Hawaii’s Tech Industry After Act 221

The tax credit nurturing Hawaii’s tech industry is dead, but here are five ways to keep the momentum going

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3. UH must step up

At the heart of every bustling tech industry is a dynamic university. Silicon Valley has Stanford, Berkeley and a host of UC schools pumping out great innovations and entrepreneurs. While UH is the state’s largest high-tech employer and generates about $250 million a year in research revenue, some feel it isn’t doing enough to convert that research into commercial applications.

“UH really has not made the kind of contribution that you would expect for the development of a robust technology industry,” Fidell says.

Susan Yamada, executive director of the UH Shidler College of Business’s Pacific Asian Center for Entrepreneurship, agrees that UH’s Office of Technology Transfer and Economic Development, whose mission is to help UH researchers identify, protect and commercialize intellectual property, needs to implement a faster, more efficient way to get big ideas to market.

Each year, OTTED receives 40 to 50 invention disclosures and is currently actively licensing about 60 technologies. One recent study of 2007 data from the Association of University Technology Managers calculated that a medium-size research university, like UH, should be generating about $900,000 in licensing revenue each year, given the amount of research revenue it generates. OTTED’s actual performance by this measure was closer to $450,000, says Jonathan Roberts, senior licensing associate at OTTED. In the late ’90s, UH brought in about $1 million annually, but that total dropped when the university’s groundbreaking Human Papilloma Virus test patent expired.

In the past several years, Roberts says, OTTED has been working with more local spinoff companies and has accepted equity in lieu of upfront licensing fees to help them through the critical startup phase. “This offers UH a greater upside potential, but lowers our current revenue,” he explains.

The HSDC’s Fooks says while many people focus on the $400 million that UH receives each year in research grants as a benchmark to rate the amount of commercialization or licensing revenue being generated, they fail to recognize that a lot of the money goes to overhead. Also, not all research can be commercialized, says Yuka Nagashima, president and CEO of the High Technology Development Corp., which oversees the Manoa Innovation Center, an incubator for local tech startups.

Still, since almost all of the R&D at UH is being funded through various programs and grants, Yamada says the university needs to quickly identify which inventions are marketable and then capitalize on these low-hanging fruits.

“I understand that OTTED is strapped for resources,” Yamada says. “That’s why I’m encouraged that (UH President M.R.C.) Greenwood is pushing for innovation. I think there needs to be a culture of entrepreneurship pervasive throughout the university and a push for commercialization. We have to do better at getting all this R&D out of the lab and into the marketplace.”

Although Hawaii will never be a manufacturing hub, that doesn’t mean it can’t specialize in R&D.
“If we can create more situations where the research team is here, the R&D is here and the ideas are generated here, then it doesn’t really matter if the technology is marketed on the Mainland,” Yamada says. “There’s not enough capital here anyway.”

With the groundbreaking for the new headquarters of the Cancer Research Center of Hawaii and Greenwood’s commitment to make innovation and research a top priority, many are optimistic. Last spring, Greenwood appointed a team of local and national experts to serve on the President’s Advisory Council on Hawaii Innovation and Technology Advancement, which will examine UH’s innovation, research and tech capabilities. The council will also provide a roadmap for the university that will help position it to make greater contributions to the state’s economy.

Yamada says what UH needs is momentum, like the kind that helped get Adama Materials recognized by Mainland VC funds. The company got its start at UH when Donavan Kealoha, a graduate of UH’s Shidler College of Business, and Dr. Mehrdad Ghasemi Nejhad, graduate chair of the Department of Mechanical Engineering, won first place and the technology prize in the 2008 UH Business Plan Competition. The company was originally funded through grants from the U.S. Office of Naval Research, successfully landed Mainland capital and an experienced management team, and currently has several active contracts with companies in the aerospace and composites industries.

“The way I learned about Adama,” Dick recalls, “is one day I got a call from Bill Richardson (owner of the VC fund, HMS Hawaii Management Partners), saying, ‘You have to look at this company.’ Then, I got a call from Susan Yamada saying the same thing, so we knew we had to give Adama a look.”

Adama’s technology has the potential to make everything from tanks to bicycle frames and bathtubs stronger and weigh less. “This has the potential to be a multibillion-dollar company,” Dick says, smiling.

Since UH was involved with Adama’s licensing, it receives royalties and owns stock in the company, so if it goes public, the university will benefit.

“I think it’s a great arrangement,” Dick says. “The university has an incentive to make the company successful and, for us, it’s been a great experience.”

4. Pool capital; provide resources

It’s not uncommon for established VC firms on the Mainland or in Asia to manage funds of more than $1 billion. In comparison, Hawaii has just a handful of small, active funds; the biggest is PacifiCap, with about $100 million under management. Local VC firms on their own are not capable of providing for ongoing capital needs. Startups can often find early-stage funding here, but can rarely land meaningful series B or C funding.

On the Mainland, some VC funds pool institutional capital from investment and pension funds, endowments, and universities to leverage themselves and create broader networks of potential investors and customers.

“To be a regional, national or global company, you need to network yourself into those environments,” Fooks says. “That’s what a good venture-capital industry does for its companies. It has those networks, it knows how to reach those people, and it can sponsor you and give you the stamp of approval. In my opinion, that’s what we need to be focused on if we want to create a sustainable infrastructure for a tech industry in Hawaii.”

With Act 221, most of the tax credits were invested and claimed by individuals and did not help create any smart pools of institutional capital.

But just because a startup is able to secure capital doesn’t guarantee it will succeed. To Fooks, another big issue is whether the state is providing the right resources and support to enable local tech companies to compete for capital.

Fooks refers to a state-funded program in Ohio called Jumpstart as a model that could work for Hawaii.

“With Jumpstart, they realized that just giving young companies money is not enough, so they surround them with resources and networks of successful entrepreneurs, successful management people, customers, investors and other resources so that they can be successful in attracting the next round of funding from a qualified venture-capital firm,” he says.

The hope is that Dick will provide the experience and connections that Fooks describes to take Adama to the next stage of development. Additionally, John Dean, the executive chairman of Central Pacific Financial, who is also a partner in Startup Capital, and Amit Shah, of Artiman Ventures, another VC firm based in Silicon Valley that is leading Adama’s financing, were named to the company’s board of directors.

According to Yamada, attracting this level of experience and talent was like hitting a grand slam for Adama’s original team. The HTDC’s Nagashima agrees, adding, “Hawaii doesn’t have enough serial entrepreneurs like Tim needed to start new businesses, develop them into successful operations and attract capital. Hawaii needs more Darren Kimuras and Henk Rogerses if we want to develop a serious tech industry. Act 221 helped birth more of these visionary entrepreneurs, but we still need more.”

Nagashima commends Adama’s founders for being open-minded and allowing a more experienced management team to take the reins for the benefit of the company.

“Hopefully this reflects the maturity of our entrepreneurs and our tech community,” she says.

Dick expects to serve as Adama’s interim CEO for the next 12 to 18 months “until the company can hire a real industry rock star,” he says.

5. Lessons learned

Whether or not you supported Act 221, the tech community agrees that we need to reflect on what went wrong and be certain not to repeat the same mistakes.

Perhaps the first step is to acknowledge that there is no silver bullet. Going forward, Nagashima says, it’s important to set clear expectations for what one piece of legislation can accomplish and if another tax credit is passed, lawmakers need to establish a realistic timeline so the law can do what it’s intended to do.

“Everyone needs to realize that a tax credit alone is not going to create a tech industry,” she says. “I think people were disappointed when that didn’t happen when that was never the expectation. Secondly, we have to realize that just because Act 221 is gone, it doesn’t mean the infrastructure we built up to this point goes away. Because of 221, we have a lot of companies. We should be focusing on how to get them to the next level and how to encourage and support new startups.”

Proponents of 221 say the Legislature pulled the plug too early to be able to see the real benefits of the tax credits. According to the state Department of Taxation, about $562 million in state tax credits were claimed from 2000 to 2008 and about $1.3 billion was invested in high-tech businesses as a result of those credits.

“Detractors were against 221 for the wrong reasons because they couldn’t measure the cross-benefit,” says the HVCA’s Spencer. “We’re just getting to a point where some of the early 221 companies are hitting that eight-year point and they might just be hitting their stride. There’s no way you can do an adequate cost-benefit analysis on Act 221 at this time because the companies who have received it haven’t had enough time to reach their potential.”

State Rep. Isaac Choy, a Democrat who represents Manoa, Moiliili and University – who Fidell says “helped kill 221” – says in an e-mail that it’s premature to be thinking about another tax credit similar to 221 and that, although the law expired on Dec. 31, the state will continue to pay tax credits to investors through 2014.

“I believe it will take time to fully evaluate the costs, benefits and lessons learned from this type of legislation. If tax credits are the tools to be used, the state must consider how to be competitive and to insure the best use of taxpayer dollars.”

PacifiCap’s Au says politics and the press played a major role in how 221 was perceived by the public. Fidell says misinformation, sensationalized headlines and biased reporting made 221 the “whipping boy” early in the game.
“Often times, the public automatically believes everything they hear in the press and their views impact the way politicians vote, so, unfortunately, a lot of people had the wrong idea about 221,” Au says.

Sen. Fukunaga says it’s the Legislature’s and administration’s job to compile good data to ensure tax incentives or any government programs can be accurately measured and reported on.

While many local leaders say the termination of Act 221 will make it even more challenging for tech companies in Hawaii to raise capital, Fidell, who fought to keep 221 alive, offers this advice for how the state should proceed post-221: “It was a good run while it lasted, but now we must say our goodbyes, mourn our losses and move on. We need to regroup and figure out other creative ways to attract venture capital. We need to educate the public on the value of developing a strong tech industry and we need to cut out all this bureaucracy and politics and just do what’s right for the people and the economy. But whatever it is that we do, we have to act quickly so we don’t get left behind.” 

Check out our story on early controversies surrounding Act 221, originally published in March 2003.


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