[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



 
     BRIDGING THE EQUITY GAP: EXAMINING THE ACCESS TO CAPITAL FOR 
                       ENTREPRENEURS ACT OF 2006
=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                      WASHINGTON, DC, MAY 10, 2006

                               __________

                           Serial No. 109-52

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house


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                      COMMITTEE ON SMALL BUSINESS

                 DONALD A. MANZULLO, Illinois, Chairman

ROSCOE BARTLETT, Maryland, Vice      NYDIA VELAZQUEZ, New York
Chairman                             JUANITA MILLENDER-McDONALD,
SUE KELLY, New York                    California
STEVE CHABOT, Ohio                   TOM UDALL, New Mexico
SAM GRAVES, Missouri                 DANIEL LIPINSKI, Illinois
TODD AKIN, Missouri                  ENI FALEOMAVAEGA, American Samoa
BILL SHUSTER, Pennsylvania           DONNA CHRISTENSEN, Virgin Islands
MARILYN MUSGRAVE, Colorado           DANNY DAVIS, Illinois
JEB BRADLEY, New Hampshire           ED CASE, Hawaii
STEVE KING, Iowa                     MADELEINE BORDALLO, Guam
THADDEUS McCOTTER, Michigan          RAUL GRIJALVA, Arizona
RIC KELLER, Florida                  MICHAEL MICHAUD, Maine
TED POE, Texas                       LINDA SANCHEZ, California
MICHAEL SODREL, Indiana              JOHN BARROW, Georgia
JEFF FORTENBERRY, Nebraska           MELISSA BEAN, Illinois
MICHAEL FITZPATRICK, Pennsylvania    GWEN MOORE, Wisconsin
LYNN WESTMORELAND, Georgia
LOUIE GOHMERT, Texas

                  J. Matthew Szymanski, Chief of Staff

          Phil Eskeland, Deputy Chief of Staff/Policy Director

                  Michael Day, Minority Staff Director

                                  (ii)


                            C O N T E N T S

                              ----------                              

                               Witnesses

                                                                   Page
Pomeroy, The Honorable Earl (ND-At Large), Congressman, U.S. 
  House of Representatives.......................................     3
Preston, Ms. Susan, Davis Wright Tremaine LLP....................     4
Sobieski, Dr. Ian, Ph.D., Founder and Managing Director, Band of 
  Angels.........................................................     6
Heinemann, The Honorable Lorrie Keating, Secretary, Wisconsin 
  Department of Financial Institutions, Department of Financial 
  Institutions...................................................     8
Loague, Mr. Dan, Executive Director, Capital Formation Institute.    10
Villalobos, Mr. Luis, Founder and Board Member of Tech Coast 
  Angels.........................................................    12

                                Appendix

Opening statements:
    Manzullo, Hon. Donald A......................................    28
    Velazquez, Hon. Nydia........................................    29
Prepared statements:
    Pomeroy, The Honorable Earl (ND-At Large), Congressman, U.S. 
      House of Representatives...................................    31
    Preston, Ms. Susan, Davis Wright Tremaine LLP................    33
    Sobieski, Dr. Ian, Ph.D., Founder and Managing Director, Band 
      of Angels..................................................    41
    Heinemann, The Honorable Lorrie Keating, Secretary, Wisconsin 
      Department of Financial Institutions, Department of 
      Financial Institutions.....................................    46
    Loague, Mr. Dan, Executive Director, Capital Formation 
      Institute..................................................    48
    Villalobos, Mr. Luis, Founder and Board Member of Tech Coast 
      Angels.....................................................    51
Additional material:
    Sohl, Mr. Jeffrey E., Ph.D., Professor of Entrepreneurship 
      and Decision Services, Whittenmore School of Business, 
      University of New Hampshire................................    59

                                 (iii)


     BRIDGING THE EQUITY GAP: EXAMINING THE ACCESS TO CAPITAL FOR 
                       ENTREPRENEURS ACT OF 2006

                              ----------                              


                        WEDNESDAY, MAY 10, 2006

                   House of Representatives
                                Committee on Small Business
                                                     Washington, DC
    The Committee met, pursuant to call, at 2:13 p.m., inRoom 
2360, Rayburn House Office Building, Hon. Donald A. Manzullo 
[Chairman of the Committee] Presiding.
    Present: Representatives Manzullo, Kelly, Chabot, Akin, 
Poe, Velazquez, Udall, Christensen, Barrow and Moore.
    The Chairman. Good afternoon, and welcome to this important 
hearing.
    On April 26, 2006, I introduced H.R. 5198, the Access to 
Capital for Entrepreneurs Act of 2006, or the ACE Act, with 
Representative Earl Pomeroy, our colleague from North Dakota. 
This bipartisan measure provides a mechanism for our nation's 
small businesses to obtain critical equity funding. It does so 
by establishing a tax credit for the individuals and 
partnerships most likely to provide equity funding to small 
early stage companies. The purpose of this hearing is to 
examine and discuss the angel investor market and its potential 
effects on small businesses through the implementation of the 
ACE Act.
    This Act was patterned after successful programs in 21 
States, 11 of which have representation on this Committee. 
These States include: Arizona, Colorado, Hawaii, Indiana, Iowa, 
Maine, Michigan, Missouri, New York, Ohio, and Wisconsin.
    Where is Illinois?
    These State tax credits have materially helped increase the 
amount of early and emerging company financing being provided 
to our Nation's small businesses. Today, a government official 
from Wisconsin is going to provide information on how the 
Wisconsin State tax incentive is working.
    The ACE Act provides a needed boost to our nation's 
qualified small businesses by helping angel investors increase 
equity stakes in these companies. If the provisions of the ACE 
Act were signed into law, many small businesses which would 
otherwise fail for lack of adequate resources could grow and 
expand, creating more jobs for Americans. The United Kingdom 
already has a similar tax program in place that encourages new 
investments in emerging and early stage companies. The UK's 
incentive has proved extremely popular and resulted in the 
influx of tremendous amounts of capital. We want to provide the 
same type of incentive to the growing and emerging small 
businesses in our own Nation.
    I now yield to the ranking minority member, Representative 
Velazquez of New York, for her opening comments.
    [Chairman Manzullo's opening statement may be found in the 
appendix.]
    Ms. Velazquez. Thank you, Mr. Chairman.
    Access to capital is the key to success for many small 
businesses, but in today's economy this is easier said than 
done. Many entrepreneurs need all the help they can get in 
securing the capital needed to start and run their businesses. 
Venture capital has long filled this role by putting seed 
capital directly into the hands of small business start-ups. 
Unfortunately, this source of financing is simply not 
accessible to many entrepreneurs starting out today, 
particularly women and minorities.
    This is why initiatives such as the Small Business 
Investment Company, SBIC, are so important in filling this gap. 
This program has a proven record, making an average investment 
per business of around $1.1 million, serving as a critical 
source of capital for early stage businesses. Now that the SBIC 
participating securities program has been shut down for over a 
year, with no plans for reopening, the need for such a 
government initiative has become more important than ever.
    As we will hear today, angel investors are working to fill 
this role. A lesser known and less formal alternative to 
traditional venture capital, angel investing is truly the wave 
of the future for thousands of small business start-ups across 
the country. Last year alone, there were 225,000 active angel 
investors in the U.S. who invested $23 billion in small 
businesses by focusing directly on early stage and growing 
entrepreneurial ventures that have faced difficulty in securing 
equity financing.
    This is the avenue for getting much-needed capital into the 
hands of our Nation's small businesses. These entrepreneurs are 
some of the most innovative out there, and these are the types 
of high-risk, high-reward investments that will pay off in the 
long run. The question is: How do we make angel investing a 
valuable source of financing for this Nation's entrepreneurs?
    Clearly, the obvious first step is providing tax credit 
incentives for angel investments in qualified small businesses. 
Investment tax credits for equity funding provides a good 
incentive to spur this investment in small firms.
    This is an important step in nurturing local companies with 
increased early-stage financing, but on its own tax credits are 
simply not enough. We need to make sure that the SBA is 
involved in this process. As the only agency tasked with 
assisting this Nation's entrepreneurs, it is the SBA that truly 
understands the challenges small businesses face, has 
experience in helping business owners, and knows the importance 
of involvement at the local level.
    This bill and support system will provide both small 
businesses and investors alike with good, reliable advice, a 
system that will go a long way in spreading angel investment to 
companies across the country.
    We also need to commit more to assist women and minority-
owned businesses, sectors that have traditionally faced 
difficulty in accessing equity financing. These companies have 
the potential to infuse innovative new ideas into the economy, 
which makes angel financing a good investment. It is clear that 
they need these investments as well, and angel funding must be 
a valuable source of financing for the next generation of women 
and minority entrepreneurs.
    Clearly, angel financing is of vital importance to small 
businesses. As the economy continues to rely on entrepreneurs 
to spur job growth and stimulate economic development, the need 
for such an initiative only grows. In that respect, we need to 
consider a variety of proposals in an effort to provide the 
best investment for our Nation's businesses and the future of 
our economy.
    Thank you, Mr. Chairman.
    [Ranking Member Velazquez's opening statement may be found 
in the appendix.]
    The Chairman. Thank you.
    The rules are that you limit your testimony to 5 minutes. 
Your complete written statements will be made a part of the 
record. We will keep open the record for 2 weeks for anybody 
that wants to add additional testimony. It is limited to two 
typewritten pages, and the smallest type print is 10 point, 
okay? No books or anything like that appended at the taxpayers' 
expense.
    When you see the yellow light, that means that you have one 
minute. When you see the red light, that means wrap up in a 
hurry.
    The Chairman. We are going to lead off with a last-minute 
addition. My cosponsor of the bill is Earl Pomeroy from North 
Dakota; and, Earl, as soon as you feel comfortable--obviously, 
you can leave the panel to get back to your congressional 
duties--but we look forward to your testimony and statement.

  STATEMENT OF THE HONORABLE EARL POMEROY (ND-AT LARGE), U.S. 
                    HOUSE OF REPRESENTATIVES

    Mr. Pomeroy. Thank you, Mr. Chairman.
    The opening statements of you and the ranking member 
reflect once again the Small Business Committee is one place 
where often we see some rare but wonderful glimpses of 
bipartisanship as Republicans and Democrats across the aisle 
try to answer the real problems facing growing our economy.
    Certainly in the small business area, Congresswoman 
Velazquez has it exactly right: Access to capital continues to 
be and will always be one of the most significant hurdles in 
growing and developing new opportunities through the small 
business sector.
    It has come to my attention that the opportunity to seek 
equity funding, especially from venture capital funds, has 
diminished as these funds have gravitated towards larger, more 
established businesses, driven by a number of factors, 
including the higher risk of the smaller, newer start-ups.
    I look at the ACE Act, the investment tax credit copied 
after State initiatives which have long been in place in this 
area. North Dakota's effort, for example, was initially passed 
in 1989 and has been extended and improved several times. That 
is the value we believe this has back home, is a model that I 
think will help incent capital in this way; and it will, in my 
opinion, offer a balance to the higher-risk premium that 
capital is going to take as they go down to this level of what 
is known as angel investing.
    We have at the University of North Dakota the Center For 
Innovation, led by Bruce Gjovig. He was instrumentally involved 
in the creation of this legislation.
    I do commend you, Mr. Chairman, for the vetting that this 
proposal has had in terms of trying to make certain that we 
have developed a proposal that wasn't just good in spirit but 
that actually works; again, has been closely copied by that 
which has already been marketed and tested at the State level. 
Those of us with experience in local and State government truly 
do believe that that is where the laboratories of innovation 
for our country are. In my opinion, the lab results are in. It 
is time now to federally move to an even greater incentive that 
the Federal Tax Code could represent and offer the ACE Act.
    These comments are extended on in my testimony, but the 
real experts are with us, so I want to keep my remarks short 
and move to the other panel members, Mr. Chairman. I would be 
happy to take any questions before I have to leave to get back 
to my other Committee, but I do want to thank my fellow panel 
members for their leadership in this area and helping us 
understand the critical role of angel capital.
    The Chairman. The Chair thanks the gentleman from North 
Dakota very much. We appreciate your testimony.
    [Congressman Pomeroy's testimony may be found in the 
appendix.]
    The Chairman. Our next witness is Susan Preston. She comes 
all the way from Seattle, Washington. A microbiologist by trade 
and also an attorney. We look forward to your testimony.

     STATEMENT OF SUSAN PRESTON, DAVIS WRIGHT TREMAINE LLP

    Ms. Preston. Thank you very much.
    Chairman Manzullo, Ranking Member Velazquez, and members of 
the Committee, thank you for inviting me here today to testify 
before this Committee on bridging the equity gap and examining 
the Access to Capital for Entrepreneurs Act, or ACE Act.
    I am testifying before you as an expert in the field of 
angel financing and the funding gap and, in fact, testified 
before this Committee in April of 2005 as such an expert with 
regard to SBA's defunding of the SBIC program.
    Just to remind you and give you context to my testimony and 
highlight my background, I am considered a national and 
international expert on angel and private equity financing. I 
have lectured, conducted workshops, written articles, white 
papers, consulted with various government and NGO organizations 
on the topic in close to 100 different settings to date.
    I am the founder of an angel organization in Seattle called 
Seraph Capital Forum, the first all-women's angel organization 
in the United States.
    I have a well-written and well-received book on angel 
organizations that is being used in a number of different 
locations nationally and internationally on establishing angel 
organizations; and I am currently writing a book, an 
entrepreneurship guide to angel financing, under contract with 
Wiley Publishing.
    I am also a founding member of Angel Capital Association 
and a continuing board member for the successor Angel Capital 
Education Foundation.
    I am an entrepreneur-in-residence with the Kauffman 
Foundation and have been, for the last 6 years, focusing my 
attention entirely on angel financing. I am one of four lead 
instructors for the Power of Angel investing program that 
Kauffman puts on.
    About 6 months ago, I approached staff on the House 
Committee with the idea of an income tax credit for private 
equity financing, in part as a response to the chairman's 
request for ideas to fill the ever-expanding fund gap, which 
had been partially filled by the now defunded SBIC program. 
Over these months, I have worked with staff on my own time as 
an individual citizen to develop what is now currently the ACE 
Act.
    Considerable work went through and into the development of 
ACE, including the establishment of a working group of experts 
in private equity financing and representation from national 
organizations, as well as representation from the States that 
currently have income tax credits, a total of 21 States.
    The roundtable discussions with this working group were 
highly informative and valuable in defining many critical 
structure aspects for ACE. ACE now represents what we consider 
the best of State programs and benefits from the lessons 
learned by these States in development and implementation of 
their own programs. The result is a considerable effort in time 
and thought-out program into the ACE Act.
    It is simplistic, self-executing; and that is part of the 
beauty of it as a Federal income tax credit for early stage 
investors. It represents and gives opportunities both to 
individual angels as well as to partnerships or angel funds, 
and it also provides that well-needed--as the chairman and 
ranking member have pointed out, that well-needed fund for 
those young companies and growing companies in that area.
    The initial responses from the angel community have been 
extremely enthusiastic for the bill as it targets exactly where 
their interests are in several aspects. As mentioned and as has 
been put into the record, this is a very important aspect of 
funding, between the friends and family round of small amounts 
for companies just starting and the venture capital rounds.
    Venture capital is, on average, an investment of $6 million 
to $7 million per deal, far above what a young company needs 
from the standpoint of early investing. Therefore, with only 
3.3 percent of venture dollars going into seed and early stage, 
we clearly need another area of investment. Angels fill that 
and have been filling that to a certain extent with 55 percent 
of their $23.1 billion going into seed and early stage. In 
fact, they invested in nearly 50,000 deals in 2005, which is an 
average of a little under $.5 million per deal, a very good and 
interesting spot for funding for these early stage companies.
    Moreover, angels are being asked to invest in second and 
third rounds of financing because of the absence of VC funding 
and also the lack of need sometimes of entrepreneurs for large-
scale VC funding. Therefore, again, angel investors provide 
that critical and essential part of a healthy economy.
    The attributes of this bill are, I think, self-evident in 
its independence, allowing lone-ranger angels to invest rather 
than through angel funds and providing both for the individual 
angel as well as for the angel groups. It allows the angels to 
remain anonymous. It allows for some reduction of risk at a 
high-risk investment time period for them and allows them to 
choose their own investment at their own time period, as angels 
prefer to do.
    It addresses these critical attributes, and I believe that 
it is a well-defined and well-structured tax credit providing 
those needed incentives to angel investing.
    Thank you.
    The Chairman. Thank you. I like this jargon. Lone-ranger 
angels. It is interesting.
    [Ms. Preston's testimony may be found in the appendix.]
    The Chairman. Our next witness, Dr. Ian Sobieski, is an 
aeronautical engineer and founder and managing director of Band 
of Angels, which sounds like a motorcycle club, in Menlo Park, 
California. And I notice that you graduated from Virginia Tech 
with a double major in aerospace engineering and philosophy. 
That is a good mix.
    Mr. Sobieski. Well, thanks.
    The Chairman. Good mix. We look forward to your testimony.

        STATEMENT OF IAN SOBIESKI, PH.D., BAND OF ANGELS

    Mr. Sobieski. Thank you, sir.
    Chairman Manzullo, Ranking Member Velazquez, members of the 
Committee, it is a pleasure to be with you here today. As you 
said in your kind introduction, I come from neighboring 
Virginia, and it is nice to be back in my old neck of the woods 
once again.
    Since 1997, I have been privileged to help run an 
organization called Band of Angels in Silicon Valley, 
California. This organization of angel investors, like many, is 
made up of SEC-accredited investors who have an interest in 
investing their time and their money in new young start-ups.
    What sets the Band apart is that an additional requirement 
for membership in our organization is that the angel has to 
have actually been an entrepreneur or a senior officer in a 
high-technology company. So members of our organization include 
the founders of Logitech, Symantec, National Semiconductor, the 
former CEO of Hewlett-Packard, the former CFO of Intuit, the 
former VP of Marketing for Intel, and a slew of other C-level 
executives from important companies that are less well-known 
than these.
    These are people whose average age is in their late 50s; 
and they have reached a point in their lives where, as I like 
to say, they want to stay in the game but not stay up till 2 
a.m. Any more. As important as their capital is to the company, 
what is more than important to many of these entrepreneurs is 
the mentorship they provide, the guidance on how to build their 
business, as they did early in their careers, from nothing to 
something.
    Since its inception in 1994, the Band has invested in more 
than 180 start-up companies. Of those, nine ended up going 
public; and that is quite a feat. We are talking about nine 
companies that we seeded with the first money eventually going 
public on the NASDAQ. Thirty-three more were acquired for a 
profit to the investors and, of course, to the founders. And it 
is worth noting that 60 have failed, completely bankrupt, for a 
complete loss.
    But win, lose, or draw, every company that the Band seeded 
allowed an innovation to occur, allowed jobs to be created, and 
allowed an entrepreneur to pursue his dream. In total, we 
estimate something like 3,500 jobs have been created by 
companies that were seeded by the Band of Angels; and this 
story is copied over and over again across the country, both in 
formalized angel groups, in small networks of angels, and 
individual angels acting on their own.
    It has been mentioned here before and it seems to be an 
accepted fact that venture capital can't service the 
entrepreneurial marketplace, and it really is the case that 
venture capital gets far too much credit as the font of 
innovation in this country. It is the latest development in the 
financial food chain, the financial structure that has been 
developing over the entire history of this country to more 
cleverly and efficiently deploy capital earlier and earlier in 
the whole life cycle of a company.
    But venture capital, as Sue just mentioned, is really 
structured to deploy several million dollars per company. The 
partnerships are limited to 10-year lives. Their entire 
structure requires liquidity in that period of time and needs 
the kind of return multiple that many companies simply are 
never going to produce, companies that are still valuable both 
to society and to the entrepreneurs. This is where angels have 
always fit in. They have always provided that critical capital 
to these companies.
    So that is where these bills that we are considering here 
today could play such an important value. If you imagine the 
life-cycle of all the companies in the marketplace as a funnel, 
with the biggest end of the funnel being the seed stage, 
narrowing down to the Googles of the world, those very few 
exceptional companies that change the entire order of magnitude 
of things, angels play at that seed stage.
    Currently, there simply is not enough capital and not 
enough resources to supply the constellation of companies that 
can and would provide innovation. The tax credits that we are 
considering here today would essentially add fuel to the 
furnace of innovation. You know, if you have gasoline in a 
tank, you can heat it very hot and it won't catch fire. What 
you need is oxygen. What we are talking about here is 
increasing the flow of oxygen to a part of the food chain that 
is deprived of enough to create as much innovation as we would 
like.
    If we do this, I am not saying that all these companies 
will be successful. All of them won't necessarily be the next 
Google. In fact, there might be more money losers. But the 
bottom line is: Win, lose, or draw, these kinds of tax credits 
will create more start-up companies. More failures but more 
successes. Which ones? We don't know. But if you pass a version 
of this kind of proposal, I'm confident that I can guarantee 
that you will help create another Google, another Apple, 
another Microsoft, another Sysco.
    Thank you very much. We look forward to your questions.
    The Chairman. Thank you.
    [Dr. Sobieski's testimony may be found in the appendix.]
    The Chairman. Our next witness is from Wisconsin, and 
Congresswoman Moore will be introducing her. But, before that, 
the witness has already forgiven me for attending Marquette 
University. A little bit of a rivalry there between the 
University of Wisconsin and Marquette University.
    Ms. Moore.
    Ms. Moore. Well, thank you so much, Mr. Chair, for this 
privilege--although I am a Marquette grad--for this privilege 
to introduce a native daughter of Wisconsin. We are so proud of 
our Secretary of Financial Institutions in Wisconsin.
    She has really been doing this--she is an expert and has 
been doing this for a long time. She has over 18 years 
experience in the banking and securities industry in Wisconsin 
and has done a variety of things, including helping 
municipalities and municipal treasurers with their mutual funds 
and managing corporate accounts.
    Prior to having been appointed as Secretary of Financial 
Institutions, she was the adviser to Virchow Krause, which is 
the third largest accounting firm in the United States, to 
ensure their compliance with ERISA.
    She is a scrapper. She was born in central Wisconsin, 
Thorp, where she was the youngest of 12 kids. So that is a 
story of survival.
    She does it all well. She is married to Jack; and she has 
four daughters, Catherine, Sarah, Margaret, and Alexandra. So I 
know that that is a challenge keeping up with her jewelry and 
her perfume. I know the story, trust me.
    She is very active in a variety of non-profit organizations 
Statewide, a very responsible and well-balanced citizen; and it 
is with such great pride that I introduce Secretary Lorrie 
Keating Heinemann.
    Welcome.
    The Chairman. Sounds like a nomination speech.

  STATEMENT OF SECRETARY LORRIE KEATING HEINEMANN, WISCONSIN 
 DEPARTMENT OF FINANCIAL INSTITUTIONS, DEPARTMENT OF FINANCIAL 
                          INSTITUTIONS

    Ms. Heinemann. Well, thank you. I have got to tell you, I 
was not expecting that. I am very honored, Congresswoman Moore.
    As many of you know, Congresswoman Moore was the author and 
one of the main instigators of Act 255, which is our tax credit 
package in the State of Wisconsin, and I am here to talk today 
a little bit about the success of that program that she put 
into place and what we have achieved. So certainly thank you, 
Mr. Chairman, for the opportunity here to testify.
    The Department of Financial Institutions, many people 
probably may not have heard of that. But what we do is we 
primarily regulate banking, security, credit unions; and then 
we are also the corporate filing agent for about a quarter of a 
million corporations in the State of Wisconsin. However, under 
Governor Jim Doyle's Grow Wisconsin Plan, he also indicated he 
wanted us to focus on economic development; and this is my role 
as the Department of Financial Institutions Secretary, is 
working with the other departments throughout the State.
    In 2003, Wisconsin Act 255 was put into place. It is a 25 
percent tax credit for angel investors and seed funds, also for 
their investments in qualified new business ventures in the 
State of Wisconsin. It went into effect January 1st of 2005. 
Since that time, we have achieved significant results. There 
were $3 million of total angel tax credits available in 2005. 
All of the credits were used. Over 290 individual angel 
investors participated. Over 40 companies were funded. The 
total amount of measurable angel investing was $19.5 million.
    By measurable, I mean we actually have the company names, 
the investors, and we have avoided duplication. But we do 
believe that the total angel investing, which is more through 
the data that we got through our attorneys, is about $50 
million in the State. So it is a very, very important function 
of growing businesses in the State of Wisconsin.
    I had the honor to help cofound a Statewide angel network 
called the Wisconsin Angel Network; and we provide education, 
networking, and deal flow to the angel networks in the State.
    I have to take just a moment to thank Sue Preston. She did 
come into the State of Wisconsin a couple of years ago, when 
Act 255 was just going into play; and we were able to 
significantly increase the amount of organized angel networks 
in our State. We had six at that time. We now have 15. Again, 
very important to bring and partner with Kauffman Foundation in 
educating and making sure that the angels in our State are very 
comfortable with the process.
    Just to give you a couple of examples. eMetagen Corporation 
is a company that was funded by the Golden Angels Network, and 
this was as a result of Act 255. They did take advantage of 
that credit. Up to 10 jobs will be created over the next 12 
months. It is a very high-tech company that was seeded actually 
with the Wisconsin Alumni Research Foundation, which is at UW 
Madison.
    Also, another company you may be interested in that was 
just funded, Mithridion, a $1.6 million angel round, is 
currently in the process of establishing its lab at the 
University of Wisconsin Research Park.
    So if I were you, in your position, I would say, well, why 
is a tax credit package good for government economic policy? 
Well, first, I think it encourages the private sector to invest 
in the American economy. Second, I think it provides an 
increased availability of capital, that access to capital that 
Ms. Velazquez was talking about; and it attracts high-tech, 
high-growth entrepreneurial companies because this is what 
angel investors invest in.
    Yesterday, I had the honor of joining the Phenomenal 
Angels, which is a new fund that just announced yesterday they 
have raised several million dollars and they are focusing on 
investing in women and minority-owned businesses in the State 
of Wisconsin. So we are thrilled to have them on board.
    Finally, it puts a positive focus on our economy. As many 
of you know, the U.S. is a leader in angel and venture 
investing; and this tax credit package I believe is a win-win 
proposal. It leverages private investments at a very low cost 
to the government.
    So, again, thank you for the opportunity to testify in 
support of H.R. 5198.
    [Ms. Heinemann's testimony may be found in the appendix.]
    The Chairman. Our next witness, is it Loague?
    Mr. Loague. Loague. That is correct.
    The Chairman. Dan Loague is from Reston, Virginia. Mr. 
Loague is Executive Director of Capital Formation Institute. He 
has a very interesting background, working in China; and I 
notice that you worked on electronic reconnaissance systems on 
the RF4C Mach 2 aircraft in your tenure in the Air Force.
    Mr. Loague. That is right.
    The Chairman. It is just fascinating to see the educational 
backgrounds of the folks here. I am delighted that there are no 
economists, because a band of ill-advised economists just 
raised the interest rate again for the 16th time. Here we are 
trying to create more capital, and those clowns are out there 
making capital harder to get.
    They believe that if they decrease the money supply, people 
will buy less fuel, because it is petroleum that is causing the 
bit of increase in inflation. The problem is that people are 
charging fuel on their credit cards because they do not have 
enough money to pay it at the gas stations, and they are just 
increasing the amount of inflation themselves.
    So I just love to be around real people and not have the 
economists come in here and tell us how to run our world.
    Mr. Loague, we look forward to your testimony.

      STATEMENT OF DAN LOAGUE, CAPITAL FORMATION INSTITUTE

    Mr. Loague. Thank you very much, Chairman Manzullo, and my 
thanks also to Representative Pomeroy and Ranking Member 
Velazquez. Thanks for holding this hearing today.
    The Access to Capital for Entrepreneurs Act of 2006 is an 
exciting opportunity to expand seed-stage capital for start-up 
and growing U.S. companies. This is a remarkable piece of 
legislation. It is an impeccable match with the practices of 
angels and seed-stage fund investors; and it also targets seed 
capital, the most important and continuously unfulfilled need 
of start-up companies.
    Let me talk a little about Capital Formation Institute and 
the National Association of Seed and Venture Funds. I am now 
the Executive Director of the Capital Formation Institute, 
formerly Executive Director of NASVF.
    CFI is an independent 501(c)(3) spin-off of the NASVF. The 
NASVF, I think, after working some dozen or so years with seed 
and early-stage investors, is now the largest network of seed 
stage and technology investment professionals.
    Now, both these organizations are concerned with expanding 
capital for start-up in high-growth companies. But, 
unfortunately, outside of these organizations, when you get 
beyond these organizations, the whole business, this part of 
the market, is under the radar and largely unknown. I get up in 
the morning and I think to myself, this is old stuff. But when 
you start talking to people, they are just simply not aware of 
it. They do not know what it is, and it is significant.
    Dr. Jeffrey Sohl, the Director of the Center for Venture 
Research at the University of New Hampshire, the leading 
researcher in this area, who has done research for years now, 
has said that, year after year, since the '90s, that the angel 
investing market component has either exceeded or matched all 
of the combined VC investments in seed-stage companies. And 
more importantly than that, whereas you will see the VC 
companies investing in a few hundred start-ups, the angels will 
invest in tens of thousands and, as Sue has said, up to 50,000 
companies per year. This is the driver of an innovative 
economy, and it is the heart of our competitive economy.
    When I was with the NASVF, I did about 100 events that were 
invitation only, which means I had to research who were the 
best people to come to participate in a peer-to-peer 
environment. So over about 9 years I got to know some of the 
really, really great people in this area, and a lot of them are 
seated at the table right now. I am happy to see them again.
    So when I heard about the Committee hearing last week, I 
contacted eight people around the country and asked them what 
they thought would be the effect of the Act's passage, and I 
hope I can get through all eight here, but I will go ahead and 
try.
    The first person I talked to was a gentleman by the name of 
Steve Mercil, with RAIN Source Capital in St. Paul, Minnesota. 
RAIN Source is a multistate network of angel investors. It is 
an incredible operation, and Lorrie is familiar with that.
    What Steve told me was that the benefits--and here I am 
kind of summarizing, but I don't want to get into the details--
the benefits of the Act are beyond the tax credit. It raises 
the importance of investing in entrepreneurs. With the Act, we 
expect a 50 percent higher number of investors in our funds and 
50 percent more dollars in our angel investment pools; and, 
more importantly, raising the funds will be quicker. The tax 
credit could be the last little push needed.
    Then I went to Burt Chojnowski, with Brain Belt Consulting 
in Fairfield, Iowa. Burt's part of a rural miracle in 
Fairfield, Iowa. That is a wonderful town. You ought to check 
that one out. He is an active proponent of enterprise 
development in rural areas; and he said, quote,"This is 
fantastic. It parallels what the Iowa Capital Investment Board 
has done with State tax credits and would be a real boon for 
angels and a community seed fund."
    Orlan Johnson, with the Tri-State Investment Group in 
Research Triangle Park, North Carolina--TIG it is called--is 
one of the most successful angel groups in the U.S. besides the 
Tech Coast Angels. And he said, "It sounds similar to the North 
Carolina situation, which I would say works, but I am biased 
because I participate in the credits. There is a significant 
leverage generated for the State for this kind of tax credit 
program. It has been a factor in getting people that may not 
have taken the risk into the early-stage game. At 25 percent, 
it is substantial enough to get wealthy individuals to at least 
take a look at this investment class as an option for their 
portfolio."
    Woodrow Maggard, with UB-STOR in Amherst, New York, is 
building the New York tech-based economy and says, "It would 
facilitate stronger angel networks and help bridge deals that 
now flow into early-stage capital."
    Liz Marchi at Montana West Economic Development in 
Kalispel, Montana. Thanks to Ms. Marchi, Kalispel now has an 
angel group; and she says, "You know, we need to be driving 
innovation capital in all parts of the country, and our group 
believes this is a way that the private sector can contribute 
it in a needed and positive way to the local economy. Having 
the Federal Government realize that this is essential to 
competitiveness would be very, very nice."
    The Chairman. One thing I cannot reinvent is the clock.
    Mr. Loague. Okay, sorry. Let me just mention the three last 
people on the list. I won't quote them.
    But Larry Peterson, with Camino Real Angels, El Paso; 
Robert Mitchell, Alpha Omega Capital Partners, Richmond, 
Virginia; and Barry Moltz, with the Prairie Angels. And what 
Barry said was, "How Can this be a bad thing?"
    Thank you.
    The Chairman. Thank you very much.
    [Mr. Loague's testimony may be found in the appendix.]
    The Chairman. Our next witness is Luis Villalobos, the 
founder of Tech Coast Angels. I just love the names of these 
organizations. He has handled 108 portfolio companies and 
received nearly $724 million in capital.
    Mr. Villalobos, we look forward to your testimony.

        STATEMENT OF LUIS VILLALOBOS, TECH COAST ANGELS

    Mr. Villalobos. Thank you.
    Chairman Manzullo, Ranking Member Velazquez, and members of 
the Committee, I thank you for the opportunity to testify. I am 
Luis Villalobos, testifying as an individual.
    My entire career has been involved with small companies as 
an entrepreneur and as an angel. I was founding CEO of two 
start-ups. When we sold them, their revenues exceeded $80 
million and had created hundreds of jobs. Over a 25-year 
period, I have personally invested $3.5 million of my personal 
capital in 57 small companies. To date, their returns are 
nearly five times my investment; and they have created more 
than a thousand jobs.
    I started Tech Coast Angels in Southern California, and now 
it is the largest angel group in the country. I ran TCA for the 
first 2 years and continue to be very active. In 8 years, we 
have funded 108 small companies with $68 million of member 
capital and attracted another $656 million from external 
capital, mostly VCs. These 108 companies have created over a 
thousand jobs.
    I was one of nine founders of the Angel Capital 
Association, and I conduct workshops for angel group leaders. 
My undergraduate degree is from MIT, my MBA from Harvard, and I 
was a National Merit Scholar. I am in the course of raising a 
VC fund to coinvest with angel groups.
    I would like to make five quick observations:
    First, only a tiny fraction of small companies are what GEM 
calls high-expectation entrepreneurs, but they create the 
preponderance of jobs and wealth and economic growth.
    Second, that is where the severe funding gap is, for these 
high-expectation entrepreneurs.
    Third, investing in early stage ventures is extremely 
challenging. Fortunately, we know what succeeds: Active 
investors who use a professional investing process and who have 
extensive networks to support the companies they fund.
    Fourth, the emergence of angel groups offers a robust model 
for early-stage investing.
    And, finally, about 10 million individuals annually invest 
around $100 billion into entrepreneurial companies. Nine 
million of them each invest less than $20,000 per year, but 
only about 10,000 of the 10 million individuals are in angel 
groups. There is no consensus on a definition for angel 
investors and almost no data.
    Some comments on the bills:
    I can and do support both bills. However, if I had to 
choose between tax credits, I would favor the one in H.R. 4565 
because it more narrowly targets small business and because it 
should be more capital efficient by putting the credits in the 
hands of presumptively successful investors.
    I believe the proposed angel finance program is excellent, 
though I would like some changes. The recycling of profits is 
commendable.
    I also support the grant program for development of angel 
groups and the establishment of an Office of Angel Investing.
    The Federal Angel Network may need an intermediary, for 
example, angel groups, between the entrepreneurs and the 
individual investors. That is a lesson we learned in ACE-Net.
    Five recommendations:
    First, focus on closing the funding gap for what GEM calls 
the high-expectation entrepreneurs, the companies that create 
the most jobs and economic growth.
    Second, focus on investors who meet the success profile: 
Active, have professional investing processes, and have broad 
networks.
    Third, provide support for existing angel groups and to 
develop new ones.
    Fourth, support the Department of Commerce's group on 
venture capital. And what they recommended was to combine the 
activities of angels who are active in seed and early stage 
investing with mainstream venture capital through some form of 
coinvestment models.
    Finally, collect statistics on the 10 million individuals 
that GEM calls informal investors and on angel investors.
    I am grateful to this Committee for holding this hearing 
and for the opportunity to testify. I welcome your questions. 
Thank you.
    The Chairman. Well, thank you very much.
    [Mr. Villalobos' testimony may be found in the appendix.]
    The Chairman. What I would like to do is for Secretary 
Heinemann to walk me through a transaction, perhaps one that 
you were involved in, where you would see a benefit to an angel 
network.
    Ms. Heinemann. Well, I was not involved in any particular 
transaction, but I can certainly give you examples of 
transactions that have occurred in the State of Wisconsin.
    The Chairman. That would be fine.
    Ms. Heinemann. Okay. We developed an organization called 
the Wisconsin Angel Network, and it is a network for angel 
networks in the State. We provide services. One of those 
services is networking and deal flow.
    The largest angel network at the time in 2004 in our State 
was the Golden Angels Network, which is out of Marquette 
University. It had about 150 members, a good regional, very 
active angel network. Had never set foot on the University of 
Wisconsin Madison's Research Park. Had never set foot.
    The Chairman. We know why, don't we, Ms. Moore? Something 
to do with basketball, I think.
    Ms. Heinemann. The reason I mention that to you is because, 
through the Wisconsin Angel Network, which came out of the Act 
255 tax package that Congresswoman Moore was so instrumental 
in, we were able to create this Wisconsin Angel Network, and we 
started talking about tax and angel investing in our State. 
This network came over and met with eMetagen Corporation. 
eMetagen helped them package a $535,000 seed round through the 
Golden Angel Network, and that is what created the 10 jobs at 
the research facility in Madison--additional jobs, actually, 
throughout the United States and New Jersey.
    So that particular transaction became a certified company, 
as a qualified new business venture, under Act 255. That put it 
on the radar screen along with the Wisconsin Angel Network. 
That made the connection to the Golden Angels Network, which 
then they turned around and invested in the deal and the 
business was created and the money was able to create those 
jobs.
    So that is kind of the A to Z: The tax credit package went 
into place, the network came out of it, the company became 
certified, the certification attracted the angels, the angels 
invested, and now the company is up and running with ten new 
jobs.
    The Chairman. I have a question here for Mr. Villalobos. 
The term "high-expectation entrepreneurs."
    Mr. Villalobos. Yes, sir. There is an organization that 
puts out--it is a combination of Babson in Boston and the 
London School of Business. It used to be Kauffman that was 
their primary sponsor. They put an annual report out on global 
entrepreneurship, and they have a section on the U.S. Last 
year, for the first time, they put out a specific report on 
what they called high-expectation entrepreneurs, the ones that 
create the job growth.
    I can certainly submit a copy for the record, if the 
chairman would like.
    The Chairman. We don't want to attach that book to the 
record. Is that a book that you want to put in?
    Mr. Villalobos. No, no, it is their report.
    The Chairman. A report? That would be fine. We will have to 
use an executive summary for that. Is there one in there?
    Mr. Villalobos. I am sure there is.
    Mr. Villalobos. But, anyway, that is their term for it. 
There are lots of other terms.
    The Chairman. Are these the entrepreneurs that have given 
themselves that name?
    Mr. Villalobos. No, it is what they gave them. Because what 
they found is, of the huge number of small companies, a tiny 
fraction of them are the ones that--and that is where it came 
from. They did a survey and said, "Do you expect to have 
created 20 jobs or more in 5 years, or 50 jobs or more in 5 
years?" and if their expectations met that, they fell in the 
high-expectation category. And it was those that create the 
jobs.
    Now, they are a tiny fraction of all the start-ups.
    The Chairman. Really?
    Mr. Villalobos. Yes.
    The Chairman. So it is a self test?
    Mr. Villalobos. It is a self test that says, when you are 
starting this business, are you expecting to create at least 20 
jobs within 5 years.
    The Chairman. And a tiny fraction only say yes to that?
    Mr. Villalobos. Correct. Keep in mind that the SBA 
definition of small business encompasses 99.7 percent of all 
companies in the U.S. So it covers everything. Most of our 
little companies--and they are great, and I am not saying we 
shouldn't support them. But they are the ones that started the 
little neighborhood barbershop and corner grocery store, et 
cetera. They are not the ones that take off and eventually 
become our Googles and MicroSofts and Home Depots and Federal 
Express.
    The Chairman. My dad had a corner grocery store, and he had 
a restaurant, so I can relate to that.
    Ms. Velazquez.
    Ms. Velazquez. Mr. Villalobos, judging by your experience, 
you appear to be an expert in angel groups.
    Mr. Villalobos. Correct.
    Ms. Velazquez. Obviously, you have concluded that such 
groups are effective in soliciting projects and then analyzing 
and funding angel investments. Can you tell us about that and 
about the importance of the government helping to stimulate 
such groups and such interest?
    Mr. Villalobos. Sure. What I like to do before I get into 
something is to really study it first. I had already been an 
angel investor as an individual, and I was approached by our 
business counsel locally on a pro bono basis to stimulate 
Orange County economy.
    I talked to, in fact, the founder of the Band of Angels, 
Hans Severiens, who effectively helped me think through the 
idea of the angel group; and I modeled it after the Band of 
Angels and added some process. But, at the same time, I read a 
Federal Reserve report; and they analyzed in detail why venture 
capital funds succeeded. And the reasons that they found were 
really two, on the operational side, what they called alignment 
and a process. Alignment simply being whoever is responsible 
for making the investment decision should have either their 
capital at risk or their compensation at risk. If you do that, 
that is one key element of success; and the other was having a 
professional investment process.
    What I found with the Tech Coast Angels is when you have--
and Ian can probably tell you the same thing. When you have a 
group of 25 CEOs, former CEOs, sitting in a room talking to a 
company and analyzing what they are doing or coaching them 
across the whole process, you need both that critical mass of 
20, 25 minimum, and you need that diversity of expertise. That 
really ameliorates the risk.
    So if you want to put capital into that segment and reduce 
the risk and increase the capital efficiency, I think an angel 
group is an excellent way to do it.
    Ms. Velazquez. My second question to you is, why do you 
think it is so important that we target the investment into 
small high-growth companies?
    Ms. Keating Heinemann. If the goal is to create jobs in 
economic growth, that is where you are going to get it. I think 
you will find statistics from lots of places that will show 
consistently that that is what creates jobs. That is not to say 
that the other small companies don't because it is--it is, you 
know, where you have a fraction of maybe a percent or 1 percent 
may create a huge amount of jobs, but then when you have got, 
you know, the big numbers that each incrementally, it is like 
an army of ants.
    So both are very useful to our economy; but if you are 
interested in focussed capital to create lots of jobs, that is 
where it should go.
    Ms. Velazquez. Thank you. Ms. Keating, you mentioned 
creating a team between the State government and the Wisconsin 
Technology Network that created a mechanism that provides 
education and networking assistance. How important do you think 
such a government partnership is to the success of your 
program? And would you recommend that any angel bill this 
committee moves forward to take into consideration, this kind 
of public/private partnership tools?
    Ms. Keating Heinemann. Thank you. That is a great question. 
I will say one of the first things we did, our governor was 
facing a $3 billion deficit when he took office in 2003, and 
our focus was, how could we leverage the private investments at 
the minimum cost to the government and really spirit the 
economy? So the first thing we did was we went out, and we 
looked to see what was out there, and we found the Kauffman 
Foundation was starting the Angel Capital Association, and they 
provided us tremendous tools and expertise and came into our 
State, taught us about angel investing, helped us start the 
networks. We felt it was very important not to duplicate the 
efforts that were already occurring in the private sector. And 
so the Wisconsin Technology Council is who we partnered with 
the State of Wisconsin, and we felt very strongly an angel-led 
program should not be in a State agency because they had tried 
it, and it didn't work because angel investors are very private 
people.
    They want to invest their own money and it is really no one 
else's business. But they are willing to provide data to us in 
an aggregate form and that is why we created the Wisconsin 
Angel Network. And we purposely funded it outside of the State 
agencies, Commerce and the Department of Financial Institutions 
gave a grant to the Wisconsin Technology Council to run the 
Wisconsin Angel Network, and the State agencies are not 
involved in the day-to-day operations, but the governor, the 
cabinet, the commerce, my department, we all highly encourage 
angel investing in our State, and we try to educate people on 
the tax credits that are available.
    Ms. Velazquez. I don't think the question implies that the 
program will be run by the government, but that is healthy to 
have that type of public/private partnership.
    Ms. Keating Heinemann. Oh, absolutely. I would agree.
    Ms. Velazquez. You know, we have, under SBA, the private 
loan programs. They are created by the SBA, but it is run by 
the private industry. It is a private/public partnership. One 
of the best we have.
    Ms. Keating Heinemann. Our SBA in Wisconsin is fabulous. So 
I would agree with that. It does great job partnering with our 
banks and our investors.
    Chairman Manzullo. Ms. Moore.
    Ms. Moore. Thank you so much, Mr. Chairman and ranking 
member. I want to welcome you all again, and it has really been 
a very interesting having you here. I guess I want to put this 
question to our Secretary of Financial Institutions from 
Wisconsin. Any of the others that would like to chime in would 
be become welcome to do it.
    One of the reasons why I was so excited about engaging in 
venture capital development in Wisconsin is because literally, 
the area that I represented in the State senate was just 
decimated by the loss of manufacturing jobs. At that time, we 
had a 59 percent unemployment rate among African-American men. 
I know it is really no exaggeration. Bureau of Labor 
statistics.
    Also, I think Wisconsin has had one of the groups, the 
women's business initiative with Wendy Ballman, and they have 
taken advantage to the extent that they have been available of 
the SBA products, the micro-lending they have done a fantastic 
job as a women's organization in promulgating business activity 
among women. And I became very interested in angel investments, 
and indeed, I had done another program called the CAPCO 
program, which was very, very targeted. One of the--so I am 
really excited about this bill.
    I am an author of the ranking member's bill, and one of the 
reasons why I was interested in that bill was because it 
recognized the real need for capital, venture capital, but also 
in terms of when I look at my district, it is important to me 
to have a diversity in the kinds of businesses that we invest 
in, and that we really get this additional source of capital 
down to small businesses that hit the whole socioeconomic 
strata, and so specifically--like when you gave your example to 
the Chairman about eMetagen, the research part at Madison.
    There's more than one reason to be mad at them, not just 
because their Madison, it is like they are not Milwaukee and it 
is not where the unemployment and underemployment exists. So 
that was one reason why I was sort of interested in a broader 
initiative that looked at putting the technical assistance, the 
grant programs together, kind of package that with the venture 
capital, so you can really capital the network where it would 
really make the most difference.
    It is wonderful to have this extra add capacity for our 
research park in Madison, but talk to me about how you see 
venture capital being put together with other initiatives and 
what is happening in Wisconsin, maybe to direct that to--you 
know, help low-income areas.
    Ms. Keating Heinemann. Well, to address the issue of--I 
give the one example of eMetagen, Milwaukee, Madison. However, 
there were 40 companies that were certified, and there were 
several from Milwaukee. I apologize I do not have that list, 
but I would be happy to provide that to you. There's some great 
partnerships that are going on in Milwaukee. And one of them 
that will reach to all communities is the Governor's Business 
Plan Contest where anyone can enter that contest. There's been 
a tremendous amount--all of the planning is being done in 
Milwaukee. The governor's business plan conference and 
entrepreneur's conference will be held in Milwaukee in June, 
the second week of June, and people are encouraged to apply 
through that process, and then they get mentored by--most of 
the VCs, there are two or three VCs that are based out of 
Milwaukee. So they are really trying to reach down--
    Ms. Moore. There are resources for mentoring and above--in 
255, as it passed, there is the venture capital fund, but what 
other resources are brought to bear, you know, to provide the 
technical assistance and the other networking opportunities 
that are not haphazard?
    Ms. Keating Heinemann. Well, it is a great question, and I 
will try to address it. It is the Department of Commerce, 
Bureau of Entrepreneurship. We have been very active. Pam has 
been active in going out into the State, certainly in 
Milwaukee, to try to make people aware of the grant programs 
that are available so people can write businesses--business 
plans and then connect them to the Wisconsin Angel Network, 
which is kind of the center where people can start looking for 
access to capital. And then we tried to identify the angel 
networks in all the States, and we put that on the 
angelnetwork.com Web site, so if someone is seeking capital and 
a mentor to help them with their business, they should be able 
to very visibly find out who that name and contact person is 
and the Milwaukee Angel Networks include the Silicon Pastures 
and the Golden Angel.
    Ms. Moore. My time is due to expire. Mr. Chairman, am I 
indulged? Good.
    I am very happy, sir, that you have agreed to respond to 
this question because we are talking about putting a national 
venture capital program together, so we need to make sure it is 
part of a package. Go on, sir.
    Mr. Villalobos. One thing I would urge you is to consider 
leveraging the angel groups in the community, we do that 
locally. So, for example, we sponsor an entrepreneur's 
conference, which is now in its 22nd year. Through the people 
from the conference we also--and the angels, we do community 
college entrepreneurship programs. One of the women that went 
through that program then we put into the Tech Coast Angels 
Fast Pitch Competition. She won the competition and got funded. 
We can show you lots of success stories, but I think you do 
what I suggest to distinguish between the high-growth companies 
that are going to become the Microsofts and the other ones that 
are just myriad, but are the heart of our entrepreneurship. So 
all I am saying is not to not support them, but you need 
different programs through the two classes.
    Ms. Moore. That is true. Thank you so much for your 
indulgence, Mr. Chairman.
    Chairman Manzullo. Thank you. I spend most of my time in 
this Congress working on manufacturing issues or areas deep in 
that area, along with Ms. Moore. We make a lot of parts for the 
Harley-Davidson motorcycle. And whoever wants to tackle this. 
Perhaps Dr. Sobieski, because of your background in 
manufacturing and aeronautical engineering. Tell us--I don't 
want to say the attitude towards manufacture, but tell us how 
manufacturers could be helped by this program. Well, what you 
are doing now or how they could be the beneficiaries of the 
program?
    Mr. Sobieski. Well, thank you for that. It depends on what 
you mean by this program.
    Chairman Manzullo. I am sorry. The angel program. What are 
you doing for the manufacturers that otherwise would not be 
available?
    Mr. Sobieski. I think the answer to that question fits into 
the context of the several questions we have had here from 
Representative Moore and Velazquez as well, and that is this 
distinction that is being made between the so-called high 
expectation entrepreneurs, which I had to laugh at because 
every entrepreneur I have ever met is high expectation. And 
the--I guess what you might call low expectation entrepreneur, 
the ones who only want to employ--run the restaurant or the 
corner store or a small manufacturing concern.
    You know, my thought, Representative Moore, is that if the 
next Google started, it is not going to stick around in 
Milwaukee. No matter what program you have, it is going to 
migrate somewhere else. And no matter how targeted the--and 
well intentioned the design of some kind of a structure, if you 
really want to drive in a job creation and innovation creation, 
you need to do something that is more environmentally focussed.
    It changes sort of the environmental structure that one 
accesses capital with, rather than pull one's hair out trying 
to figure out how one can design a targeted program. It is just 
extremely challenging. We have been, all of us here, in this 
business for years, and it is still a matter of debate about 
how it actually really works at the angel level. We all have 
our anecdotal stories and our gut impressions, but if we were 
to actually design a program, it would be quite tricky.
    And so what is appealing about these tax credit notions is, 
you know, if you make capital easier to access, it will be just 
as easy to access in Milwaukee as it is in Madison. And if 
people run out of high tech entrepreneurs in Madison, they will 
come over looking in Milwaukee for more of them. And that is 
the way you would actually create opportunities in every 
sector, including manufacturing, which is, you know, if you 
have a choice between investing in $100,000 to buy a yacht or 
investing $100,000 to invest in a sheet of paper that says 
10,000 shares of Acme Incorporated, the proposals in the tax 
credit provisions you are proposing would make that sheet of 
paper with that stock certificate a little bit more valuable, 
and you would be a little bit more inclined to maybe forgo the 
yacht and go for helping out someone.
    Chairman Manzullo. You say that because there are a lot of 
yacht owners in Milwaukee? Anybody else want--Ms. Preston, do 
you want to take a whack at that question? Manufacturers.
    Ms. Preston. A lot of times what we are seeing now with 
traditional industries and sort of the reawakening of the 
industry is the application of high technology, of software 
systems and those type of things to the manufacturing sector, 
and having dealt with this question in a number of places 
around the world, particularly such as in Canada, in Alberta, 
where it is really hard to talk about anything but oil and gas, 
particularly right now, but telling them that the most 
important thing for them to do is to diversify their economy is 
that identifying technologies that have applications in a 
multiplicity of silos of industries, and one of them is in the 
manufacturing area.
    So I see where the high-tech computer software type of 
industries can have a multiplicity of applications and actually 
increases efficiencies in those manufacturing industries, and 
those type of companies that are adjunct or complementary to 
the traditional-based industries in those regions do very well 
because they complement those traditional industries and take 
them into the 21st century and give them a revitalization.
    Chairman Manzullo. You know, one of the hidden secrets of 
manufacturing is that people look at Google, for example, as a 
service. Well, it may be a service, but look at the mass of 
manufactured items that are used to run that service. You know, 
from the search engines themselves right down to the individual 
computers, which obviously are all involved in manufacturing.
    Ms. Velazquez, do you have more questions? Oh, I am sorry. 
Oh, yes, go ahead, please.
    Mr. Villalobos. Two quick remarks. We do, as angels, fund 
manufacturing companies. For example, LandRoller is a roller--
it is the next generation of inline skates. Very exotic. It is 
direct manufacturing. Cargo Tech, they make the shipping 
packages to be able to ship things that are frozen or very 
cold. So angels will fund manufacturing companies.
    And my second point I wanted to make, the key point I am 
trying to distinguish is the size of the company. If we provide 
tax credits, I don't think we should be--I think we should be 
doing them for two classes, the small start-ups that can grow 
very fast and the little companies that are the heart of our 
industry; but if we are not careful with the definition of a 
small company, we will be funding a Google when it was already 
$20 million in revenues or $5 million in revenues.
    I don't suggest that we fund companies that can already get 
venture capital or other funds easily that we focus our credits 
and our efforts in truly the little companies, whether they are 
able to grow large or not because they each have a very strong 
impact on our economy.
    Ms. Velazquez. Mr. Villalobos, following that, the comments 
that you were just making, what factors should be included in a 
new definition of angel investment companies, qualifying 
companies to ensure that incentives are targeted to the most 
appropriate companies?
    Mr. Villalobos. That they be very early stage; and I don't 
know if you would want to put implicit criteria, like $2 
million in revenue or less or 20 employees or less, at the time 
that you are funding them. A company that has got even 25 
employees probably is doing 2.5 million or more in revenue, 
even 100,000 per employee, that is right in the sweet spot of 
where VCs will come plunging in or a bank will.
    So it is that, that they are very small and young, and then 
distinguish two classes, the ones that are very high risk 
because that is where you want to put angel money in, and then 
the ones that are more what Congresswoman Moore is looking for, 
to develop the infrastructure in neighborhoods and those you 
want to find a way to involve again, individual investors that 
huge pool of 10 million in some way ideally intermediated with 
an angel group or somebody that can help to make their 
investment safe but have their own capital at risk.
    Ms. Velazquez. What do you think the Federal Government's 
highest priorities should be in regard to angel investing? And 
any of the members of the panel can comment.
    Mr. Villalobos. Well, I think the model that has certainly 
been proven that angel groups, per se, work very well. So that 
should be one, is help to drive more investors into angel 
groups, help to elevate the level of professionalism within our 
angel groups, and then use the angel groups to leverage because 
again, back to that concept of alignment, if I am in an angel 
group, and I have got my capital at risk, it is a lot easier 
for Dan, who may not be an angel, to put in $5,000 along with 
me, whereas if he is trying to do it alone, it would be very, 
very risky.
    Ms. Preston. Oh, I am sorry.
    Mr. Loague. I see innovation is very important because 
competitiveness is very important. I have been to China, seen 
some of the things that are going on over there. The angel 
market, by the way, is developing over there. The technology 
marker. Some of the folks that got their Ph.D. From the 
University of Maryland are back in China right now, funded by 
VC companies over there. Innovation is very important, and I 
think that it cuts through every kind of programmatic thing you 
are looking at. It goes to more than just low income. It is 
anything that is innovative, anything that has a high-growth 
potential, anything that has a global competitive quality is 
where we want to be at and without participation by angels, we 
are not going to get there, and that is why this bill is 
important.
    Mr. Sobieski. In terms of the Federal priorities, I would 
differ with Luis that the Federal Government should have any 
priority in terms of angel groups. I think angel groups are a 
natural manifestation of the development of the financial food 
chain. And they are forming on their own, they are figuring out 
how to operate as businesses, and I would, in fact, be wary of 
any kind of government incentive or interaction with angel 
groups because of the danger of perturbing a natural market 
process that is still good for it.
    The tax credit changes sort of the environmental 
environment in which capital decisions are being made to be 
deployed. People criticize American society that we are too 
consumptive, and it is really making someone, to use my yacht 
example, but that is an extreme. It is making someone make a 
choice between, should I buy a new car with this $25,000, or 
should I invest in that--my neighbor's nephew's company that I 
heard about that he is looking for $25,000? Car, piece of 
paper? Car, piece of paper? Oh, yeah, there is that tax credit. 
I can get a little bit of a break. Okay. I will give that 
$25,000.
    So in terms of the prioritization, I would agree with Luis. 
It should be focussed on that kind of entrepreneur.
    Ms. Velazquez. What about data collection?
    Mr. Sobieski. I think data collection, no one can complain 
about data collection. That is an absolute missing piece in the 
puzzle, and the more data we can get, the better. The danger 
is, in all data collection is the implied authority by which it 
is collected. So you have enormously different data between the 
survey that Luis cited and University of New Hampshire, order 
of magnitude different data.
    And if the Federal Government gets involved in collecting 
data that has the imprompter of the United States Government, 
that speaks with great weight. If it is wrong and influences 
future policy decisions then that is, of course, a danger. The 
beauty of the venture capital system is it kind of developed in 
the absence of any of this. It wasn't taken seriously until 
really Apple Computer started, and then people took it 
seriously.
    Ms. Preston. I wanted to add partly to what Dr. Sobieski 
indicated. I think we need to remember that the vast majority 
of investments by angels are done by individuals, not members 
of angel groups, and that process in the economy has been 
working very well for a number of years, and what we are trying 
to do is further promote it and enhance it to putting more 
money into innovative ideas so that angel groups are a 
relatively new concept here in the United States and elsewhere, 
and a very interesting and obviously I support them. I have 
written a book on angel organizations, but I do also recognize 
that it is, by far, the minority way of investing. And even 
within angel groups, individual angels make their own decision 
on investing, and therefore, as Dr. Sobieski was indicating, 
the process and the economy has its own ways of creating the 
right system for investing.
    When we talk about investing, angels aren't going to be 
investing in a company that is worth $30 or $40 million because 
they are going to be raising more than $50,000, $100,000, 
$500,000. That is where angels play. So angels will naturally 
be investing in companies at an early stage. That is where the 
market is for them because of the amount of money they have to 
invest and that the company needs at that time.
    And angels, I would like to think, are relatively smart, 
intelligent individuals that although we do make bad decisions 
at times, but we play the odds. We are right some of the times, 
and we make money doing this. And that process is part, again, 
of that process, just like venture capitalists develop, angels 
are developing in a much more sophisticated way and do a very 
good job on their own of investing.
    These are highly independent autonomous anonymous 
individuals that don't want their name in databases and aren't 
interested, for the most part, in joining groups. However, that 
is not to say angel groups are bad. I think they are a fabulous 
idea. I just don't think it is something that we necessarily 
need the government to interject themselves into.
    Mr. Villalobos. Well, two comments. One, I would question, 
one, we know in any level that the investment by these, quote, 
large group of angels of some 220,000 angels that we know the 
results of. I would challenge anybody to produce anything that 
remotely claims some kind of results from that investment. I 
don't think we know who they are. I don't think we can--I would 
like to see anything that supports that statistic. I don't 
think it exists. And the second point is, I think the ranking 
member's approach to the angel groups to provide a co-
investment fund that recycles and puts the profits from that 
back into that fund, I don't think it would perturb the 
ecocycle of the angel groups any differently than providing 
them credits.
    You are essentially giving a credit to an individual. You 
can give them to the angel group; and the thing I like even 
better about that is it recycles the money back into that pool. 
So it keeps on fueling. Either of the two I can support, but I 
think--I don't see any problem with disturbing that ecosystem.
    Ms. Preston. One of the things we need to remember 
regarding the ACE Act is the one piece at the end for a 
taxpayer to have the ability to use a tax credit is the 
separate document that they file with their IRS return that 
indicates the name and the Tax Code number of the company to 
which they are requesting a credit.
    Therefore, we probably have the ability to gain more 
information about angel investors than we ever had before, 
including the 225,000 from that simple reporting requirement. 
It has the opportunity of being one of the most invaluable 
pieces of information we could get in a passive manner for the 
Federal Government.
    Chairman Manzullo. Mrs. Kelly?
    Mrs. Kelly. Thank you, Mr. Chairman. You may have covered 
this. I am sorry I got here late. Very busy day for a lot of 
us. I represent the 19th district in New York and in New York 
State. I understand that angel investors in New York State 
actually are--we have a tax incentive that is available to 
angel investors. What I am concerned about is that New York's 
tax incentive that is available to our investors could be 
destroyed by the AMT. I want to know if it is correct that tax 
exempt funds that would be created by this bill would still be 
subject to the AMT, unless we reform the AMT so that these 
things don't get wiped out. Anybody want to talk to me about 
that?
    Mr. Villalobos. Well, the assertion was made at the angel 
capital, at the annual meeting that that was the case, but 
there was no basis given for it, but somebody said that they 
had looked at it, and that the tax credit would be illusory 
because for most angel investors, the AMT would kill it. Now, 
that was just made as a bald assertion with no backing for it. 
So, and people were concerned, but I couldn't tell you.
    Mr. Sobieski. I think that comment also highlights the 
distinction amongst angels. That was indeed a comment. We were 
both at this angel capital association conference, and the feed 
back was, oh, the tax credit is great, but if you really want 
to spur investment, get rid of that AMT thing but again, these 
are extremely active angel investors who tend who invest in 
companies like Luis was describing that have the potential to 
become the next Google. It is not the small nephew's company 
employing six people making widgets and that would be sold 
locally. The tax credit, in its pure form, might very well be 
that beneficial to the vast majority of angels who only make 
one or two investments a year of the 25,000 to 50,000 size 
piece. It may arguably be less helpful to say members of my 
organization, who may be extremely helpful in investing 
hundreds of thousands of dollars in high-growth companies and 
they tend to have lots of other income that may very well be 
interfered with the AMT but in terms of the overarching goal 
unleashing innovation across the board in every community from 
Madison to Milwaukee and in every different kind of little 
company as well as potential companies that might become 
Google, I don't know if AMT would be as much a disincentive.
    Mrs. Kelly. I take it from your comments, none of you on 
this board would know whether or not the current AMT we have 
going forward would wipe out that New York State tax incentive? 
You do not know for sure?
    I wanted to ask you, Ms. Preston. You were talking about 
the ratio of the potential angel investors to active angel 
investors. It is pretty big.
    Ms. Preston. Yes, it is.
    Mrs. Kelly. I would like to know what kind of an 
improvement to that ratio you would expect if we had a Federal 
tax incentive. You think that would be a better--that ratio 
would change? And how?
    Ms. Preston. I think it would take the ratio to having 
individuals that are, right now, either sitting on the fence or 
have not done angel investing. It would give them that final 
incentive to look more seriously at the opportunity because in 
some respects, up-front investment tax credit, as we are 
proposing, reduces the risk, and so it gives them an inducement 
to make that investment that they might not otherwise make.
    And as Dr. Sobieski was saying, between buying the yacht or 
putting the $100,000 into the company of interest, that 
provides a greater benefit to do that. So yes, and we have had 
anecdotal responses from a number of angels out there that have 
said, this is fabulous. I can get more individuals involved 
directly in angel investing, and I think Secretary Heinemann, 
her experience in Wisconsin bears that out.
    Mrs. Kelly. So what you are saying you think instead of 
seven to one or ten to one, we would get a far better ratio 
with a split like five to four or something, people digging in, 
doing something like--actually getting involved as angel 
investors.
    Ms. Preston. Even if we get a 10, 20 percent, 20 percent 
increase, when you look at $23 billion right now estimated 
being invested or other numbers you look at, that is a 
significant additional money into our economy to create jobs, 
and to advance innovation.
    Mrs. Kelly. Okay. Thank you. I am out of time.
    Chairman Manzullo. Let me ask this question: How far should 
government get involved in what you are doing? Secretary 
Keating, you seem to draw a very clear line between a 
government function; and private functions. I appreciated your 
answer.
    Ms. Keating Heinemann. Well, I think the government can 
drive investments from the standpoint of providing incentives. 
And I would like to just kind of address, and I guess Ms. 
Velazquez mentioned, and also Congresswoman Moore talking about 
urban communities and also businesses that need to be funded in 
areas that might be low-to-moderate income.
    And I think if you, you know, tossed around the idea of 
putting a Federal tax package together, that had some type of 
incentives maybe to focus on those particular areas, and the 
most need for those types of businesses, certainly if, you 
know, the government were to put those incentives in place, 
usually the investors follow that particular incentive if the 
business is a good business opportunity for them.
    And, you know, I will just give you an example. I regulate 
banks, and I have done, you know, I have seen a lot of data on 
angel investing and the majority of bank decision makers who is 
deciding who is getting those loans are not women or 
minorities. I mean, they make up less than 12 percent. And if 
you look at the angel investing, less than 8 percent of the 
angel investors out there are women. So when you are a person 
going to look for access to capital, if there is something that 
drives them there, some type of tax credit, that they are 
actually seeking to invest in your type of business, I think 
that is a good incentive.
    And when we were talking to the phenomenal angel fund 
yesterday and their focus is women and minorities, they are 
very interested in actively pursuing these businesses, and one 
of them is in Resina. That is a manufacturing company, and the 
woman is the CEO, and she has had an extremely difficult time 
finding capital for a very high-tech, high-growth-type 
business. And phenomenal funds is now looking at them because 
now they know that, you know, there's this tax package out 
there, 25 percent credit for seed funds, and their seed fund is 
focussed on this particular area. So I would just target your 
policy around where you want the results.
    Chairman Manzullo. Ms. Moore--I jumped ahead of you. I am 
sorry.
    Ms. Moore. Mr. Chairman, you can always jump ahead of me, 
but you know what, thanks for yielding because I have got a 
group of constituents outside waiting on me. And I will be 
brief, Mr. Chairman.
    Thank you so much, Madam Secretary, for revisiting that 
question, because I was feeling a little bit perplexed by some 
of the comments that Dr. Sobieski made, and perhaps you have 
answered that. He said that he would be, you know, and if I am 
characterizing them incorrectly, please let me know.
    You said that you would be concerned about the government 
directing some of the creating incentives, perhaps, for tax 
credits to go in a certain place. And that you would rather see 
sort of the market forces drive that decision.
    And I think the Secretary just said, you know, we can 
create a market by having certain priorities because, for 
example, there are people who want to do socially responsible 
investing. You know, they might say I want to invest my money 
in only environmentally pure activities. And they can actually 
create an opportunity for somebody who wants to do that, who 
wouldn't otherwise have an investor. They may say, we want it 
targeted. I want to help women get themselves together. I want 
to help minorities. I want to help new immigrants. I want to 
help this region. You know, I am Magic Johnson from this 
particular inner city community, and I want to give back to 
that particular community.
    And only God knows why certain things like the Cabbage 
Patch Doll or Pet Rocks or Elmo made it, but for the fact that 
they had enough money to do it. So it seems to me that, you 
know, that I think the government can do a great deal toward 
providing grants and incentives and so forth. And, you know, as 
the Secretary suggested, not invest in projects that don't have 
any prospects, and I think many of you have said it already 
here today. That I think, it was Mr. Loague. How do you say 
your name?
    Mr. Loague. Loague.
    Ms. Moore. Loague. Some are going to make it; some are not 
going to make it. I think if we give tax credits, that we do, 
as a government, have the right to create some expectations. I 
mean, we don't have any doctors in a certain rural area. We 
want to create incentives for medical facilities there. That we 
can sort of direct this. And I just want to sort of--I wanted 
you to clarify what you meant by we should just let the market 
do it. I mean, I am a capitalist, but free fall and capitalism 
are kind of different things.
    Mr. Sobieski. Sure. Thank you. I think we are actually in 
agreement. I was tailoring my comments to the provisions in one 
of the bills that would have the SBA provide grants to angel 
groups with a targeted focus on certain areas of investing, 
which I felt was just given the scope of the problem that you 
outlined, which is copied across the country, is not going to 
be nearly as effectual as tax credits could be. And they could 
be targeted tax credits.
    I think, though, that that would be orders of magnitude 
more effective than attempts to design a program that would 
give grants to an angel group to invest in certain kinds of 
deals in certain areas.
    Ms. Moore. Okay.
    Mr. Sobieski. If you just created, say, tax credits for 
women and minorities, that would be hugely more effective than 
having an effort inside the SBA to give money to angel groups 
to invest in women and minority groups. So I am a big believer 
in the ability of the government to create incentives. I am 
just arguing that it should be done with tax credits, not with 
additional bureaucracy or design programs.
    Ms. Moore. Thanks for that clarification.
    Mr. Villalobos. Yes, Congresswoman. I think I agree--I know 
I agree with Ian, but I think the area that we are talking 
differently is, which companies are we talking about?
    If you are talking about the ones you are interested in, 
creating that broad level of economic activity, then I think a 
tax credit, a broad tax credit is great, provided you don't 
allow that tax credit to be used to be investing in companies 
that are far along, you know, much more developed.
    If you are looking to create jobs and growth overall, then 
the focus is on the ones that can grow very fast, and I am not 
saying we shouldn't do both. I am just saying, separate those 
two programs and don't try to use the incentives from one to 
the other.
    The other point is, if I am understanding this right, if 
you give me a tax credit, you are not reducing my risk. Or if 
you do, the program doesn't work.
    Let us say I am going to invest $100,000 in a venture. 
Well, if you give me a tax credit and I only effectively invest 
75, we haven't won at all. We haven't expanded the investment 
base. So for this to work, if I am going to invest 100,000, you 
give me the tax credit for 25, and I am going to reinvest that 
25 you gave me, now we have grown the capital pool. And again, 
if I am looking at that venture, if I am investing 100,000 
versus 75, my risk is that it goes all down the tube. The only 
thing you do is cut down the amount I have at risk. Not the 
risk. The risk of that company going broke is the same if I put 
75 or a hundred in it.
    So we have to be careful, and we need to make sure that the 
program, and I think the program, a tax credit would stimulate 
me if I will invest 100,000, I will invest 100,000. If I get 25 
credit, I will invest that too.
    Ms. Moore. Thank you so much. And thank you, Mr. Chairman.
    Chairman Manzullo. Thank you. This has been very 
interesting. I ran into a gentleman last night, Adam Heller. He 
is a floor trader, is that it, at the MERC and wanted to do 
something different in his life, and he bought a sheet metal 
fabrication company in Galva, Illinois. It has 35 employees. 
And he had a very difficult time convincing anybody that 
somebody who was a floor trader could run a factory. And I 
said, well, I could understand the concern with that question. 
But he has done the most amazing thing. He has taken all the 
market principles he learned on the floor, including his wealth 
of knowledge in international relations to successfully own and 
run a company that does classical sheet metal fabrication. They 
also make point of display fixtures, such as the rug samples 
that are held on display at Home Depot. They manufacture those. 
He has been able to begin exporting those to Europe?
    So I had never met anybody who came from the financial 
world who just wanted a change in his life and went into 
manufacturing. I was very impressed because I think this shows 
the power of the angel investors, and the wealth of knowledge 
that they can give to somebody who is involved in 
manufacturing, because it is not just the money, but it is the 
know-how and advice that can take the investors' capital along, 
obviously with that of the entrepreneur's capital, and make 
that work in seemingly impossible situations.
    Well, I want to thank you all for coming. You came from 
Washington and Wisconsin and California. Dan, you came last, 
but that is because you are the closest.
    Mr. Loague. That is right. I got caught up on the Metro. I 
used to live next to Lorrie, though.
    Chairman Manzullo. You did? Where?
    Ms. Keating Heinemann. Well, in Madison. He was in Madison.
    Mr. Loague. We were in Madison together.
    Chairman Manzullo. Ms. Moore isn't here. You are ganging up 
on us now. I appreciate it. You have really shed a lot of light 
on this subject. I can't tell you the tremendous amount of 
interest that there is in this. And a lot of it has to do with 
the fact that the participating securities program was 
eliminated. But if something can be picked up in the private 
sector, so be it, and more power to you.
    And thank you for coming. This hearing is adjourned.
    [Whereupon, at 3:45 p.m., the committee was adjourned.]

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