Here, in Part III, the paper will explore issues related to the development of the larger information economy infrastructure. The experience of other states, and indeed national efforts, demonstrates that the private sector has provided the leadership critical to such development. The experience of other states also demonstrates that the public sector is best able to support the growth of the industry by providing an appropriate regulatory framework based on the needs of companies and not on what the public sector thinks are the needs of companies. Most states with a strong technology industry share certain characteristics. Most of these states encourage triangular partnerships among universities, public sector agencies and private sector companies. All of these state governments value education very highly, and recognize that the secondary and post-secondary institutions are fundamental to the economic health and technology industries of their states. All of them have anchor companies that have provided jobs, tax revenues, and employees who have left to form their own startup companies.

Despite these similarities, every state faces different challenges and requires different needs. In other words, the legislative and private-sector initiatives necessary to develop state economies are rarely identical. Each state needs to tailor legislation and corporate decisions according to their individual needs. While the technology industry in Hawaii is small, relative to other states, it does enjoy a strong technical infrastructure and there are strong possibilities for commercial and legislative reform. The approach of policymakers and businesspeople in Hawaii, as they look towards a more developed information economy, must include proposals to address their specific sector needs as well as the larger industry-wide issues. Therefore, while Part II of the paper assessed the potential of specific industry sectors, and, in some cases, offered suggestions for reform, Part II will offer suggestions for changes that affect most if not all sectors.

I. TECHNICAL INFRASTRUCTURE AND THE HAWAII BOARD OF TECHNOLOGY (HBOT)

One of the reasons why Hawaii's potential for moving into the digital age is so high is because its technical infrastructure is extremely sophisticated. The private sector needs to lead the effort to maintain the state's infrastructure by frequently communicating their needs to state and federal representatives. Secondary and post-secondary schools must make the needs of Hawaii's students known to government officials as well. Public and private secondary schools stand to benefit from networking their information technology together and from improving the access of young students to internet and technical capabilities. The technical capabilities available to post-secondary institutions are critical for three reasons. First, if information technologies are not regularly updated, university students and professors will be unable to compete with researchers at other schools who may be developing new software, code, or technologies with superior IT capabilities. Second, in addition to the research advantage, local universities require a cutting-edge technical infrastructure to develop new methods of education. For example, online classes, coursework that requires hands-on work with client-server architectures, online businesses for business school students or computer science students enrolled in business school courses, and other methods of learning that may be facilitated by existing technology would be enhanced significantly. This is important because learning new technologies for the sake of developing an understanding of how to learn new technologies is critical in a constantly evolving information-based economy. Third, the technical capabilities are critical to post-secondary institutions because the knowledge that locally-educated students are trained with new technologies raises the confidence level of companies looking to do business in Hawaii. If students are comfortable with new technologies, and with the ability to adjust to new technologies, they add value to the companies that hire them.

After listening to the needs of the private sector and the educational institutions, the public sector, in turn, needs to find creative ways of financing and building the elements that are critical to these businesses and schools. Creative financing may include the financial participation of relevant corporations and certainly should include the support of federal lawmakers, who would best be able to appropriate federal funds themselves or find a federal department that could provide that role for them.

One of the first steps, then, should be the creation of a Hawaii Board of Technology (HBOT), the members of which represent high-level officials from the state executive branch, state legislative branch, the private sector, academia and the US House and Senate. The mission of this board should be to improve the technical infrastructure of the state to maintain the competitiveness of Hawaii's companies in the digital age. The board should meet twice each year to talk specifically about how to develop Hawaii's (1) supercomputing capabilities, (2) cables and other terrestrial telecommunications networks, (3) satellite and other non-terrestrial telecommunications networks, and (4) dual-use technologies. To the extant that institutional memory is important for learning from past mistakes, these board members should be encouraged to participate for as long as is reasonable. The chair of HBOT, elected by HBOT members, could be Hawaii's point person for all technology industry-related matters.

In addition to ways to further develop the state's technical infrastructure, HBOT members should be responsible for sharing information with other members about new opportunities. For example, there are a number of reasons why the Maui High Performance Computing Center is managed by the University of New Mexico and not the University of Hawaii. While there are obvious benefits to having an outside institution with experience and expertise manage the facility, there are also obvious benefits to having an in-state institution with relationships to local businesses and schools manage the facility for the use of more in-state clients. HBOT members should be looking for news stories and information relevant to the Board's mission. In May 1998, for example, Bermuda-based Tyco International announced that it was awarded a $1.2 billion contract to build a 13,000-mile cable connection between the United States and Japan. The "Pacific Crossing," it was announced, would carry voice and data information at 80 gigabytes per second. It is not clear if the state government has seized this opportunity to ensure that the cables surface in Hawaii, or if locally-based companies would be able to bid for work as sub-contractors.

II. VENTURE CAPITAL, CAPITAL FORMATION AND INVESTMENT

According to the 1998 PriceWaterhouseCoopers Money Tree Survey Report on Venture Capital, more than 700 companies nationwide received $3.77 billion in Venture Capital (VC) financing during the third quarter of 1998. Of this total, Silicon Valley companies attracted $1,245,307,027, Los Angeles companies received $289,742,000, San Diego companies received $70,191,000, New York Metro companies received $192,786,675, and Massachusetts companies received $468,080,000. These are impressive figures, particularly when the totals reflect only selected regions of particular states. They are especially staggering when contrasted to the amount of venture financing supporting Hawaii companies. In Hawaii, VCs invested a total of $432,000 in companies during the third quarter of 1998. According to the Money Tree Survey Report, Pacific Information Exchange, Inc., an Internet Service Provider, received $62,000 from HMS Hawaii Management Partners (HMS). HMS also invested $70,000 in Kona Bay Oyster & Shrimp Company Inc., which grows shrimp using proprietary technology on a bi-valve farm. The remaining $300,000 was invested by Pacific Century SBIC Inc. in Barking Dogs LLC, a manufacturer of patented dog chew toys.

The Money Tree Survey Report states that $2.9 billion of the VC investments during the third quarter across the nation were made in Biotechnology, Communications, Computers & Peripherals, Electronics, Environmental, Medical Devices, Semiconductors, and Software & Information companies. That dollar figure represents the highest proportion of total investments and highest dollar amount ever stated by the Report. These are important figures for the purposes of this paper because it reflects that while 78% of the billions of dollars in VC funds went to technology companies on the mainland, almost 70% of the investments made during the same period in Hawaii were in dog chew.

The investments of $70,000 and $62,000 in technology-related companies, both made by the same Honolulu-based VC firm, reflect two realities of the technology industry in Hawaii. First, there is a dearth of venture funds backing technology companies. HMS, for example, receives approximately 80 inquiries annually for possible investments. Of the 80 plans, HMS selects 10 for review and, of those, chooses three to five fortunate companies. Second, the investments by HMS reflect a larger problem of investors fearing technology investments. Traditionally, investments have been made in asset-based companies, not information-based companies. Technology industry companies typically sell information-based products and services, such as software or web-hosting. They are typically not in the business of selling many products - with the obvious exception of original equipment manufacturers - that they manufacture. In other words, VCs are asked to invest in ideas, and not in pre-existing tangible goods. This risk has obviously paid off for mainland VC firms. However, most institutional investors in Hawaii have been hesitant to put their money in such companies.

The problem facing Hawaii VCs that do want to invest in technology companies is that, as a result of the fear of information-based investments and other reasons, it is difficult to raise capital for their funds. The question, then, is how these VCs can raise capital for technology companies in such an environment. The answer to this question will not be fully answered here, but this paper will attempt to provide a moderate approach to capital formation that addresses the present reluctance to invest in technology companies.

The main issue to remember here is that, in the context of Hawaii's business climate and preference toward asset-based companies, capital formation will initially be somewhat piecemeal. The total fund that each VC seeks to form may be substantial, but the number of investors backing the fund may have to be unusually high since each will likely contribute an amount appropriate to their risk-averse tendencies.

A. Local Investment Clubs

One way for firms to raise capital is by calling on investment clubs, or by encouraging people to start an investment club. An investment club (IC) is a group of investors, typically comprised of 10 to 20 individuals, who meet monthly to educate themselves about various portfolio companies and to discuss whether to invest in certain companies as a group. Each individual in the group contributes a certain amount to start the club and a set monthly amount as required by the group's bylaws. The monthly contributions are added to a fund, which is invested in companies chosen by the group. In addition to educating each other about methods for analyzing stock prices and corporate performance, IC members frequently discuss the investment-worthiness of particular companies and listen to presentations by local publicly-held corporations.

The portfolio of one IC, Ladies Investing and Perhaps Speculating (LIPS), totaled $201,600 in February of 1998. Members who joined in 1985 with the $500 fee and have paid the monthly contribution of approximately $100 now have an investment worth approximately $30,284, approximately double the amount actually invested.

While the portfolios of most ICs are not very large, they do present one opportunity for groups of individuals to invest in local companies without much risk and to help keep capital from flowing out of the state. If, for example, 25 members of an IC in Hawaii paid a startup fee of $500 and contributed $100 every month for a year, they would collectively present approximately $30,000 per annum, not including the initial $500 fee. This is not a very large sum, but it would help to retain capital in the state, especially if many clubs decide to invest locally.

More to the point of this section, ICs present a second opportunity for investors to develop Hawaii's capital infrastructure. If investors were willing to make more substantial contributions to ICs, they may be able to help generate capital for venture capital firms, which, in turn, could fund companies at various stages of growth and possibly provide a significant return on the investment. Suppose 25 members of an IC paid a startup fee of $500 and a monthly contribution of $750. Obviously, this is a more substantial sum than most IC members contribute, but the difference could mean greater returns as well as a greater possibility of providing critical funding for an entrepreneur's company. The total IC fund would present $225,000 per annum, not including the $500 startup fee. In addition to keeping capital in Hawaii, this hypothetical IC could potentially help start a new technology company by asking a local VC to invest the funds properly.

One of the attractive benefits of calling on ICs to provide funds for venture capital firms is that each individual investor does not have to spend an entire retirement savings to support an entrepreneur and, depending on risk, a possibly high return on the investment. The investment is relatively small, but, when multiplied by other IC members, totals a significant amount, particularly within the context of Hawaii's 1998 third quarter investments of $430,000.

B. Corporate Investment Clubs

Corporate officers and directors responsible to shareholders would obviously be uneasy about investing in high-risk deals. The alternative that could be offered to corporate officers and directors, in order to encourage corporate participation, is to extend the model of the individual Investment Clubs to form Corporate Investment Clubs (CICs). These CICs could be made up of 10 corporations, with a startup fee of $1000 for administrative costs and a monthly contribution of, say, $15,000. This would generate $1,800,000 for a VC to invest in entrepreneurs, not including the $1000 administrative startup fee, without an excessive risk to participating companies, depending, of course, on their own revenues and assets.

C. Pension Funds and the Hawaii Pension Investment Board

While there are federal limits on the amounts that which pension officers may invest in companies or funds, there are still significant amounts of capital that may be available to venture capitalists, depending, again, on whether the investing officer is a risk-taker or risk-averse. Pension funds are not, to the best of the author's research and knowledge, used in Hawaii for venture-backed deals. This may be the result of three factors. First, locating a list of Hawaii-based pension funds and their estimated value is a difficult task in and of itself. Second, convincing the officers of these funds to invest in many deals is another problem altogether, simply because of the risks involved with the ventures. Third, complying with federal ERISA regulations requires a high degree of costs that many possible officers with fiduciary duties may not want to incur.

Nevertheless, other states have found innovative ways to raise pension funds for investment purposes. The State of Alaska has developed a board within its State Department of Revenue which may serve as a model for a similar board in Hawaii. In 1993, the Alaska State Pension Investment Board (ASPIB) was established by statute to "provide prudent and productive management and investment of state pension funds." Eight trustees make up the board, which is staffed by the Alaska Department of Revenue's Treasury Division. ASPIB is required by law to appoint an investment advisory council of between three and five members, each of whom have demonstrated expertise and experience in the investments and management of portfolios for corporate, private, or union pension funds, endowments, or foundations. The board invests funds from six plans and systems: (1) Public Employees' Retirement System, (2) Teachers' Retirement System, (3) Judicial Retirement System, (4) National Guard/Naval Militia Retirement System, (5) Alaska Supplemental Annuity Plan, and (6) Alaska Deferred Compensation Plan.

If Hawaii did set up a Hawaii Pension Investment Board (HPIB), it could look into the possibilities of investing pension funds from both the public and private sectors. Both types of investments - public sector pension funds and private sector pension funds - are subject to different laws under ERISA, but may be of significant use to local VCs looking for new and creative ways of raising capital for their funds. There are obvious considerations that would prohibit the investment of any pension money. First of all, pension fund managers are under certain fiduciary duties that would prohibit them from investing in high-risk deals. Second, these managers must constantly assess the value of their funds, particularly when members want to claim their pensions. This makes investment in technology companies or VCs difficult because, unlike stocks, equity in company is problematic to value without significant effort. In other words, the managers would probably have to hire an accounting firm to value the company in which they invested. Even after an audit, there is no guarantee that that valuation would stand two weeks later. However, even if some pension managers in Hawaii were able to invest 2 percent of their funds, the resulting number could total somewhere in the hundreds of millions of dollars. The work of HPIB could amount to a modest, but successful, method of capital formation for local VCs and entrepreneurs.

D. Angel Investors

The net worth of the four richest residents in 1996 amounted to $6.2 billion. In 1995, the net worth of the two richest residents totaled $6.1 billion. There are individuals, or families, in Hawaii with money to invest. If these residents were enticed to spend fractions of their wealth on entrepreneurial work in Hawaii, the returns could be extremely high for both investors and the companies that benefit from them.

Take, for example, a prominent angel investor in Silicon Valley named Audrey MacLean. MacLean invested $20,000 in an engineer who had an idea for a company that would develop software that enabled companies to debug their products in less time, which would allow the companies to get to market faster. MacLean sat on the board of this startup, and helped raise more funding, approximately $6.4 million, from her VC friends and her own checkbook as her confidence in the company increased. The company went public after five years, making MacLean's investment of $245,000 instantly worth $5 million. With the right expertise from VCs and capital from investment clubs, this could happen in Hawaii.

Many of Hawaii's wealthy residents would probably not want to commit the time that MacLean has offered to companies. That would likely be an initial reason for not financing certain ventures. However, these angels could play a critical role by financing venture capitalist firms, which would provide companies with the business advice and direction that usually accompanies such financing. Supporting venture capitalists, it seems, is the best way to support the technology industry right now, given the stage of the industry's growth in Hawaii.

E. Foreign Investors

Although the Asian economies are still extremely volatile, there are still many investors who are holding on to their money until the economic crisis passes. In fact, there are a number of entrepreneurial investors who are actually able to make considerable profits because of the nature of the Asian crisis. There is a venture capital firm based in Hong Kong, AsiaTech Ventures, which opened with $18.5 million in 1997 and plans on expanding their investments in the United States this fall with $43 million in new funding. Their profits so far are not primarily the result of investing in geographically diversified markets, though that has helped. The executive director of AsiaTech has said that Asian investors typically prefer to see tangible assets on a balance sheet, and would invest in such companies before investing in promising entrepreneurs with intellectual property such as software code. Furthermore, typical Asian VCs give money to ventures with government or business connections. In contrast, AsiaTech has succeeded by investing in companies that may not be as well-connected and may not have the same tangible asset value as other lower-risk companies. While this is seen as a risk by many investors, the AsiaTech founders point out that the traditionally safe industries such as retail and real estate have been hit much harder by the Asian economy than companies with fewer tangible assets. "The two main stories on the front page [of a Singapore newspaper] were a company experiencing a 22 percent drop, and another laying off 40,000 people. In between them was a chart reading, 'Number of Singapore Internet users continues to skyrocket.'"

The lessons to be drawn here for the purposes of venture capital formation are the following. First, there is money in Asia from which Hawaii VCs and companies can draw. 90 percent of the $43 million raised by AsiaTech's latest round of financing came from institutions and individuals in Taiwan. Second, while the economies in Asia have done significant damage to companies with tangible assets, information companies have survived and some actually succeed. That note, particularly when juxtaposed to any news story about the role of technology in the American economy's success, underscores how investments in information-based companies can be successful in Hawaii, despite the company's risk factor and the state's economic depression. Third, even if local VCs are unable to secure financing from Asian sources for their funds, Hawaii companies could probably seek capital from Asian investors to finance their ventures.

III. EDUCATION

There is no question that Hawaii needs to improve its schools in order to provide a better-trained workforce for a technology industry. Part of the problem is funding. While the state's teachers are well-paid -by national standards, anyway - Hawaii was ranked the third worst in the nation in a study of education deficits conducted by the National Education Association. According to the study, "Hawaii's expected state revenues will fall 15.1 percent short of expected costs to maintain today's education services" by 2006. In addition to funding, student scores are not generally strong. A study conducted in January 1998, published annually by Education Week, used 75 indicators of education quality to assess state education and found that Hawaii schools lacked in almost every one. The state received a C- in "quality of teaching," an D- in "adequacy of education," a C- in "allocating the money" and an F in "school climate," which includes class size, parental involvement, and physical conflicts. However, the state did receive an A for distributing resources fairly among school districts. It may be fair to note here that there is only one state school district in Hawaii. The report text also explains that only 16 percent of the 4th and 8th graders in Hawaii scored at or above the proficient level, well below the national average, on the National Assessment of Education Progress in math in 1996.

While state educational reform is far beyond the scope of this paper, it may be useful to also note that there are no charter schools in Hawaii. Charter schools are public schools, grades kindergarten through 12, that are founded by groups of parents, community members, teachers, or community based organizations. Many of these schools have been founded on the mainland for the purpose of encouraging innovative methods of teaching, making teachers accountable for the learning program, and emphasizing a particular field or set of skills. For example, some schools are organized with a fine arts emphasis, or incorporates an element of community work experience into the curriculum. It may be useful for community boards, or even the state Board of Education, to look at models on the mainland in order to encourage the development of charter schools with a focus on science and math. While this will not solve many of the problems plaguing the school system, it would at least promote the development of science-oriented students who are fundamental for the sake of their own professional and intellectual growth and for the state economy.

There are a number of other innovative approaches to expanding or improving the schools to support the state's information economy. One interviewee has suggested that the private sector should initiate, and the public utilities commission (PUC) should allow, a program that would involve companies investing in high-speed networks for primary and / or secondary schools. The purpose would be to expose students to technology generally and networks specifically by connecting them to community members, students at other state schools, and to students at schools outside Hawaii. The business advantage to companies that invest in these networks is that these students would hopefully develop an interest and familiarity with network technologies that they would carry into their post-secondary education and then into the work environment. The most significant barrier is that such investment may lead to an increase in costs that would be passed on to rate payers. The PUC, this interviewee argues, should allow that increase because of the long-term benefits to the state.

IV. ELECTRONIC COMMERCE

There are a number of ways that the state could encourage the development of electronic commerce. Because this is an area that may be potentially the most effective way for companies in Hawaii to grow, it may require further study in a separate paper. For the purposes of this paper, there are three ways that electronic commerce companies based in Hawaii could grow.

First of all, the state legislature could consider proposals similar to those recently proposed in California which would provide a permanent ban on new taxes and online transactions in addition to some cuts in existing taxes. The proposal, though radical, may provide an equally dramatic rise in internet companies, which would raise the income level of many people who presently work or hope to work in companies that do business online. It would also make it financially more feasible for both startups as well as individuals who want to start their own small business to provide or expand their services. In addition, although this is not in the California version, it may be feasible for the state to extend this legislation to offline local businesses. In other words, the state could exempt businesses from taxes on all income generated online if: (1) the business is based in Hawaii, (2) the business either uses its own server or a locally-based web host, (3) the site is designed and maintained by a web designer or network administrator who is a resident of the State of Hawaii, and (4) in the instances where the business already does business offline, prices for identical or similar products or services are not different from the prices offered online. The first three provisions are designed to encourage Hawaii residents to call on local services, rather than pay for mainland consultants to support their business. The reason for the fourth provision is that, if a product is sold online and not taxed as income to the company, there would be a temptation to lower the price of a good offered online and compensate for that lower online price by raising the cost of a good sold in the offline world. The result of that would be increased prices for people who cannot buy goods online because they either cannot afford a computer or cannot afford a monthly fee for Internet access. The fourth provision would attempt to preclude that result.

Second, the state should sponsor a board within the High Technology Development Corporation which would link electronic commerce companies to each other. In other words, in addition to providing the catalog it presently has online, HTDC could create something similar to the Virginia Procurement Pipeline, which essentially links Virginia businesses with local service providers of all kinds. This would make it easier for companies that are starting up to locate resources and other companies that could help with any situation, whether the need is, for example, web design, legal work, or software development.

Third, the state legislature should pass Senate Bill 961. While this paper mentions the state legislation related to digital signatures in Part I, § 3(B), it should be underscored primarily because digital signatures in and of themselves are critically important for the development of electronic commerce. Two of the several important issues in global electronic commerce development are authentication and security. Digital signatures, while not addressing the security issue, do and will address the problem of authenticity. By making a digital signature as enforceable as a handwritten signature, the state legislature would enable local electronic commerce companies to significantly improve and expand their services.

Go to Part IV

© 1999 Kalama M. Lui-Kwan
Last updated 3.22.99