Changes to Illinois Angel Tax Credit Rules [Updated]


UPDATE 1/9/19: The program is reauthorized for 2019, with a total of $10 million in credits set aside by the state.

We’ve written in a past edition of our goodnews newsletter about an Illinois program to encourage investment in innovative early-stage companies, the Illinois Angel Tax Credit Program. Illinois has recently made an important change, which could affect the way that companies would want to structure an early investment round.

To summarize, the Angel Tax Credit provides tax credits of up to 25 percent for investors of up to $2 million in qualified new business ventures. To qualify, the business must be less than 10 years old, principally engaged in innovation, headquartered in Illinois, and have fewer than 100 employees, at least 51% of whom must be located in Illinois. (Other criteria are listed on the DCEO’s webpage and in the application itself.)

If a company qualifies, this means that investors may clam a credit against Illinois taxes of 25% of the investment amount. For example, an investor of $100,000 can take a credit of up to $25,000 on her state taxes, which is a serious benefit. (Of course, at Illinois’ tax rate of 3%, one has to have about $800,000 of taxable income in order to have a tax bill of $25,000 against which to use the credits, however, excess credits can be carried forward for up to five years.)

Here’s the change: in the past, an investment in a convertible note would qualify for the credit. That has now changed. Convertible note investments only count if converted to equity, and only if the conversion to equity takes place in the same calendar year. That might work under limited circumstances, such as a convertible note investment done early in the year, with a short maturity. For companies that want to take seed/bridge money without quite so short a string, the DCEO has specified an alternative: using a SAFE instrument.

“SAFE” stands for “Simple Agreement for Future Equity.” Developed by Y Combinator, SAFEs were designed to replicate the key features of a convertible note – discounted conversion and a price cap – but to eliminate the debt features, i.e.,  maturity and interest. (Read more about SAFEs in my previous post, here.)

The DCEO website specifies that companies wishing to use SAFEs “must follow the approved template,” which they provide. It appears to be the standard form of the SAFE from the Y Combinator website, with provisions for a conversion discount and price cap. What would be helpful to know is whether one could make changes to the “approved template” and still qualify for the Angel Tax Credit. For example, the standard SAFE document – lacking a maturity date – does not provide any outside date by which a SAFE must be converted or otherwise satisfied. One could imagine adding a provision that if a SAFE is not converted by some outside date, it would become convertible at the option of the holders at some valuation (e.g., the price cap or as determined by some appraisal process). Would this blow the Angel Tax Credit qualification? It seems to be a risk, since that language is not in the template that the DCEO website offers up.

These nuances aside, it is clear that if a company wants to raise a seed round that will qualify for the Illinois Angel Tax Credit Program, SAFEs are the way to go.

Categorised as: Fundraising

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