Cleveland HeartLab's new investor is using a tactic that's pretty rare in the world of tech investing.
But real estate developers should be familiar with it.
Over the past 12 months, Advantage Capital Partners has invested $10.9 million into five companies in Ohio. It did so with the help of state and federal tax credits that are normally used to finance construction projects.
But there's no rule against using New Markets Tax Credits in other ways.
The credits are designed to promote economic development in low-income neighborhoods. Thus, Advantage was required to invest in companies in those neighborhoods. And it had to describe how the growth of those businesses would benefit the people who live nearby.
That's why the investment firm, which has offices in several states, tracks 61 different factors designed to measure the community impact of its investments. They include job creation, job accessibility, wage levels, minority ownership and a company's environmental impact, according to Ryan Dressler, a senior associate based in Advantage's office in Napa, Calif.
The company believes it can create jobs in Ohio: Since 1992, it has invested in 645 businesses across the country, and those businesses created 20,800 new jobs while Advantage held a stake in them.
“We count jobs as much as we count returns. It's just in our nature,” he said.
Cleveland HeartLab certainly meets the geographic criteria: The medical testing company is located at the corner of Carnegie Avenue and East 69th Street in Midtown Cleveland — not a wealthy part of town. Among its 140 employees are people of all educational backgrounds, according to CEO Jack Orville.
For instance, the employees who register the blood and urine samples that doctors mail to Cleveland HeartLab's headquarters only need a GED diploma. Same goes for people serving as lab assistants or clerical employees. Lab technicians only need a two-year degree.
On the other end of the spectrum, senior managers and the researchers who develop the company's tests often have advanced degrees.
“You walk the property of Cleveland HeartLab, you see every type of degree,” he said.
The 7-year-old company raised an undisclosed amount of money from Advantage and a majority of its existing investors, Orville said.
The new capital should help Cleveland HeartLab finance initiatives designed to jumpstart its growth, which slowed down significantly a few years ago.
For instance, it aims to launch two new tests over the next 12 months, and it recently doubled the size of its sales team. Plus, it's breaking into the Chinese market through a partnership with SK Telecom, a South Korean telecommunications company that's getting into the health care industry. Cleveland HeartLab will provide technology and expertise to SK Telecom, which has its own clinical laboratory in China and plans to open more.
Though Cleveland HeartLab has endured some “tough years” lately, the company appears to be “going in the right direction,” said Chris Harris, a senior vice president at Advantage Capital.
“I really like their products. I really like their target market,” he said.
And of course, it helps that they're based in a low-income neighborhood.
At least in Northeast Ohio, it's rare for investors to use New Markets Tax Credits to finance operating companies like Cleveland HeartLab.
More investors could start doing it, but they should realize that it's not easy, Dressler said, noting that Advantage has been doing similar deals in other states since the federal program was created in 2002.
“You really have to come in from the get-go knowing that you're a partner with the state,” he said.
Although Ohio's program was created in 2009, it took Advantage a few years to show the Ohio Development Services Agency that it could create a fund that would meet the program's standards, Dressler said.
It eventually won them over: State and federal tax credits helped Advantage raise a $12.8 million fund focused on Ohio in 2014. Roughly half of the money came from investors who bought the tax credits from the fund. Advantage took out a bank loan as well.
The equity investors stand to get all that money back in the form of reduced taxes over the course of seven years: The 39% state credit applies to the entire $12.8 million, and the 39% federal credit applies to half of it, so in the end the investor group will split $7.4 million in tax credits. They should make more money at the end of the seven-year period, since Advantage has agreed in advance to buy their equity.
Only banks and insurance companies can serve as investors, according to a representative from the Ohio Development Services Agency.
So why do so many of these tax credits go to real estate developers?
They have an easier time meeting the law's requirements, Harris said. For one, a building is guaranteed to remain in the targeted low-income neighborhood throughout the seven year period; operating companies aren't.
Plus, companies that receive funding from Advantage often end up paying back their investors before the seven year period is up. When that happens, Advantage is required to reinvest the money into another qualified business. By contrast, it's easier to structure a real estate deal that lasts exactly seven years, Harris said.
“You can set up a real estate deal for success on day one and then walk away,” he said.
"Unique investor is placing faith in Cleveland HeartLab" originally appeared in Crain's Cleveland Business.