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First Customer Program Economic Impact Analysis & Payback Periods for the

State (9/2012-5/2015)

Introduction The First Customer Program (FCP) assists technology start-ups with identifying and addressing critical

gaps in business development, marketing, and sales. The FCP is funded by the Michigan Strategic Fund

with program oversight by the Michigan Economic Development Corporation (MEDC) and administered

by the University of Michigan Institute for Research on Labor, Employment, and the Economy

(IRLEE). As of April 2015, there have been 55 co-funded projects among 28 clients. This report compares

the cost of funding the FCP with the payback period to the state of Michigan. The program award totals

$999,376; currently, $753,264 has been disbursed between December 2012 and April 2015. In total, FCP

clients created 170.3 new full time equivalent (FTE) jobs with 84 directly attributed to the FCP. 344 FTE

jobs were retained among FCP client companies that were provided services. Of these, 18 FCP clients

credited retaining 49 jobs directly because of FCP support through full assessment, delivery of Market

Specific Overview and/or Action Plan, and execution of projects.

This report features a conservative payback period estimate reviewed by the FCP, IRLEE, and other

University of Michigan economists. The other University of Michigan economists have a contract with

MEDC to update and improve current payback period estimates using the Regional Economic Models

Inc. (REMI) model; however, the FCP and IRLEE team do not have access to the REMI model. As a result,

the FCP and IRLEE team used the Regional Input-Output Modeling System (RIMS) to calculate the

payback period. Numbers presented for job creation, job retention, and sales may have been collected

after the MEDC reporting period and therefore do not match MEDC progress reports.

The payback period to the state of Michigan has been calculated by estimating 1) income tax and sales

tax from job growth and 2) the corporate tax from revenue growth. FCP was directly attributed to the

creation of 84 jobs created directly attributed by clients to FCP support to date. The conservative

payback period to the state is estimated to be 2 years and 2 months and the optimistic payback period

to the state 1 year and 4 months as seen in Figure 1.

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Figure 1. FCP Impact & Metrics

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Methodology & Analysis for Job Creation, Income Tax, & Jobs Impact To estimate income tax and sales tax, the first step was to survey the job creation attributed to FCP. To track this, FCP has clients fill out a self-reported survey biannually across reporting periods that begin or end on October and April. This survey quantifies the total jobs created. Then, each client was verbally surveyed to ask if the new job creation was attributed to FCP activity; if new jobs were created and attributed to FCP activity, this total job creation figure was then discounted by the general industry job growth. A second adjustment is made to the total jobs created to account for the broader economic impact of job creation. Finally, the payback periods to the state were calculated from income tax arising from job creation.

Survey Results Data gathered for three reporting periods (Table 1) show a consistent increase in revenue and jobs created by FCP clients as the program progresses. A total of 84 jobs were created directly as a result of FCP activity.

Table 1: FCP Survey Results 2013-2015

Period Dates Jobs Created Increase in Revenue

1 Oct 2013- Apr 2014 8.0 $237,000

2 Apr 2014- Oct 2014 10.5 $367,204

3 Oct 2014- Apr 2015 65.5 $2,833,656

Total 84.0* $3,437,860

*Please note the total number differs from MEDC Progress Report Oct 2014 – Apr 2015 based on updated

information from clients.

Adjustment for Industry Growth It would be incorrect to assume that FCP clients would not experience any natural growth or decline had FCP intervention not occurred. To account for this, the calculation discounts jobs created due to FCP activity by the jobs growth by client’s industry. The Bureau of Labor Statistics (BLS), State and Area Employment’s customized tables provide the monthly employment numbers in Michigan for a particular industry. Had FCP intervention not taken place, the FCP estimates the client’s growth or decline to be equivalent to that of the industry for a given period.

Most FCP clients are new technology start-ups and do not have a corresponding niche industry classification. In such cases, a broader classification was used. For example, Arborlight LLC, an electrical equipment and appliance manufacturing company was classified as a durable goods manufacturer and Detroit R&D Inc., a biotechnology manufacturing company, was classified as a non-durable goods manufacturer.

For each of the three reporting periods, the percentage change in employment is calculated (Eq. 1) from the BLS data corresponding to the client’s industry. From the percentage change and the number of initial full-time employees (FTEs) at the start of each reporting period, the expected change in employment was calculated for each client. The expected change was subtracted from the number of FTEs created due to FCP activity to calculate the effective jobs created due to FCP activity adjusted for industry growth (Eq. 2). Eq.1 Industry Job Growth (%) = Change in Employment / Initial Employment [for each period] Eq. 2 Effective Jobs Created = FCP Jobs - {Initial FTEs x (Industry Job Growth) (%)}

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The calculations only consider clients who attributed growth to FCP activity. If client change in employment was not attributed to FCP, the calculation disregards those jobs created and any industry growth or decline.

Adjustment for Economic Multiplier Growth in business results in increased purchasing and spending and has a broader economic impact in a region. For instance, as a company grows, it purchases more from suppliers and increases in income result in increased spending in the region. The Bureau of Economic Analysis (BEA) Regional Input-Output Modeling System (RIMS)1 is used to estimate this impact. The FCP use change in employment numbers as the basis for measurement. For each job created by an FCP client, the multiplier2 estimates change in overall jobs in Michigan. The estimate includes client new job creation.

The RIMS provides estimates for three types of economic impact that resulted from client’s growth. 1. Direct Impact (Tier-1 Suppliers): Economic impact as a direct consequence of the first round of

inputs purchased by FCP clients. 2. Indirect Impact (Tier-2 and beyond Suppliers): Economic impact related to the subsequent

rounds of inputs purchased by supporting industries. The sum of direct and indirect impacts is also known as inter-industry effects.

3. Induced Impact (Household Spending): The increase in spending on goods and services as a consequence of changes to the payroll of the directly and indirectly affected businesses.

Using RIMS, the FCP developed a conservative and optimistic estimate for the payback period to the state of Michigan based on total job growth attributed to FCP assistance. The conservative estimate relates to the direct and indirect impacts of employment (Impacts 1 & 2). The optimistic estimate considers direct, indirect, and induced impacts (Impacts 1, 2 & 3). For each client, the RIMS3 multiplier is applied to the effective number of employees created. Table 2 shows the results of the calculations.4 The following results are used as inputs in calculations for conservative and optimistic payback periods to the state.

Table 2: Results and Impact of Jobs Created

Period Dates Jobs Created Due to FCP1

Conservative Jobs Impact2

Optimistic Jobs Impact3

1 Oct 2013- Apr 2014 8.0 17.02 28.44

2 Apr 2014- Oct 2014 10.5 18.10 29.44

3 Oct 2014- Apr 2015 65.5 129.23 213.53

TOTAL 84.0 164.35 271.41 1 Obtained from client surveys. 2 Include direct and indirect impacts of employment (RIMS Type -1). 3 Include direct, indirect and induced impacts of employment (RIMS Type-2).

1 The Bureau of Economic Analysis (BEA) Regional Input-Output Modeling System (RIMS)1 is used to estimate this impact. is widely used in

private and public sectors for estimating the economic impact of an event based on output, earnings or employment in one industry.

<https://bea.gov/regional/pdf/rims/RIMSII_User_Guide.pdf> 2 The RIMS direct effect employment multiplier estimates the change in number of jobs in all industries for every additional job in the industry

corresponding to the entry. 3 United Stated. Bureau of Economic Analysis. RIMS II Multipliers. Michigan (Type 1)N.p.: n.p., n.d. Print 4 The Excel workbook can be provided upon request, contact FCP for further information.

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a. Calculating Income Tax

To calculate the payback to the state from income tax, the average tax return per new FTE was estimated using a tax per capita survey by the U.S. Census Bureau (2014 Annual Survey of State Government Tax Collections) using Equation 3. In Michigan, the total individual income tax collected was $7.874 billion and the total population of working adults (aged 18 and over) in Michigan was 7.56 million.5

Eq. 3 Income Tax Per Capita = Total Individual Income Tax Collected/Total Population of Working Adults

The resulting estimated income tax per capita totaled $1,041.53.

b. Calculating Sales Tax

The total sales tax per capita collected may be estimated using Equation 4. In Michigan, the total sales tax collected was $12.309 billion and the total population of working adults (aged 18 and over) in Michigan was 7.56 million.6

Eq. 4 Sales Tax Per Capita = Total Sales Tax Collected/Total Population of Working Adults7

The resulting estimated sales tax per capita totaled $1628.17.8

There are two reasons why using the average tax collection per capita in Michigan for income tax and sales tax is a defendable approximation for new FTE tax returns. First, the jobs resulting from direct, indirect and induced impacts encompass all industries in Michigan. Second, for jobs created by FCP clients, the FCP collected salary information directly from each client reporting job creation. The average salary for a new FTE position directly attributed to FCP was $53,849. This average is higher than the Michigan 2014 annual mean wage of $45,000; therefore the approximation for the total new FTE tax returns is conservative.

5 “Profile of General Population and Housing Characteristics: 2010 , Michigan” U S Census Bureau 6 “Profile of General Population and Housing Characteristics: 2010 , Michigan” U S Census Bureau 7 Though the FCP team recognizes that the total sales tax may be collected from working adults and other entities such as a small business or sole

proprietor, most sellers do not track whether the purchaser is a working adult or other entity. This also recognizes that businesses with less than $350,000 in allocated or apportioned gross receipts and/or less than or equal to $100 in annual liability are not required to file or pay the

Corporate Income Tax (CIT). This calculation is an approximation which provides a conservative estimate of the total sales tax per capita.

(Source: Michigan Taxes. Michigan Department of Treasury. http://www.michigan.gov/taxes/0,4676,7-238-59553---,00.html ) 8 Sales Tax Per Capita = Total Sales Tax Collected/Total Population of Working Adults = $12.309 billion/7.56 million = $1,628.17

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Methodology and Analysis for Revenue Increase, Corporate Tax, and Revenue Impact

To estimate sales tax, the FCP has clients fill out a self-reported survey biannually to quantify new or increases in client revenue attributed to FCP activity. Finally, the payback periods to the state are calculated including corporate and sales tax arising from new revenue or increases in revenue.

Survey Results

Data gathered for three reporting periods (Table 1) show a consistent increase in revenue. $3.4 million is the total increase in revenue for FCP clients since engagement with the FCP and $1,627,860.22 is the total revenue increase as a direct result of FCP activity.

Calculating Corporate Tax

FCP clients experienced a total increase in revenue of $3.4 million since engagement. 12 clients claimed

FCP was directly responsible for $ 1,627,860.22 in new or increased revenue9. Earnings before interest, taxes, depreciation, and amortization (EBITDA) can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. The EBITDA ratio for the technology sector was 21% for Q1 2015.10 The resulting earnings for FCP clients total $341,850.11 The corporate tax12 return at 6 %13 collected from these earnings totals $20,511.

9 The FCP recognizes that businesses with less than $350,000 in allocated or apportioned gross receipts and/or less than or equal to $100 in

annual liability are not required to file or pay the Corporate Income Tax (CIT). All FCP clients attributing increase in revenue have demonstrated

gross receipts in sales of greater than $350,000 or otherwise do not qualify for that exemption. 10 "CSI Market." Profitability by Quarter, Gross, Operating and Net Margin from 1 Q 2015. N.p., n.d. Web. 25 June 2015. 11 $341,850= 0.21 x $1.627 million 12 Michigan corporate tax = 6% (Source: IRS) 13 The Michigan Corporate Income Tax (CIT) of 6% for C corporations and taxpayers taxed as corporations federally was used versus trying to

include the small business alternative credit which offers an alternate tax rate of 1.8% of adjusted business income. This is to provide a more

conservative approximation of corporate tax returns. (Source: Michigan Taxes. Michigan Department of Treasury. http://www.michigan.gov/taxes/0,4676,7-238-59553---,00.html )

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Methodology for Payback Period for the State Investment

The payback period for the state may be calculated as a total of income tax and sales tax arising from effective jobs created due to FCP adjusted for industry growth and corporate tax derived from new or increased revenue (Eq. 5).

Eq. 5 Payback Period to State = Corporate Tax + Income Tax (j) + Sales Tax (j) [j: jobs created]

Multiplying these average income tax and sales tax per capita with the conservative and optimistic jobs estimates yields total payback period to state. Table 3 provides a summary of results.

Table 3: Payback Period for the State Investment

Conservative Optimistic

Direct and Indirect Direct, Indirect, and Induced Job Creation including

Multipliers 164.35 271.41

Corporate Tax $20,511 $20,511

Income Tax Return $171,175.46 $282,681.66

Sales Tax Return $267,589.74 $441,901.62

Total Returns $459,276.20 $745,094.28

Payback Period* 2.18 (2 years 2 months) 1.34 (1 year 4 months) *Payback period is based on FCP program total award of $999,376 for grant period 12/01/2012 to 11/30/2015.

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Conclusion on First Customer Program Economic Impact Analysis FCP has had the opportunity to demonstrate considerable economic impact within the state of

Michigan. In total, FCP clients created 170.3 new full time equivalent (FTE) jobs with 84 directly

attributed to the FCP. 344 FTE jobs were retained among FCP client companies that were provided

services. Of these, 18 FCP clients credited retaining 49 jobs directly because of FCP support through full

assessment, delivery of Market Specific Overview and/or Action Plan, and execution of projects. On

average, the program spent $1,198.59 of grant money retaining 1 full time position. The program spent,

on average, $3,285.37 of grant funding to create 1 full time job. The conservative payback period to the

state is estimated to be 2 years and 2 months and the optimistic payback period to the state 1 year and

4 months as seen in Figure 1.

The FCP team has developed a method for identifying critical business development, marketing, and

sales gaps in startups. FCP is a useful entrepreneurial resource for early stage startups and those that

have revenue under $5 million seeking a repeatable and scalable sales model. FCP’s identification of key

projects and providing co-funded support has helped startups significantly scale up business

development, marketing, and sales efforts.

To continue supporting the FCP and its expansion, the FCP team recommends expanding reach through

Mid- and Western Michigan. Bringing on additional professional personnel would help the team expand

regional expansion efforts on the ground, expand bandwidth to assess a larger portfolio of startup

clients, and speed up response time and the delivery of market intelligence, Market Specific Overviews,

Action Plans, and projects to clients.

Another way to support the FCP could include increasing the amount of grant funding that may be

awarded per client. Currently co-funding is up to $25,000 per client which means that a project or series

of projects may total $50,000. It may be useful to increase the amount of co-funding that may be

awarded per client; less experienced startup teams average 3 projects with $25,000 but more

experienced startup teams average 5-6 projects. Increasing the co-funding which may be awarded per

client may increase the spectrum and depth of assistance provided through FCP projects.

Finally, it may be useful to increase the funding for projects overall to provide the FCP team with the

ability to award more potential projects to a greater number of eligible clients.

Impact on Regional Partners

The First Customer Program (FCP) has also demonstrated considerable impact on its employees and

regional consultants. The FCP works with a larger network of consultants in and around Michigan. Many

of the consultants are small businesses directly benefiting from FCP projects. Of the total $999,376 grant

funding, $303,000 was spent on consultants. The FCP employs a director, a program manager and part-

time research associates. Over the course of the program this amounted to a total taxable payroll of

$232,604. Research associates are graduate level students many of whom gained valuable experience

for future positions. Ten associates, including 4 who were international students, have since begun

working full time, sponsored, and salaried positions with Michigan companies.