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Business Observer Friday, Aug. 22, 2008 12 years ago

Walsh: Review and Comment

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How SunHydraulicslearned perilsof state funds

Walsh: Review and Comment

How Sun

Hydraulics

learned perils

of state funds

All Sun Hydraulics wanted was $4 million.

Call it a subsidy. Call it an investment. Maybe even call it a reward for exemplary behavior.

In the end, it was an eye-opening, frustrating odyssey into the often nonsensical world of state government and the nonsensical business of corporate incentives.

When it was over, just this past June, as Sun Hydraulics executives sat in a conference room at their Sarasota headquarters, evaluating what they learned, Kirsten Regal, a longtime executive at this 38-year-old manufacturer, summarized:

"I learned our founder is right. We're not designed well to work with the government."

There are many lessons in Sun's adventure into government incentives. For Al Carlson, Sun Hydraulics chief executive officer, just the telling of the story of Sun's experience was cathartic. He wants legislators to know what Sun experienced. If Florida wants to keep companies similar to Sun, Carlson says, lawmakers will need to change the rules.

"Their program, in essence, is to drive people out of the state," he says.

Adds Tricia Fulton, Sun chief financial officer: "It's so irrational, we can't believe it to be true."

$4 million incentive

At least twice a year, Nancy Engel, executive director of the Manatee Economic Development Council, and Kathy Baylis, executive director of the Sarasota Economic Development Council, stop in at Sun Hydraulics to inquire whether their EDCs can assist Sun's growth.

They are always eager to help. But there has always been a state-mandated catch: Assistance would have to be tied to creating jobs.

This bugs Carlson. "That's not our objective," he says. "Increasing productivity is the key to our success." Additional jobs, Carlson says, are an effect of investment, not the cause.

Last winter, Carlson and Sun's management decided nonetheless to put the EDCs to the test. Over the past two years, Sun management has been mapping out the company's 10-year expansion plans - a typical business cycle in Sun's industry.

The company decided it wants to build a third 65,000-square-foot plant near its headquarters just north of Sarasota-Bradenton International Airport. Over the 10-year period Sun would invest $20 million in the plant and equipment and hire another 250 people.

Sun management decided it would explore obtaining $4 million in state incentive money to purchase an 8.2-acre tract next to an existing Sarasota plant.

Sun designs and manufactures cartridge valves and manifolds used in hydraulics systems. It employs 1,000 people in eight offices around the world, 650 in Florida. In 2007, its net income was $22.1 million on $167.3 million in sales, a 13% net profit margin and 17.6% increase in sales. Sales have been growing more than 20% a year for the past five years.

Carlson had misgivings about asking for the money. Sun had never asked for government assistance in its 38-year history.

"One part of me says we're entitled," Carlson says. "We've paid taxes for the last 38 years ($12.2 million alone in 2007). We're a good citizen. We've paid for it.

"You hope you have a good relationship with the community, and that it would be reciprocal," he says. "I wouldn't call it a subsidy. I'd call it an incentive for future investment.

"Another part of me said it's a hassle, not worth pursuing. And another group said, 'You're asking for something you don't need," Carlson says.

Fulton, Sun's CFO, saw it as a business decision. "We're a public company," Fulton says. "We have a fiduciary responsibility to our investors." In other words, build the new plant as economically as is practical - even if it means government assistance.

The process

Sun thought about building in another state. It had eager suitors in Georgia, South Carolina and North Carolina who were ready to build Sun's building for it.

"Fundamentally, we prefer to stay in Sarasota and Florida," Carlson says.

So Sun called Engel at the Manatee EDC around the beginning of March. She told Carlson and his team what they didn't want to hear -funding would have to be tied to job creation. Nonetheless, she encouraged Sun to make its pitch to Enterprise Florida, the public-private organization that brokers expansion funding between companies and the state.

This was new territory for Sun's management. It hired Michelle McKay, a Tallahassee lobbyist and wife of former state Senate President John McKay, to work the system at the capitol.

Then the process began. There were application forms, the primary one an 11- page questionnaire. It called for financial and narrative information about the company almost as detailed as an annual report or investment prospectus. It took the equivalent of a week for one person - including multiple telephone calls and conferences with Enterprise Florida officials - to complete the application.

From there, Sun officials continued back and forth conversations over such things as Sun's equipment purchases and sales taxes paid over the past three years. It became clear that Enterprise Florida and state economic development officials wanted to work out $4 million in tax credits or come up with formulae to give the same amount in tax rebates.

"They put us through all kinds of accounting gymnastics," Carlson says.

At one point, Carlson and his team felt blindsided when they woke up to a story in the morning local daily that said it was requesting $102,000 each from the Manatee and Sarasota counties' commissions. Enterprise Florida had conveyed the request to the two counties unbeknown to Sun.

More telephone meetings and e-mail exchanges with state and Enterprise Florida officials followed. On April 22, Enterprise Florida sent an e-mail proposal with a $1.32 million sales-tax credit and $970,000 in funding from the state's "Qualified Targeted Industry" funds and "Quick Action Closing Fund."

Then a month later, on June 18, the state's director of the Office of Tourism, Trade and Economic Development in Gov. Charlie Crist's office, sent a letter to Sun with good news - at least he thought it was. Dale Brill wrote: "It is my pleasure to inform you that Gov. Crist has approved Sun Hydraulics Corp. to receive a $562,000 award from Florida's Quick Action Closing Fund."

Two paragraphs later, however, Brill outlined six conditions. One specified the company must create 125 net new full-time jobs by Dec. 31, 2013 - with at least 25 of these jobs created each year between now and the deadline.

Carlson called the conditions "rubberbands." Sun executives were puzzled that state officials couldn't grasp Sun's 10-year investment horizon. "They work in five years," Fulton says.

What's more, Sun executives said, the state's conditions would have required the company to install new accounting procedures just to keep track of everything the state required. Most bothersome was the same old stipulation - the money was tied to job creation.

In the end, the state's incentives would have totaled $2.5 million.

Sun management said thanks but no thanks.

Tie it to investment

In their postmortem, Sun executives are glad they went through the process - at least now they know what it is. It's not likely they'll do it again.

Says CFO Fulton: "The whole thing was extremely bureaucratic and frustrating. The rules are not flexible. If they are going to attract companies, they are going to have to have a more flexible criteria and process."

Carlson: "They should come to grips with the idea that assistance should not be tied to job creation. It should be tied to investment. If they think creating jobs is the objective of companies, those companies are not going to stay in business long."

Sun's executives are appreciative of the efforts of the local EDC officials. But because of legislative limitations, Carlson used the analogy that the local EDC office was a "dead door." CFO Fulton says the local EDC offices "need to be able to plead their cases to the state" on behalf of companies, rather than have the companies hire lobbyists to work Tallahassee.

What's next

Sun's expansion plans are on hold. It went ahead with the purchase of the 8.2-acre lot - for $2.5 million. Carlson is unsure when - and where - the company will build its next plant.

"Everything is still on the table," he says. "We're looking at adding to our Kansas facility. We've looked at a leasing opportunity."

Another option, Carlson says, is to re-engage a site-selection company that it used to scout incentives available in other states while it was dealing with Enterprise Florida.

"We're not surprised this came out the way it did," Carlson says. "But we had a glimmer of hope. All of the people involved in the process agree, it needs to be revised."

He adds: "I'm ready to close this chapter of the book."

Lessons learned

Sun Hydraulics' experience clearly demonstrates the perils of the business of governments offering specific economic incentives to begin with.

It would be refreshing if lawmakers who have created all of these "accounting gymnastics" and bureaucratic processes would step back and see that the corporate incentive business is one of the worst forms of government officials picking winners and losers, based on their whims of who they favor and disfavor. And, it's a nasty form of legalized thievery.

Former Gov. Jeb Bush led the charge to give Scripps Research $300 million in incentives because it was his desire to try to bring high-tech jobs to Florida. Did Bush ask any of the fixed-income widows whether that's what they would do with their limited money?

Bush and those who backed the Scripps deal justify it by saying the state will receive royalties from the products Scripps commercializes. But here again, will any of that bounty go to those fixed-income widows? That will be another decision for lawmakers to decide - how to dole out and spend other people's money.

Furthermore, look at what happens to business executives' thinking. To be sure you can identify with Sun Hydraulics CEO Carlson in the way he viewed the incentive money. His company has been a huge taxpayer for 38 years. It has been the source of wealth for 650 taxpaying employees in Florida, not to mention all those people who benefit from Sun's employees' consumption and spending. Carlson expressed a view that perhaps his company should be rewarded for all that it has done.

There is validity to this view.

But in the end, you can never justify awarding a government incentive to one business but not another. It's always redistribution of wealth.

It comes down to a state's overall economic framework. There is nothing better than a simple framework of low taxes, low regulation, strong property rights and a marketplace where individuals have the best incentive of all - the freedom to make their own decisions on whom and where they spend and trade.

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