This report was prepared by Ross Gittell, Chancellor of the Community College System of and John Orcutt, Professor of Law at the University of New Hampshire School of Law.

Gittell and Orcutt received substantial assistance from business and legal experts throughout New Hampshire, including Bill Ardinger, Rath, Young and Pignatelli, Eric Herr, Commission on Innovation, Efficiency and Transparency in State Government, Jeremy Hitchcock, Dyn, Paul Holloway, Holloway Automotive Group, Paul Montrone, Liberty Lane Partners, Matthew Pierson, Dunn Rush & Co., and Dick Samuels, McLane, Graf, Raulerson & Middleton. The assistance and comments from Ardinger and Samuels was particularly valuable and enlightening. Some of the language used in this report came directly from commenters. Any errors in this report, however, are solely those of Gittell and Orcutt.

Sponsor: Coalition for Job Creation and Economic Innovation www.nhbusinessalliance.org

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IMPROVING NEW HAMPSHIRE’S STARTUP ENVIRONMENT

SCIENCE & TECHNOLOGY AND NEW HAMPSHIRE’S ECONOMIC ADVANTAGE The New Hampshire Science & Technology Plan, which is currently being updated,1 identifies New Hampshire among the leading states in making the transition from an industrial to an innovative economy. Over the last six decades, innovation-based development has helped positively transform New Hampshire’s economy. New Hampshire’s strong position in high technology industries—consistently ranking in the top 20 percent of states in high technology industry concentration—has brought numerous tangible benefits to the state, including significantly raising the standard of living for New Hampshire residents as a whole.  New Hampshire’s high technology intensity rank = 10th in the nation.  Average high technology wages in New Hampshire = $86,314.  Average private industry wages in New Hampshire (all industry) = $47,091.  New Hampshire’s per capita income rank = 9th in the nation.

The plan highlighted that New Hampshire has the opportunity to build on the strength of its innovation system to grow and diversify the state’s economy, create well-paying jobs, and increase economic well-being throughout the state. New Hampshire’s position as an innovative, technologically-advanced economy, however, is being challenged.  The current level of high technology employment in New Hampshire has dropped by nearly 25 percent since 2000.  During the early 2000s “technology bust,” New Hampshire was the United States’ worst performing state in high technology employment percentage change.  The recovery of New Hampshire’s high technology industry since the early 2000s has been weak and below the national average.  New Hampshire’s recovery from the 2008-09 recession has been slow. New Hampshire’s job recovery lags Massachusetts and in the New England region. While Massachusetts has recovered all its lost jobs, New Hampshire has not. This contrasts to New Hampshire’s job recovery in the previous three recessions, when New Hampshire led the New England states.  In 2013, New Hampshire tied for 7th worst state in employee perceptions of job creation per the Gallup Job Creation Index.

1 The New Hampshire Science & Technology Plan is sponsored by New Hampshire EPSCoR (http://www.epscor.unh.edu/). New Hampshire EPSCoR advances New Hampshire’s competitiveness in science and engineering by strategically investing in research infrastructure; promoting education in STEM; and partnering with businesses that enhance job creation and economic development. The 2012 version of the New Hampshire Science & Technology Plan, which is available at http://nhepscor.org/STplan, was funded by a grant from the National Science Foundation, # EPS 0701730. 2 | Page

The future success of New Hampshire’s economy will be determined by the decisions New Hampshire makes over the next two years. As the national economy gains momentum, New Hampshire has an opportunity to leverage existing innovation strengths and address weaknesses to improve the state’s competitive position and foster high technology industry growth. Without action, New Hampshire will lose out to other states and nations in innovation-based, and overall, economic growth.

The New Hampshire Science & Technology Plan highlights a number of areas of declining performance in the state. This policy paper highlights one of the most troubling areas for New Hampshire’s economic future: declining business starts.

DECLINING BUSINESS STARTS In the early 2000s, New Hampshire ranked in the top third of states in business starts per 100,000 people. Since 2008, New Hampshire has ranked in the bottom half of states in that category and currently ranks 35th out of 50 states (Table 1). The lack of business starts is clearly not a one- or two-year issue. It has become a fundamental problem for the state and has inhibited its recovery from the last recession.

Table 1: New Hampshire’s Declining Business Starts New Hampshire’s rank among the 50 states 2002 2004 2008 2010 2012 Business starts per 100,000 people 14th 16th 35th 30th 35th

The business starts indicator is calculated as the annual increase (or decrease) in “employer firms” recorded by the U.S. Census Bureau, Small Business Administration, and U.S. Department of Labor, divided by 100,000 increments of the state’s population. The business starts indicator measures only businesses with at least one employee because it seeks to provide information about job creation. The indicator omits self-employment. New Hampshire had 297 net business starts in 2002 compared to 657 net business closures in 2012 (Figure 1).

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Figure 1: New Hampshire Business Starts

On a regional basis, New Hampshire ranked fifth among the six New England states in 2012 business starts (Table 2). Most significantly, Massachusetts ranked 1st in the nation in business starts per 100,000 people. This has contributed significantly to Massachusetts leading New England and being one of the strongest performing economies in the nation coming out of the 2008-09 recession. New Hampshire went from producing seven fewer business starts per 100,000 people than Massachusetts in 2002 to 62 fewer in 2012. From 2009 through 2012, Massachusetts’ per capita business creation rate was eight times New Hampshire’s rate.

Table 2: Business Starts for the New England States 2012 rank among the 50 states Mass. Rhode Conn. New Vermont Island Hampshire Business starts per 100,000 people 1st 4th 25th 29th 35th 36th

New Hampshire has been among the worst performing states in business starts for close to ten years. From 2004 through 2011, New Hampshire annually generated an average of 12.2 business starts per 100,000 people, which is almost 50 percent worse than the national average (Table 3). During this same period, Massachusetts, Vermont, and Maine produced significantly more business starts per 100,000 people (Table 3).

Table 3: Average Number of Business Starts from 2004 through 2011 2004 through 2011 Mass. United Vermont Maine New Rhode Conn. States Hampshire Island Average Number of Business 28.9 22.9 20.4 18.7 12.2 5.0 1.6 starts per 100,000 people

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WHY BUSINESS STARTS MATTER A slowdown in New Hampshire business “High levels of entrepreneurship are closely correlated starts bodes poorly for the state’s economic future. with regional economic growth. Places with abundant Young, innovative firms (startups) are some of the most valuable companies a state can have in its new start-ups also experience faster income and economy. They have the ability to grow and employment growth.” become the large, dominant companies of the Edward L. Glaeser (Harvard University) and future. Startups, particularly those that become William R. Kerr (Harvard Business School) medium- and large-size firms, generate a disproportionate amount of the United States’ macroeconomic growth, innovation, and net new jobs. In addition, startups in high-technology sectors are associated with higher value-added productivity and increased exports, which, in turn, leads to business expansion and more skilled, high-wage jobs. With fewer companies being started in New Hampshire, the pool of young, innovative firms will dry up.

Startups play the same critical role for New Hampshire. Take for example Dyn, a startup based in the millyard in Manchester, New Hampshire. Dyn solutions are at the core of Internet Performance. Through traffic management, message management, and performance assurance, Dyn connects people through the Internet and ensures information gets where it needs to go, faster and more reliably than ever before. Dyn has more than 13 million users in 242 countries and territories, and its customers include such leading companies as Twitter, Tumblr, Netflix, and Pandora. Over a decade, Dyn has grown from a handful of employees to nearly 300 and opened a new 25,000-square foot office in Manchester, while also opening satellite offices in London, England and San Francisco, California. Dyn’s founders are New Hampshire natives, which led to their building the company in New Hampshire even with the challenges of starting a company in the state.

Relying solely on state loyalty for startup success is not a sound economic development strategy. Maintaining a pro-startup environment, should be one of New Hampshire’s top policy objectives. Business starts provide New Hampshire with its future job creators. New Hampshire’s dramatic reduction in business starts is a strong and problematic forewarning of future economic troubles. Namely, fewer business starts today will lead to less job creation and economic growth in the future.

CREATING AN IDEAL REGULATORY ENVIRONMENT FOR STARTUPS New Hampshire business and legal experts have worked with the authors of this report to identify major regulatory barriers to business startup activity. New Hampshire is fortunate to have a relatively positive economic foundation and strong business and legal leadership in the state. However, there are regulatory improvements that should be made to improve startup formation in New Hampshire and better position the state to benefit from a national economic recovery. Timing

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is critical as the national economy is expected to gain momentum and grow above 4 percent in 2014 and 2015 for the first time since 2007.2

Startup formation and growth is particularly sensitive to the regulatory environment. Complying with legal mandates is disproportionately more expensive for startups than for large, well-established companies. Burdensome regulations can mean the difference between survival and bankruptcy for new ventures. Entrepreneurs have a choice where to form and grow their companies. Rapidly increasing competition from other states and internationally for entrepreneurs and startups means New Hampshire must continuously evaluate its regulatory environment to ensure the state is attractive to startups and fast-growing firms.

DEFFICIENCIES IN NEW HAMPSHIRE’S REGULATORY ENVIRONMENT THAT IMPEDE FORMATION AND GROWTH OF NEW HAMPSHIRE STARTUPS This report identifies a number of clear deficiencies in New Hampshire’s regulatory environment that should be addressed to improve New Hampshire’s startup climate. They are: 1. Outdated systems and technologies for doing business with New Hampshire’s government. 2. Problematic tax provisions. 3. Uncertain enforceability of employee non-competition, non-disclosure, and non- solicitation agreements in New Hampshire. 4. Expensive and non-uniform state securities regulations. 5. Inadequate assessment of legislative impact on business.

Outdated Systems and Technologies for Doing Business with New Hampshire’s Government The New Hampshire government’s systems and technologies for interacting with the business community have failed to keep pace with the modern digital world. Despite widespread adoption by other states, New Hampshire does not allow electronic filings to create registered business entities (e.g., corporations, limited liability companies, limited partnerships, or limited liability partnerships), reserve and register trade names, or file amendments. These activities require filing original, hand-signed documents (mailed or hand-delivered) with the Secretary of State’s office in Concord. This cumbersome and expensive process is aggravated by the fact that time-sensitive filings must be hand-delivered to the Secretary of State’s office in Concord, because notification that a mailed filing has been rejected may not be received for weeks after the filing is made. Not surprisingly, some law firms choose to form companies in or Massachusetts, which accept on-line filings, when an entity needs to be formed quickly.

New Hampshire should fully automate its company formation, registration, and amendment filing process. The capability clearly exists, as the state automated annual report filings a few years

2 Moody’s Analytics, U.S. Economic Forecast, NEW ENGLAND ECONOMIC PARTNERSHIP (Nov. 2013). 6 | Page

ago. The concern is not only that New Hampshire-based companies are incorporating in Delaware or Massachusetts. The concern is also that New Hampshire’s filing process creates the impression of an outdated regulatory scheme. Rather than demonstrate New Hampshire’s desire to create a pro- business climate, the outdated hard copy system causes the state and its regulatory system to appear non-responsive to entrepreneurs and their needs.

Problematic Tax Provisions New Hampshire has a unique tax structure that has helped the state prosper. The Tax Foundation, a non-partisan tax research group, consistently ranks New Hampshire in the top ten states for overall business tax climate. This unique tax structure creates some specific benefits for the economy. The absence of a personal income tax has encouraged high-income workers and households to locate to the state. The absence of a broad-based retail sales tax has also encouraged retails sales activity. Yet the state’s unique tax structure also presents some challenges for young, innovative firms. This report does not seek to examine New Hampshire’s broad tax policies. Rather, this report seeks to identify and resolve technical aspects of New Hampshire’s tax structure that inadvertently, but seriously, have a negative effect on startups and fast-growing firms.

1. Eliminate the “phantom gain” tax. A major deterrent to forming and retaining startups in New Hampshire is the “phantom gain” tax. New Hampshire’s business tax system taxes income at the entity level, not the individual labor or owner level. For-profit businesses operating in New Hampshire are subject to the business profits tax (BPT). The BPT is an 8.5 percent tax on “taxable business profits,” which are generally equal to the portion of a business’s federal taxable income attributable to its New Hampshire activities.

The phantom gain tax results from the Department of Revenue Administration (DRA) applying the BPT to more than traditional profits. The DRA has asserted a broad interpretation of a New Hampshire tax statute to create taxable business profits at the entity level based on transactions between business owners. This approach by the DRA makes New Hampshire the only state to create taxable gain—phantom gain—when businesses experience capital transactions such as transfers of membership interests or capital infusions by new investors.

The statute in question is RSA 77-A:4, XIV, which reads:

Chapter 77-A—Business Profits Tax 77-A:4 Additions and Deductions.—The following adjustments shall be made to gross business profits in determining taxable business profits: … (XIV) In the case of a business organization where an interest or beneficial interest in the organization has been sold or exchanged, an addition to gross business profits of an amount equal to the net increase in the basis of all underlying assets transferred or sold through the sale or exchange of the interest. The increase in the basis of the assets shall be determined in accordance with the provisions of the Internal Revenue Code as defined by RSA 77-A:1, XX.

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This provision was apparently enacted to address a situation where a business might experience an increase—or step up—in the basis of its assets in connection with a transaction where it would not recognize taxable profits.3 Such a situation might present an opportunity for a business to avoid paying BPT.

Unfortunately, the DRA has sought to extend the application of this provision well beyond this narrow situation, even where no opportunity for tax avoidance exists. For example, when an owner transfers an interest in a growing business to a new investor, that new investor may be entitled to a “basis adjustment” for federal income tax purposes (usually because the business is treated as a partnership for federal purposes and has made an election under section 754 of the Internal Revenue Code). This new investor is now entitled to recover the cost of the investment through this “basis increase” as the partnership recovers its cost in the underlying assets.

But this treatment is only for federal purposes, and is inconsistent with New Hampshire’s longstanding separate entity requirement. For New Hampshire purposes, the transfer of the interest should not result in any increase in the basis of the entity’s assets and therefore no gain should result for BPT purposes. If the business later sells its assets, then the business would owe BPT on the full difference between the fair market value actually realized for the assets, and no opportunity for BPT avoidance exists. Indeed, the DRA position requires the business to pay tax on a “phantom gain” even when later the business may never actually realize any gain when it sells its assets.

This provision is a trap for the unwary and is often cited by advisors as one of the most negative aspects of New Hampshire’s legal regime for new startups as it creates an 8.5 percent tax on a firm’s improved valuation. The New Hampshire Legislature should enact an amendment to clarify the scope of the provision and to eliminate the phantom gain tax.

3 The Chair of the House Ways and Means Committee testified in 1989 that “this is a bill that I introduced and am trying to prevent the transfer of assets after there has been a gain without their being a tax on the BPT.” 8 | Page

2. New Hampshire should adopt the same twenty-year net operating loss carryforward period allowed by federal law and most states. Federal and state tax law allows businesses to carry forward their net operating losses (NOL) from prior years to Box 1 offset current income. The Internal Revenue State Comparison of NOL Carryforward Period Code (IRC) and most states (see Box 1) allow New Hampshire is in the minority of states in taxpayers to carry NOLs forward twenty limiting the NOL carryforward period to ten years. years. New Hampshire limits the NOL Of the 46 states that impose a corporate income tax: carryforward period to ten years.  Twenty six generally permit a 20-year carryforward New Hampshire should strongly  Nine generally permit a carryforward between 12 consider adopting the twenty-year NOL and 15 years carryforward period used by most states.  Four, including New Hampshire, permit a 10-year NOLs are important to startups. Startups are carryforward often built for growth and will sacrifice near-  Seven have a carryforward of less than 10 years term profitability for this growth. As a result, these companies begin with several years of Source: U.S. MASTER MULTISTATE CORPORATE TAX GUIDE (2014), CCH TAX LAW EDITORS (2013). losses and expect to use the NOLs to offset their future prosperity. NOL carryforwards help incentivize the risky investments needed to create and grow startups.

The ability of NOL carryforwards’ to promote startups is clear. What is unclear is the optimal carryforward period for incentivizing entrepreneurs and their investors. Is ten years a sufficient incentive, or is a twenty-year carryforward needed? We do not have a definitive answer to this question. However, we are concerned that New Hampshire’s limited carryforward period signals to entrepreneurs that New Hampshire is a higher tax, less business-friendly state. Massachusetts, by comparison, changed from a five-year carryforward period to a twenty-year period in 2010. Moreover, New Hampshire’s limited carryforward period is negatively compounded by a double apportionment of the NOL deduction that can drastically limit a company’s deduction (see Appendix 1 for an explanation of the double apportionment problem). New Hampshire’s limited carryforward period and double apportionment of the NOL deduction is well known by accountants and other tax specialists. And, these professionals play a critical role in advising entrepreneurs where to locate their businesses. We propose the DRA examine the tax revenue impact of (a) raising the carryforward period to twenty years and (b) eliminating the NOL double apportionment. If these amendments would cause little-to-no reduction in tax revenues, the legislature should immediately adopt a twenty-year carryforward period without double apportionment. If these amendments would cause a meaningful reduction in tax revenues, an analysis of their ability to encourage more company formation (and the corresponding positive economic outcomes) should be undertaken so the legislature could make an informed decision on this important issue.

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3. Business Profits Tax should “piggy back” the current Internal Revenue Code. The current business profit tax (BPT) defines the tax base by reference to IRC rules as they existed in 2000. This “piggy backing” of laws that are now thirteen years old leads to administrative complexities for taxpayers and their accountants who prepare returns. The BPT should be based on the current IRC, which would simplify tax return preparation and administration.

4. Real Estate Transfer Tax should not be applied to “non-transfers.” New Hampshire’s Real Estate Transfer Tax (RETT) taxes every sale, grant, or transfer of a real estate interest unless an exception applies. The RETT should not be applied to transfers that are not really transfers, such as occur in many types of business reorganizations. In the past, there were RETT exceptions (Non-Transfer Exceptions) for tax-free reorganizations under IRC § 368(a) and for business reorganizations that involved converting to another form of entity (where the assets, liabilities, and ownership of the resulting entity is unchanged—e.g., an LLC-to-corporation conversion). Because the RETT is so costly, its application to these reorganizations can drive the decision to not reorganize, despite all other business reasons supporting the transaction. The RETT’s Non-Transfer Exceptions were repealed for revenue-raising reasons. The Non-Transfer Exceptions should be reinstated. It is a common strategy for startups to originally form as LLCs, then later convert to corporate status when sufficiently mature to attract venture capital funding. Such reorganizations should be encouraged, not discouraged, and these successful startups should not be penalized. In addition, the overall application of the RETT to non-transfers gives the impression of a business-unfriendly state that is non-responsive to entrepreneurs’ needs.

Uncertain Enforceability of Employee Non-Competition, Non-Disclosure, and Non- Solicitation Agreements in New Hampshire Information, data, and intellectual property can be a company’s most valuable assets in today’s knowledge-based world. Protecting these assets involves a variety of legal measures, including employee non-competition agreements. Employee non-competition agreements, however, raise concerns about unfairly restricting an employee’s right to earn a living and depriving the public of the employee’s services. Courts and legislatures around the world seek to properly balance an employer’s right to protect its intellectual property with an employee’s right to work. In July 2012, the New Hampshire legislature disrupted this interest balancing when it adopted RSA 275:70. The statute, which is only two sentences long, reads:

275:70 Notice of Non-Compete and Non-Piracy Agreements Required. Prior to or concurrent with making an offer of change in job classification or an offer of employment, every employer shall provide a copy of any non-compete or non-piracy agreement that is part of the employment agreement to the employee or potential employee. Any contract that is not in compliance with this section shall be void and unenforceable.

RSA 275:70 has noble intentions. If an individual must agree to a non-compete agreement as a condition of employment, then the employer must give the individual a copy of the agreement at the time of, or prior to, the job offer. The statute prohibits employers from using unfair surprise to

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extract restrictive covenants from employees. Unfortunately, the statute’s vague wording goes well beyond this focused objective and creates a number of significant problems that seriously undermine New Hampshire job creation and retention.

1. Ambiguous terms cause uncertainty and inappropriately high costs for businesses. RSA 275:70 does not define any of its key terms. The statute does not define the term “non-compete” agreement. An employee non-compete agreement generally refers to a contract prohibiting an employee from doing similar work for a reasonable time after termination. However, the lack of a definition means the statute could encompass other types of agreements that do not pose the policy concerns of classic employee non-competes. For example, RSA 275:70 could be read to cover agreements restricting working for a competitor while the employee remains employed by the employer.4

The failure to define “non-piracy” agreements is even more problematic. Non-piracy agreement is a loose business term that does not have a precise, corresponding legal meaning. It could include confidentiality agreements, agreements not to solicit customers, agreements not to solicit other employees, and agreements not to misappropriate the employer’s intellectual property. Each of these categories of agreements poses different policy concerns, most of which do not justify placing on employers additional administrative burdens and legal risk. For example, the statute could be read to prohibit an employer from requiring an employee to sign a non-disclosure agreement (which is meant to protect the company’s valuable trade secrets) if the employer did not recognize the need for the agreement at the time of the original job offer, or failed to implement the bureaucratic procedures needed to comply with the statute.

The ambiguity surrounding the meaning of non-compete and non-piracy agreements is compounded by the statute’s failure to define “offer of change in job classification” or “offer of employment.” An employer informally telling an individual “we want to hire you” or “we want to give you a promotion” could qualify as an offer even though the offer letter or other formal paperwork has not yet been presented. The statute discourages any such informal communications. Employers should be wary of talking with individuals about job offers or promotions without first consulting with attorneys and designing comprehensive procedures to avoid violating the statute. This is not how New Hampshire’s legal system should operate. The law should encourage entrepreneurial behavior, not needless legal bureaucracy.

Finally, the statute’s penalty provision is also ambiguous. What contract is rendered unenforceable if the statute is violated? Is the restrictive covenant void, or the entire employment agreement? Once again, the statute provides no clarity.

4 See e.g., William E. Hannum III, New Law in New Hampshire Will Invalidate Non-Compete and Non-Piracy Agreements of Unwary Employers, LEGAL UPDATES—SCHWARTZ HANNUM PC (Dec. 2012). 11 | Page

2. No cure provision. If an employer violates RSA 275:70, even inadvertently, the statute does not provide for a cure provision. What if an employer informally makes a job offer and notifies the candidate of the need to sign a non-compete, but does not provide a copy of the non-compete because it mistakenly believes the statute is not triggered until the formal offer letter is sent? Can the employer correct its mistake? The statute does not allow for it. A particularly troubling situation involves companies considering moving to New Hampshire. The employer probably did not comply with RSA 275:70 when originally hiring its employees. Would the employer be able to comply with RSA 275:70 before relocating the employees? Or, would the employer forever be prohibited from obtaining a non-compete (or even a non-disclosure agreement) from these employees? The statute does not provide any clarity on this issue. Faced with such uncertainty, employers are much less likely to move to New Hampshire.

3. No transition rule. RSA 275:70 did not contain a transition rule to address agreements entered into prior to its effective date (July 14, 2012). The enforceability of these existing agreements is uncertain.

4. There was no need for the statute. Ironically, there was never any need for RSA 275:70. New Hampshire case law already addresses the statute’s main objective and prohibits employers from using unfair surprise to extract employee non-competes.5 Non-competes obtained in bad faith are unenforceable, and failure to provide advance notice can constitute bad faith.6 New Hampshire’s courts have long taken a measured approach to employee non-competes. A body of case law exists that restricts an employer’s ability to extract non-competes from employees. New Hampshire law does not look with favor upon non-competes and only enforces those that are reasonable and sufficiently limited.

5. Fixing the statute would be onerous and likely create more problems. Because RSA 275:70 is already on the books, the temptation may exist to reform the statute to address the concerns expressed in this paper.7 Such an approach would be a mistake. To begin with, there are too many problems with the statute. The legislative cost to work on the problems would be considerable. More importantly, there are no clear answers to some of the problems. Employment relationships are extremely varied. Trying to develop a “one-size-fits all” statutory rule to address all the various contingencies is unwise unless the legislature is ready to do all the legal and policy analysis required for an informed non-compete strategy.

6. Recommendation—repeal RSA 275:70 immediately. RSA 275:70 should be repealed immediately. The legislature’s well-intended attempt to protect employees was, unfortunately, misguided and never truly necessary. The statute discourages all employers, including startup

5 Smith , Batchelder & Rugg v. Foster, 119 N.H. 679 (1979) and Merrimack Valley Wood Products, Inc. v. Near, 152 N.H. 192, 197 (2005). 6 Smith, supra note 5. 7 New Hampshire’s Senate adopted SB 351 on February 19, 2014 to substantially amend RSA 275:70 and eliminate its most egregious problems. 12 | Page

entrepreneurs, from operating information-based companies in New Hampshire. The backlash against the provision has been considerable and has undoubtedly harmed the state’s reputation as a favorable place for information-based companies. Correcting the problem quickly is advisable.

Expensive and Non-Uniform State Securities Regulations Startups need substantial capital to launch and grow. They need capital to develop the company’s core products or services, build operational capacity, and fund the company’s day-to-day operations. Because few entrepreneurs have sufficient resources to self-finance their startups through profitability, they must find external funding to sustain and develop their companies. Selling stock in the company is the primary method for startups to raise this capital.8

The regulation of stock sales is primarily a matter of federal law, but state securities regulation remains important—particularly when it comes to transactions involving startups. Over the years, the scope of state securities regulation has declined—in particular after the adoption of the National Securities Market Improvement Act of 1996 (the NSMIA). While narrowing state authority over securities transactions, the NSMIA did not completely eliminate it. States retain significant regulatory oversight. In New Hampshire’s case, its state securities regulations are too expensive and are not uniform with other states, which makes capital raising more cumbersome in New Hampshire. Because access to capital is so critical to startup formation and growth, unnecessary obstacles to capital should be identified and eliminated. Expensive and cumbersome state securities regulation may also discourage the growth of New Hampshire’s venture capital industry.

1. Renewal fees for open Rule 506 offerings. When a company offers and sells securities, federal securities law (the Securities Act of 1933, or the Securities Act) requires the company register the transaction unless an exemption applies. Registration involves filing an extensive disclosure document (a registration statement) with the U.S. Securities and Exchange Commission. Producing a registration statement is cost-prohibitive for most startups. To avoid registration, startups usually rely on a registration exemption when offering and selling stock. The most commonly used exemption for private companies raising capital is Securities Act Rule 506 of Regulation D. In addition to being exempted from federal registration, Rule 506 transactions are also exempt from state registration and reporting requirements. However, states retain the right to impose notice and filing fee requirements. The New Hampshire Securities Act (specifically, RSA 421-B:11 and B:31) includes such a notice and filing fee requirement. Requiring a notice and filing fee is standard among states and not problematic. What is atypical about New Hampshire’s approach is its requirement that issuers pay renewal fees on offerings that remain open at the end of the calendar year. Because this renewal fee is a unique requirement, issuers commonly fail to make the payment. The New Hampshire Bureau of Securities Regulation eventually figures out which issuers have not made their renewal filings and seeks fines, sometimes totaling tens of thousands of dollars. While the Bureau has proven willing to compromise and work with offending issuers, the

8 Some companies also use convertible debt to raise private capital. 13 | Page

process is embarrassing for issuers and their securities counsel and discourages future company formation in the state.

There is no public policy benefit and no investor protection benefit from the renewal filings. The purpose of the renewal fees appears to be entirely revenue generation for the state, ultimately at the expense of the investors that should be protected. The annual renewal fees for open Rule 506 offerings should be repealed.

2. Issuer-dealer registration. Another unique feature of the New Hampshire Securities Act is its issuer-dealer license requirement. RSA 421-B:6 makes it unlawful for New Hampshire businesses to offer or sell their securities in New Hampshire in most securities transactions unless they first obtain an “issuer-dealer” license from the Secretary of State’s office. The licensing process does not involve any substantive review of the issuer, and instead consists of a notice and filing fee. As with the renewal fee for open Rule 506 offerings, there is no public policy benefit and no investor protection benefit to issuer-dealer licenses. The only material benefit of the issuer-dealer licensing regime is revenue to the state, which is ultimately at the expense of investors. Ironically, if an out-of-state issuer sells securities in New Hampshire in an otherwise identical offering, there is no issuer-dealer license requirement. The issuer dealer license requirement only applies to an entity:

organized in this state or having its principal office in this state, and issuing its own securities for sale directly to any member of the general public who is not a general partner, executive officer, manager, or director of the issuer. RSA 421-B:2, XIII-a.

This unique quirk of New Hampshire securities law mystifies out-of-state securities lawyers, who view New Hampshire unfavorably and may dissuade entrepreneurs from forming businesses in New Hampshire. The issuer-dealer license requirement should be repealed.

3. New Hampshire’s Uniform Securities Act is no longer uniform. Startups often raise capital from investors in multiple states. Having to comply with state securities regulation in multiple states increases the capital raising cost. One way to reduce these regulatory compliance costs is for states to adopt a uniform set of laws. Uniformity lowers transactions costs and therefore encourages more transactions. The Uniform Commercial Code is the classic example of a uniform code and its positive economic effect. New Hampshire’s Securities Act is based on the Uniform Securities Act of 1956, as updated through 1981. There now exists a 2002 version of the Uniform Securities Act that has been enacted by a number of states. Some attorneys have expressed concern that New Hampshire’s Securities Act has diverged sufficiently from other states’ acts as to no longer be uniform. If New Hampshire is viewed as having a non-uniform act, lawyers and financial advisors may steer companies away from New Hampshire to avoid the extra regulatory costs. Lack of uniformity with other states imposes a significant cost on startups doing business in New Hampshire. The legislature should (a) appoint a committee to identify and consider differences in New Hampshire’s Securities Act from other states, and (b) consider eliminating any unnecessary

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differences. This same committee should also look for best regulatory practices that have proven effective at encouraging local startup financing while continuing to protect investors.

Inadequate Assessment of Legislative Impact on Business A stable and predictable regulatory environment is important for all businesses, but it is particularly important for startups. Starting a business requires making investments, many of which are long term. These long-term investment decisions require making assumptions about the costs and benefits of the state regulatory environment. Starting a business venture already involves significant risk and uncertainty. While entreprenuers are, by nature, risk tolerant, their appetite for risk is not unlimited. Moreover, their risk tolerance tends to be for technology risk (will the newly developed product work?) and managerial risk (will they be able to run the company successfully?). Most entrepreneurs are not trained to operate in a world of significant political or regulatory uncertainty and risk. Taking on risk from exaggerated business policy swings can make the state less attractive for startups.

Obviously, businesses cannot demand or expect the electorate to moderate the variance in their political preferences. But, the risks of political and legislative swings disrupting business investment returns can be reduced by requiring that all legislation include “business notes” that explicitly assess and make transparent the implications of proposed legislation on business. And the business notes could require specific information on the expected costs and benefits on startups. This would help make for greater regulatory and legal policy stability and a more attractive policy environment for startups and businesses generally. It is all too common for well-intended laws seeking to address one issue to inadvertently, but seriously, harm New Hampshire’s business environment (e.g., RSA 275:70). Business notes would help reduce such occurrences by requiring the legislature to be thoughtful about the business impact.

CONCLUDING THOUGHTS This policy brief is focused on the important economic issue of New Hampshire’s business climate for startups and fast-growing companies. New Hampshire is losing its competitive advantage in this area, most strikingly to Massachusetts, which is negatively effecting New Hampshire’s employment growth. Massachusetts is a national leader in startup activity while New Hampshire has recently become one of the poorest performing states. New Hampshire’s poor climate for startups is problematic now, but its consequence will be even more pronounced in the future. With fewer startups, New Hampshire will experience less employment growth, particularly in areas most associated with startups such as technology-based employment.

New Hampshire’s economy cannot be vibrant and strong without improving the climate for startups. This report identifies deficiencies in New Hampshire’s regulatory and tax environment that impede the formation and growth of startups. Addressing these deficiencies will encourage economic development. These deficiencies can be resolved with little state fiscal cost, but can produce significant long-term economic benefits. Addressed collectively as a “New Hampshire

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Startup Promotion” legislative package, the recommendations in this report can significantly improve New Hampshire’s startup climate and performance.

We recommend that a bipartisan, multi-industry group that has been emerging around New Hampshire’s declining business starts issue be engaged to develop a legislative package (the “Startup Legislation”) that includes the regulatory improvements proposed in this report. The Startup Legislation, if it passes, can be used by the New Hampshire Department of Resources and Economic Development and regional economic development groups across the state to market and promote New Hampshire to startups. This will be particularly advantageous as the U.S. economy improves and as entrepreneurs, faculty and students in colleges and universities in the greater Cambridge-Boston area (which includes New Hampshire), continue to be global leaders in inventing new products and developing new ideas for business ventures.

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APPENDIX 1 NEW HAMPSHIRE’S DOUBLE APPORTIONMENT OF THE NOL DEDUCTION

Because the BPT only taxes a business’s New Hampshire income, the NOL deduction is apportioned to represent the business’s NOLs attributable to New Hampshire. Apportioning the NOL deduction is not controversial. What is controversial is the DRA’s practice of apportioning the NOL carryforward twice:  Once in the year incurred; and  Again in the year used.

The following example illustrates New Hampshire’s double apportionment of the NOL deduction. The taxpayer position column demonstrates how single apportionment would work, while the DRA position column shows the effect of double apportionment. NOLs Derived from Prior Years 2009 1,000,000 The amounts of NOLs carried 2010 1,000,000 over from prior years. These 2011 1,000,000 amounts have already been 2012 1,000,000 apportioned (and capped). 2013 1,000,000 Carryover 5,000,000

2013 Tax Year Taxpayer DRA Position Position (single (double apportionment) apportionment)

Gross Business Profits 20,000,000 20,000,000 Additions and Deductions — — NOL Deduction [DRA position] n/a (5,000,000) Is it proper, or even Constitutional, Adjusted Gross Business Profits 20,000,000 15,000,000 to apportion the NOL carryforward NH Apportionment Percentage 30.00% 30.00% twice (once in the year incurred and Subtotal 6,000,000 4,500,000 again in the year used)? NH Water’s Edge Taxable Business Profits 6,000,000 4,500,000 NH Foreign Dividends Taxable Business Profits — — NH Taxable Business Profits 6,000,000 6,000,000 NOL Deduction [Taxpayer position] (5,000,000) — NH Taxable Business Profits after NOL Deduction 1,000,000 4,500,000 NH Business Profits Tax Rate 8.50% 8.50% NH Business Profits Tax 85,000 382,500 Business Enterprise Tax Credit — — NH Business Profits Tax Net of Credits 85,000 382,500

Business Enterprise Tax Net of Statutory Credit — — Business Profits Tax Net of Statutory Credits 85,000 382,500 Value Lost by NOL “Double Apportionment” 297,500

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