investment Incentive Tax Credit works well and meets its objectives. However, a few changes to the program would potentially broaden its application to include more Maryland companies, reduce the amount of taxpayer funds flowing out of state, and reduce the opportunity for gaming the system. These changes include:

• Eliminate age criteria and number of years in the program under qualifications. The gist of this proposed change is whether the intent of the legislation is to only support young, entrepreneurial firms, or whether Maryland wants to support all innovative biotechnology companies, regardless of age, if they have the potential to grow rapidly. While young firms are demonstrably more innovative than small firms and responsible for most job growth,45

this caveat in the BIITC has the effect of reducing access to capital for firms who may have been in business for longer than ten years, but are now starting on innovative, new product development requiring equity capital. It may also stifle access to capital for companies facing an extraordinarily long regulatory process.

• Add a lifetime maximum amount of credits that any one company can access, e.g. $2 million. Rather than seeking to limit the pool of qualified companies by using age as a criterion, there could be a limit to the maximum amount of credits that a company could claim, either annually (which is in statute) or over their lifetime. A lifetime maximum of $2 million would cover 90% of past companies while a limit of $1 million would have covered 80% of past companies.

• Separate more fully the “qualification” step administratively from the process of asking for investors to get “certificates.” Commerce has already begun implementing

45http://www.kauffman.org/~/media/kauffman_org/resources/2014/entrepreneurship%20policy%20digest/september%202014/entrepreneurship_policy_digest_september2014.pdf)

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this change. However, the Department could even provide more clarity to potential QMBCs by having the Qualification step happen year-round, and be in force for more than one year. This allows QMBCs to be able to go to investors with the full knowledge that an investment will qualify, rather than having to wait for qualification.

• Administratively, move to 4 deadlines a year when investors can file for certificates, to reduce gaming. Set aside one-fourth of the total appropriation for each period. Right now, QMBCs move rapidly to put their requests for certificates into the Department annually on July 1. This causes several actions. First, QMBCs and their investors put in for amounts that are later lowered. Second, the workload of the Department in highly concentrated, increasing the cyclical need for headcount, and increasing the potential for errors. If the availability of the credits were spread out over the year, QMBCs and their investors would not have any incentive to file ahead of time. And, the workload would be lowered for the Department as well.

• Survey investors as well as QMBCs annually. The objective of the program is to change the behavior of investors, with the intent of this having a positive effect on Maryland biotechnology companies. This annual survey of investors would coincide with their survey of QMBCs. This survey could help document the changes in behavior of investors, such as whether the credit influenced their decision to invest. [See the Minnesota Evaluation.]

Amend Cybersecurity Investment Incentive Tax Credit All the changes suggested for BIITC also apply to the CIITC. In addition,

• Change the CIITC so that the credit accrues to the investor, rather than the company. As discussed in the Findings section, this credit is unique in the nation for this approach, and the rather lukewarm reception from the cybersecurity community shows that this is a problem. In fact, it may well be that an investor would suggest that the company move to an adjacent state where the investment tax credit will accrue to the investor.

• Remove barriers to eligibility for QMCCs. Since Maryland’s information technology business community is quite mature, but still has the ability to innovate into the cybertechnology arena, lessening the criteria that relate to age, size and number of employees would increase the likelihood of gaining equity investment in new product lines.

Create an “Emerging Technologies Tax Credit” This new tax credit would be in addition to the signature BIITC and CIITC programs. The objectives of this change include: (1) Broadening the program to include more Maryland innovative companies in the program, and coincidentally expanding its usage beyond the urban counties; (2) Reducing the need for Commerce to be the arbiter of what is or isn’t a qualified company; and (3) Simplifying the program for businesses.

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Emerging Technologies Tax Credit: Modeled on BIITC statute with changes noted as above.

• Credit should be 33%; Could have 50% for investments in qualified companies that are in rural areas, distressed areas, or whatever “tiered” system is proposed.

• Max credits per qualified company $2 million. • No limit on age of company in qualifications, or in number of years in program – you want

the successful companies to stay successful and not be cut off arbitrarily • Eliminate refundability. Could add a 5 year carry forward • Define Emerging Technologies clearly: The objective is to focus on companies in traded

sectors (those that are adding to the economy), reduce ambiguity about who is qualified and who isn’t, maintain flexibility in the ace or rapid changes in technology and sector preferences; and reduce the administrative burden on the Department. Some options are: o Require that a company must have patented or licensed a technology or be patent

pending. This is easy to administer and verify, but doesn’t cover all technologies. For instance, business models (e.g., Uber, Airbnb) aren’t patentable.

o Specifically omit sectors that are primarily local from coverage.. Common industries include: Retail, Wholesale Trade, Finance and Insurance, Real Estate related, Accommodation and Food Service, Government. However, there are emerging innovations in many of these sectors that could end up be transformative (e.g., Airbnb for accommodations).

o Use generic language: (ME) “a manufacturer or a value-added natural resource enterprise; must provide a product or service that is sold or rendered, or is projected to be sold or rendered, predominantly outside of the State; must be engaged in the development or application of advanced technologies”; (MN) “rely on innovation, research or development of new products and processes for growth.”; and (NM) “high technology research or manufacturing.” In all of these cases, the Department has to rule on each application separately, and make a determination. This is both time-consuming and potentially opens the Department up to appeals and unhappy companies.

o List sectors with Commerce Department equivalent left to sort out the definitions. The specific definitions are not in statute. This approach has two downsides. One, it leave the Department in the role of arbiter and two, is time-consuming. The benefit is that the credits are used in sectors that the state is presumably focusing on, so there is a positive effect on the growth of those sectors. In many cases, however, the sector list is so broad as to accommodate almost any company.

o Be silent. Sophisticated investors do significant due diligence before investing in these companies, and the characteristics of companies suitable for equity investing are similar to those Maryland would like to support: they have a unique and defendable innovation, a strong team, and a unique market approach. In addition, technologies and markets are changing faster than government regulations, so a state stands the chance of missing out on a particular company if it doesn’t fit the sectors, even if it ends up growing big (e.g., Under Armour in Maryland).

• Set annual budget for this Tax Credit at same as BIITC.

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Chapter 5: Incentive Programs Targeted to Attraction of Significant Employers

Maryland Economic Development Assistance Authority and Fund

Program Overview The purpose of the Maryland Economic Development Assistance Authority and Fund (MEDAAF) is to provide financing and incentives for economic development projects that maximize job creation, retention and capital investment per dollar invested; target core strategic industries in priority areas of the state; and seed potential future job creation and capital investment. The Fund provides grants, loans and investments for business attraction and retention, infrastructure and buildings, and several special purposes. Awards are made on a competitive basis backed by a rigorous approval and monitoring process. MEDAAF is a consolidated fund, administering multiple loan and grant capabilities that have been added to the MEDAAF portfolio over time. Commerce summarizes MEDAAF’s twelve programs under five capabilities:

• Capability 1: Significant Strategic Economic Development Opportunities. Funds are generally used for repayable loans made directly to a business or through MEDCO for projects that result in significant job creation or retention and capital investments.

• Capability 2: Local Economic Development Opportunities. Funds are provided in the form of a loan, conditional loan or grant directly to a business or through MEDCO for project use. A local jurisdiction must participate with at least 10% of the total assistance.

• Capability 3: Direct Assistance to Local Jurisdictions or MEDCO. Funds are provided in the form of a loan, conditional loan or grant directly to a local jurisdiction or MEDCO for local economic development needs, including buildings and infrastructure.

• Capability 4: Regional or Local Revolving Loan Funds. Funds are provided to local governments to create revolving loan funds for small business assistance.

• Capability 5: Special Purpose Grants and Loans include five targeted programs with diverse purposes: day care, animal waste technology, brownfields, aquaculture and arts & entertainment districts.

For the purposes of this project, the analysis focuses on capabilities 1-3 as most germane to the needs and interests of major employers. MEDAAF was created under Chapter 301 during the 1999 legislative session as a revolving loan fund to provide below market, fixed rate financing to growth industry sector businesses 54


locating or expanding in priority areas of the state. Ten programs were added through the Financing Programs Consolidation Act of 2000. The Smart Growth Economic Development Infrastructure Fund (One Maryland) was consolidated into MEDAAF in 2004 and is now part of Capability 3. The original funding plan for MEDAAF called for $100 million in general fund appropriations over a five-year period ending in 2004. Instead, $56 million was appropriated over 15 years, but $42 million was transferred to other programs, resulting in net useable funds of $14.4 million. Loan recoveries, use of special funds, and “depleting the repayable portion of the fund” have helped sustain the programs. MEDAAF’s appropriations have been increasing since FY14 from $7.4 million (the highest amount since 2006) to $27.5 million in FY15 and $20 million in FY16. The FY14 year-end Fund balance stood at $12 million, which represents total cash less existing encumbrances of $28.5 million.

Results and Analysis MEDAAF has had 496 transactions with a total aggregate original balance of $222.7 million since 2000. Most transactions (425) were structured as grants or conditional loans, with the remainder structured as loans (49) and investments (22). Figure 5-1 depicts the dollar amount and distribution of approved transactions by Capability from FY04 through FY14.

Commerce reports that these transactions contributed to the retention of more than 29,000 jobs, the creation of over 20,000 new jobs, and investment of $3.8 billion. Total program charge-offs as of June 2014 were $18.3 million ($8 million of which was recovered), with 5 transactions accounting for most of that amount.

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The current portfolio (as of June 2014) includes 142 transactions with total principal outstanding of $102 million. According to the Maryland Jobs Development Act Report (January 2015), in FY14 MEDAAF approved 30 transactions totaling $22 million. Transactions are first approved internally and then settled (finalized) with the recipient, so the numbers of approved and settled transactions are not exactly the same in a given year. Among the programs of interest here:

• Capability 1: 0 transactions settled (based on budgetary constraints) and 1 approved • Capability 2: 12 recipients and $9.05 million settled (10 and $6.96m approved) • Capability 3: 8 recipients and $11.25 million settled (8 and $6.4m approved) – does not

include One Maryland for FY07-FY14 As seen in Figure 5-2, use of Capability 2 has grown in recent years because of its flexibility in form (ability to provide loans, conditional loans, or grants) and because budget limitations have made it more difficult to offer higher amounts of funding that are technically possible under Capability 1 (up to $10 million or 20% of the current Fund balance). In FY14 the Fund balance was $12 million, which created an effective cap of $2.4 million on funds per project under Capability 1 based on the 20% rule. By comparison, the cap for grants provided under Capability 2 is $2 million and the cap for loans is $5 million.

Economic Development Opportunities Program Fund (Sunny Day)

Program Overview The Sunny Day Fund was created in 1988 to enable Maryland to act on extraordinary economic development opportunities that require financial assistance beyond the capabilities of other state and local financing programs. Extraordinary opportunities are those that would create or 56


retain substantial employment (with preference for jobs in areas of high unemployment), create significant capital investment, pose minimal risk, and be consistent with the state’s strategic economic development plan. Sunny Day is structured as a non-lapsing revolving fund. Funds may be loaned, granted or invested. The Fund “belongs” to the legislature but is administered by Commerce. The Legislative Policy Committee of the General Assembly must approve projects.

Results The Sunny Day Fund has had 121 transactions with a total aggregate original balance of $180 million (as of June 2014). Most transactions (75) were loans or conditional loans, but almost 35% (42) were grants or conditional grants. Only 4 transactions were investments. Commerce reports that these transactions contributed to the retention of more than 36,000 jobs, the creation of over 24,000 new jobs, and investment of $2.4 billion. Of the total over time, 48 are “complete,” 13 remain active, 26 were subject to clawbacks and some projects were written off.46 By dollar volume, most of the “charge-offs” were related to five transactions with entities that declared bankruptcy. There was no new program activity in FY14. The most recent approval occurred in FY12. The lack of activity is attributed to use of MEDAAF for eligible projects and lack of budgeted funds for Sunny Day that has hindered the ability to make new commitments to companies. The program has not received new funding since FY02.

Experience of Other States

Flagship Incentive Programs for Major Employers Tax credits and grants rather than loans or conditional loans are the basis of most states’ incentive vehicles for major employers. For example, North Carolina has used job creation tax credits, Job Development Investment Grants (JDIG), and the One North Carolina Fund, which provides grants for job creation/retention in conjunction with a local match. However, North Carolina’s main job creation tax credit (3J) sunset in 2014. The state recently restructured its state economic development activities and approved higher funding for the JDIG program. South Carolina’s main incentives include a Job Development Credit, an Economic Development Set-Aside Program that provides infrastructure or site improvements related to business attraction or expansion, and the Governor’s Closing Fund. Virginia uses more grant programs than many states for business attraction and expansion, including the Commonwealth Opportunity Fund, the Virginia Investment Partnership Grant/Major Eligible Employer Grant, and Virginia Economic Development Incentive Grant. It also offers the Major Business Facility Job Tax Credit.

46 We are verifying the number of transaction charge-offs to account for the total of 121 transactions.

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State-level workforce and infrastructure incentives are also frequently part of major employer incentive packages.

Eligibility and Benefits The discretionary funds designed for major business attraction and retention examined here have different structures and rules. Figure 5-3 below summarizes the main eligibility criteria that affect program utility for businesses.

Figure 5-3. Eligibility Criteria for Major Business Attraction and Retention Programs

State/Program Location Sector Limits on Funds

per Project Eligible Uses

Capital Investment

Requirement MARYLAND

MEDAAF 1 Priority funding areas

Eligible sectors (not defined)

<70% of total project costs AND capped at $10m OR 20% of current fund balance

Land acquisition, infrastructure

improvements, buildings, fixed assets, leasehold improvements, working

capital



Loans capped at $5m; grants capped

at $2m

Land, infrastructure, buildings, fixed assets,

leasehold improvements



Capped at $3m or <70% of total project

cost unless to MEDCO or qualified distressed project

Buildings, infrastructure, fixed assets, leasehold

improvements

Sunny Day Prefer projects in areas of high

unemployment

Consistent with state strategic plan

No limits

5 X Sunny Day

assistance

VIRGINIA Commonwealth

Opportunity Fund

All Virginia $1.5m but can be waived

Utility extension; transportation; site

acquisition and preparation; construction;

training

Range from $1.5m-$100m by job creation and location

VIPG All Virginia Targeted to manufacturers or

R&D services supporting

manufacturing

Designed to encourage capital investment but not clear if a required use of

funds

$25m

MEEG All Virginia Major employers investing $100m and creating 400-

1000 new jobs

No clear limits on uses of funds

$100m

VEDIG All Virginia, but scaled benefits by

location

Significant HQ, admin and service sector operations

No clear limits on uses of funds

NORTH CAROLINA One North

Carolina Fund All NC, but can

show preference in review

High value-added, knowledge-driven

industries

$1,000-$3,000 per job as rule of thumb

Equipment, building repairs & improvements, utility

improvements, and "any other purposes" specified

by Gen. Assembly

No clear investment threshold

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Funding Reliable comparative data on funding by incentive program is difficult to obtain. Available funding for future project activity (business attraction and retention) by program can be quite different from annual program appropriations or actual program spending given the long-term commitments many states make to companies and the ways funds are managed. For example, in 2014, the appropriation for the SC closing fund was $45.4 million, but 2014 funding from all sources was $58.8 million and total awards were $76 million. In NC, the annual commitment level for the JDIG program had been capped at $15 million but actual liability for FY15-16 was expected to be $67.3 million, accounting for prior-year commitments, and the appropriation was $63 million. Maryland’s interest in comparative funding levels is designed to ensure competitiveness for attracting and retaining major employers, so annual funding for future activity is of primary interest. Given the caveats provided above, our own research yields the following rough order of magnitude estimates of funding likely to be available for major project attraction/retention from the highlighted incentive programs in the comparison states:

JDIG All NC, but can show preference in review; also

strive for geographic diversity in

program use

NOT retail, warehouse, or

sports team

Maximum liability of $20-35m per year; cap of $6500 per

position; generally 10-80% of

withholdings of eligible positions

Can be used for any purpose

Importance varies by

project but aim for

$10,000/job; $500m for High Yield

Project SOUTH CAROLINA

Job Development

Credit

All SC but scaled benefits by

location

Mfg. & processing; corporate office warehouse &

distribution, R&D, agribusiness,

tourism, qualified service related

facility

$3,200/employee cap

Training costs and facilities; real estate

acquisition & improvements; leases in certain circumstances;

infrastructure and transportation

improvements, certain real property & fixture

improvements

Job Development

Credit

All SC but scaled benefits by

location

Mfg. & processing; corporate office warehouse &

distribution, R&D, agribusiness,

tourism, qualified service related

facility

$3,200/employee cap

Training costs and facilities; real estate

acquisition & improvements; leases in

certain situations; infrastructure and

transportation improvements, certain real

property & fixture improvements

Set-Aside Program

All SC Consider industry sector but no hard

rule

Rule of thumb $10k/new job

Primarily for land acquisition, road

improvements, water & sewer infrastructure and

site preparation costs related to location and

expansion

Governor's Closing Fund

All SC High impact projects

Rule of thumb $10k/new job

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Virginia - $35 million North Carolina - $40 million South Carolina - $90 million

Approval Processes The state programs examined here involve elected or appointed officials in the approval process in the following ways:

South Carolina The South Carolina Coordinating Council for Economic Development (chaired by the Commerce Secretary) approves all applications for grants from the Economic Development Set-Aside and Governor’s Closing Funds, among other programs. In addition to the Chairman, “ten additional members are drawn from other state agencies involved in economic development, and the member agency heads are either board chairmen or cabinet officials:”

• SC Department of Commerce • Santee Cooper • SC Department of Transportation • SC Research Authority • Jobs Economic Development Authority • SC Department of Employment and Workforce • SC Department of Revenue • SC Department of Agriculture • SC Department of Parks, Recreation and Tourism • State Ports Authority • State Board for Technical and Comprehensive Education

Applications are submitted to the SC Department of Commerce Grants Administration Division, and requests for funding are presented to the Council at quarterly meetings. The Council can approve, disapprove and negotiate terms and amounts of agreements. Performance agreements are contracts between the company, the local government applicant and the Council. The Council prepares an annual report (apparently required by statute) that is to be forwarded to the Governor’s Office, Budget and Control Board, Senate Finance Committee and House Ways & Means Committee.

Virginia The Commonwealth Opportunity Fund grants are determined by the VA Secretary of Commerce & Trade based on Virginia Economic Development Partnership recommendation and subject to the approval of the Governor. Offers always have the permission of the Secretary. There are certain circumstances in which the Secretary must furnish written explanation of offers to the

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Chairmen of the Senate Finance and House Appropriations Committees. These seem likely to be rare, as the approval process would not favor projects in those circumstances.

North Carolina The NC Department of Commerce is responsible for program administration, but a five member Economic Investment Committee (EIC) evaluates projects and makes decisions regarding JDIG awards. The Committee “is the only body that can decide whether to award a grant.” Parties to the agreement are the EIC and the grantee. Committee members include:

• Secretary of Commerce • Secretary of Revenue • Director of the Office of State Budget & Management • One member appointed by the General Assembly upon recommendation of the Speaker

of the House (2 year term) • One member appointed by the General Assembly upon recommendation of the

President Pro Tempore of the Senate (2 year term) The appointed members may not be members of the General Assembly.

Maryland (MEDAAF) Finance specialists within the MD Department of Commerce gather the necessary information and present the transaction to the Credit Committee comprised of Office of Finance Programs (OFP) management. The Attorney General’s office participates in Credit Committee meetings. Once the Committee approves the transaction, it is prepared for final approval authority via either the Secretary’s signature (up to $2.5m) or the MIDFA/MEDAAF Authority (over $2.5m). Authority members are appointed by the Governor with the consent of the Senate and include citizens with business or economic development experience. The Secretary and Treasurer or Comptroller are ex officio members. The Attorney General’s office is responsible for final documentation of the incentive award.

What Wins Deals for Major Employers? Annual funding by incentive program is only the beginning of the story. Incentive benefits/spending, especially for major employers, are spread out over several years. Further, states that tend to attract high profile deals involving major employers are adept at packaging multiple programs across agencies and at the state and local level. States that have consistent success are able to combine several incentives into tailored offers that offer access to several state programs, typically include substantial local contributions, and often offer something “special” for the largest projects. For example, the announced $211.5 million incentive package for Baxter International’s 1,500 employee pharmaceutical operation in Georgia (announced 2012) included the following elements:

• $27.2m sales tax exemptions on machinery & equipment

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• $28.1m Quality Jobs Tax Credit • $14m bioscience training facility • $13.8m infrastructure grant • $10.4m QuickStart job training • $4.7m jobs tax credit • $2.5m sales tax exemption on construction materials • $1.47m job training funds from Georgia Works Ready • $1.35m energy sales tax exemption • $94.1m local real and personal property tax abatements • $6.5m site improvements • $5.9m new wastewater treatment plant • $1.3m waived fees • Freeport tax exemption, industrial development bonds, and road improvements

Major project success is built on combined offerings from several partners to create a compelling and unified incentive package tailored to client interests.

Findings: Comparing MEDAAF to Similar Incentives in Other States This section answers the question, “How does MEDAAF compare to other States’ primary incentive vehicles in structure, benefits and funding level?”

• Most states use a combination of tax credits and grants for their major employer attraction and retention programs. MEDAAF Capability One (significant strategic opportunities) is structured as loan program and the Sunny Day fund (extraordinary opportunities) has been used more often for loans than grants or investments. Feedback from companies indicates that loans are less compelling to the type of companies Capability One and Sunny Day are intended to serve because their cost of capital is already low and they must carry the loan (conditional or not) on the balance sheet. Capability Two tends to be used for conditional loans and grants, which is more in keeping with practices in other states.

• The other state programs examined here generally include more flexible location and industry sector eligibility criteria. Most significantly, they do not limit program uses to defined areas of the state. Program benefits may be scaled by location, however, during the negotiation process. In practice, MEDAAF has more flexibility on both factors during the review process than the eligibility criteria suggest, with the ability to modify both areas and sectors to accommodate requests.

• MEDAAF rules capping funds per project may limit its attractiveness for major employers. The caps on the grant programs within MEDAAF Capability Two are low for this purpose. Other states appear to strive to maintain flexibility on per project funding or attach their funding rules of thumb to jobs rather than a set dollar figure.

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• Other states evaluated for this project consider capital investment as part of their review process and would tend to favor projects with higher investment, but they do not all set a hard threshold on the value of investment. Virginia is an exception but the range starts at $1.5 million and goes to $100 million. MEDAAF does not have hard requirements on capital investment, but Sunny Day requires that capital investment be at least 5 times the amount of Sunny Day assistance.

• Reliable comparative data on funding is difficult to provide. Our best estimates of funding available for comparable programs designed for major employer attraction and retention suggest that MEDAAF is under-funded relative to other states.

Successful attraction and retention of major employers rarely rests on a single program. Maryland’s ability to compete in this arena will depend on its ability to combine its multiple state-level programs along with competitive local offerings into tailored packages addressing client interests.

Policy and Administrative Options for Improvement This section answers several questions posed as part of this study.

1. If MEDAAF can be successfully modified to provide incentives to younger companies – predicated on capital investment – how should the State best structure these kinds of incentive deals? These transactions present both greater reward (faster growth than mature businesses) and risk (more potential for stumbles, with thinner balance sheets)?

This question seeks to determine whether capital investment guidelines should be loosened so that younger, potentially fast-growing but less capital-intensive companies are eligible for state funding. Sunny Day encourages a high level of capital investment by tying incentive funds to investment levels. MEDAAF Capabilities One and Two do not have such a rule, though investment levels are one factor considered during the review process. Similarly, other states evaluated for this project consider capital investment as part of their review process and would tend to favor projects with higher investment, but they strive for flexibility in program awards. Accordingly, as with MEDAAF, they tend not to impose hard-and-fast rules on capital investment for most (but not all) of their discretionary incentive programs or allow for a wide range of eligibility. MEDAAF has a robust approval and compliance process that examines many project factors beyond capital investment, which should continue to mitigate risk. Further if MEDAAF Capability One is modified to allow conditional loans (as in Capability Two) or performance grants, these conditions should continue to lower risk.

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2. In addition to the changes proposed in last year’s legislative proposal, which loosened capital expenditure requirements, what other modifications should be made to MEDAAF overall?

MEDAAF Capability One could be modified and funded to serve the original purpose of the Sunny Day Fund. The suggestions below take the best aspects from Sunny Day and the heavily used Capability Two and apply them to Capability One for significant state projects. The overarching objective is to increase program flexibility and expand the state’s options when facing promising opportunities. These suggestions for Capability One include:

• Maintain the list of eligible uses for Capability One (under which working capital is already eligible) OR remove all restrictions on eligible uses of funds to match the current Sunny Day rules.

• Allow conditional loans and performance grants, instead of loans only. • Remove up-front restrictions on location and industry eligibility, but be clear that these

factors will continue to be considered when evaluating opportunities. • Maintain the $10 million cap on funds per project and continue to limit awards to no more

than 70% of project costs but prepare guidelines that indicate this cap would not be the norm. Consider implementing a tiered structure of benefits by location in program guidelines (not statute) to align with recommendations for other state incentive programs.

• Fund Capability One sufficiently so that the 20% of fund balance rule does not limit the ability to respond to opportunities OR enable fund transfers from other MEDAAF-administered programs if needed OR remove this rule entirely.

• Continue to package Capability One funds with other state and local incentives, which are likely to account for the majority of the announced incentive deals for major prospects and significant employers.

3. Should MEDAAF be expanded to offer working capital funding? Working capital is already an eligible use under Capability One and should be made allowable under Capability Two.

4. Should MEDAAF be modified to allow the Secretary broader powers to utilize the program beyond its statutory limitation for extraordinary events?

MEDAAF Capability One allows for funding for “significant” strategic opportunities as opposed to the “extraordinary” opportunities for which the Sunny Day program was designed. Combined with the other capabilities, MEDAAF may already be structured with sufficient flexibility on this point. Underlying this question appears to be an interest in other states’ approval processes and the level of involvement by elected or appointed officials in the review and approval process. 64


Processes vary, but in general, appointed officials comprise most of the decision-making bodies examined here. Some states require the governor’s approval for certain discretionary incentives but decision-making tends to reside with a board or committee. In most of the states where we examined the process, legislative leaders are informed of decisions over a certain level but rarely are engaged in the decision itself.

5. How do other states make multi-year commitments and manage the political risk of funding potentially evaporating in the out years?

The Virginia Commonwealth Opportunity Fund does not make multi-year commitments, and grants are generally only made from current appropriations and available funds. In North Carolina, the JDIG program allows grants for up to 12 years. JDIG is subject to a legislative cap on grants based on the cumulative financial impact of those grants in any future grant year. For the period July 1, 2013 through June 30, 2015, the maximum total liability for all grant agreements entered into during that period was $22 million. The Economic Investment Committee is required to determine on an annual basis the minimum funding level required to implement the program successfully, both to meet the terms of previous agreements and to enter into new agreements. Total funds needed in FY15-16 for JDIG payments were estimated to be $67 million. The process for managing multi-year commitments is not clear in South Carolina. However, data provided in the Coordinating Council’s Annual Report implies that Governor’s Closing Fund may be used more often to pay for infrastructure or property improvements rather than cash grants to a company, so the risk is different in these cases.

Summary Recommendations

• Re-define MEDAAF as a “strategic fund” by introducing greater flexibility in shifting funds across capabilities and create focus by limiting the purpose of the incentive grants or loans.

• Adapt MEDAAF Capability One to provide conditional loans and performance grants in addition to traditional loans, while maintaining or broadening project eligibility by location and sector to enable maximum flexibility in the state’s decision-making.

• Continue to allow funds to be used for working capital under Capability One and maintain the capital investment standard as one element that is evaluated rather than a hard-and-fast rule. Expand the list of eligible uses for Capability Two to include working capital.

• Increase funding and/or remove the 20% restriction that limits Capability One’s capacity for major employer attraction/expansion opportunities

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• Market the MEDAAF capabilities separately by end user – in general, business or community. Highlight, externally, Capability One and Two as separate programs designed for major business attraction and expansion projects.

• Clarify the current guidelines for companies to help steer them through the discretionary incentive process and explain the evaluation criteria employed. Focus guidelines on shepherding the best prospects through the process and scaling up an incentive offer based on evaluation criteria, rather than weeding out projects based on eligibility criteria. Maintain maximum flexibility in decision-making.

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Chapter 6: Small Business Lending and Investment

Maryland Small Business Development Financing Authority Lending and Investing Programs

MSBDFA Overview The Maryland General Assembly created the Maryland Small Business Development Financing Authority (“MSBDFA”) in 1978, making this program one of the oldest minority business lending programs in the country. The original purpose of MSBDFA was to promote the viability and expansion of businesses owned by economically and socially disadvantaged entrepreneurs. In the 2001 session of the Maryland General Assembly, Chapter 172 modified the MSBDFA statute concerning eligibility. MSBDFA’s borrower base was expanded to include small businesses in general. The current statute includes small businesses that do not meet the established credit criteria of traditional financial institutions, and consequently are unable to obtain adequate business financing on reasonable terms and conditions. Figure 6-1 outlines the MSBDFA portfolio by program. The MSBDFA lending programs—Contract Finance, Loan Guaranty, Surety Bond, and Equity Participation—provide financing at terms and conditions more favorable than traditional banks. The MSBDFA loan and guarantee programs provide capital that its borrowers are unable to obtain from traditional funding sources. In fact, as part of the MSBDFA due diligence process, the borrowers are required to provide a loan decline letter from a traditional funding source. The majority of the MSBDFA borrowers have three choices to help fund operations: 1) secure a MSBDFA loan, 2) secure capital from a factor/on-line lender or 3) go out of business due to lack of funding. The MSBDFA program provides a critical need for affordable capital to help sustain and grow local jobs. The latest available MSBDFA program financial audit was for the period ending 6/30/2014. Figure 6-2 outlines MSBDFA’s total assets and overall asset allocation by program. The surety bond program represents the largest exposure in terms of both dollars allocated ($5,100,000) and exposure per borrower ($853,000), however, almost 37% of the loans are in the Equity Participation category. The portfolio’s average exposure per loan is approximately $350,000 and the total number of loans in the portfolio is 76. The majority of MSBDFA financing programs have a maximum borrower credit limit of $2 million. That maximum represents about 9% of the organization’s $22.4 million portfolio. Approximately 50% of the portfolio loans provide some form of collateral support to a traditional lending institution. In addition, borrowers self-reported approximately 1000 jobs created and retained in the State of Maryland at the time of the original underwriting.47 An independent study of the economic impact of MSBDFA’s lending activity over ten years showed 3000 jobs

47 MSBDFA Maximum Exposure Report – FY 2014.

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created, a cumulative economic impact of $3.4 billion, and cumulative portfolio company income of $1 billion.48 The MSBDFA program provides direct lending/investing resources (contract finance and equity participation) and indirect lending resources (loan guaranty and surety bonds). The majority of the MSBDFA programs help to address the following key borrower needs:

• Working capital • Equipment purchases • Acquisition, real property, renovation or construction • Contract financing • Contract bonding support

Historically, the MSBDFA portfolio has experienced portfolio losses averaging 9%, but market dynamics during and immediately following the recession impacted portfolio performance (see Figure 6-3). Fifty percent of the total $5 million in losses sustained by MSBDFA from 2011-2014 were accounted for in two transactions under very unusual circumstances. These transactions included an ornamental steel contractor and a construction contractor that had been a client of MSBDFA for more than ten years. The ornamental steel contractor simply stopped performing on the job. The construction contractor was a victim of fraudulent activity by the much larger joint venture contractor. If the losses from these two (2) companies were excluded, the loan loss rate would have been more consistent with the pre-recession loan loss rates.

48 Economic and Fiscal Impact Analysis of MSBDFA’s Portfolio of Firms on Maryland’s Economy, 2000-2009, Towson University

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Figure 6-1. MSBDFA Program Overview

Contract Finance Loan Guaranty Surety Bond Equity Participation

Stature

Types of Financial Assistance

Loan guaranty, equity guaranty, direct loan

Guaranty of up to 80% of the P&I on long-term

loans. Interest subsidy up to 4% for life of

guaranteed loans

Guaranty of surety bonds. Direct issuance

of surety bonds. Establishment of surety

bonding lines.

Loan, investment, guaranty of investments

Amount Available

Maximum payable under loan guaranty not

to exceed $2 million. Lesser of 10% or $250,000 equity

guaranty. Up to $2 million direct loan

Loan amount not less than $5,000. Maximum payable under loan guaranty not to

exceed $2 million

Guaranty up to lesser of 90% or $1.35 million of surety losses. Direct

bonds not more than $1 million each

Not to exceed $2 million

Eligible Uses

Working capital and equipment needed to perform contracts at least 51% funded by

government agencies or public utilities.

Working capital, refinancing debt,

machinery/equipment. Improvements to real

property leased or owned. Acquisition of real

property used in business.

Bid, payment & performance bonds related to contracts

funded by government agencies, public utilities

or private entities.

Purposes approved by authority, including working capital, purchase

of inventory, equipment or real property, construction/renovation,

leasehold improvements

Contract Finance Loan Guaranty Surety Bond Equity Participation

Unable to obtain adequate bonding at

reasonable rates through normal

channels

Unable to obtain adequate financing through normal channels

because: group historically deprived of access, physical handicap,

social/economic impediment or does not meet the credit criteria of

at least one financial institution

Finding of Substantial

Economic ImpactNot required Required Required Not required

Inability to Secure Other Funding

Required, turn -down letter required for loan

guaranty only

Required, turn -down letter required for all

RequiredRequired, turn -down letter

required for loan guaranty only

Other Terms

Term of loan or loan guaranty may not

exceed contract term. Restrictions on equity guarantees to owners,

management, etc.

Prime +2% rate cap on guaranteed loans. Lien required on real estate

acquisition loans. Maximum loan term 10

years

Term of bond guaranty may not exceed contract

term plus applicable warranty period. Principal may not

subcontract more than 75% of dollar value

n/a

Unable to obtain adequate financing through normal channels because: group historically

deprived of access, physical handicap, social/economic impediment or does not meet the

credit criteria of at least one financial institution

Good moral character, financially responsible, resident of or business located in Maryland

Qualifications of Applicant

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Program Summary MSBDFA programs seek to uplift Maryland-based borrowers and communities that do not have access to traditional funding sources. The following key indicators reflect MSBDFA public benefits:

1. Increased Maryland’s tax base via small business growth, 2. Sustained and created jobs (especially economically and socially disadvantaged

populations), and 3. Created borrowing opportunities for business owners that are unable to access

traditional capital sources. As discussed in Appendix 3, minority- and women-owned businesses continue to experience difficulties in accessing capital.

Figure 6-2. MSBDFA Asset Allocation by Program As of 6/30/2014 Audit

Source: MSBDFA Audit and Management reports

Organization $ %Total # of

LoansAverage Credit

Exposure per Loan

# of New/Retained

Jobs by ProgramMSBDFA 22,400,000$

Programs:Contract Finance 3,855,000$ 17.2% 19 202,895$ 330Loan Guaranty 4,551,780 20.3% 23 197,903 373Surety Bond 5,115,000 22.8% 6 852,500 59Equity Participation 4,481,844 20.0% 28 160,066 328Other 4,396,376 19.6% - - MSBDFA Total Assets 22,400,000$ 76 1,090

Total Assets

Figure 6-3. MSBDFA Historical Losses by Fiscal Year

Source: MSBDFA FY 2014 Audit and management reports

2000 2001 2002 2003 2004 2005 2006 2007Portfolio loss rate 0.81% 13.35% 24.20% 3.27% 2.97% -2.27% 2.87% -0.23%

2008 2009 2010 2011 2012 2013 2014Historical Average

Portfolio loss rate, cont. 12.07% -1.20% 0.86% 46.40% -18.83% 106.95% 9.21% 9.02%

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The MSBDFA program receives financial support to help cover operating costs as well as program growth. In FY 2013 and FY 2014 the primary funding sources were from Invest Maryland and State appropriations. (See Figure 6-4.)

During FY 2014, the MSBDFA program approved thirty loans and funded twenty-three loans. In addition, the MSBDFA program made loan disbursements of $3,855,000 and received loan repayments of $4,551,000 (repayments represent approximately 20% of MSBDFA total assets). (See Figure 6-5.)

MSBDFA Outcomes by Program Figure 6-6 shows the outcomes for each program including new and retained jobs as reported by the companies when applying for the loan. Following are discussions of each program area, including trends.

Contractor Financing Program (CFP) The Contract Financing Program provides financial assistance to eligible businesses in the form of direct loans. As of 6/30/14, the entire CFP portfolio was $3,855,000. The funds may be used for working capital and the acquisition of equipment. Additionally, funds can be allocated to continue or complete work on contracts where a majority of funds are provided by a federal,

Figure 6-4. MSBDFA FY 2013 and FY 2014 Funding Sources

Source: MSBDFA FY 2014 Audit

2013 2014

Invest Maryland grant revenue 2,287,717$ 2,310,000$ State appropriation 2,500,000 1,500,000 Other 4,787,717$ 3,810,000$

Figure 6-5. MSBDFA Summary Outcomes and Inputs

Source: MSBDFA FY 2014 Audit and management reports

$ # of Deals Reviewed

# of Loans Approved

# of Loans Funded

Jobs Retained

Jobs Created

Loan disbursements 3,855,000$ 70 30 23 131 223

Proceeds from loan repayments

4,551,780$

Figure 6-6. MSBDFA Outcomes by Program Contractor Financing

186 184 $3,855,000 $768,610 $3,855,000

Guaranty Financing

109 238 $13,796,000 $7,084,681 $4,391,050

Surety Bond

30 29 $5,115,000 $2,842,086 $5,115,000

EPIP 169 159 $5,869,084 $4,480,693 $4,619,979 Total 494 426 $28,635,084 $15,176,070 $14,481,029

Source: MSBDFA Maximum Exposure Report – June 30, 2014

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state or local government agency or utilities regulated by the Public Service Commission. Financing in either form is limited to $2,000,000 and may be repaid during the term of the contract. Applicants may qualify for financing prior to contract award. As of June 30, 2014 the CFP portfolio has nineteen active loans with an average credit exposure per borrower of approximately $200,000. As of June 30, 2014, the CFP portfolio is credited with maintaining or creating approximately 330 jobs. The portfolio’s current balance represents the outstanding loan amount and the portfolio’s maximum exposure represents total credit availability to borrower. As of 6/30/14, the majority of contract financing loans are in the form of lines of credit, of which the MMG management team actively manages the borrower’s current exposure.

Trends The Contractor Financing Program has been the most active portfolio within MSBDFA. The program primarily provides working capital financing for businesses that secure public sector, public utility and to a lesser extent private sector-based projects. The Contractor Financing Program has helped to provide capital to a number of start-up enterprises with public sector contracts. Historically, the Contractor Financing Program funded construction-related deals; however, over time the portfolio has begun to migrate into helping information technology and service-based businesses. MSBDFA will underwrite the borrower based upon its total cash flow from current and proposed contracts. The Contract Financing Program is used primarily for receivables financing and to a lesser extent mobilization financing. The mobilization financing enables the borrower to obtain working capital before the submission of an initial invoice. The mobilization funding is typically used to cover up-front equipment, insurance, payroll, etc. The term of the mobilization financing is typically matched to the duration of the contract. The receivables financing represents financing that is available after submission of an invoice. In addition, the Contract Financing Program has been very helpful to borrowers that are currently utilizing factoring or receivables financing alternatives. The Contractor Financing Program has been steady in terms of year-over-year deal flow. MMG believes the Contract Financing Program portfolio has the potential to grow based on a number of Maryland based firms that are pursuing federal, state and local contracting opportunities.

Guaranty Fund Program (GFP) The Guaranty Fund Program provides financial assistance to eligible businesses in the form of loan guarantees and interest rate subsidies for loans made by financial institutions. A loan guaranty cannot exceed the lesser of 80 percent of the loan or $2,000,000. Guarantees cannot exceed 10 years in duration. The GFP can also subsidize up to four percentage points of the primary loan, subject to an annual review of the interest being charged by the financial institution making the loan. The subsidy’s terms of repayment are negotiated directly with the borrower. Loan proceeds can be used for working capital, the acquisition and installation of machinery or equipment, refinancing of existing debt and the purchase of, and improvements to, real property owned or leased by the applicant. 72


As of June 30, 2014, the Guaranty Fund has twenty active loans within the portfolio and the average credit exposure per borrower is approximately $220,000. As of June 30, 2014, the guarantee portfolio has maintained or created approximately 350 jobs.

Trends According to MMG and MSBDFA staff, the current banking partners have experienced challenges in accessing the Guaranty Fund capital pool. In general, the lenders use the SBA loan guarantee program to obtain collateral support for its small business lending portfolio. The Guaranty Fund, however, has been structured to provide credit support for borrowers unable to secure traditional bank loans. The Guarantee Fund lending partners submit loan proposals for approval, but in a number of cases, the MSBDFA loan committee restructures the loan terms and credit support levels. The loan restructure approach has not been received well by bank partners, resulting in a decline in overall lending parameters. Also, the Guaranty Fund approval process results in a delayed approval process because deal terms have to be negotiated between lender and MSBDFA, which may create liquidity challenges for the borrower.

Surety Bond Program (SBP) The Surety Bond Program assists eligible small businesses in obtaining bid, performance or payment bonds necessary to perform on contracts where the majority of funds are provided by a government agency, public utility or private contracts. The SBP directly issues the bid, performance or payment bonds or guarantees a surety’s losses incurred as a result of the contractor’s breach of a bid, performance or payment bond. Bonds that are directly issued are limited to $5,000,000. Guaranties are limited to 90% of the face amount of the bond not to exceed a maximum participation of $5,000,000. Guarantees on bonds remain in effect for the duration of the surety’s exposure under the bond. Bonds issued directly will remain in effect for the duration of the qualified contract and any related warranty period. Bond premiums generally range from 2% to 3%. Also, a surety bond revolving line of credit may be established to directly issue or guarantee multiple bonds to a client within pre-approved terms, conditions and limitations. As of June 30, 2014, the Surety Bond Fund has six active loans in the portfolio and the average credit exposure per borrower is approximately $220,000. Approximately 60 jobs have been maintained or created by the firms in the Surety Bond portfolio as of June 30, 2014.

Trends The Surety Bonding loans are trending towards larger size transactions. The Surety Bond Fund is experiencing fewer small bond requests (those less than $500,000) and an increased number of large bond requests (those greater than $1,000,000). In general, larger bonds require higher net worth and cash flow thresholds to achieve minimum bond underwriting requirements. Traditional surety bond underwriters use conservative underwriting standards. Because of this, most of the MSBDFA portfolio borrowers are unable to access the traditional surety bond underwriting market. The MSBDFA underwriting process takes a more non-traditional credit approval approach by focusing on the contractor’s ability to perform the job as well as their

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financial profile. While the surety bond is made based upon the contractor’s ability to perform, the structure of the surety bond will be based upon the contractor’s financial strength.

Equity Participation Investment Program The Equity Participation Investment Program (EPIP) is designed to extend business ownership by socially- and economically-disadvantaged entrepreneurs and small businesses. Typically these entities do not meet the established credit criteria of financial institutions. Additionally, many are unable to obtain adequate business financing on reasonable terms through normal financing channels. Financial assistance is provided through the use of loans, loan guarantees and equity investments. The proceeds must be used for the specific purpose of purchasing a franchise, acquiring an existing profitable business, developing a technology-based business or to start or expand other types of small businesses. Equity investments may take the form of the purchase of qualified securities, certificates of interest, interest in a limited partnership of other debt and equity investments. All equity investments must be liquidated by the end of the seventh year. Before a financing relationship has begun, a general agreement regarding the probable method of liquidation must be developed. The most common form of repayment is for the owner to buy back the EPIP investment at a pre-determined pricing formula between the fourth and seventh year. In all cases, the recovery amount shall be the greater of its percentage of the business’ current value or the initial investment. An independent appraisal of the business entity may be required to determine its value at the retirement of the debt investment. The details of the four individual components of EPIP are:

• Franchising Investments – Limited to 49% of the total project cost or a maximum of $2,000,000. The applicant is required to make an equity investment of no less than 10% of the total project cost.

• Business Acquisitions – Limited to 49% of the initial investment or a maximum of $2,000,000. The applicant is required to make an equity investment of not less than 5% of the total cost of the acquisition. Business acquisition was added as a program element in 1989.

• Technology Investments – Limited to a maximum of $2 million in a business entity with a proven technological product or service. The technology investment program element was added in 1992.

• Other Small Businesses – Limited to a maximum of $2 million to start or expand a business. The other small business program was added in 2005.

As of June 30, 2014, the Equity Participation Investment Program has twenty-nine active loans/investments within the portfolio and the average credit exposure per borrower is approximately $195,000. The EPIP portfolio as of June 30, 2014 has maintained or created approximately 330 jobs.

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The program strives to help businesses achieve long-term objectives of growth and profitability. To accomplish this objective, the financing must be structured to build equity and expand market share. Ultimately the program seeks to enable the business to graduate from the program by successfully repaying the loan and securing financing from a traditional funding source.

Trends The EPIP portfolio represents one of the most attractive growth opportunities for the MSBDFA portfolio. The flexibility of the loan/investment type (traditional debt, mezzanine or equity structures) provides management with the opportunity to help finance high-impact companies with creative deal structures. The EPIP program allows MSBDFA to identify the capital needs of the borrower and design a funding solution for the borrower. The other MSBDFA funding programs address specific financing needs, but the EPIP program can address a much more diversified set of small business needs.

A Financial Overview of MSBDFA MSBDFA was created to provide financial resources to small businesses located throughout the State of Maryland. As of 6/30/2014, the MSBDFA program’s total assets were $22.4 million as shown in Figure 6-7. Total assets have grown by approximately $1 million per year over the past three years. This net financial position represents the flexibility of the MSBDFA balance sheet (equity equivalent). Significant unrestricted net assets allow the management team to provide patient capital to meet borrower’s on-going capital needs. The cash balance is used primarily to provide financing to loan guarantees, surety bonds, unfunded commitments and general working capital for the MSBDFA program.

Figure 6-7. MSBDFA Summary Balance Sheet as of June 30, 2014 Audit

Source: MSBDFA Financial Audit – June 30, 2014

2012 2013 2014AssetsCurrent assets 17,031,774$ 19,989,982$ 20,402,979$ Non-current assets 3,414,766 1,352,396 1,997,536 Total Assets 20,446,540$ 21,342,378$ 22,400,515$

LiabilitiesTotal Liabilities 989,344$ 1,996,818$ 1,895,720$

Net PositionNet position, restricted - Federal 65,500 65,500 - Net position, unrestricted 19,391,696 19,280,060 20,504,795 Total Liabilities and Net Assets 20,446,540$ 21,342,378$ 22,400,515$

June 30,

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However, the balance sheet does not adequately reflect the lending activity of the MSBDFA program. By way of example, the majority of the current assets represents guarantee commitments, but these are not reflected in the financials as restricted cash. Also, the financial audit reflects notes receivable of $4,420,000 (note #4 in the MSBDFA 2014 Financial Audit Report); however, the majority of the notes receivable have durations that exceed one year. Figure 6-8 further illustrates the challenges in the structure of the MSBDFA audit. According to the 2014 financial audit, the MSBDFA program has $19.1 million in unrestricted cash; however, MSBDFA actively manages four separate loan fund programs. On the financial audit’s balance sheet, cash is classified as unrestricted, but should be classified as restricted because guarantees/obligations have been made to borrowers/banks. When a line of credit is issued or a guarantee is made to support a small business loan, MSBDFA is contractually obligated to fund its commitment in the event of default. As an external reviewer analyzing the financial audit, the cash balance implies MSBDFA has $19 million in investable capital and $2.3 million in loan exposure. As demonstrated in Figure 6-9, the MSBDFA program does not currently generate sufficient loan interest income to cover expenses. In 2014, the net operation loss was $2.7 million. MSBDFA generated $3.8 million in state appropriations and grant revenue in that year to manage the program and replenish available loan funds. For public policy reasons, the loan guarantee products and direct loan products are not priced to maximize profit. Instead, MSBDFA seeks to meet the need of the state’s small business owners. Because MSBDFA program has a historical loan loss rate of 9.0%, there is also a periodic need to replenish the loan reserve account to cover actual losses. The operating expenses include a contract for the management of the program, held by Meridian Management Group since the inception of MSBDFA, and a separate allocation to Commerce for certain costs associated with MSBDFA administrative services, to include managing wires to borrowers and managing default/write off borrower activities.

MSBDFA Management The Meridian Management Group (MMG) manages MSBDFA under contract to the Department of Commerce (DOC). The leadership of MMG includes former Maryland state employees who pioneered the development of MSBDFA’s financing programs and have continued to help the MSBDFA programs evolve. The firm’s corporate mission is to help capitalize small businesses within the state of Maryland, especially businesses represented by historically disadvantaged

Figure 6-8. MSBDFA Total Assets Summary

$'s %

Cash 19,160,024$ 86%Loan receivable 2,387,876 11%Other assets 852,615 4%Total Assets 22,400,515$ 100%

Total Assets

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populations. MMG has managed the program since 1995 (when MSBDFA was spun out of Commerce) and conducts all due diligence and portfolio management activities. The MMG team consists of professionals with experience in accounting, banking and law who maintain active communication with existing MSBDFA borrowers. Staff has developed a process of analyzing and monitoring each of the portfolio companies. In addition to MMG’s internal due diligence and portfolio management process, the MSBDFA programs maintains an external loan review committee that consists of experienced bankers, venture capital professionals, small business owners, accountants as well as an MSBDFA representative. Management is contractually obligated to recommend at least 30 fully underwritten transactions per year and ensure that at least 20 loans are ultimately funded. Management has a monthly goal of conducting preliminary due diligence on five transactions to achieve its contractual goals. MMG provides these portfolio management and deal underwriting services in exchange for a direct management fee. In addition to a number of other services, MMG also provides active technical assistance services to prospective borrowers, portfolio borrowers and borrowers in the underwriting stage. Many of the MSBDFA portfolio companies require some form of technical assistance.

Figure 6-9. MSBDFA Income Statement Summary as of June 30, 2014 Audit

Source: MSBDFA Financial Audit – June 30, 2014

2013 2014RevenuesInterest income on loans receivable 139,566$ 101,911$ Insurance/guarantee fees 109,201 69,193 Recoveries 11,096 126,355 Other 118,799 47,925 Total operating revenue 378,662$ 345,384$

ExpensesManagement Fees 1,556,693 1,628,024 Administrative allocations 681,296 955,502 Provision for loan losses 826,408 279,592 Provision for guarantee losses 2,097,905 169,879 Other expenses 261,687 32,127 Total expenses 5,423,989 3,065,124

Net Operating Loss (5,045,327)$ (2,719,740)$

Non-Operating RevenueInvest Maryland grant revenue 2,287,717 2,310,000 State appropriation 2,500,000 1,500,000 Other 145,974 68,975 Adjusted Net Operating Income (Loss) (111,636)$ 1,159,235$

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The current contract between Commerce and MMG addresses the following key areas: 1) underwriting, 2) authority meetings, 3) loan documentation, 4) loan closing, 5) loan monitoring, 6) loan servicing, 7) mandatory notification to Commerce regarding key issues, 8) designation of problem loans, 9) marketing/public relations, 10) legal assistance, 11) accounting assistance, 12) MSBDFA legislation and 13) standard of care. According to the existing contract, MMG will provide an annual marketing and promotional budget to Commerce for approval, separate from the current Commerce management fee contract, but no current marketing and promotional budget is in place.

Other States’ Small Business Loan Programs In response to capital access disparities, states have begun to take notice of capital gaps within its local communities. Although a few states are embracing new and different approaches, models similar to Maryland are limited. As states compete with each other, strive to best leverage their unique assets, and respond to their unique challenges, leading practices have continued to diverge by offering a variety of programs, including:

• Providing capital access programs for disadvantaged and minority borrowers • Scaling contract based financing and surety bonding programs • Leveraging private capital sources through risk mitigation • Leveraging alternative capital sources to capitalize revolving loan programs

Capital Access for Disadvantaged and Minority Borrowers Several states have initiated capital access programs focused on minority borrowers. Such programs feature flexible collateral requirements and lower rates and terms; however, they do not lend to startups. Capital access programs fill a market need that is NOT currently being met by predatory private sector lenders. Ohio and Mississippi’s programs provide fixed, low-interest rate loans to certified minority-owned businesses that are purchasing or improving fixed assets and creating or retaining jobs. Several states have programs focused on disadvantaged and/or minority borrowers that provide capital access along with other components (surety bonding, contract based financing, and loan guarantees). Mississippi responded to trends in its state by creating a microloan fund focused on helping the smallest disadvantaged businesses. This supplements another program focused on helping contracts that may not have adequate working capital to fulfill their public contract bids. The details of such programs in New York, Mississippi, and other examples are discussed below.

Scaling Contract Based Financing and Surety Bonding Programs Several states have implemented loan programs focused on a contractor that has secured a public sector contract for construction (or some form of infrastructure), but is facing a working capital gap. Contract based financing has been successfully executed in a handful of states (including Mississippi, New York, as well as Maryland).

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Mississippi’s Minority Surety Bond Guaranty Program provides socially and economically disadvantaged minority businesses with technical assistance throughout the construction bonding process. The program's main goal is to increase minority participation in construction and building trade contracts with federal, state and local units of government. The program also provides eligible businesses with a bond guaranty where necessary. The annual interest for these loans is zero percent, with a limit of $75,000 or 75 percent of a given contract. There is little publicly available data on the economic impact, default rates, or other performance indicators for this program. NY State’s Bond Access Program (BAP) was created in order to increase the amount of contracts awarded to Minority and Women Business Enterprises (M/WBEs) and other small businesses. BAP initially received $10,400,000 million from New York’s SSBCI allocation and was designed to enable small and M/WBE construction firms to secure the bid bonds, bid lines, performance bonds or payment bonds. There is also significant demand and several sub-state organizations (e.g., cities, loan funds) are beginning to implement them. For instance, the city of St. Louis announced in May 2015 that it would be launching a $10,000,000 minority contracting revolving loan program.

Leveraging Private Capital Sources Through Risk Mitigation Several states (Texas, South Carolina, Massachusetts, New York, and California to name a few) have leveraged risk mitigation (loan loss reserves) to bring significant scale to their programs within a few years as opposed to several decades. Modeled similarly across states, the programs provide a public sector match of 1:1 for combined borrower and lender contributions (typically between 3.5 and 7 percent of the loan amount). The reserve is established at the participating financial institution willing to make the loans. The state provides matching funds that are placed on deposit in the reserve account equaling the amount that the borrower and lender have deposited. The capital access program (CAP) is often used to support open lines of credit and working capital. While these programs tap only a small amount of public resources, they can generate a relatively large amount of private financing. However, lenders of late have been slow to accept this model, especially since the 2008 financial crisis. Many banks participating in these state programs had loss rates larger than the reserve amount, and they deemed the risk too high the resources available. The exception to this rule is in California, which has been able to make this program work well during the past few years. The primary participating lenders have been Community Development Financial Institutions and smaller community banks that have enrolled a large number of small transactions. This adds new capital reserves to the participating institutions, and the relatively small size of each enrolled transaction has help to mitigate risks in the event of individual loans defaulting. The benefit is that CAP model, when instituted properly and accepted by partner institutions, can leverage significant lending activity in low- and moderate-income communities with only limited public investment.

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The NYC Capital Access Loan Guaranty Program helps micro and small businesses experiencing difficulty accessing conventional bank loans to obtain loans and lines of credit up to $250,000 for working capital, leasehold improvements, and equipment purchases. Some micro lenders will consider start-up loan applications. The program provides up to a 40 percent guarantee on loans for qualified NY City micro (under 20 employees) and small (21-100) businesses experiencing difficulty in accessing loans.

Leveraging Alternative Capitalization Sources Michigan’s’ 21st Century Jobs Fund is financed by the sale (or "securitization") of tobacco revenues that accrue to Michigan from the Master Settlement Agreement between the major tobacco companies and the various U.S. states. In Michigan, state government decided to allocate up to $1.0 billion of proceeds from the Tobacco Settlement proceeds to help strengthen and diversify Michigan's economic base. Up to 40% ($400 million) of the amount allocated to the 21st Century Jobs Fund may be invested through the Capital Investment Program over the life of the 10-year initiative, of which the Michigan 21st Century Investment Fund, L.P. is a part. Arizona, New York, and Texas have private equity funds that are capitalized by non-public investors. Hence, the program’s performance with regards to returns is the primary concern and it is benchmarked similarly to other private equity funds. Job creation and other impacts are secondary considerations.

Lessons from the State Small Business Credit Initiative Congress authorized up to $1.5 billion to the US Department of Treasury in 2010 as a transfer to the states to help expand access to capital for small businesses and small manufacturers. The funds were allocated to more than 150 state programs, including several in Maryland. This State Small Business Credit Initiative (SSBCI) provides some insights for Maryland’s lending and investment programs. While not specifically focused on minority or other disadvantaged borrowers, this large-scale experiment in a variety of loan program schemes across the country did have an emphasis on ensuring that underserved small businesses were able to access capital and provided many lessons for public lending programs. An analysis of SSBCI found that the most successful loan programs were simple to use and to administer. They made the application process easy and the fees modest. The programs were “lender-friendly” in their design and management, using guidelines that were closely aligned with standard lender operating procedures. Wherever possible, states would use the lenders’ own documents during the closing process to reduce paperwork and the need for educating loan originators.49 Furthermore, the SSBCI study found that lenders were most interested in working with programs that fulfilled clear market needs, including help for small businesses that:

• Do not meet the guidelines for SBA or USDA loan programs; • Require some degree of credit support, but do not justify the cost and paperwork of a typical

government-guarantee program; and • Provide short-term working capital and bridge financing.

49 CREC, 2015. “Filing the Small Business Lending Gap: Lessons Learned from the US Treasury SSBCI.” https://www.treasury.gov/resource-center/sb-programs/Documents/CREC%20January%202014%20FINAL.pdf

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The SSBCI study also found that the best way to implement a program focused on underserved populations was by working with specialized lenders, community banks, and CDFIs.

MSBDFA Peer Comparison While not a perfect comparison, one close analogy to the MSBDFA portfolio is found in the Community Development Financial Institutions (CDFI) sector, which consists of community-based economic development loan funds. CDFIs fill a market gap by supplying financial products and services tailored to the needs of underserved communities and are targeted to promote community development. CDFIs may take the form of loan funds, credit unions, banks, holding companies, and venture funds within the finance/insurance/real estate industry. As of November 30, 2010, there were approximately 907 certified CDFIs in operation in the United States, including 572 nonprofit loan funds, 197 credit unions, 72 CDFI banks, 41 bank holding companies, and 25 venture funds.50 CDFIs are typically legally structured as stand-alone non-profit entities, which have both a financial and social mission. Like MSBDFA, CDFIs serve low-income, minority- and women-owned businesses (75, 52 and 48 percent respectively), and focus on riskier loans to underserved communities. CDFIs are required to market for deal flow as well as provide the borrower technical assistance. Figure 6-10 provides a financial comparison between MSBDFA and the CDFI industry. The CDFI peer group produces approximately 50% of revenues from grants/operating support and

50https://www.richmondfed.org/~/media/richmondfedorg/conferences_and_events/community_development/2012/pdf/cdfi_industry_analysis.pdf.

Figure 6-10. MSBDFA Peer Comparisons – Balance Sheet and Income Statement

Source: Opportunity Finance Institutions 2013 Side-by-Side Report Note: MSBDFA expenses include $1.6 million management fee to MMG and a $1.0 million fee to the Department of Commerce.

Peer GroupMSBDFA

(2014)

Balance SheetCapital 27,193,176$ 22,400,515$ Net assets 22,048,820 20,504,795

Income StatementRevenues 5,262,812 4,155,384 Expenses 3,554,049 3,065,124 Net Operating Income 1,708,763 1,090,260

Contributed revenue/total revenue 50% 92%Earned revenue/total revenue 50% 8%Self-sufficency ratio 74% 11%

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approximately 50% of revenues from interest income. The interest income covers approximately 75% of a typical CDFI’s operating cost. The MSBDFA program has a lower self-sufficiency ratio, as compared to CDFI peers. As shown in Figure 6-11 on the following page, the CDFI peer group has an average staff size of nineteen (19) full-time employees of which 45% are allocated to financing, 15% to technical assistance, and 40% to administrative/other activities. The MSBDFA team spends time on technical assistance as part of the underwriting process, but does not have dedicated technical assistance resources as compared to traditional CDFIs.

Overall, the MSBDFA program has higher losses and a higher expense load as compared to its CDFI peer group. The portfolio loss threshold indicate that MSBDFA’s loans represent a higher risk profile or a more diverse population as compared to the broader CDFI peer group. This is not surprising since some CDFI loan portfolios include a higher percentage of real estate loans, and a lower concentration of minority borrowers. In terms of small business lending, the CDFI is still in the early stages of meeting minority-lending needs. The MSBDFA program is incurring costs from the loan fund manager and Department of Commerce, but it is not clear whether these expenses are unreasonably high.

Figure 6-11. MSBDFA Peer Comparisons – Staffing Level By Category CDFIs With Assets between $15-50 Million

Note: the MSBDFA operating expense per full time employees includes approximately $1 million in additional costs attributable to the Department of Commerce.

Peer GroupMSBDFA

(2014)

Staff# of FTE's 19 12 % for financing 45% 33% % for technical assistance 15% 0% % for Admin/Other 40% 67%Total 100% 100%

Peer Group MSBDFA

Operating expense/FTE (1) 216,339 255,427 Salary expense/FTE full time equivalent 82,546 135,024

# direct financing closed & loans underwritten/packaged in FY2013/# of financing FTEs

8 7.5

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MSBDFA Findings The MSBDFA program provides an attractive public benefit to the State of Maryland in terms of providing capital to small businesses unable to access capital from traditional banks. In addition, the MSBDFA program, with a focus on historically disadvantaged populations, represents an innovative program because of its specialization on addressing the unique needs of minority- and women-owned enterprises.

• Programs: The MSBDFA programs help small business owners in accessing capital typically unavailable from traditional lenders. Also, the MSBDFA programs help existing small businesses avoid the trap of seeking funding from predatory sources.

• Small Business Industries: The MSBDFA programs help provide capital to small businesses from a variety of industries including construction, Information Technologies, franchises, service, etc.

• Flexible Financing: The MSBDFA program provides capital to borrowers at rates and terms more flexible than traditional sources. Also, the MSBDFA programs enable borrowers that may not have perfect credit to access credit sources.

• Technical Assistance: The MSBDFA program offers technical assistance resources to help prospective borrowers better understand their business model, financial profile, borrowing capacity and evaluation of contract opportunities.

• Marketing: The MSBDFA program offers an array of products to a diverse set of business owners, but with only limited resources to effectively market the program.

• Loan Guarantee Program: The Loan Guarantee Program requires more standardization in terms of guarantee amount and underwriting criteria to make the program simpler to access for existing and future lending partners.

• Financial Audit: The financial audit should be restructured to reflect a loan fund structure. By way of example, the cash account should be reclassified as restricted and unrestricted cash because the majority of the cash account appears available on the accounts but is actually restricted because the funds support portfolio loan guarantees and surety bond commitments.

• Portfolio Risk: Over the past fifteen years, the MSBDFA portfolio has experienced historical annual losses of approximately 9.0%. This may have be skewed by two unusual but significant losses. Discounting for these events, the projected loss rate of 7.0% is acceptable given the borrower profile and inherent risk within the portfolio.

MSBDFA Recommendations • Develop strategy to address MSBDFA marketing and technical assistance

program shortfalls

MMG and Commerce should discuss the MSBDFA marketing and promotional needs for FY 2016 and implement a strategy and budget to help ensure the program’s maximum exposure and overall success. MSBDFA should consider establishing a formalized partnership with existing technical assistance programs aimed at small businesses (e.g. Small Business

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Development Centers, SCORE,51 Women’s Business Center) to help portfolio companies as well as small businesses across the state.

• Re-evaluate the MSBDFA approval process for loans below $250,000

Establish a threshold for an accelerated loan approval process for loans below a certain size. The existing loan committee and the fund manager can determine the actual threshold. Currently, the loan approval process requires all loans to go through a formal loan review. The MSBDFA loan review committee meets one time per month; however, the fund manager may identify attractive lending opportunities, which may require an accelerated loan approval and loan closing process. The MSBDFA program should establish a maximum loan amount in which the fund manager has the flexibility to approve loan requests without formal approval from the loan committee.

• Re-design the financial audit

Re-design the financial audit structure to better reflect a traditional loan fund structure. The annual audit is a very important tool for evaluating the MSBDFA program; however, the financial audit should be restructured to reflect the financial profile of a traditional loan fund or a CDFI.

• Establish pipeline development strategy

Carve out a portion of the existing management contract to provide a minimum level of marketing efforts, participate in a certain number of outreach events per year and hire a full time business development officer (or contract with a 3rd party business development entity). In addition, we recommend building out a dedicated social media effort to raise the awareness of the program as well as its product offerings and success stories. Currently MSBDFA sources new loans from the fund manager’s existing referral networks. The fund managers have been able to successfully underwrite approximately thirty (30) loan requests per year; however, there is an opportunity for the MSBDFA program to reach a broader small business community by actively marketing the loan programs.

• Broaden MSBDFA’s program flexibility

Eliminate the program designations (Contract Financing, Surety Bonding, Guaranty Fund, & Equity Participation Investment Program) and implement the program as a single pool of capital with the ability to offer different products: 1) lines of credit, 2) term loans, 3) letters of credit, 4) loan guaranties, 5) surety bonding and 6) equity investments. Eliminating the loan program designations will provide the MSBDFA program with the broadest level of product flexibility and the broadest service offering to the Maryland small business community. Overall, the MSBDFA program should continue to offer broad versus narrow loan product offerings because the financing needs of Maryland based small businesses will continue to shift based upon market

51 SCORE is a nonprofit association dedicated to helping small businesses get off the ground, grow and achieve their goals through education and mentorship.

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forces. While the MSBDFA product offerings are fairly flexible, these structural changes will enable the program to reach a broader network of clients.

Small, Minority- and Women-owned Business Account – VLT Fund During the 2007 special session, the General Assembly enacted legislation to license Video Lottery Terminal (VLT) gaming in Maryland contingent on the legislation being ratified by the voters of the State. In the November 2008 general election, the voters of Maryland ratified a constitutional amendment authorizing VLTs in the State. Because of the ratification of the constitutional amendment, the Small, Minority-, and Women-Owned Businesses Account (Account) was established. State Law generally requires that 1.5 percent of VLT proceeds be paid into an Account, which is a special, non-lapsing fund administered by the Comptroller of Maryland under the authority of the Board of Public Works (BPW). State Law specifies that the Account be used by the BPW to provide capital to eligible fund managers to finance loans and investments by Maryland small, minority, and women-owned businesses. At least 50 percent must be allocated to such businesses in the jurisdictions and communities surrounding a video lottery facility defined as the “targeted area” (an area defined as 10-mile radius around an existing casino location). BPW is responsible for ensuring that the fund managers allocate the funds in accordance with the State law. BPW has designated the Department of Commerce to manage the VLT Program. Currently, the VLT proceeds are funded from five casinos licensed by Commerce to operate in Cecil County, Worcester County, Anne Arundel County, Allegany County and Baltimore City as shown in Figure 6-12.

The State of Maryland has awarded grant amounts over three years into the VLT program as shown in Figure 6-13.

Figure 6-12. VLT Casino Locations

Casino Names Date LaunchedCecil Casino September 2010

Worcester Casino January 2011Anne Arundel Casino June 2012

Allegany County Casino May 2013Baltimore City August 2015

Figure 6-13. VLT Program Award Deployment by Year

Note: The VLT annual state fund allocation has increased approximately 20% per year

2014 2015 2016

7,900,000$ 9,100,000$ 11,500,000$ n/a 15% 26%

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Over the past three years, seven Fund Managers have been awarded VLT Grant Funds: 1) Anne Arundel County Economic Development, 2) Baltimore County, 3) Baltimore Development Corporation, 4) Howard County, 5) Maryland Capital Enterprises, 6) Meridian Management Group, and 7) Tri County Council of Western Maryland. Each fund manager is also required to use at least 50% of its award in a Targeted Area. Figure 6-14 shows the amounts awarded to each of the fund managers by year.

VLT fund managers enter into a five-year contract, with a one-time five-year extension (ten year total award), to manage the VLT grant funds. However, the fund manager must deploy at least 50% of the current year proceeds to Maryland-based small businesses to be eligible for future capital awards. To be eligible for the next year’s funding round, VLT managers must demonstrate that they have:

• Effectively deployed previously available VLT loan capital • Effectively deployed capital to the target geographical targets • Made sound lending decisions as measured by historical delinquency rates

Currently, the program does not have any formal written requirement to lend specific percentages of VLT capital within its specific underserved sectors (i.e., small business, minority and women owners). The current program specifics allow the VLT fund managers three ways to cover operating costs:

• 8% Administrative Fee (First Year Only) – The VLT program allows the fund manager to use 8% of the contract award to cover a portion of its first year administrative expenses.

• Interest Income - Existing Loan Portfolio – The VLT program allows the fund managers to retain the loan origination fees and interest income from the loan portfolio.

• Annual Overhead Allowance (Excess Allowance Fee) – The annual overhead excess allowance fee is capped at 5% per year, available beginning in the second year of operations. The actual excess allowance fee award will be determined based upon a

Figure 6-14. VLT Program Award by Fund Manager

2013 2014 2015 TotalsAssetsAnne Arundel Economic Development 3,360,000$ 2,000,000$ 1,850,000$ 7,210,000$ Baltimore County - 1,500,000 1,600,000 3,100,000 Baltimore Development Corporation - 1,000,000 1,700,000 2,700,000 Howard County - 1,500,000 1,700,000 3,200,000 Maryland Capital Enterprises 1,000,000 - 1,000,000 2,000,000 Meridian Management Group 3,500,000 2,000,000 2,150,000 7,650,000 Tricounty Council of Western Maryland - 1,100,000 1,000,000 2,100,000 Totals 7,860,000$ 9,100,000$ 11,000,000$ 27,960,000$

Award Year Beginning July 1,

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review of the fund’s annual income and expenses. At the end of the fiscal year, the fund manager is eligible to apply for reimbursement, but there is no guarantee payment will be made to the fund manager. As a result, fund managers incur operating costs during the year, but they do not know whether they will actually be reimbursed.

Figure 6-15 assumes the VLT manager receives $1 million in a funding award. Other fund size table assumptions include:

• Fund manager fully deploys award on the same day as the award, • Portfolio weighted average interest rate is 4% (the actual average of VLT fund

managers), and • The Fund manager receives the full amount of the excess allowance fee.

According to the seven VLT managers, all existing VLT loan programs are operating at a loss. The loss is magnified by the uncertainty of receiving the full amount of the excess allowance fee. The total VLT portfolio’s average interest rate is 4%. In addition, there are certain aspects of the VLT loan program that differs from their existing loan programs:

• A number of loan managers indicated their other loan programs are loan guarantee programs, which enable the managers to leverage existing banking relationships. The VLT program requires the establishment of a direct loan marketing and outreach strategy.

Figure 6-15. VLT Program Award – Sample $1 Million

Year 1 Year 2 Year 3

Sample VLT Capital Allocation 1,000,000$ - - Sample VLT Outstandings (%) 50% 100% 100%Sample VLT Outstandings ($) 500,000$ 1,000,000$ 1,000,000$

Initial Fund manager Fee (%) 8% - - Initial Fund manager Fee ($) 80,000 - -

Interest Rate on Loans (%) 4% 4% 4%Interest Income on Loans ($) 20,000$ 40,000$ 40,000$

Excess Allowance Fee (%) 5% 5% 5%Excess Allowance Fee ($) 25,000$ 50,000$ 50,000$

Total Fund Manager Income 125,000$ 90,000$ 90,000$

Loan Outstanding Overview

Fee Income Overview

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• A number of the VLT managers operate local or previously defined geographic markets within the state of Maryland. The VLT program has provided both the opportunity and challenge of expanding market outreach beyond existing market boundaries.

• The VLT is marketed as a statewide program, so the VLT managers have operated in a more collaborative manner with other VLT managers, as opposed to independent loan programs.

Following are snapshots of each of the seven VLT managers and their programs. Figure 6-16 summarizes their portfolios.

Anne Arundel County Economic Development Corporation (AAEDC) The mission of the AAEDC is to: 1) support business and serve as a catalyst for business growth in Anne Arundel County, 2) help increase job opportunities, 3) expand the tax base, and 4) improve overall quality of life. The organization’s core mission:

• Recruit new businesses to Anne Arundel County plus the expansion of existing businesses

• Provide financing assistance to local county businesses • Promote redevelopment and revitalization along older commercial corridors • Promote technology development • Provide technical assistance

AAECD performs economic development activity on behalf of the local county government; their mission is to grow jobs and expand businesses within the county. The organization manages a number of loan funds, including SBA programs. Overall, AAECD has financed approximately

Figure 6-16. VLT Portfolios by Manager

Manager Number of Portfolio Loans

Total Loan Amount Average Loan Amount

Average Portfolio Interest Rate

Anne Arundel County Economic Development

Corporation

29 $4,015,318 $138,459 4.0%

Meridian Management Group

40 $5,229,802 $130,745 5.5%

Maryland Capital Enterprises

38 $1,076,769 $28,336 7.5%

Baltimore Development Corporation

5 $980,000 $196,000 4.0%

TRI County Council for Western Maryland

5 $800,000 $160,000 6.0%

Baltimore County Economic Development

12 $1,500,000 $125,000 2.5%

Howard County Economic Development Authority

11 $1,200,000 $109,091 5.5%

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200 loans and achieved approximately $10 million in loan volume. Also, the organization manages a loan fund with proceeds from a $4 million line of credit from a consortium of banks to promote small business lending. Under the VLT program, approximately 70% of loan activity is to conventional businesses (including gas stations, retail stores, service based businesses, professional services) and 30% of loan activity is to technology-based businesses. Overall, loan sizes have been in the range of $25,000 to $500,000. AAEDC has deployed approximately twenty-nine loans with no portfolio losses to date. AAEDC has partnerships with a number of economic development agencies across the state to expand outreach and deal flow. In addition, AAEDC collaborates with minority- and women-focused organizations to help achieve targeted loan volume activity. The organizations are paid partnership fees ranging from $7,500 to $35,000 per year depending upon the sourced level of deal flow. Overall, the partner organizations have been key in developing AAECD’s VLT program across the state. Currently, the AAEDC VLT loan program’s economics are not covering operational costs. The organization uses funding from other sources to cover VLT operating shortfalls. Based upon AAECD’s operating cost structure, the VLT program needs approximately $10 million in assets to achieve operating cash-flow break-even. However, since one-third of the current loan portfolio is allocated to start-up technology based businesses, there is not sufficient cash flow to meet the VLT manager’s current income needs.

Meridian Management Group Meridian Management Group (MMG), a fund manager that focuses on investing capital and providing expertise to small, minority- and women-owned businesses, uses VLT to provide affordable and flexible financing to assist in the acquisition of businesses, equipment, owner-occupied commercial real estate, furniture/fixtures and leasehold improvements. Over the past three years, the MMG VLT fund has financed forty-eight (48) transactions that were approved totaling $6,900,000. To date, there have been twenty-five (25) approved transactions totaling $3,800,000 located in the targeted areas and twenty-three (23) transactions totaling $3,100,000 outside of the targeted areas. MMG markets its loan products through its own conferences (called the “Money Tour”) as well as participating in third-party conferences. The firm has primarily used its existing staff to market the VLT loan fund. Their existing staff are actively calling on local businesses as well as small business intermediaries including the Baltimore County Small Business Resource Center. The MMG VLT loan program consists of both early-stage borrowers and mature companies. The VLT program has a separate loan approval process from the MMG-operated MSBDFA program. The VLT program has an interest rate range of between 2%-8% and a weighted average rate of 5.5%.

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Maryland Capital Enterprises Maryland Capital Enterprise (MCE) provides business loans, business education and business consulting to support Maryland-based micro-lending activity. MCE is a SBA, USDA and CDFI certified intermediary lender and is funded through Federal and State grants as well as private contributions, foundation proceeds and general fund raising efforts. MCE’s marketing efforts have been primarily through newspaper articles, TV news, local appearances and networking events. The networking events include participation in expos, workshops, chamber of commerce meetings, etc. MCE also leverages blogging, Facebook, Twitter and LinkedIn to promote the fund. MCE manages a number of loan programs and operates a women’s business center to help start-up businesses. The MCE VLT loan program provides loans with terms up to ten-years, at interest rates ranging from 5%-12%. The VLT loan approval process includes a review of the borrower’s credit score, collateral type and business plan.

Baltimore Development Corporation The Baltimore Development Corporation (BDC) is a quasi-public, non-profit corporation. The organization, formed by the merger of the Baltimore Economic Development Corporation and the Center City-Inner Harbor Development Corporation, serves as the economic development agent for the City of Baltimore. Excluding the VLT program, BDC manages five loan programs consisting of approximately sixty-nine loans and $22 million in loan capital. Most of the BDC loan programs limit lending activity to Baltimore City, and the VLT program enables the organization to establish a loan portfolio outside of its historical boundaries. The mission of the organization is to help retain and expand existing employers and attract new employers within the city of Baltimore. The focus of the BDC is to insure that Baltimore is meeting the needs of its business community by:

• Expanding companies located in Baltimore. Attracting new businesses to Baltimore, and retaining existing companies in Baltimore

• Promoting real estate development role for the City of Baltimore • Promoting its Small Business Resource Center, which is responsible for the day-to-day

management and coordination of services to small, minority and women owned businesses in Baltimore City.

• Revitalizing neighborhood commercial districts, supporting small businesses and fostering economic growth and job creation in Baltimore City

TRI County Council for Western Maryland, Inc. (TCC) TCC is the regional development and planning agency for the three counties in Western Maryland. Through a comprehensive economic development strategy planning process, TCC annually conducts an analysis of economic problems and opportunities that address the region’s economy, population, unemployment, geography, workforce, transportation, education, telecommunications, health care and infrastructure. TCC’s overall program goals, as related to its lending programs include: 90


• Increase job opportunities and per capita income in the region • Strengthen the capacity of the people of region to compete in the global economy • Work directly with new and expanding businesses to provide referrals for technical

assistance and access to capital – focus: create and/or retain jobs • Work closely with the Small Business Development Center to provide technical

assistance • Coordinate efforts with local banks and economic developers to enhance marketing and

outreach • Expand the TCC revolving loan fund capacity through a diverse set of funding sources,

including VLT, to achieve a variety of flexible funding options TCC’s loan committee consists of five members (of which two are public sector and three are private sector). TCC markets the program to specific rural areas of the state that are experiencing limited access to capital. Marketing efforts include:

• TCC bi-monthly newsletter reaching over 700 people • Presentations to the local Chambers of Commerce • Meeting with local financial institutions and making presentations and providing

marketing materials • Joining additional chamber of commerce organizations

The TCC VLT program manager has allocated significant time to ramping up its marketing efforts.

Baltimore County Department of Community and Economic Development (BC-DCED) The mission of BC-DCED is to support and stimulate business growth in Baltimore County, which helps to increase job opportunities and expanding the tax base. BC-DCED works directly with new businesses that are interested in locating within Baltimore County and assists in the expansion of existing businesses in the county. BC-DCED performs the following functions within Baltimore County:

• Redevelopment opportunities in the seventeen Commercial Revitalization Districts and three designated Enterprise Zones

• Workforce development needs of the County’s business community • Support and promote the County’s Small Business Resource Center • Provide financing assistance to county businesses (including VLT) • Promote technology development and assists start-up ventures at the UMBC and

Towson University incubators BC-DCED markets the VLT program by the following strategies:

• County websites • Social media • Local bankers • All economic development offices across the state

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• Marketing/presenting at networking events including the SBA • Leverage the existing DCED staff

The Baltimore County Economic Development group is a department within the county. As a result, the VLT fund manager does not take any fees for managing the program, but uses fees generated to fund additional loans.

Howard County Economic Development Authority (HCEDA) HCEDA is a quasi-governmental entity, which is under contract to represent the general economic development activity of Howard County. Operating support is provided directly by the county plus a small portion from the private sector. The organization houses an incubator/accelerator program, Small Business Development Center (SBDC), federal procurement group, SCORE and entrepreneurs in residence. Also, the organization has a business development group, which manages the county’s financing and incentives programs. HCEDA management views the VLT program as an opportunity to hire additional resources to manage its overall loan programs. The majority of the fund’s portfolio loans are technology- based. The HCEDA VLT program is marketed as part of HCEDA’s overall loan fund marketing efforts; the organization uses the SBDC network and the local economic developers within each market. The majority of the HCEDA VLT referrals come from the SBDC.

Overall, the HCEDA loans range in pricing from 3.5% to 7.0% and the loans are collateralized to include personal guarantees. According to management, break-even is approximately $5 million in assets under the VLT loan fund program. Currently the HCEDA VLT manager is using operating funds from other sources to cover operational costs.

VLT Findings

Compensation Structure The current compensation structure has been designed to help the VLT manager cover operating costs in three ways: 1) a one-time start-up administrative fee – 8% of the VLT commitment amount, 2) origination/transaction fees plus interest income earned on the loan portfolio and 3) an annual 5% operating shortfall fee – the fund manager applies at the end of the year. The approval process is subject to an annual review plus available funds. As the VLT fund managers ramp up their lending programs, they will incur operating losses until the loan program reaches break-even. Currently, all of the VLT fund manager’s loan programs are operating at a loss. In addition, many of the VLT fund managers are providing a portion of their loan portfolios to early stage and start-up businesses, which may not generate revenues to support traditional debt service obligations. The early stage and start-up borrower profile results in additional fund manager cash flow strain due to a reduced amount of current interest income to cover operating costs.

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Geographic Coverage The current targeted geographical areas are based upon a 10-mile radius around the operating casino facilities at the time of the award. Currently, the VLT fund managers have been able to meet the 50% targeted area test, but as the VLT fund manager continues to make additional loans within the target area, they expect to experience challenges in meeting the programs geography restrictions in the future.

Marketing Efforts While a number of the managers utilize similar marketing strategies to secure lending opportunities, their efforts are not currently coordinated. Although many of the VLT managers operate in markets that do not overlap with other managers, there are opportunities to promote the VLT program on a statewide basis, which may result in additional opportunities to generate deal flow for each respective fund managers.

VLT Program Recommendations • Restructure VLT Fund Manager Compensation Structure

Establish a management fee structure to enable the VLT fund managers the time to cover operating costs, while ramping up the loan program. The management fee can be structured as 1) a fixed fee throughout the life of the VLT contract, 2) an annual declining management fee structure to cover shortfalls until the portfolio interest income can cover operating costs, or 3) a management fee structure that declines based upon increases in the amount of funds under management.

• Re-evaluate VLT Program Geographical Boundaries

Restructure the 10-mile radius as the “target area” to a broader geography or broader customer group that will help ensure the portfolio will have a sufficient pool of qualifying lending opportunities. Redefining the geographic boundaries by county or dividing the state into regions in which each casino will fall into a specific region may help to provide sufficient lending opportunities and diverse lending areas across the State of Maryland.

• Consider Strategies to Help Streamline Marketing Efforts

Establish a statewide marketing outreach effort to help provide additional marketing. The VLT fund managers utilize similar marketing strategies to secure lending opportunities, many of which, such as linkages and partnerships with small business technical assistance organizations, are very effective. However, statewide promotion may result in additional opportunities to generate deal flow for each respective fund managers.

• Establish VLT Fund Manager Minimum Assets Under Management Threshold

According to many of the VLT fund managers, the minimum amount of assets under management to achieve cash flow break-even is approximately $5 million. The current design of the VLT program precludes the fund managers from breaking even, a disincentive to building the portfolio and proper operation of the program. 93


Chapter 7: Credit Enhancement, Loan Guarantees and Bond Financing

Maryland Industrial Development Financing Authority Program Overview The Maryland Industrial Development Financing Authority (MIDFA) operates the Maryland programs that provide credit enhancement and bond financing for small and mid-sized firms. MIDFA was established by the General Assembly in 1965 to promote significant economic development by providing financing support to manufacturing, industrial and technology businesses located in or moving to Maryland. MIDFA stimulates economic development by issuing private activity revenue bonds and providing credit insurance in the form of a loan guaranty to reduce lenders’ risk. Taxable and tax-exempt bonds enable businesses and organizations access to long-term capital markets primarily for fixed asset financing. MIDFA’s credit insurance programs help fill gaps so businesses can meet lenders’ commercial loan collateral and cash flow requirements. Both the bonds and credit enhancements are intended to increase access to capital for small and mid-sized companies and to direct funding to state-defined Priority Funding Areas.52 Analysis of MIDFA approved transactions since 2006 shows that the Authority’s programs have led to $800 million in new private investment and 6,000 new or retained jobs for Maryland. However, wide fluctuations can occur between fiscal years in the total amount of program activity (See Figure 7-1). In 2011, the combined new private investments leveraged from MIDFA-approved transactions (total loan amount) exceeded $183 million on 28 separate transactions, whereas this total was under $25 million in 2013 on only 6 transactions. The average amount of new private investment leveraged annually by MIDFA programs over the period was $88 million on an average of 13 new transactions approved each year. The average approved loan amount based on the number of transactions was $6.7 million over the period (See Figure 7-2). MIDFA's transactions are subject to the review and approval of a nine-member Authority. Two of the Authority’s members are ex-officio and seven are private business members appointed by the Governor with the advice and consent of the Senate.53 In addition to credit risk assessment, the statutory charge of the Authority is to consider a transaction’s impact on a balanced economy, employment, and quality of life. The Authority appoints an Executive Director who serves as Secretary and also has the authority to approve transactions of $250,000 or less. The Authority meets the 4th Thursday of each month (if there are deals to approve) and these meetings generally occur via a phone conference.

52 The 1997 Priority Funding Areas Act directs State spending to Priority Funding Areas. This includes: every municipality, as they existed in 1997; areas inside the Washington Beltway and the Baltimore Beltway; and areas designated as enterprise zones, neighborhood revitalization areas, heritage areas and existing industrial land. 53 The previous process included appointment to five-year terms by the Secretary of Commerce with the approval of the Governor. The Commerce Secretary or designee, and either the State Treasurer or Comptroller of the Treasury as designated by the Governor, or their designees to serve ex officio.

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Figure 7-3 shows the MIDFA approved transactions by county between fiscal years 2006 and 2014. The largest number of MIDFA funded transactions occurred in Baltimore City (23) followed by Washington (12) and Baltimore (11) counties. Harford, Kent, Calvert and Somerset counties had no direct MIDFA program activity over the period. All other counties in Maryland had program activity ranging between 1 and 6 approved transactions.

Figure 7-2. MIDFA Total Approved Transactions and Average Dollar Amount of Loans

$-

$2,000,000

$4,000,000

$6,000,000

$8,000,000

$10,000,000

$12,000,000

$14,000,000

$16,000,000

$18,000,000

0

5

10

15

20

25

30

2006 2007 2008 2009 2010 2011 2012 2013 2014

Approved Transactions Average Loan Amounts

Figure 7-1: MIDFA Total New Private Investments from MIDFA-Approved Transactions

Source: CREC review of MIDFA Annual Financial Status Reports. Includes information from the Approved Reports for both bond and credit insurance total loan amount.

$-

$20,000,000

$40,000,000

$60,000,000

$80,000,000

$100,000,000

$120,000,000

$140,000,000

$160,000,000

$180,000,000

$200,000,000

2006 2007 2008 2009 2010 2011 2012 2013 2014

Total Loan Amounts

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The operating expenses of MIDFA are funded through the interest earned on the fund balances, bond issuance fees and through annual premiums of ½ of 1% of all insured transactions, unless waived in “qualified distressed” (One Maryland) jurisdictions. Therefore MIDFA is “self-funded” and not subject to annual state appropriations for its operating expenses. MIDFA can leverage by statute up to five times (5:1 leverage) the amount of its capital base in order to support its portfolio of transactions. The current MIDFA Fund balance is $37 million and the present leverage amount is <1:1.

Private Activity Bond Comparisons Private activity bonds are revenue-backed bonds issued by a state or local authority on behalf of a private project. MIDFA’s taxable and tax-exempt bonds may be issued to finance fixed assets. Tax-exempt bonds may finance 501(c)(3) non-profit organizations, manufacturing facilities, and certain solid waste projects.54 The tax exemption enables the project to access capital at a lower interest rate than could otherwise be achieved, thereby facilitating a larger or more secure project. The program charges 1/8th of 1% annual issuance fee on bond transactions. MIDFA can insure approved bond transactions up to 100%, not to exceed $7.5 million.55

54 The issuance of most categories of tax-exempt private activity bonds is subject to the federally-mandated volume cap. Qualified 501(c)(3) bonds are an exception, along with Veterans’ Mortgage Revenue Bonds and some Exempt Facilities bonds. Other categories, including Small Issue Bonds, Single-Family Mortgage Revenue Bonds, and most Exempt Facilities Bonds are subject to federal volume cap. 55 MIDFA also provides a Conventional Loan Program insuring transactions to a maximum of $2.5 million. CLP is addressed later in this chapter.

Figure 7-3. MIDFA Approved Transactions by County, 2006-2014

Source: CREC review of MIDFA Financial Status Reports. Note that map excludes transactions with “multiple” as location description. Report data by location not available for 2012

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This tool can be used to facilitate the issuance of bonds by creating additional security to move projects forward56 The total dollar amount of private activity bonds issued nationally in 2014 increased compared to 2013, to $11.6 billion. This reversed a three-year trend of decline to a low point of $8.8 billion in 2013.57

Industrial Development Bonds Qualified Small Issue Bonds, commonly known as Industrial Development Bonds (IDBs), can offer a critical source of low-cost financing for small manufacturers. These bonds are a type of qualified private activity bond that are subject to the volume cap. Current federal rules limit these bonds to $10 million and place substantial restrictions on who can use the bonds and how proceeds can be used concerning expansion. IDBs are the most direct type of bonds issued by MIDFA to meet its charge to support manufacturing, industrial and technology businesses located in or moving to Maryland. Across the U.S. in 2014, the issuance of IDBs decreased from $356 million in 2013 to $270 million. In 2012, issuance of IDBs was also below $300 million, but as recently as 2009, IDBs accounted for nearly $1 billion of private activity bond issuance. Twenty-two states reported issuing at least one bond for small manufacturers in 2014. Four states topped $20 million in IDB allocations, including Illinois ($39.3 M), Massachusetts ($26.3 M), Georgia ($25.9 M), and Wisconsin ($20.4 M). Minnesota, New York, California, Missouri, Iowa, and Kentucky all exceeded $10 million in IDB allocations. The remaining twenty-eight states, including Maryland, reported no IDB issuances in 2014.58 Over the last five years, Pennsylvania has issued the most IDBs. Massachusetts, Virginia, Georgia, Michigan, Wisconsin, Illinois, Missouri, Arizona, and California are in the top quintile (top ten) among states. Maryland falls in the third quintile (21-30) among states in the same grouping as Rhode Island, North Carolina, Tennessee, Arkansas, Iowa, Colorado, Utah, Idaho and Washington (See Figure 7-4). The bond market is sensitive to interest rates. Bank loans and taxable bonds, issued at market-level interest rates, provide competition to the tax-exempt bond market—particularly when rates are low. Rates have remained low in past several years, but an uptick in interest rates is expected in the near future. Higher interest rates could result in new opportunities for bond issuance. Federal program changes may also help bolster the demand for IDBs. For instance, legislation introduced in Congress recommends specific reforms including raising the maximum

56 A scan of state finance authorities similar to MIDFA found this capability to insure approved bond transactions to not be in widespread practice. Maryland, therefore, has an added and potentially advantageous tool to promote bond financing. 57 CDFA Annual Volume Cap Report, July 2015 58 Ibid.

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bond size to $30 million, doubling the capital expenditures limitation, and expanding the definition of manufacturing.59

Credit Enhancement Comparisons MIDFA’s Conventional Loan Program (CLP) insures transactions made by financial institutions for up to 80% of the obligation, not to exceed $2.5 million. This program supports businesses seeking access to capital for a variety of critical needs: working capital, land acquisition, building acquisition, construction costs, machinery and equipment, furniture and fixtures, leasehold improvements, and energy-related projects among others. Export-related transactions may be insured up to 90%.

59 Industrial Development Bonds (IDBs) are a primary financing source for small- to medium-sized manufacturers. While manufacturing practices of the early 1980s have changed, reformers argue, the tax code regulating Small Issue Manufacturing Bonds has not. Legislation, like the Modernizing American Manufacturing Bonds Act of 2015, seeks to modify existing bond issuance rules to better serve 21st century manufacturers. Specifically, the proposal: (1) expands the definition of "manufacturing" by permitting bond financing for both tangible and intangible production; (2) eliminates restrictions on "Functionally Related and Subordinate Facilities" for manufacturing bonds to avoid arbitrary challenges and unnecessary inefficiencies that are currently associated with issuances; (3) increases the maximum bond size limitation from $10 million to $30 million for manufacturing bonds; and (4) increases the capital expenditure limitation from $20 million to $40 million for manufacturing bonds.

Figure 7-4. Amount of Industrial Development Bonds Issued, 2010-2014

Source: CDFA Annual Volume Cap Report, July 2015

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Small- and mid-size companies are often constrained by traditional bank lending parameters given their typically weaker balance sheets. Specifically, companies that are experiencing growth frequently require capital at a rate that exceeds the advance rates banks are willing to offer for loans against accounts receivable and inventory. For growth that requires the expansion of plant, property or equipment, the companies’ financing requirements often exceed traditional bank leverage ratios. Moreover, for many of these types of loans, businesses may not have sufficient capital on hand to satisfy bank down payment requirements. Further complicating small business access to bank capital has been the adoption by many banks of more stringent underwriting approaches in which exceptions are not permitted (due to a combination of increased regulatory scrutiny of lenders and lenders’ search for alternative revenue streams to make up for declining revenues resulting from lower interest rates). As a result, many small business credit requests for capital are left unmet. A loan guarantee program, such as MIDFA’s CLP, addresses many of these challenges and enables small businesses to obtain term loans or lines of credit to help them grow and expand their businesses. The program provides a lender with the necessary security, in the form of a partial guarantee, for the lender to approve a loan or line-of-credit. With an approved CLP transaction, MIDFA funds are set aside in a dedicated reserve to guarantee a specified percentage of each approved loan (which is often lower than the 80% guarantee maximum). Under the CLP, the banks underwrite the loans and MIDFA does a review of the underwriting. MIDFA CLP transactions are a “deficiency guarantee” so the state is protected from possible losses to the extent that MIDFA funds covering bad loans is the “last dollar in” after other remedies including the bank foreclosing on collateral is completed.

State Loan Guarantee Program Practices Loan guarantee programs (LGPs) are run in a number of states.60 Loan guarantee programs are usually run at the state level if the state has an existing economic or business financial incentive department with an experienced lending staff. Almost two-thirds of states run at least one their loan guarantee programs in a state department. The remaining states turn to third-party contractors, most often Community Development Financial Institutions or quasi-public economic development authorities, to administer loan guarantee programs on behalf of the state. Lenders are responsible for underwriting the loans initially. States review guarantee applications based on the lender’s initial underwriting. Upon approval, a commitment letter is issued to the lender outlining the terms of the guarantee. The question is how much the state trusts the lender’s underwriting activities. Around a quarter of states with LGPs perform their own independent underwriting analysis to supplement the lender’s; most other states conduct credit reviews on loan guarantees in lieu of independent underwriting. Some states operate preferred lending programs in which pre-approved lenders are certified and then delegated sole

60 The state comparisons in this section are based on observations for state loan guarantee programs operated as part of the State Small Business Credit Initiative.

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underwriting responsibility, including enrollment of loans in the guarantee program, based upon pre-defined program guidelines. Origination and annual utilization fees are determined by each state to defray the cost of program operations and ensure sustainability. Many states charge annual or origination fees on the guaranteed portion of loans ranging from 0.25% to 4.0%. While varying from state to state and from loan to loan; the average maximum term is approximately seven years among all programs. The proportion of a loan to be guaranteed can also vary from state to state. The maximum support level is often limited to well below 100% of the loan because states wish to see private capital at risk in a transaction. In addition, lower maximum support levels can mean that the state’s limited resources can be leveraged for a total volume of loans above the dollars available in the guarantee fund. In addition, some states further leverage their guarantee by placing only a portion of the guaranteed amount in a deposit account as a reserve, assuming that most loans will be repaid and the guarantees will not ultimately be needed.

Lessons Learned There are several lessons learned about state loan guarantee programs61, including for fixed asset loans. For instance, state programs guarantee traditional financing gaps in total loan-to-value ranges from 80% up to 100% depending on quality of the appraisal (professional, tax-assessed value, market estimates). Experience suggests that guarantee levels that are set too low are not attractive to lenders seeking out some form of credit enhancement. As a result, many states will allow for a maximum guarantee of typically 80%, but as lenders become more familiar with the program and as state agency staff better understand the credit request, it becomes clear that the amount of guarantee required to help the deal go forward can be significantly less than the maximum, especially if the program is easy for lenders to tap at the transaction stage and simple to access in the event of a default. Often, this amount is negotiated on a deal by deal basis. In a review of Treasury’s State Small Business Credit Initiative-sponsored loan guarantee programs, the average level of guarantee support for loans is 47% among all the state programs, regardless of loan type. By comparison, since fiscal year 2010, MIDFA’s guarantee support has averaged 36.7%.62 However, an “average” guarantee may belie the nature of the portfolio. States may offer higher guarantees for certain types of loans than for others. For instance, standard practice for export guarantees is 90%. However, states willing to provide up to 100% to finance exported inventory or fixed assets usually do so if a borrower does not have immediate liquidity but is forecast to generate sufficient cash flow to service debt. Guarantees on working capital loans and lines of credit, especially to startups, are based on the financing gap for projected short-term working capital needs.

61 See U.S. Department of Treasury, Best Practices from Participating States: Loan Guarantee Programs, 2015, http://www.treasury.gov/resource-center/sb-programs/Documents/LGPBestpracticesfinal.pdf 62 CREC review of MIDFA Financial Status Reports

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Guaranteeing construction loans is typically based on the final appraised value of the project. Borrowers or a third-party subordinate lender provides equity to finance construction costs beyond the appraised value of the project. States with active SBA 504 programs have found that the ability to guarantee construction loans can be an advantageous niche for state programs because SBA can only finance permanent financing. Marketing the state’s loan guarantee programs is also critically important for program success. States have used a wide variety of media ranging from emails, letters through bankers’ associations and joining or co-sponsoring economic development and financial conferences to build awareness through live announcements. Conferences with lenders and borrowers can be efficient because they illustrate that the same information is distributed to both groups. One of the most effective means to lender program adoption was through either meeting small business loan officers who actively use the program or meeting with bank executives who approve program use. Hence, collaborating with bank executives and loan officers during the program formation process is important for early training. Marketing to small business owners is dually important so they are aware of the program’s availability and can suggest it when working with lenders.

Other State Practices and Components to Success We contacted state program managers operating or overseeing loan guarantee programs to better understand the mechanics of their programs and also to relay important components to the success of running these programs. They address issues such as:

• How can LGPs be aggressively marketed to commercial lenders? • Should states market to financial players outside of the commercial bank arena? • How can LGPs be marketed as a better alternative than similar SBA programs? • What are potential ways the program might boost transaction volume without

significantly increasing portfolio risk? The section also looks at the use of state-chartered quasi-public financing authorities.

Alabama The Alabama Loan Guarantee Program (ALGP) provides up to a 50% contingency guarantee on loans up to $5 million. The Alabama Department of Economic and Community Affairs (ADECA) charges a 1% fee on the amount guaranteed and the term of the guarantee coincides with that of the loan. All business types, sizes, and loan purposes are eligible if consistent with SSBCI requirements. According to ADECA, the ALGP program worked well for (1) transactions originated by smaller community banks that do not participate in SBA programs; (2) transactions that required credit support, but did not justify an 80% guarantee as provided by comparable SBA programs; and (3) promising start-up businesses that would otherwise not qualify under existing bank-established lending standards. ADECA reviews the quality of the bank underwriting, but does not independently underwrite each transaction. The department

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maintains a revolving loan fund with the 1% fee charged on the guaranteed portion of loans and possibly supplemented with other federal and state funding sources.

Components to Success

• Banks began utilizing the program once Alabama hired a former bank lender who could effectively communicate the value proposition of the program and who dedicated extensive time to sustained personal outreach.

• The state-run guarantee program is meant to differ from SBA programs. Businesses such as non-profits and start-ups are eligible, whereas SBA guarantee programs prohibit these types of businesses.

• ADECA enjoyed support from the Governor and Bank Superintendent, executive sponsorship that lent the program credibility when marketing the Alabama loan guarantee program.

• According to ADECA, lenders described the loan guarantee program as less cumbersome in terms of paperwork and less costly in terms of customer fees than SBA. Also, bankers have found the 50% loan guarantee attractive.

• The state minimized its role in loan approvals by establishing an initial lender enrollment process, which reviews the enrollee to ensure their good standing and adequacy of underwriting criteria and loan experience. Enrolled lenders are solely responsible for underwriting, packaging, and managing the loans.

• ADECA implemented a loan checklist that ensures program requirements are met. The checklist is completed for each loan to ensure compliance with requirements and policy guidelines prior to funding.

Minnesota The Small Business Loan Guarantee program has gained only modest attention because there appears to be little interest in loan guarantees outside the state’s very active SBA lending. This is the case even though SBLG is easy to use and provides up to 70 percent of a loan for nonprofit lenders. CDFIs have been the primary vehicle for offering the guarantees, which have a maximum of $5 million. The largest guarantee has been for a $750,000 loan. Most of the guaranteed loans finance machinery, equipment, or real estate. The guarantees are for the term of the loan, most of which have been in the 5- to 7-year range, and Minnesota funds about 50 percent of guarantee in cash (although this began at 100 percent early on). The fee for the guarantee is 0.25% of the guarantee amount.


• Anticipating demand for new programs proved quite difficult, and Minnesota found that it underestimated the amount of time required to launch a new program.

• Lenders willing to engage with the state in developing new programs rarely participated in the subsequently implemented programs because they (1) were operating in a rapidly changing market themselves, (2) had different lending priorities than the public sector, or (3) anticipated that the public sector would be more risk tolerant than it actually was.

• Bankers are slow to change and extremely slow to adopt new, unfamiliar programs.

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• Lender relationships are vital, even in the program design phase, because lenders unfamiliar with the Minnesota Department of Employment and Economic Development who offered program design ideas were seldom willing to participate even if their ideas were adopted.

Oregon The Oregon Credit Enhancement Fund (CEF) is a loan guarantee program which provides guarantees of up to 80% of the loan amount. The focus of this program is primarily on operating lines of credit and secondarily on term loans for equipment and commercial real estate. Oregon’s CEF is limited to businesses that sell goods or services to a national or international market. However, if a business is located in a distressed area, this limitation is waived.


• Oregon’s loan guarantee program helped deepen relationships with the lending community. • The CEF guarantee program is viewed as easier to use than SBA and other government-

backed credit enhancement programs, attracting regional and community banks to look into the state’s array of financing programs.

• To facilitate deal flow, the state has developed a strong connection with the Oregon Bankers Association and a strong understanding of what local lenders need in terms of credit enhancement.

Utah Utah’s Small Business Loan Guarantee Program guarantees up to 80% of a qualified loan, term or line of credit, so that private lenders will have at least 20% of their capital at risk. An amount equal to 10% of each guaranteed amount is placed into a state-managed reserve account that can pay claims to a partner bank after all collection efforts have been made by that financial institution. All applicants to the Utah guarantee program must have a financial institution sponsor to apply, with loans underwritten by financial institutions and subject to the review and recommended approval for program enrollment by the Utah Small Business Credit Advisory Council (CAC), composed of a volunteer group of Board members from the Utah Small Business Growth Initiative (USBGI), a non-profit private entity that administers the guarantee fund. The Utah Housing and Community Development Director, the state’s contracting entity, chairs the CAC. The loan guarantees have proven particularly useful in facilitating deals that refinance SBA loans with step ups for expansion, companies hurt by the recession but now have prospects to return to traditional business operations, bridge construction loans to the SBA 504 program, and working capital lines of credit with maturities in the 1-2 year range. Fees for participation in the LGP amount vary from 2% - 4% of the guaranteed portion of a transaction.


• The LGP has worked well for several start-up companies in the state, providing critical capital by offsetting lenders’ reluctance to lend when a business has limited financial history.

• USBGI has significant banking experience, and Utah turned to this nonprofit once the state determined that it did not have sufficient staff experience in-house. The decision to contract

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with USBGI and intensify marketing efforts to lenders helped to significantly increase program activity.

• Only a limited number of guarantees have been provided to underserved communities, despite the best intentions, because the deal pipeline was simply inadequate and the program would not be sustainable without addressing a broader market need.

Louisiana The Louisiana Economic Development Corporation (LEDC) provides loan guarantees through the Small Business Loan and Guaranty Program (SBLP) to facilitate lending that will help develop, expand, and retain Louisiana small businesses. Originally created in 1988, the SBLP provides lenders a maximum guarantee of up to 75% of the loan amount, but the actual amount is negotiated based on each project’s specific guarantee needs. For the first few years of the program, LEDC charged a fee on the guaranteed amount of the loan, ranging from 2% to 4%, but LEDC recently waived fees to entice greater use of the program. LEDC tends to charge the fee in the most risky deals, in order to offset any potential default that could occur in these higher risk transactions. In addition, LEDC has the option of applying an annual fee to generate income to support the program, but this is applied on a case-by-case basis. In operating the federally funded SSBCI program, LEDC management opted to waive fees or keep them low to encourage program use by lenders and pass the savings on to the business. LEDC limited the guaranty to $1.5 million or less and provided credit enhancement to loans of $2 million or less. LEDC directly funds a cash set-aside using 25% of the amount guaranteed for each loan, and LEDC recycles funds as the loans mature. LEDC does its own underwriting. While banks make a variety of loans under the program, LEDC has found their niche is in providing access to lines of credit for small businesses.


• LED began by offering a guarantee for the initial three years of the loan, but the agency recently extended the potential length of the guarantee for up to seven years in response to lender concerns.

• Experienced loan staff have provided increasing levels of loan approval authority to allow for quicker loan processing.

• Smaller and younger businesses in particular need access to credit enhancement for lines of credit. LEDC is concentrating on providing guarantees for lines of credit and equipment acquisition.

• The decision to charge or waive administrative fees represents a balance between the desire to incentivize participation among firms that are least able to participate and the desire to generate resources to cover administrative costs and offset potential program losses.

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Neighboring State Practices

Virginia The Virginia Loan Guaranty Program provides a maximum guaranty of $750,000 or 75% of the loan amount, whichever is less. This program, operated by the Virginia Small Business Financing Authority (VSBFA), offers loans to operate lines of credit for inventory and accounts receivable, purchase fixed assets, and restructure debt. Eligible borrowers are businesses operating in Virginia that meet at least one of the following criteria: have $10 million or less in annual revenues over each of the last three years; or have a net worth of $2 million or less; or have fewer than 250 employees; or are a 501(c) 3 non-profit entity. The guaranty ensures that lines of credit are provided for up to five years (or seven years for term loans). The fee charged is 1.5% of the guaranty amount and a $200 application fee.

Pennsylvania The Pennsylvania Second Stage Loan Program, which is administered by the Commonwealth Financing Authority (CFA), guarantees up to 50% of outstanding principal, up to $1 million, for the first two years of the loan. The program then guarantees 25% of the outstanding principal for years three through seven. The program is limited to two- to seven-year old businesses engaged in life sciences, advanced technology, or manufacturing. Loan use includes the purchase or expansion of land or buildings, the purchase of machinery and equipment, and to provide working capital. Borrowers are required to demonstrate that the use of the loan proceeds will result in job creation or retention within Pennsylvania, with an estimated number of resulting positions provided. Recent reform legislation has sought to allow other, older businesses to participate in this loan program.63

Characteristics of Quasi-public Financing Authorities Quasi-public financing models are common among the most active states. These models operate as hybrids of state agencies and private contractors: while they can operate outside of state agency legal frameworks to some extent, they also have many of the characteristics of a state agency. The state government can often delegate authority and transfer funds to state-chartered authorities more expeditiously than to private contractors. Their primary advantage is allowing states to offer more competitive salaries to personnel with lending and investment experience and to allow greater flexibility in designing and managing public financing programs. Fifteen states have quasi-public authorities created by state legislation to achieve a specified mandate, typically governed by boards consisting of gubernatorial or legislative appointees with business or banking expertise. Usually, the chief executive officer is selected by the governor in consultation with an advisory board or by the authority’s board with the consent of the governor. As an example, the Finance Authority of Maine (FAME) was established as Maine’s business finance agency in 1983 and charged with supporting the start-up, expansion and growth plans

63 See Pennsylvania Business Daily Reports, “Thomas hopes to streamline Second Stage Loan Program,” March 26, 2015.

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of Maine’s business community. FAME offers a wide array of business assistance programs, ranging from offering traditional loan insurance programs for both small and larger businesses to managing investment tax credits. FAME also has taxable and tax-exempt bond financing programs. In April of 1990, FAME’s mission was significantly expanded when it assumed responsibility for administering the State’s higher education finance programs. Another example, the Oklahoma Finance Authorities (OFA), was created in 1992 by the consolidation of the Industrial Finance Authority and Development Finance Authority. In this case, the Authorities' funds have not been commingled; only the administrative functions have been combined. Consolidation of the finance authorities was made possible through the voluntary actions and consent of the Boards of Directors. This allowed for a smooth transition without the need for new legislation. With policy direction provided by both the Governor and legislative leaders, a unified approach to economic development lending programs can help eliminate duplicative or competing efforts. For instance, the Missouri Development Finance Board (MDFB) administers 12 programs including revenue bonds, select tax credits, direct loans, loan guarantees, technical and financial assistance for downtown revitalization, community development entity for new markets tax credits.

Preliminary Findings

Marketing

• The programs administered by MIDFA are underutilized when compared to historical performance levels and gauged by the extent of use in a number of other states.

• MIDFA makes periodic efforts to reach out to banks. In particular, many states actively market loan guarantee programs to potential lender beneficiaries. These marketing efforts often involve partnering with other state agencies and state sponsored programs to market the program efficiently and effectively, which may include jointly calling on financial institutions to market lending programs.

• States are finding that the best loan guarantee program salesperson is a happy lending partner. Having visible lending partners who publicly advocate and who provide testimonials can boost acceptance and participation by other lenders. Marketing involves both the identification and cultivation of program champions at individual financial institutions; that person is generally a loan officer who may benefit financially from increased small business loan production.

• Common components to success for state loan guarantee programs include using dedicated program staff with expertise in commercial lending who can potentially “talk the talk” with lenders and advance the program. A consistent message from successful state loan guarantee programs emphasized trust and relationship building as a key component to the success of the program. Since banking is an inherently small world, a bad reputation will immediately hurt the program goals.

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Program Design

• Certain program design changes can make state guarantee program more attractive to lenders. Among these are higher limits. For instance, MIDFA offers conventional loan coverage to $2.5 million. Limits elsewhere may reach $5 million. Higher limits can help make LGP programs more attractive but may also increase a state’s exposure to risk.

• The maximum guaranty under the MIDFA LGP is 80%, of which 20% of the guaranteed portion is set aside in cash. The typical state guaranty is in the range of 20% to 50% of the loan amount. A higher percentage of the guaranteed amount to be set aside in cash is a tool in some states to get more interest from lending partners until the state builds a strong reputation with those lenders.

• MIDFA has a “rapid response” approval that promises a 24-hour turn-around on loan approvals up to $250,000. Internal processes that lead to a faster rate of the deployment of funds are components to success in some states.

• The MIDFA conventional loan program uses funds to guarantee fixed asset purchase, letters of credit, leasing and other working capital needs of small businesses. State success in LGP utilization requires finding new ways to maximize the program’s reach and to distinguish it from SBA and USDA guarantee programs. For instance, one example is using the program to guarantee the unsecured lines of credit that typically accompany an SBA-guaranteed term loan.

Bond Use

• Part of the lower level of bond use in states is attributable to the collapse of bond markets (and very low interest rates) since the Great Recession. Bond use may be poised to pick up again once interest rates begin to climb, but that is not expected within the next year or two.

• The federal government sets bonds limits and the limits have not changed since 1986. The maximum tax-exempt cap is low at $10 million on financing fixed assets (most manufacturers invest many times this level of investment in projects). Federal legislation, including the Modernizing American Manufacturing Bonds Act of 2015, H.R. 2890, seeks to change the current structure.

Policy and Administrative Options for Improvement Policy and administrative options include:64

1. Build Staff Capacity to Market and Administer MIDFA Programs The MIDFA Loan Guarantee is an underutilized tool within Maryland’s broader economic development finance toolkit. The program itself, meant to cover deficiencies when loans originated by lenders do not fully repay, is structured similarly to those operating in other states.

64 The policy and administrative options discussed in this section are based upon CREC’s substantial work with the U.S. Treasury on the State Small Business Credit Initiative (SSBCI). This work includes working groups of state program managers who have identified best practices across a variety of lending program types, interviews with lenders from across the country, and one-on-one interviews with program staff of Loan Guarantee programs in a number of states.

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However, Maryland’s program has the prospect to be more fully utilized and effective for achieving economic development goals with a few key program changes, including:

• Staff the program adequately. Successful LGPs generally have staff dedicated to the program. Currently, Maryland spreads responsibilities over a number of staff and no single person devotes full-time attention to MIDFA activities. Staff should be fully dedicated to the LGP so that someone owns the program.65 If Commerce is unable to provide additional staffing resources, the agency might consider whether MIDFA might benefit from being administered by another state entity or outsourced to a capable contractor.

• Emphasize staff skills in commercial loan underwriting experience and familiarity with lenders in the small business market. Knowledgeable staff will gain the confidence of lenders by demonstrating that they can “talk the talk” and facilitate deals that work for the borrower, the lender, and the state.66 In the absence of being able to hire staff, an effective internal training program is warranted to help staff effectively engage the banking and business community and to understand the markets the program will support.

• Plan for staff succession. Develop operational manuals and policies that address tasks and processes and keep them up-to-date. Maryland should also enhance its existing checklists to incorporate all key operational activities, such as loan approvals and closings, collections, reporting, and compliance. Similarly, each staff member should identify his or her primary responsibilities and commit them to writing.

2. Actively Market the MIDFA Loan Guarantee Consultations with lenders and state banking associations should be ongoing to identify the evolving needs of lenders to support continued program utilization.

• Develop and execute a marketing strategy for MIDFA programs. MIDFA should institute a concerted outreach effort for bank education in the coming year. Most states with effective LGPs schedule appointments and talk to banks individually or in groups on a regular basis. They also foster a close relationship with the state bankers association. This provides opportunities to get in front of banks. Although most states don’t have a formal marketing plan, some do have money for targeting advertising through print and electronic media.

• MIDFA should also consider partnering with other state agencies and state sponsored programs to market the program efficiently and effectively, which may include jointly calling on financial institutions to market lending programs. The MIDFA marketing strategy should clearly outline a target for bank visits and related event attendance.

• Identify and establish program champions and power users. A key to program acceptance by lenders is the identification and cultivation of program champions at individual financial institutions; those persons are generally CEOs, chief credit officers, and

65 Staffing varied in the states examined. For instance, the Virginia Small Business Financing Authority employs an eight person staff that is shared between ten to twelve programs. The Alabama Department of Economic and Community Affairs operates its LGP under a hybrid model. In Alabama, the program director is the lone dedicated staff member. The program also utilizes a part-time accounting department whose staff is shared with the other programs in the department. 66 In Virginia 5 of the 8 staff members involved with the LGP have lending backgrounds at banks. Likewise, the Alabama Director’s background is in banking.

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small business loan officers who may benefit financially from increased small business loan production. A corollary is to promote successful transactions that can garner more attention by establishing goals for generating lender testimonials and press releases.

3. Consider Program Design Changes to MIDFA’s Loan Guarantee It is imperative that experienced lenders be involved in state lending program product design. Lenders have an understanding of why creditworthy borrowers struggle to obtain loans. Their market knowledge and experience make it more likely the state’s program will be accepted and used by the wider lending community.

• Convene a group of experienced lenders to review the existing MIDFA LGP program and to recommend changes to make it more appealing to the banking community. The group would address all aspects of program design that can potentially make the guarantee program more attractive to lenders and useful to business borrowers. Among the issues to address are whether raising the conventional loan coverage to $5m (from $2.5m) makes the program more attractive; whether to increase the guaranteed portion which is set aside in cash;67 or whether to change the state’s financial exposure to a “first loss” position.68 The lender review committee would also consider all other aspects of operations and customer service. For instance, are MIDFA marketing materials, forms, checklists, and approvals efficient? MIDFA has a “rapid response” approval that promises a 24-hour approval for loans up to $250,000. Is this appropriate or should this amount be higher? Many lenders have emphasized that they are more willing to consider a loan to a business with weak collateral than one with weak cash flow. To these lenders, state products are most effective if they address weakness in a borrower’s collateral position rather than focusing on short-term reduction in debt service requirements. MIDFA program offerings should address these issues. Furthermore, it is important for Maryland to work with private sector partners to assess how MIDFA’s loan guarantee program can be positioned in comparison to existing SBA and USDA loan guarantee programs (to ensure that MIDFA is filling a void left by the federal programs). Some banks have used state programs in unique ways to complement these federal programs and improve the capital flows to small businesses.69

67 The typical guaranty is in the range of 20% to 50% of loan amount. Experienced programs have enjoyed success with higher guarantee levels though this generally requires more re-underwriting by state program managers or their contractors. Guarantee percentages lower than 50 percent generally are not attractive to lenders. 68 Pro rata guarantees minimize the state’s financial exposure, but “first loss” guarantees encourage lenders to use the program to expand access to credit. Some states vary the approach based on the loan; others decide on the approach for the entire program. 69 Several banks used state lending programs to support their participation in the SBA’s 504 program, improving capital flows to small businesses. Under the 504 program, a bank finances up to 90% of total project costs, with the SBA eventually “taking out” up to 40% of the financing through an SBA-guaranteed debenture. The state programs were used to reduce the bank’s risk during the period prior to take-out, which can be a year or more if extensive construction is involved.

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The most effective state lending products are designed to focus on clear and addressable gaps in credit quality. Convening a group of knowledgeable lenders can help MIDFA achieve this goal. An ancillary benefit will be that lenders who participate in the design process will have “bought into” the MIDFA program, increasing the likelihood of their promoting the product within their institutions as well as among peers.

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Chapter 8: Credits and Funding for Workforce and Job Creation This chapter examines the state’s job training and job creation tax credit initiatives. The job-training program, the Partnership for Workforce Quality, emphasizes assistance to individual companies designed to fill customized skill gaps. A job creation tax credit exists in most states to reward companies that add new positions. Maryland, like many other states during the state fiscal crisis immediately, before and during the Great Recession, shifted its approach to economic development by emphasizing tax incentives, especially tax credits, to help businesses over providing grants and loans.70 In many states, this shift was less about strategic or ideological concerns and more about the budgeting process. States monitored grants and loans directly through the budgeting process while tax credits were considered foregone revenue and were never calculated in the process. In recent years, state legislatures have expressed concerns about how well tax credits actually work, have paid greater attention to transparency about these programs, and have begun to assess the “real” cost of many tax credit programs (especially those without spending caps). Consequently, states are looking more carefully at their tax credit programs and are renewing interest in grant and loan programs as more closely managed and monitored forms of aid to businesses. In some cases, they are reserved for companies that create large numbers of jobs at a time, for companies that create jobs offering family-sustaining wages, or for companies that locate in certain underserved areas of the state. On the other hand, a training fund provides resources designed to reduce the barrier to adding jobs in Maryland and reduce the up-front costs associated with a new location or major expansion associated with preparing the most productive workforce. These funds are often targeted to help firms that are offering family-sustaining wages, but they are typically offered on a first come, first serve basis or reserved for major investment opportunities that could help change the growth trajectory of an individual community or county. Several southeastern states, in particular, see this as a two-pronged approach to incentivizing business expansions and relocations and emphasizing the public benefit (in the form of job creation) anticipated from their investments.

Partnership for Workforce Quality (PWQ) The Maryland Partnership for Workforce Quality, or PWQ (Economic Development Article Sec. 3-404(e) of the Annotated Code of Maryland), was established in 1989 as a tool for encouraging incumbent worker skill development through training grants. Throughout its history, PWQ has used 1:1 reimbursable grants to cover the direct costs of training and help support Maryland-based manufacturing and technology companies upgrade the skills of their workers. In doing so, PWQ makes it easier for Maryland-based companies to improve their efficiency and respond to the foreign and domestic competitive pressures. This is particularly true for smaller

70 Center for Regional Economic Competitiveness, “Business Incentives and Economic Development Expenditures: An Overview of Maryland’s Program Investments and Outcomes,” February 2015.

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companies—firms with less than 150 workers—that may lack the resources and capacity to aggressively pursue this kind of specific incumbent worker training. In the past, PWQ was the incumbent worker training complement to the Maryland Industrial Training Program (MITP), which was used to support training for new projects. These programs had a common training application as Commerce administered both programs. However, the budget cuts during the recession led to the elimination of MITP (which was a budgetary line item) in 2009 and a significant reduction in the budget for PWQ (which was in statute). In FY 2015, the allotment for PWQ was $100,000. As a result, many recent PWQ grants are small in number and dollar value and only $85,000 was expended. For now, PWQ remains in statute, but will not likely receive future funding. This leaves the state with no resources to meet employer need for specific and immediate incumbent worker training. Maryland also has the Employment Advancement Right Now (EARN) grant program. EARN is a competitive program focused on meeting the needs of industry-led consortia to address workforce needs. A group of companies located in a region must come together and then identify a set of training needs. The purpose of EARN can be distinguished from PWQ in several ways. Because the program works with industry consortia, the companies must come to consensus on the skill development needs common to all or most of the companies in the targeted industry. The assistance may also focus on worker needs for developing career pathways or addressing barriers to employment. The program can focus on issues of common concern such as job readiness and soft skill training. Technical skill training tends to be generic in nature because firms may not wish to share training needs that could give away proprietary business strategies. Because EARN works with a group of existing companies, it is not typically useful for emerging new companies that may have unique training requirements nor do the industry consortia represent the needs of companies not participating in a consortium. As a result, the EARN training often addresses remedial education issues as well as basic skills that are commonly required across multiple companies. The process of developing consensus and competing for EARN funding can take a significant amount of time. On the other hand, PWQ is focused on quick response, customized training solutions for individual companies with unique or proprietary technical skill requirements. It is more suitable as a program designed to focus on helping firms up-skill workers when the company adds a new product line, purchases new equipment, or hires a new group of employees to meet a fast-growing market opportunity. For other states, programs like PWQ are funded so that training resources can be incorporated into incentive packages designed to facilitate major expansion or relocation opportunities.

Application and Review Process Since PWQ is intended to support specialized training, there are some limitations on eligible training programs. For instance, PWQ can provide specialized technical training, but not leadership training. In areas such as safety—standard training for many manufacturing operations—PWQ will only support training if it is specific to what that company does. For example, PWQ was used to help a mining company do safety training in Western Maryland’s

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Garrett County given that it was fundamental and specific to this company’s operations. This need for specialized training is one of the reasons why companies are encouraged to use external trainers or specialists. That said, PWQ can pay for both in-house and external training. For internal training, the program can only pay for materials or online resources, but not the time of the internal trainer. In the past, the PWQ application process was complicated and there were stringent reporting requirements. Some firms believed the paperwork was not worth the effort and as a result did not use PWQ. As the fund got smaller, this process became more streamlined and now there is a short, five-page application and one page invoices. Another limitation is that firms are limited to receiving PWQ funds in three consecutive years. Given the current small size of the fund and the elimination of future PWQ, the program is not actively marketed to companies. If companies are unaware of the fund, they may find out about it through their regional MEDC representative who may present it as a tool to meet a specific training need.

Measuring the Impact of PWQ Over the past several years, the number and volume of PWQ grants has been increasingly limited. As the PWQ fund allotment has diminished, so too has its effectiveness as an economic development tool (see Figure 8-1).

State Experiences with Incumbent Worker Training Grants Many state use incumbent worker-training programs as economic development tools. These programs are often intended to support the state’s business retention and expansion efforts. They do so not by building a basic level of skills within the broader workforce (e.g., training more welders), but rather by supporting company efforts to build the skills of their existing workers so that they can to adopt new processes or equipment. Other mid-Atlantic states possess these programs and fund them at varying levels and in different ways. Below we discuss the basic elements of these programs in these other states.

Delaware Blue Collar Training Grants The Delaware Blue Collar Training Grant program is the state’s primary incumbent worker training program. It is funded through the state’s unemployment taxes (0.25% of the first $10,500 of employee salary) and these funds are shared between the Department of Labor and the Delaware Economic Development Office’s Workforce Team. These grants can be used to fund training for entry-level staff to front-line supervisors and for a variety of training ranging

Figure 8-1: Funding Allotment for the Partnership for Workforce Quality, 2011-2014

Partnership for Workforce Quality FY 2011 FY2012 FY2013 FY2014

Number of Awards 13 9 9 9 Total Award

Volume $278,780 $131,362 $87,164 $99,989

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from basic skills to on-the-job training, but it must be custom or specific to the needs of an industry. The format of the training can include online, classroom or a mixture of the two. In addition to providing training that is specific to that industry, there are several other conditions that must be met. First, 25 percent of the workers being trained must be Delaware residents and all of them must be full-time permanent employees with benefits. Second, grants cannot pay for past training sessions. Employers must complete a training grant application and have a letter of agreement signed before proceeding with the training. This approval process normally takes 45 days. Once the training has taken place, employers can then submit their receipts for reimbursement. In order to track the impact of this training, employers are asked to complete a survey of workers to the Delaware Economic Development Office. This survey asks information about how many trained workers are still employed, the number demonstrating the skills they learned in the training, and whether the training achieved its expected results. In FY 2014, 41 Blue Collar Training grants were issued to 37 unique Delaware businesses. These businesses received a combined $1.1 million through this program, and contributed another $2.7 million in matching funds. Of these 37 businesses, 23 were small businesses with less than 100 employees. In total, 1,314 employees received training.71

New Jersey Skills4Jersey Training Grant Program The Skills4Jersey Training Grant Program provides funding to support employer efforts to upgrade the skills of current employees or train new employees.72 Like a number of other states, these training grants require employers to pay a minimum of 50 percent of the training costs. Applications for training grants are typically accepted twice a year, summer and winter. Firms in key targeted clusters (e.g., Manufacturing, Financial Services, Life Sciences, etc.) are eligible to apply, and priority is given to businesses that have not received training grants in the past. In FY2015, there was $3.5 million allocated to this program. Individual businesses can receive up to $100,000, but no more than $1,000 per employee trained. A consortium of businesses can undertake a shared training, with the award amount capped at $100,000 per business in the consortium. The training can consist of classroom, online or on-the-job. Once the training has been completed, employers receiving training grants are required to summarize what the training accomplished as part of the closeout process. This typically includes information about how much the training accomplished relative to its original expectations and the promotions or certificates that were achieved as a result of the program.

71http://inde.delaware.gov/dedo_pdf/NewsEvents_pdf/publications/annualreports/FY14%20Workforce%20Development%20Annual%20Report.pdf 72 http://jobs4jersey.com/jobs4jersey/documents/NGO/FY15/FY15Skills4JerseyNGO.pdf

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Virginia Jobs Investment Program (Workforce Retraining Program) The Worker Retraining Program of Virginia’s Jobs Investment Program (VJIP) supports the efforts of companies looking to upgrade the skills of their existing workforce.73 This is a 50-year-old program whose administration was recently moved from the Virginia Department of Small Business and Supplier Diversity to the Virginia Economic Development Partnership. It is specifically designed to help companies looking to implement new technology and equipment, change product lines, or add new skills or capabilities to their workforce. In order to qualify, firms must meet requirements:

• Number of workers trained: Firms under 250 employees must retrain at least 5 or more employees; firms over 250 workers must train at least 10 employees.

• Capital investment: Firms over 250 employees must make an investment associated with the training of at least $500,000.

• Wages earned: Employers must pay an entry-level wage rate of at least $9.79 per hour, but in areas that have an unemployment rate of more than one and a half times the state level, this wage requirement can be waived. These workers must also be full-time employees and eligible for benefits.

There are also restrictions as to the number of times that firms can access these training funds, in that they can only use funds once in a three-year period. The dollar amounts of training are negotiated, but they average $850 per worker trained. The state typically reimburses 10 to 40 percent of the training costs and these reimbursements are made in cash, not tax credits, and made within 90 days after the retraining has occurred. VJIP training partners conduct the training. In FY 2014, this program supported 37 retraining projects and eight small business-retraining projects.74

Workforce and Economic Development Network of Pennsylvania (WEDnetPA) Pennsylvania’s WEDnetPA training program has been the state’s worker training program and delivered training related to Basic Skills and Information Technology. These programs have eligibility requirements for the employers, employees and type of training. Employers must be an existing Pennsylvania company or one new to Pennsylvania. Employers must be involved in activities other than point-of-sale retail, gaming, and they cannot be non-profit, government, or education and training providers. Additionally, employers with more than 25 percent turnover are ineligible. Employee eligibility requires workers to make 150 percent or more of the Federal minimum wage, they must be Pennsylvania residents, and they must be full-time employees eligible for benefits. The WEDnetPA program offers an online application, and once approved, training costs are limited to $450/worker with a maximum of $75,000 per firm for the Basic Skills program and $850/worker and $50,000 per firm for the Information Technology program. Training funds can

73 http://www.yesvirginia.org/Content/pdf/VirginiaJobsInvestmentProgram.pdf 74 vamanufacturers.com/wp-content/uploads/2014/07/VJIP-Overview.pptx

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be used for third party trainers, WEDnetPA partners and in-house training. There are some restrictions on in-house training as firms are not able to expense staff time or pay for activities like on-the-job training or new worker orientation. There is also an expectation that firms will complete surveys so the state can track the impact of these training investments. These survey data are reported in the WEDnetPA’s annual report. According to WEDnetPA’s most recent Annual Report (2013-2014), roughly $7.8 million was spent to training over 40,000 employees. The majority of the funds invested ($6 million) and employees trained (37,200) were in the Basic Skills program.75 Private-sector trainers conducted almost three-quarters of this training, with the rest being split evenly in house trainers and WEDnetPA partners. Small companies (defined as less than 100 employees) received about a third of the training dollars. As of this writing, the program is undergoing a transformation to make it more responsive to the changing needs of employers, and particularly manufacturers. As a result, WEDnetPA is attempting to shift its focus to more advanced skills. As a result, the Basic Skills program has been rebranded as the Essential Skills program and the Information Technology program is now the Advanced Technology program.76

North Carolina (NCWorks) Customized Training Program In 1958, North Carolina became the first state to make customized training available to manufacturers and businesses. In 2008, North Carolina merged two programs—the New and Expanding Industry Program and the Focus Industry Training Program—into the Customized Training Program.77 The North Carolina Department of Commerce also has an incumbent worker-training program, but this program is relatively small when compared to the North Carolina Community College Systems’ Customized Training Program. In fact, companies must demonstrate that they were not eligible for the Community College program before receiving the incumbent worker training dollars. As a result, within North Carolina, the community colleges play a far more important role than the Department of Commerce for worker training. In order to be eligible for the Customized Training Program, firms must be engaged in activities related to: manufacturing, technology-intensive industries, national or regional distribution centers, customer support centers, air courier services, headquarters of national or regional companies, or government contractors supporting North Carolina-based military installations. In addition, businesses must demonstrate that they are doing two of the following: making a capital investment, deploying a new technology, creating new jobs, enhancing productivity, or building worker skills. Once these criteria are met, companies are eligible for support that can pay for the training assessment, design and delivery. In FY 2013-2014, the NCWorks Customized Training for New and Existing North Carolina Companies resulted in 307 projects that trained 21,224 workers. The total project expenditures

75 http://www.wednetpa.com/pubs/WEDnetPA-AnnualReport.pdf 76 http://www.wednetpa.com/pubs/WEDnetPA-Brochure.pdf 77 http://www.nccommunitycolleges.edu/sites/default/files/state-board/program/prog_12_-_customized_training_program_2013-2014_annual_report.pdf

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were $8.7 million, with an average total cost per trainee of $410.55. Additionally, the NCWorks customized training program also has existing industry support programs that provide additional support to existing businesses. Through this program an additional 513 companies and 8,075 trainees were served in FY 2013-2014. The total instructional and operation expenditures for this program were $2.9 million with an average cost of $364 per trainee.

South Carolina readySC Since 1961, South Carolina’s primary workforce training program has been readySC (initially known as Special Schools). This program is run through the South Carolina Technical College System and delivered by the state’s 16 technical colleges.78 In FY 2013-2014, the state of South Carolina appropriated $7.5 million to readySC. This program provides worker training at minimal or no cost to the employer. The program is seen as an important business attraction incentive as more than 85 percent of companies relocating to South Carolina indicated that readySC factored into their decision making.79 Employers must provide a sufficient number of workers to make the training cost-effective and these workers must be full-time employees. Approximately half of the training is done for workers employed by companies new to South Carolina, and the other half are for existing employers. These employers are drawn primarily from industries in the manufacturing sector (e.g. automotive, metalworking, etc.), but also from industries such as warehousing and professional, scientific and technical services. In FY 2013-2014, readySC provided workforce training to 4,700 employees from 81 different companies.

Georgia Quick Start80 Since its creation in 1967, Georgia’s most prominent workforce development program has been Quick Start (www.georgiaquickstart.org). The Quick Start program is seen as a national leader and a very attractive incentive for manufacturers looking to locate or expand in Georgia. Quick Start provides free, customized training. It can draw on expertise in advanced manufacturing areas including biotechnology, automotive, and food processing and agribusiness. Programs like Quick Start help to reduce uncertainty about workforce quality for new investors. Quick Start works with the Technical College System of Georgia to deliver training either at a technical college, in a mobile lab, or on the shop floor. There are four Quick Start offices throughout the state. In addition, Quick Start also manages a newly opened bioscience training center at the new Baxter International bio-pharmaceutical manufacturing facility.81 In 2013, Quick Start completed 133 customized workforce-training programs.82 Just over half (52 percent) of these programs were completed for new companies locating in Georgia, with the

78 http://www.readysc.org/faqs.html 79http://dc.statelibrary.sc.gov/bitstream/handle/10827/17474/SCTCS_Annual_Accountability_Report_2013-2014.pdf?sequence=1&isAllowed=y 80 http://www.georgiaquickstart.org/content.php?cid=about 81 http://www.rockdalecitizen.com/news/2015/sep/12/gov-deal-cuts-ribbon-at-bioscience-training-center/ 82 http://www.georgiaquickstart.org/uploads/misc/QSNewsW14V16No1.pdf

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http://www.georgiaquickstart.org/


other half for existing companies. Ninety percent of these companies were in the manufacturing sector. In total, Quick Start estimates that over 9,400 jobs were created and 3,000 jobs were saved in part due to Quick Start’s assistance.

Key Trends in Workforce Training Programs Many of the other Mid-Atlantic States allocate significant resources to their workforce training programs. Whereas Maryland directed $100,000 to PWQ in the last year it was funded, states like Delaware ($1.1 million), New Jersey ($3.5 million), South Carolina ($7.5 million), and Pennsylvania ($7.8 million) devoted significantly more to their comparable workforce training programs. In a number of instances, the state’s community and technical college system plays a significant role either in delivering or even administering the program. These programs typically offer companies a choice about how they wish to implement this training either by contracting with a third party vendor (e.g., private, community college, etc.) or by allowing in-house training. The community colleges are often seen as a trusted third party that has an educational mission and are stewards of public funds. As such there are often fewer restrictions on what a company can contract with the colleges to do. At the same time, there are a number of restrictions for in-house trainers. For instance, direct expenses associated with using in-house trainers are allowed, but the funds cannot be used to pay for the time of in-house instructors. Other common requirements found in these programs relate to the number of trainees (i.e., enough to make it cost effective), as well as trainee employment status and wages. Some states, like Virginia, also require that some form of capital expenditure accompany the training. All of these requirements tend to differ according to firm size, with smaller firms facing less restrictive requirements. In other Mid-Atlantic States, particularly in the Southeast, these kinds of workforce training programs and grants are key elements in their state’s respective incentives portfolio. As noted above, South Carolina’s readySC program was identified as a factor in the location decision of 85 percent of companies to locate in the state. Similarly, Georgia’s Quick Start program factored significantly into the decision making of several large investment projects including in Baxter International’s decision to move to Stanton Springs and Kia’s decision to locate its automotive assembly plant in West Point, Georgia.

Maryland Job Creation Tax Credit The Maryland Job Creation Tax Credit (JCTC) (Maryland Economic Development Code Ann. Article 6-301 (2014)) is one of the state’s most commonly used tax credits for economic development. It was enacted in 1996 to incentivize businesses to locate in Maryland and to encourage existing Maryland-based businesses to expand. Through this tax credit, Maryland businesses that create a minimum number of net new jobs in the state may qualify for income tax credits of 2.5 percent of annual wages, but not exceeding $1,000 per new job. If the business locates or expands in a revitalization area (e.g., enterprise zone, empowerment zone or Department of Housing and Community Development sustainable community), then they may claim a credit up to 5 percent of annual wages, but not exceeding $1,500 per new job. These limits have not changed since the launch of the tax credit in 1996. 118


Maryland-based businesses are eligible for this tax credit if they create at least 60 qualified jobs.83 These jobs must be net new jobs for the State of Maryland, and not just the result of jobs relocated from one Maryland-based facility to another. Job creation thresholds are reduced if employers meet several additional criteria. For instance, employers can receive the credit for as few as 30 new jobs if the total wages paid to the qualifying jobs exceeds what 60 people would have been paid at the State’s average wage. Similarly, if employers are located in a Job Creation Tax Credit Priority Funding Area (PFA) they must only create 25 new positions. PFAs are areas adequately served by infrastructure or within a county's 5- or 10-year master plan. This means that in order to qualify for the lower threshold, firms must be located in:

• Enterprise zones, • Department of Housing and Community Development Sustainable Communities, • Areas inside the DC or Baltimore beltways, • Incorporated municipalities, or • No more than one area in a county designated by the county as a priority funding area

under § 5–7B–03(c) of the State Finance and Procurement Article. These restrictions place rural areas at a relative disadvantage when compared to the more developed parts of the state. The PFAs in rural areas tend to be smaller and less contiguous than the more suburban and urban parts of the state. These restrictions can prove challenging for rural areas because they really need the lower jobs threshold to make the Job Creation Tax Credit a valuable economic development incentive. In order to claim these tax credits, firms must also undertake eligible business activities. These activities include:

• Manufacturing, • Transportation or communications, • Agriculture, forestry, fishing or mining, • A public utility, • Warehousing, • Research, development or testing, • Biotechnology, • Computer programming, data processing or other computer related services, • Central financial, real estate or insurance services, • The operation of a central administrative office or company headquarters, or • Business services firms (only if located in PFAs).

83 Qualified jobs pay more than 150 percent of the Federal minimum wage over a 2 year (24-month) period.

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This list presents a broad range of activities, but the primary goal of setting these eligible business activities is to incentivize higher-quality and better-paying jobs. For instance, some call center operations may be eligible, but only if they meet the wage requirements. For this reason, a distinction is typically made between inbound technical service call centers that often require more skill and knowledge and are therefore eligible for the JCTC and outbound sales call centers that typically require lower skills, offer lower wages, and are not eligible. Moreover, the companies eligible for these credits are intended to serve multi-state regional, national, or international markets, bringing new sales into the state rather than industries that recycle money within the local community—such as retail.

Application and Review Process Applying for the tax credit requires companies to provide a letter of intent to Commerce. This letter will indicate the establishment’s plans to expand its Maryland business by the end of the next year and that they plan to apply for the Job Creation Tax Credit. Once Commerce has received the letter of intent, it will send out in paper copy the preliminary application and employment affidavit. This allows Commerce to set the bar for the base level employees, and to begin counting net new employees created in the State of Maryland. The preliminary application also asks for information related to expected wage levels and industry sector and allows the state to certify the eligibility of the company. After meeting the minimum job creation targets (25, 30, or 60 jobs) for 12 months, the company can then apply to claim its tax credit. Once the company has submitted its final application and received approval, it can claim the tax credit in that tax year. After claiming its credit, the company then must continue to demonstrate compliance by showing that the new jobs created have been retained. To do so, companies self-certify that these jobs have been retained. After three years, employers must undertake a CPA review to make sure that there is no recapture due to the state. This review is then shared with the state Comptroller in order to close the process and allow firms to receive their final certificates. The process of applying for a tax credit requires extensive interaction with the company in advance of using the credit. This represents a barrier for its use, and the state reports that many of these steps were put into place in response to concerns raised by legislative audits seeking more complete reporting and management of the credits.

Measuring the Impact of JCTC In 2001, Commerce began requiring companies to report actual jobs created. During that period of time, Commerce has issued 179 Final Certificates, providing companies with tax credits for 16,321 new jobs that paid on average $48,000 per year within the State of Maryland. Since FY2006, employers have been able to collect tax credits for 7,573 jobs created. Over time, the number of new jobs created outside of the Greater Baltimore region has become a greater proportion of the total. Figure 8-2 shows the distribution of these jobs created since 2001. Over 8,900 of these jobs, or almost 54.5 percent of the total, were created in the Greater Baltimore region. This is consistent with the Baltimore-Columbia-Towson MSA’s 49.7 percent

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share of total state employment.84 In the past this gap was even greater. The FY 2006 annual report shows that 5,988 of the 8,748 jobs created since 2001, or 68.4 percent of the total, were in the Greater Baltimore region. This shows some greater regional balance of JCTC usage, and through FY 2014, businesses in 16 of Maryland’s 24 counties had used the Job Creation Tax Credit. However, to date no Southern Maryland firms have used the JCTC.

State Experiences with JCTCs Job creation tax credits can be found in 40 states, according to the National Conference of State Legislatures.85 A review of those programs found that states often set specific dollar amounts for the tax credit provided for a new job created, ranging from $100 per new job in Louisiana to $6,000 per job in Connecticut. In many states, however, the credit is based on payroll per job rather than a specific dollar amount. For instance, Delaware’s job tax credit is based on 40 percent of payroll withholding taxes. Iowa sets their credit based on 6 percent of wages and Kansas provides a credit of 95% of employee withholdings. In some states, the credit amount allowed varies depending on the individual hired, the location of the job, or the wage paid. For instance, Louisiana provides a higher per worker credit to firms hiring economically disadvantaged workers. Georgia’s credit ranges from $750 to $3,500 per new job depending on whether the business is located in a Tier 1 or a Tier 4 county. Mississippi offers a credit of 2.5 percent of payroll for new jobs in Tier 1 counties and a credit of up to 10 percent of the payroll for new jobs located in Tier 3 counties. Finally, some states determine the level of the credit based on the wages paid. Idaho offers a corporate income tax credit of $1,500 per worker for new jobs paying above $50,000 per year, but the credit increases as the pay increases with a maximum credit of $3,000 for new workers earning over $90,000 per year. Because the ultimate purpose of these job creation tax credits vary so widely from state to state, it is difficult to identify the best benchmarks. Some states focus on creating jobs in certain communities, some focus on creating high-end jobs in targeted industries with large spin-off impacts, and some are focused on jobs aimed at the economically disadvantaged. Moreover, a clear statement of purpose rarely exists in the legislation to guide an assessment of whether these credits are actually achieving their intended purpose. Figure 8-3 summarizes the job tax credit programs offered by the other Mid-Atlantic States. These states all have JCTCs, but differ in credit value, job requirements, target industries and geographies. This section describes Maryland’s JCTC competitive position relative to these other states.

84 US Bureau of Labor Statistics, Quarterly Census of Employment and Wages, 2014 Annual Average. 85 National Conference of State Legislatures. http://www.ncsl.org/research/financial-services-and-commerce/job-creation-tax-credits.aspx, downloaded October 17, 2015.

Figure 8-2: Job Creation Tax Credit Activity by Region since 2001

RegionActual jobs

created Greater Baltimore 8,902Suburban Maryland 5,812Southern Maryland 0Eastern Shore 519Western Maryland 1,088Total 16,321Source: JCTC Annual Report FY 2014

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Figure 8-3. Job Creation Tax Credits in Mid-Atlantic States State Program Name Employment Requirements Eligibility Geographic Focus

Maryland Job Creation Tax Credit86 • Minimum of 60 jobs,

income tax credits of 2.5 percent of annual wages, but not exceeding $1,000 per new job.

• 30 new jobs if the aggregate annual wages of those positions exceeds 60 multiplied by the State’s average annual salary.

• Jobs in Job Creation Tax Credit Priority Funding Area (PFA) must only create 25 new positions.

• 31-33 - Manufacturing; 48-49 - Transportation and Warehousing; 22 - Utilities; 21 - Mining, Quarrying, and Oil and Gas Extraction; 11 - Agriculture, Forestry, Fishing and Hunting; 51 - Information; 52 - Finance and Insurance; 54 - Professional, Scientific, and Technical Services; 55 - Management of Companies and Enterprises; 56 - Administrative and Support and Waste Management and Remediation Services

• Qualified jobs pay more than 150 percent of the Federal minimum wage over a 2-year (24-month) period.

• Statewide, less in Priority Funding Areas

• PFAs include 1) an enterprise zone, 2) areas of the state located between 495 and the District of Columbia and between 695 and Baltimore City, and 3) the one PFA designated by a county as being eligible to receive JCTC.

Delaware Job Creation Tax Credit87 • The business must hire five

or more qualified employees, make an investment of at least $200,000 ($40,000 per qualified employee) and operate in a qualified facility.

• Eligible businesses receive credits of $500 for each qualified employee and $500 per employee for each $100,000 invested.

• Manufacturing; wholesaling; scientific, agricultural or industrial research, development or testing; computer processing or data preparation or processing services; engineering services; consumer credit reporting services, including adjustment and collection services and credit reporting services; aviation services; son-custom computer software; telecommunications services;

• Any combination of the activities described above; or, the administration, management or support operations, including marketing, of any activity described above

• Some retail activities are eligible within designated areas.

• Statewide, with the credit increasing from $500 to $650 per job in targeted undeveloped areas.

• Commercial retail activities within targeted census tracks have less restrictive standards for investments.

86 http://taxes.marylandtaxes.com/Resource_Library/Tax_Publications/Business_Tax_Credits/Job_Creation_Tax_Credit.shtml 87 http://revenue.delaware.gov/services/Business_Tax/FullBC.shtml

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State Program Name Employment Requirements Eligibility Geographic Focus Georgia Employer’s Job

Tax Credit88 • Range from $3,500 per job and a minimum of 2 jobs in Tier 1 counties (most distressed) to $1,250 per job and a minimum of 25 jobs in Tier 4 counties.

• Tax credits can be used for up to five years.

• Manufacturing, telecommunications, broadcasting, warehousing and distribution, research and development, processing, and tourism.

• Credits are still available to employers outside the strategic sectors, so long as they create jobs in Opportunity Zones, Military Zones or Georgia’s 40 least developed counties.

• Companies are not allowed to claim both a Job Tax Credit and an Investment Tax Credit.

• Statewide, but value depends on Distress Tier.

• Additional opportunities in Designated Less Developed Census Tracts, Opportunity Zones and Military Zones.

New Jersey Grow New Jersey Assistance Program89

• $5,000 per year per qualified full-time position for a period of 10 years.

• Businesses must create 100 fulltime positions with benefits.

• Must be in an industry identified as desirable by NJEDA.

• Point of sale retail facilities are not eligible. • A business must make a minimum of a

$20,000,000 capital investment in a qualified incentive area

• Must be located in a Qualified Incentive Area—Urban Transit Hub Municipality, Garden State Growth Zone, Distressed Municipality, Part of a Mega-project or projects in a priority area.

North Carolina Article 3J Tax Credits90 • Minimum of 5 jobs in Tier 1

counties (40 most distressed), with credit of $12,500 per job

• Minimum of 10 jobs in Tier 2 counties (next 40 distressed counties) with credit of $5,000 per job

• Minimum of 15 jobs in Tier 3 counties (20 least distress counties) with credit of $750 per job

• Aircraft maintenance and repair, air courier services hub, company headquarters, customer service call centers, electronic shipping and mail order houses, information technology and services, manufacturing, motorsports facilities, motor sports racing teams, research and development, warehousing, and wholesale trade.

• Statewide, but value depends on Distress Tier

88 http://www.georgia.org/competitive-advantages/tax-credits/job-credit/ 89 http://www.state.nj.us/treasury/taxation/noticegnjap.shtml 90 http://marketing.thrivenc.com/acton/attachment/4901/f-0035/1/-/-/-/-/file.pdf

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State Program Name Employment Requirements Eligibility Geographic Focus Pennsylvania Job Creation Tax

Credits91 • $1,000 per job to approved businesses that create 25 new jobs or expand workforce by 20 percent within 3 years.

• Tax Credit increases from $1,000 to $2,500 per job if the person hired was unemployed.

• 25 percent of tax credits must go to businesses with less than 100 employees.

• Businesses must demonstrate the ability to create and develop new product and process technology, or improve productivity by using innovative processes.

• Statewide

South Carolina Job Tax Credit92 • $1,500 - $8,000 per year

for each new, full time job created, depending on county designation.

• Additional $1,000 per job if jobs are in a multi-county industrial park or qualified brownfields site.

• Taxpayer must create a minimum monthly average of 10 jobs through the 5-year tax period; higher for employers in some tourism and qualified service-related firms.

• Companies that establish or expand corporate headquarters, manufacturing, distribution, processing, qualified service-related, research and development facilities.

• Statewide, but value depends on 4 tiers of distress.

91 http://community.newpa.com/programs/job-creation-tax-credits-jctc/ ; http://www.employmentincentives.com/state_incentives/documents/Pennsylvania/jobcreationtaxcredit_guidelines.pdf 92 https://dor.sc.gov/resources-site/publications/Publications/SC%20Tax%20Incentive%202014%20Edition-Web.pdf

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State Program Name Employment Requirements Eligibility Geographic Focus Virginia Major Business

Facility Job Tax Credit93

• $1,000 per job for businesses that establish or expand by 100 jobs in Tier 1 counties (reduced to 50 2009-2014), or 50 jobs in a Tier 2 counties (reduced to 25 for jobs in distressed areas or enterprise zones)

• The credit can be claimed in equal installments of $500 per job over two years

• Available to companies from all sectors, except those whose primary activity is retail trade.

• The taxpayer cannot claim both the Major Business Facility Job Tax Credit and other credits such as the Coalfield Employment Enhancement Tax Credit, Clean-Fuel Vehicle and Advanced Cellulosic Biofuels Job Tax Credit, the Green Job Creation Tax Credit or the International Trade Facility Tax Credit.

• Credits are subject to recapture if employment not maintained over five years.

• Non-qualifying jobs include seasonal positions shifted within Virginia, building and grounds maintenance, security, and other positions ancillary to the principal activities of the facility

• Statewide, but value depends on Distress Tier, or location is a VEDP-designated distressed area or enterprise zone.

93 http://www.tax.virginia.gov/sites/tax.virginia.gov/files/taxforms/credits/2014/3042014.pdf

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Among the value of the job tax credits, Maryland’s $1,000 base is consistent with the base level tax credits in other mid-Atlantic states. It is consistent with Pennsylvania and Virginia’s tax credits, and more than Delaware’s $500 per job. This is also true for the tax credit values in the more urban and developed counties in the southeastern states. The big difference between Maryland and many of the other Mid-Atlantic States is the tax credit values and minimum job requirements for targeted development areas. Maryland’s Preferred Funding Areas allow firms to collect tax credits by creating 25 new jobs. However, in many of the state’s more rural counties this requires firms to be located in the single designated industrial park. Firms outside of these PFAs, even in rural areas, must create 60 new jobs, a high standard to reach in many rural areas. By contrast, other states, particularly in the southeast, tend to have more generous tax credits for companies creating employment in more distressed counties and target areas. For instance, employers in South Carolina can receive tax credits up to $8,000 for creating jobs in its most distressed counties. In North Carolina employers can receive $12,500 dollars per job for creating as few as five jobs in its Tier 1 counties—the state’s 40 most distressed counties. Similarly, NC employers are eligible for a $4,000 per job tax credit by creating only 2 jobs in its most distressed communities. Additional opportunities to earn tax credits are available for companies who locate in other specialized zones. In Georgia, credits are available for companies in military zones, opportunities zones and designated less developed census tracts. States sometime require more than just job creation in order to qualify for a credit. For instance, Delaware’s job creation tax credit provides a $500 credit on corporate income tax for each new job supplemented with another $500 for every $100,000 in capital investment. If the facility is located in a targeted area, the credit is increased to $750 per employee and $750 for every $100,000 of qualified investment. New Jersey’s Grow New Jersey Assistance Program is more generous than Maryland’s JCTC as it can provide firms with a $5,000 per job tax credit, but firms must also invest $20,000,000 in a qualified incentive area and create a minimum of 100 jobs. Tax credits in Maryland and the other Mid-Atlantic States are not open to all employers. They are primarily targeted to “export” oriented firms, or firms whose sales bring new money into a community. This means that in Maryland, like most other Mid-Atlantic States, firms involved in activities such as manufacturing, wholesale and distribution, research and development, and headquarters operations are all likely to qualify for tax credits provided they pay an established minimum wage. In some cases, the industries listed by the states are quite specific and align with the state’s broader economic development targets. For example, North Carolina includes motor sports teams and facilities in their list of eligible sectors as well as many of the broader sectors mentioned above. Point of sale retail operations are consistently excluded from job creation tax credits with the exception of Delaware (which also has the smallest credit) where tax credits are available to retailers located in targeted census tracts.

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Findings for Workforce Training and Job Creation Tax Credits

Workforce Training Programs

• A number of Mid-Atlantic States devote significant resources to workforce training and workforce training grants.

• Community and Technical College Systems are often key partners and in some situations (e.g., NC, SC, GA) administrators for these programs.

• In several southeastern states (e.g., NC, SC, GA), the availability of subsidized workforce training is viewed as a key element of the state’s economic development incentives portfolio.

• Workforce training grant programs allow companies to choose whether to contract with a third party vendor (e.g., private, community college, etc.) or conduct training using in-house staff. Like Maryland, in-house training guidelines are often more restrictive, with grant money able to cover direct expenses, but not the trainer’s time. Virginia requires that some form of capital expenditure accompany the training.

Job Creation Tax Credits

• About 40 states have job creation tax credits, including most in the Mid-Atlantic States, but the policy goals of those tax credits vary widely.

• In terms of value, Maryland’s job creation tax credit is generally consistent with the base job creation tax credits of other Mid-Atlantic States.

• Other states, particularly in the Southeast (e.g., NC, SC, GA), offer more generous and less restrictive (in terms of job creation requirements) job creation tax credits to companies located in rural, distressed or other targeted geographies.

• Some states (e.g., IA, KS, KY, MN) provide credits based on a percentage of total payroll paid rather than the number of jobs created.

• Several states (e.g., AL, ID) limit the credit to jobs offering wages above a certain threshold. • Capital expenditure requirements are included in the job creation tax credits for other states

like New Jersey and Delaware. • The value of Maryland’s base job creation tax credit has not changed since 1996. In

inflation-adjusted dollars, the $1,000 statutory limit is worth $657 in 2015 dollars.

Policy and Administrative Options for Improvement 1. Rebuild the Partnership for Workforce Quality (PWQ) program The PWQ program provides matching training grants and support services to small and mid-sized manufacturing and technology companies. These grants pay half of the costs for training that prepares workers to adopt new technologies and production processes. Through these training opportunities, companies can increase employee productivity and achieve more stable levels of employment. The number and volume of PWQ grants have greatly diminished and there is no longer funding allocated to support this program. The reallocation of workforce training funds away from PWQ, is partly due to the establishment of programs like the EARN Maryland program that focuses on meeting the needs of industry-led consortia to address workforce needs. While EARN Maryland addresses the longer-term 127


workforce needs of the industry consortia, it does not help individual companies address their more immediate and often pressing workforce challenges. This has created a significant gap in Maryland’s incentives portfolio. Programs like PWQ play an important role in many other states’ business attraction and retention programs. States such as North Carolina, South Carolina, and Georgia all invest significant resources into these kinds of customized training programs. They help assure potential and existing investors that they will have the workforce they need to succeed when they locate in those states. As a result, these programs can be used to facilitate major expansion or relocation projects. In addition to contributing to the state’s business attraction and retention efforts these programs bring other benefits. Unlike many other economic development incentives, investments in worker skills can create a lasting benefit because it raises the overall workforce quality. As the PWQ fund allotment has diminished, so too has its effectiveness as an economic development tool. If the program had funding it might make sense to incorporate these customized training grants into the Maryland Economic Development Assistance Authority and Fund (MEDAAF), where it might fit as a special purpose grant. However, given the lack of resources associated with the PWQ, it is not worth the time or resources required to integrate the program into MEDAAF. Nevertheless, Maryland has several options, related to funding and eligibility, for rebuilding and strengthening PWQ.

• Identify new funding options for customized training programs like PWQ. Recognizing that state resources are scarce, there are several options that Maryland might pursue to expand PWQ programs. Maryland might consider using a portion of the state’s unemployment insurance funding to support customized training. For instance, neighboring Delaware funds its customized training program (Blue Collar Training Grants) through the state’s unemployment taxes (0.25% of the first $10,500 of employee salary). The underlying logic of doing so is that improving the quality of the workforce and promoting worker retention will result not only in less unemployment usage, but also in more workers paying into the Unemployment Insurance fund.

• Beyond using unemployment insurance funds, Maryland might also consider several other options for funding PWQ and customized training. For instance, it might consider designating a portion of the EARN Maryland funding to support the more short-term needs of individual companies as a complement to the longer-term training needs of the industry consortia. Additionally the state may determine that, like many other states in the Mid-Atlantic region, it needs to fund programs like PWQ so that training resources can be incorporated into economic development incentive packages that can improve the state’s ability to attract or retain major employers. As a result, it may elect to allocate resources from the state’s general fund to support these activities.

• Adjust eligibility requirement to maximize the PWQ’s impact on its target companies. Maryland should structure PWQ match requirements to ensure that the state’s limited customized training dollars are directed toward the companies where the training can make

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the greatest impact. Currently, PWQ requires a 50 percent match from participating companies. However, these match requirements could be adjusted to make the grants more accessible to small- or medium-sized companies that are less likely to invest in significant training. Supporting these training efforts can speed up the adoption of new processes or the launch new products. These efforts can make a significant difference in those companies growth trajectory.

• Similarly, less onerous match requirements would especially benefit companies in more rural locations. In more rural economies, the retention of 20 or 25 good paying jobs might make a significant difference to the local economy. These different geographic contexts has led other states, such as North Carolina94 and Tennessee,95 to use county tier designations (based on economic factors such as unemployment, median household income, or population growth) to determine eligibility and benefit levels for many of their economic development incentive programs. The tier designations are reviewed on a regular basis to adjust for changing economic and growth trends. Maryland could then adjust its match requirements with the tier designations so that companies in the most distressed counties receive greater support.

• Maryland might also consider adjusting the match requirements depending on who delivers the training associated with the PWQ grant. Other states, such as Pennsylvania, have approved vendor lists that make sure that the training provided is done so by reputable vendors. Maryland could take this a step further by creating an incentive for companies to work with the state’s public and non-profit training providers. PWQ might require less restrictive match requirements for companies that use state entities including community colleges or non-profit organizations to deliver than training as opposed to those that use private, for-profit training providers. This would extend the benefits of state training investments.

2. Amend the Job Creation Tax Credit The Maryland Job Creation Tax Credit (JCTC) is designed to encourage companies to locate and expand their businesses in Maryland. The JCTC is one of the state’s most commonly used economic development tax credits and can continue to be an effective stand-alone tax incentive for the Department of Commerce. In spite of its popularity, efforts can be made to make it easier to use for businesses and more efficient to administer for the state. The JCTC has a sunset date of January 1, 2020 at which point it will undergo a thorough review. Described below are several options that the state may make in order to make it easier to use for businesses and more efficient to administer for the state.

• Explore options to simplify the verification of created jobs. Currently companies must undergo a CPA review to verify that they achieved their committed level of job creation and retention. Another option, utilized in other states, is to require states to submit their payroll records and attest the accuracy of the records. The state can then have the option to do more in depth verification through random examinations of company records or targeted audits for job creation numbers that raise questions.

94 https://www.nccommerce.com/research-publications/incentive-reports/county-tier-designations 95 http://www.tcigroup.com/wp-content/uploads/2013/05/73897TennesseeECDToolkit2011.pdf

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The compliance requirements for companies could be further streamlined by establishing data sharing agreements between the Department of Commerce and the Department of Labor, Licensing and Regulation (DLLR). This would allow Department of Commerce to draw upon the payroll records that companies provide to DLLR and therefore further reducing the reporting requirements placed on companies. This option, however, will require legislative fixes to facilitate this kind of data sharing between the agencies.

• Adjust the JCTC eligibility to better reflect state policy priorities. There are several ways that the JCTC can be adjusted to better align with the state policy priorities. For instance, the geographic eligibility can be adjusted to not only clarify the program alignments, but also to ensure that companies in more rural areas benefit. Currently, companies located in preferred funding areas can meet lower employment thresholds. However, these PFAs are not always clear and create some confusion for companies about their eligibility. Moreover, the lower employment thresholds are still high for many companies in smaller, or more rural areas. As noted above, other states use county tier designations to determine eligibility and benefit levels. This concept could also be applied to the JCTC eligibility requirements. For companies and local developers, a tiered system is easier to understand and explain than the current PFA designations. By connecting eligibility to the tier designation, policymakers can ensure that the benefits of the program are directed to areas with great need. Moreover, they can ensure that the eligibility requirements (e.g., job creation thresholds) fit with the economic context of those counties. Currently, the JCTC job creation thresholds are often too difficult for companies in the state’s more rural counties to achieve. While the changes to geographic eligibility will create additional opportunities for certain geographies (e.g., rural counties), wage limits can set minimum requirements that ensure that the tax credits are incentivizing job creation beneficial to the state and its regions. Therefore, firms might only be able to claim a tax credit for created and retained jobs that pay above, for example, the county median wage. Using each county’s most current median wage, will reflect the economic difference within the state and will allow the tax credit to reflect wage changes over time. Firms that are already using the tax credit would be held to their current agreement, so they would not be affected by these changes.

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Appendix 1. Characteristics of Place-based Programs in Selected Other States St

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Virginia Virginia Enterprise Zone Program (Job Creation Grant)

Cities/Counties can submit applications to the Department. Applications will include a description of the area to be included, the development potential of the areas, the need for special state incentives, the local incentives that shall be provided to support new economic activity, and other information that the Department deems necessary to assess requests for designation. (VA Code 59.1-542)

Up to $500/year per net new permanent full time position earning at least 175% of the federal minimum wage (150% in high unemployment areas) with health benefits, Up to $800 per year per net new permanent full-time positions earning at least 200% of federal minimum wage with health benefits.

No No Yes - Department reviews effectiveness in creating jobs and annually reports its findings to the Legislature

http://www.dhcd.virginia.gov/images/VEZ/VEZ-Incentive-Matrix.pdf

Virginia Virginia Enterprise Zone Program (Real Property Investment Grant)

Cities/Counties can submit applications to the Department. Applications will include a description of the area to be included, the development potential of the areas, the need for special state

Up to $100,000 per building or facility for qualifying real property investments of less than $5 million, Up to $200,000 per building or facility for qualifying real property investments of $5 million or more, Real Property grant awards may be subject

No No Yes - Department reviews effectiveness in creating jobs and annually reports its findings to the Legislature

http://www.dhcd.virginia.gov/images/VEZ/VEZ-Incentive-Matrix.pdf

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incentives, the local incentives that shall be provided to support new economic activity, and other information that the Department deems necessary to assess requests for designation. (VA Code 59.1-542)

to proration should requests exceed grant funds allocated.

New Jersey Urban Enterprise Zone

Cities submit applications for UEZ status. Decisions are based on the need of the city for economic development, the unemployment rate, the percentage of families on welfare, the potential benefits as demonstrated by the application, and other similar factors (from pdf in notes)

1. Reduced Sales Tax (3.5%), 2. Tax-Free Purchases on certain items such as capital equipment, facility expansions, and upgrades, 3. Financial Assistance from agencies such as NJEDA, 4. Subsidized unemployment insurance costs for employees who earn less than $4,500 per quarter, 5. Energy Sales Tax Exemption for qualified manufacturing firms with at least 250 employees, 50% of whom are working in manufacturing

No No No http://www.state.nj.us/treasury/taxation/pdf/pubs/uezqa.pdf

Connecticut Enterprise Zone Program

Census tracts with 1. 25% or more of the persons within the tract shall have income below the poverty level, 2. 25% or more of the families within

1. 5 year, 80% abatement of local property taxes on all qualifying real and personal property that are new to the grand list of the city/town as a direct result of a business relocation, expansion, or

No No Yes - Goals reviewed every 5 years by Commissioner of Economic and Community Development (CT Gen State 32-70(b)

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the tract shall receive public assistance or welfare income, 3. the unemployment rate of the tract shall be at least 200% of the state's average

renovation project. 2. 10 year, 25% or 50% credit on that portion of the Connecticut Corporate Business Tax that is directly attributable to this business relocation, expansion, or renovation project as determined by the Connecticut Department of Revenue Services and as provided under section 12-217(e) of the Connecticut General Statutes. 3. Exemption from real estate conveyance tax (source: C2ER State Business Incentives Database)

South Carolina Economic Impact Zone Investment Credit

Everything references the law (cited in the notes) but gives no definition of the Economic Impact Zones

South Carolina allows manufacturers locating in Economic Impact Zone (EIZ) counties a one-time credit against a company’s corporate income tax of up to 5% of a company’s investment in new production equipment. The actual value of the credit depends on the applicable recovery period for property under the Internal Revenue Code.

$5 million per entity

No No http://www.scstatehouse.gov/code/t12c014.php

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Louisiana Enterprise Zone Program

Incentives available to any Louisiana business (not involved in gaming, residential development, a church, retail business or restaurant with NAICS of 44, 45, 722) which will create a minimum of 5 permanent net new full-time jobs within 24 months of the project start date or increase their current nationwide workforce by 10% within the first 12 months; or hire 50% of the net new jobs created from one or more of the certification requirements from targeted groups (residents living in EZ, people receiving public assistance, people performing below 9th grade proficiency in reading/writing/mathematics, people unemployable by traditional standards).

1. A one-time $2500 job tax credit for each net new job created 2. A 4% rebate of sales and use taxes paid on qualifying materials, machinery, furniture, and/or equipment purchased or a 1.5% refundable investment tax credit on the total capital investment, excluding tax exempted items 3. A refundable investment tax credit equal to 1.5% of qualified capital expenditures

No No Yes - yearly employee certification report filed with business incentive services showing compliance.

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Appendix 2. State Angel Tax Credit Programs

State Name of Credit

Industries, if specified

FY2014 Appropriation

in Millions

Maximum/ company

(annual A or lifetime L)

Percent of Credit

Transferable? Y/N

Refundable? Y/N

Age limit on

company

Employment limit of

company

Annual revenues

max Arizona Angel

Investment Program

Life Science A = $500,000 and L =

$2,000,000

35%

Arkansas Equity Investment Tax Credit

33% Y

Colorado Advanced Industry Investment Tax Credit

Advanced Manufacturing, Aerospace, Bioscience, Electronics, Energy/Natural Resources/ Cleantech, Infrastructure Engineering, and Technology & Information

$0.375 A = $50,000 30% N N 5 years $5 million

Connecticut Angel Investor Tax Credit Program

Bioscience, advanced materials, photonics, information technology, clean technology or any other emerging technology

25% 7 years 25 FTE $1 million

Georgia Qualified Investor's Tax Credit (Angel Investor Tax Credit)

$10 A = $50,000 35% 3 years 20 FTE $.5 million

Illinois Angel Investment Credit Program

Innovation $10 A = $2,000,000

25% N 10 years 100 FTE

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in Millions

Maximum/ company


Percent of Credit

Transferable? Y/N

Refundable? Y/N

Age limit on

company

Employment limit of

company

Annual revenues

max Indiana Venture

Capital Investment (VCI) Tax Credit

Professional motor vehicle racing, technology transfer

A = $1,000,000

20% $10 million

Iowa Qualifying Businesses Tax Credit

$2 A = $50,000 and L =

$250,000

20% 6 years $5 million

Iowa Community-Based Seed Capital Funds Tax Credit

$2 A = $50,000 20% 6 years

Iowa Innovation Fund Tax Credit

Advanced manufacturing, biosciences and information technology, and others

25% Y

Kansas Venture Capital Credit

Bioscience, others

25%

Kansas Kansas Angel Investor Tax Credit

$6 A = $50,000 50% Y N 10 years for

Bioscience, 5 years for non-

Bioscience

Kentucky Kentucky Investment Fund Act (KIFA)

$8 50% N 100 FTE $10 million

Louisiana Angel Investor Tax Credit

$3.6 A = $720,000 and L =

$1,440,000

25.2% 50 FTE $10 million

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in Millions

Maximum/ company


Percent of Credit

Transferable? Y/N

Refundable? Y/N

Age limit on

company

Employment limit of

company

Annual revenues

max Maine Maine Seed

Capital Tax Credit Program

Visual media production; manufacturer; advanced technologies; value-added natural resource enterprise; other export industries

$4 $500,000 per transaction, L = $5,000,000

50% Y $5 million

Maryland Biotechnology Investment Incentive Tax Credit

Biotech $12 A:15% of appropriation for company; $250,000 per transaction

50% N Y 10 years, 12 with

permission

50 FTE

Maryland Cybersecurity Investment Incentive Tax Credit

Cyber $3 A:$250,000 per

transaction, no more than

two years, 15% of total

available

33% N Y 5 years 50 FTE

Minnesota SEED Capital Investment Credit Program

A:$125,000 45% N

Minnesota Angel Tax Credit

Technological innovation

A:$125,000, L:$1,000,000

25% 10 years, 25 years

for pharma

25 FTE

Minnesota SEED Capital Investment Credit Program

A:$125,000 45% N

Minnesota Angel Tax Credit


A:$125,000, L:$1,000,000

25% 10 years, 25 years

for pharma

25 FTE

Nebraska Angel Investment Tax Credit

High-tech $4 $350,000 per transaction,

$1 million per business

35-40% Y 25 FTE

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in Millions

Maximum/ company


Percent of Credit

Transferable? Y/N

Refundable? Y/N

Age limit on

company

Employment limit of

company

Annual revenues

max New Jersey Angel

Investor Tax Credit Program

Emerging technology

$25 $500,000 per transaction

10% Y 225 FTE

New Mexico Angel Investment Tax Credit

High tech, manufacturing

$2 $62,500 per transaction

25%

New York Qualified Emerging Technology Company (QETC) Tax Credits

Advanced materials and processing technologies; Engineering, production, and defense; Electronic and photonic devices and components; Information and communications technologies; Bio- and nano-technologies. Re-mfg technologies

L: $150,000-$300,000

10-20% N

North Carolina

Qualified Business Investment Tax Credit Program

Manufacturing, processing, warehousing, wholesaling, research and development, or a service-related industry

$7.5 $50,000 per investor for all

companies

25% $5 million

North Dakota Angel Fund Investment Credit

A: $45,000, L: $500,000

45%

North Dakota Seed Capital Investment Credit

Innovation $3.5 A: $112,500, L: $500,000

45%

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in Millions

Maximum/ company


Percent of Credit

Transferable? Y/N

Refundable? Y/N

Age limit on

company

Employment limit of

company

Annual revenues

max Ohio Technology

Investment Tax Credit (TITC) Program


$62,500 - $90,000 per

transaction, L: $1.5 million

25-30% N Y

Ohio InvestOhio (max $1 million per investor)

10% N $10 million

Oregon University Venture Development Fund Tax Credit

University 60%

Pennsylvania Innovate in Pennsylvania: Venture Investment Program


Rhode Island Innovation Tax Credit

Biotechnology and Life Sciences; Communication and Information Technology; Financial Services; Marine and Defense Manufacturing; Professional, Technical and Educational Services ; Industrial and Consumer Product Manufacturing and Design

50% (max of $100K)

$1 million

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in Millions

Maximum/ company


Percent of Credit

Transferable? Y/N

Refundable? Y/N

Age limit on

company

Employment limit of

company

Annual revenues

max South Carolina

Angel Investor Credit

Manufacturing, processing, warehousing, wholesaling, software development, information technology services, R&D

$5 35% (max of $100K)

Y 5 years 25 FTE $2 million

South Carolina

Venture Capital Investment

A: $20 million Lender tax credit is

limited the total of loan

principal loan & interest.

Y

South Carolina

Palmetto Seed Capital Credit

30-50%

Vermont Vermont Seed Capital Fund

50% N

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in Millions

Maximum/ company


Percent of Credit

Transferable? Y/N

Refundable? Y/N

Age limit on

company

Employment limit of

company

Annual revenues

max Virginia Qualified

Equity And Subordinated Debt Investments Credit

Advanced computing, advanced materials, advanced manufacturing, agricultural technologies, biotechnology, electronic device technology, energy, environmental technology, information technology, medical device technology, nanotechnology, or any similar technology-related field

$4.50 A = $50,000 50% N $3 million

West Virginia High-Growth Business Investment Tax Credit

A = $50,000 50% N

Wisconsin Qualified New Business Venture

Technological advancements

L = $8 million 25% Y 10 years 100 FTE

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Appendix 3: Capital Access Market Need Policy makers have long recognized the hurdles that minority-owned small business owners face in the pursuit of entrepreneurial growth. Many of these business owners cite the lack of access to capital as a critical barrier to growth and sustainability. Additionally, insufficient business networks, investment, business opportunities and various levels of management skill result in challenges to business survival. For many minority-owned business owners, the very social issues and discriminatory constructs that prevent them from success in traditional employment opportunities become the motivating factor for beginning their own businesses. Unfortunately, these practices continue even after business owners prove their business savvy. With fewer diversified assets to leverage, minority-owned businesses are often faced with the lack of capital throughout the firm’s lifecycle. The lack of capital, combined with limited opportunities to develop business relationships can further impede raising the necessary capital and support to achieve business success. In a 2010 survey of members of the National Association of Women Business Owners, African American entrepreneurs cited the following challenges to starting and growing their business:

• 63% reported using credit cards to finance businesses • 44% reported using private sources - personal savings/loans from family/friends • 37% reported using a business line of credit • 13% reported using a commercial or bank loan • 11% reported using a personal bank loan • 4% reported using a loan guaranteed by the Small Business Administration • 2% reported using equity capital

Additionally, more than half of those surveyed reported challenges when trying to obtain business financing; minority business owners and women were more likely to be rejected, received smaller loans with higher borrowing costs, and overall were offered loans with less favorable terms. It is important to note that in 2011 only 11% of capital-investment funds were allocated to women entrepreneurs, while male entrepreneurs received 89% of funding. This allocation of capital-investment funding is despite the fact that 20% of top entrepreneurs are women.96 For small business owners, business networks are also critical to their success. These relationships often lead to building a customer and supplier base, improving access to debt and equity finance, and providing useful advice and support. Similarly, peer networks may be particularly valuable and provide necessary support for entrepreneurs facing similar problems,

96 https://www.americanprogress.org/issues/race/report/2014/06/10/91241/how-women-of-color-are-driving-entrepreneurship/

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or located in the same communities. Women- and minority-owned businesses often cannot effectively access business networks even though they might benefit the most from them.97 Many entrepreneurs and small business owners need access to skills, but often training initiatives are not focused enough on their actual needs and time constraints. Training programs can help ensure that women and minorities in particular are able to more fully take part in entrepreneurship that supports the creation of new jobs, innovative ideas, and economic growth (Barr, 2015). U.S. Census data (2012) indicate that minority-owned firms are smaller as measured by both revenues and employment, less profitable as measured by return on assets, and less likely to survive than their nonminority counterparts. In addition, women-owned firms tend to start with much less capital than their male counterparts, and Census data indicate women are also less likely to start or acquire firms with business loans from banks or financial institutions (5.5 percent of women owners versus 11.4 percent of male owners). Minority- and women-headed households generally have lower levels of household wealth, which in turn can make internal investment and external borrowing more difficult.98 A recent SBA report99 references several empirical studies highlighting evidence of disparate credit market outcomes for minority-owned small businesses. These studies have found evidence of disproportionate loan denials to black-owned and Hispanic-owned firms. The report confirms these findings and further asks whether business credit scores disproportionately affect access to credit for women-owned and minority-owned firms. The report further asserts three critical findings as it relates to general access to credit and the challenges small businesses with lower credit scores face: (i) more likely to be undercapitalized; (ii) more likely to be discouraged from applying for credit when they report a need for additional credit; and (iii) more likely to be denied credit when they need additional credit and apply for credit. Results also confirm prior findings that borrower-lender relationships play a significant role in credit outcomes for small firms. Other barriers that may reduce rates of business formation among minorities include educational attainment; geographic or societal isolation from other communities and persistent discrimination may also impede entrepreneurship among women and minorities.100 These findings directly influence Maryland’s efforts to address the needs of minority- and women-owned businesses as well as the CREC team’s recommendations to invest public resources to address these known barriers.

97 Barr, Michael S. 2015. Minority and Women Entrepreneurs: Building Capital, Networks and Skills. The Hamilton Project. Discussion Paper 2015-03. 98 Cole, Rebel A. 2014. Credit Scores and Credit Market Outcomes: Evidence from the Survey of Small Business Finances and the Kauffman Firm Survey. US Small Business Research Summary No. 219. http://www.sba.gov/advocay/7540. 99 Ibid. 100 Barr, op. cit.

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About the CREC Team

The Center for Regional Economic Competitiveness (CREC) is an independent nonprofit that provides strategic economic analysis and manages networks of data and research professionals. Our technical assistance expertise produces innovative, regional job-creating strategies. CREC achieves its mission by undertaking efforts to (a) understand the economic forces impacting states and local regions, (b) assist state and local leaders in formulating knowledge-based strategies, and (c) develop transformational models that support knowledge-driven economic prosperity.

CREC believes that institutions responsible for developing state and regional economies can be more effective in their efforts to create jobs for the knowledge economy. The Center helps these organizations achieve their goals by providing better information about regional economies and a framework for developing local consensus on strategic direction.

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