2019 trends in the innovation economy

By Dan Linehan
Special to Delaware Business Times

When you go to the doctor’s office for a checkup, test or procedure, you or your insurance company are probably billed for each service. It’s called the “fee for service” model, and it means the profitability of hospitals and clinics is tied to how many services they perform.

This model is changing as the companies and government agencies that pay for most of our health care are moving toward making lump-sum payments in exchange for measurable health outcomes, like having diabetes under control. Then the hospital would be motivated to spend as little as it could while meeting these goals.

A pithy phrase has emerged to describe this transition: The move from “volume to value.”

As one of the largest purchasers of health care in Delaware, both for its employees and its residents on
Medicaid, the state government has been steering much of this transition here. The state spends about a quarter of its annual $10 billion budget on health care.

Over the next three to five years, Delaware wants to move 80 percent of its Medicaid spending, of about $1 billion a year, to paying for healthy patients instead of individual services, said Dr. Kara Odom Walker, secretary of the state Department of Health and Social Services.

The idea is that hospitals and clinics will figure out for themselves how to draw a straighter line to healthy patients if they don’t get paid for every zig and zag along the way.

“We’re giving you money to figure out where those opportunities and efficiencies are. We don’t care how you do it,” Dr. Walker says.

Even defining this transition can be slippery, as patients, doctors and insurance companies may have different definitions of “value.” To Dr. Walker, a key criterion of value is when the clinics, hospitals and companies that deliver health care stake their profits on their ability to help their patients get healthy while controlling costs.

They’re called “downside risk arrangements,” and they mean a health system could stand to lose money if it doesn’t deliver. It’s one thing to pay extra for great results, as some insurance companies do, and an altogether different one to withhold money if targets aren’t met.

Like most states, Delaware is on the front end of this change; less than 10 percent of its payments for Medicaid patients are in these “downside risk” arrangements, Dr. Walker said. Getting to 80 percent in just a few years isn’t going to be easy.

“The most important thing is having a leader willing to adopt a cultural change” in financial innovation, she said of health care companies.

So this means plenty of changes for the state’s biggest providers of health care, but what about patients?
Ideally, if hospitals and clinics are paid based on how healthy we are, they’ll do a better job at preventive services and coordinating all of the different facets of our care, Dr. Walker said.

For example, childhood asthma is one of the leading causes of missed school days. Often, doctors spend only a few minutes talking with their patients about how the inhalers work and why the medication should be taken. The result is too often that kids go off this prevention medication when they appear healthy, only to need emergency treatment later on.

If a hospital lost money every time a child came to the emergency room unnecessarily, they might find ways to ensure more kids are getting their medicine.

An Old Lease, New Again, May Help Fill Wilmington Offices

New accounting rules that take effect in 2019 will dramatically change the way companies record operating leases, including for office space. Companies will for the first time have to include these leasing costs as assets and liabilities.

The Financial Accounting Standards Board summarizes the change by saying it moves “operating lease obligations from the footnotes to the balance sheet.”

This change is important in part because companies are often evaluated based on the ratio of their profits to their assets. More assets means a smaller ratio and less profit for each dollar of assets.

But there are ways for companies that lease office space to mitigate this impact. One of them is called a “synthetic lease,” an older financing method that hasn’t been popular in recent years but is becoming more common thanks to the new accounting rules.Even with the accounting change to increase their transparency, synthetic leases may have the potential to help fill up some of downtown Wilmington’s empty office buildings, said Wills Elliman, senior managing director of Newmark Knight Frank, a global real estate advisory firm.

A series of upcoming vacancies, especially Bank of America’s sale of two large buildings, will add an estimated 800,000 square feet of empty class A office space, or about a 15 percent increase, to downtown Wilmington.

Though the synthetic lease has a few restrictions — especially that it can only be used when the renter leases 100 percent of the building — its advantages will make it an appealing option, Elliman said.

What is a synthetic lease?

A synthetic lease complicates the typical operating lease with the addition of a lender that creates a “special purpose entity” for the sole purpose of purchasing the asset.

Everyone gets paid — the lender is paid interest from its loan to create the new entity, which in turn pays the owner. Critically, the renter gets the tax benefits of ownership.

Again, synthetic leases are not new, but the new accounting rules may stimulate new interest.
How does the change affect synthetic leases?

Under previous accounting rules, synthetic leases were a way to keep leases off the balance sheets. But
the new transparency measures apply to these leases, too.

Even though these new rules put synthetic leases on balance sheets, the liabilities they incur stand to be much, much lower. Both occupancy costs and balance sheet impacts are significantly lowered, he said.

It’s too early to say whether synthetic leases will help fill Wilmington’s vacant office buildings. But Elliman, who mainly represents tenants in real estate transactions, says its balance statement and income sheet benefits will likely fuel a rising interest in synthetic leases.

Startups leaving the nest?

When their businesses are young, entrepreneurs often rely on business incubators to provide office space, advice and other services. Once they pass their initial hurdles and hit growth milestones, these businesses are ready to “graduate” and leave the supportive environment of their incubator.

They’re the teenagers of the startup world — on their way to success, with a taste of independence — but teenagers still need guidance. And, unlike teenagers, the state’s goal is to get them to stay home, in Delaware.

“There are organizations who can help someone who says, ‘OK, I’ve made my first three million or five million, now how do I get to 10 million?” said Dora Cheatham program manager of the Emerging Enterprise Center, a business incubator run by the New Castle County Chamber of Commerce.

But not in Delaware; the state doesn’t have any organizations that can shepherd a startup past childhood and into what can be a tumultuous business adolescence.

In 2019, however, that may start to to change.

Most business incubators offer intensive services in a relatively small space, usually less than 30,000 square feet, said Bill Provine, president and CEO of the Delaware Innovation Space, a Wilmington-based incubator for science-based businesses.

One way for businesses to begin to scale is by joining an entity called a business accelerator. Unlike incubators, often run by universities or other nonprofit institutions, accelerators are more likely to be run by venture capitalists looking to make equity investments in up-and-coming companies.

Moreover, an incubator offers companies physical space, often for a year or more, while accelerators are more likely to be comprised of programs, seminars and mentorship opportunities lasting several months.
While it began as a traditional incubator, the Innovation Space is planning on broadening its reach and taking on more accelerator-like roles in 2019. This includes business-building programs, hosting conferences and looking at ways to directly invest in early-stage companies that reside there.

Even so, there are no existing business accelerators in Delaware.

A company looking for one wouldn’t have to travel far; Philadelphia offers the accelerators DreamIt Ventures, Science Center’s Digital Health Accelerator and the Ben Franklin Fintech Accelerator.

One question for Delaware, then, is finding in-between spaces for businesses that are growing but perhaps not ready to be independent or scale on their own. One common hurdle is being able to commit to a long-term lease of enough size to entice a developer to build.

“It’s a growing need but not a crisis need,” Provine said, adding that Delaware has done a good job in helping to build a pipeline of startups but needs to find better ways to help them scale up in this state.

Chris Burkhard, a business advisor and entrepreneur who runs a temporary staffing company called Placers, said the need for business accelerators is less acute simply because most companies don’t survive to the point where they need to scale up.

“That’s special, when it happens,” he says.

Even if it doesn’t have a business accelerator, Delaware has plenty to offer companies that graduate from an incubator, including mentors and, in non-competing markets, groups for entrepreneurs in a given industry to compare notes, Burkhard said.

“There are all kinds of set ways that people go about collaborating, and all of those are very, very necessary,” he said.

For an entrepreneur looking to find new space, the key is to find good advice, Burkhard said. A commercial Realtor does more than show you space; they help you understand the market and make good decisions.
“It does occupy time away from growing revenues or improving the product, but I find competent people can do it,” he said.

Tax incentives and development

Two new programs that forgive investors’ taxes for helping to fund startups or businesses in high-need areas come online in 2019.

One is created by the state and the other by the federal government, and both have the same aim: to spur job creation in industries and places that often struggle to find investment.

The Angel Investor Tax Credit, created by the General Assembly and signed by the governor in May, is intended to motivate investment in early-stage, high-tech businesses, said Damian DeStefano, director
of the Division of Small Business. Capital-intensive industries, including drug development, renewable energy and aerospace, can pose a quandary for investors in that successful companies can be incredibly profitable but also very risky.

“Where I think the need really is is in early-stage, high-growth-potential business,” DeStefano said, where “a lot of capital needs to be invested to commercialize but if you can the potential is limitless.”

The tax credit works like this: In exchange for an investment of at least $10,000 in one of 19 high-tech industries, investors receive a deductible income tax credit worth up to 25 percent of their investment. The credit is limited to $125,000 for individuals or $250,000 for a married couple.

The program is limited to $5 million in 2019. Applications opened in November, and DeStefano said the process is designed to be as easy as possible.

It’s entirely online, and the law gives the department 30 days to review each submission. DeStefano said they’ve had a few applications so far and have been able to turn them around in about two weeks.

The second new tax credit is a federal program implemented by the Division of Small Business called Opportunity Zones. Part of the 2017 federal tax overall, it allows states to designate a limited number of Census tracts as Opportunity Zones.

Capital gains taxes are forgiven for investments inside these zones as long as they’re held for 10 years or more. In other words, patient investors and funds could stand to save millions on their capital gains tax, which normally scales up to 20 percent of an investment.

The individual zones, half of which are in Wilmington, were chosen because they have a higher poverty rate or as a result of other measures that suggest they could use more investment.

The state also tried to choose opportunity zones within existing Downtown Development Districts, where private construction projects can receive grants to offset up to 20 percent of their capital construction costs.
Though the law is written to apply to most types of investment, some of the regulations are still being finalized and specific questions about what qualifies are best directed to a private tax attorney, DeStefano said.

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