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Using Incentives to Tip the Corporate Capital Approval Scales

A company will be better able to pursue and justify the use of incentives in the capital approval process by communicating and illustrating their impact on its investment decision.

Q4 2017
In recent months, megadeals are the talk of the economic development community and catching headlines: Foxconn investing $10 billion to locate in Wisconsin; Toyota/Mazda looking to build a $1.6 billion manufacturing facility; and, most recently, Amazon soliciting proposals for HQ2, which is expected to have a total capital outlay of $5 billion.

In the wake of these news stories, those of us working in site selection, economic development, and corporate real estate have undoubtedly had several dinner table and cocktail party conversations about government incentives and their impact on corporate investment decisions:
  • Do the incentives really matter?
  • Do the companies need the money?
  • How are taxpayers protected in these megadeals?
The answers to these questions are the same whether we are discussing multibillion-dollar megadeal investments, a $5 million facility expansion, or anything in between. Though entertaining dinner table and cocktail-party topics, the stakes are high for corporate real estate executives to understand how to answer these questions and effectively use government incentives to tip the scales in the capital approval process.

The “But For” Requirement
There are an estimated 10,000 government incentives programs in existence across the country and wildly more when considering international programs. With that many incentive programs, there is no one answer to any of the questions surrounding corporate investments. However, of these tens of thousands of incentive programs, there is one commonality among them all: a requirement that program administrators determine the incentive is materially impacting a company’s investment decision. Stated simply, the administrator must determine that “but for” this incentive the company would not proceed with the investment. This may be called many things: the “but for” requirement, the incentive-impact effect, the material inducement resolution.

Regardless of what the statutes and bylaws call this important requirement, an effective partnership with a government entity hinges on a company’s ability to satisfy it. We’ve all seen companies approach the “but for” incorrectly, e.g., requesting incentives because their neighbor or competitor received some, infeasibility suggests a move across state lines, or a company representative making reference to certain political connections. The possibilities for how to address the requirement the wrong way are perhaps endless.

Addressing the requirement the right way comes down to one simple thing: clear and accurate communication regarding a company’s investment decision and capital approvals process. For our small or mid-sized clients, this investment decision may be made with a trusted advisor over a cup of coffee. For our larger corporate clients, the decision often requires formal approval from a capital investment committee or board of directors. Whether it’s a coffee shop or boardroom decision, clear communication of the factors influencing a company’s investment decision are imperative for achieving governmental, community, and taxpayer support for an incentives award.

"If your capital approval process includes a requirement for performance metrics such as growth margins or investment returns, don’t shy away from considering the impact of incentives on your investment decision."
Capital Approval Justifications
While the capital approval processes vary from client to client, all involve the consideration of important alternatives when making decisions, including alternative locations, project scope, or to do nothing at all. Typically, numerous other considerations create such complexity in the capital approval process that corporate executives are challenged to step back and pinpoint the impact that incentives play in the investment decision. To create some clarity on this issue, let’s further explore some of the common impacts that we see incentives have on our clients’ capital approval processes.

  • Location Determination
    Incentive awards have a significant impact on the cost comparison between alternative locations. For companies that have the flexibility to consider multiple locations for a planned investment, the value of incentives to both capital and operating budgets can very often be the deciding factor. Sometimes this is a consideration of sites thousands of miles apart, where state or foreign governments compete for the investment with significant incentive awards. Occasionally, this is a consideration of two sites on opposite sides of a street, where one side qualifies for an incentive and the other side does not. The evaluation of competing locations is one that elected officials and program administrators know well. Comprehensive costs comparisons — inclusive of labor, utilities, and building costs — aren’t necessarily required to justify an incentive award, but corporate executives should be ready to discuss how these many factors play into their investment decision.
  • Project Scope
    In a capital approval process, the term “value engineering” may be the most commonly used phrase in discussions among decision-makers. Can we make due with less space? Is there a more cost-effective way to build the same space? Can we phase our growth? Government incentives can be the catalyst in deciding to go bigger, better, or faster. Incentive program administrators want to provide the capital that makes your company stronger and more deeply rooted in the community. Corporate executives motivated to enhance the project scope with the use of incentives should be prepared to illustrate the alternative project scopes and commit to the enhanced scope in the incentives agreement.
  • Financial Feasibility
    Many company representatives are hesitant to discuss their cost of capital or investment returns in the context of an incentives discussion. But, rest assured, most elected officials and program administrators know that you need to make a profit. If your capital approval process includes a requirement for performance metrics such as growth margins or investment returns, don’t shy away from considering the impact of incentives on your investment decision. As a justification for incentives, careful communication of your performance may be able to make an infeasible project suddenly feasible.

    Each client has different drivers in the capital approval process, but we’ve seen that sometimes its location, sometimes it’s cost, and frequently it’s evaluation of performance metrics. Communicating and illustrating the impact of incentives on these investment decisions is a critical role of the corporate executive in pursuing and justifying incentives, while internally defeating the status quo. Those executives undoubtedly tip the scales in their capital approval decisions and allow for bigger, better, and faster investments through partnership with public entities.

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