Mark Gritter (markgritter) wrote,
Mark Gritter

Biting the Hand That Feeds Me

The National Venture Capital Association has some advice for Donald Trump: don't tax us. The letter is long on generalities except where tax issues are concerned. While most of the policy issues are ones to which I'm at least a little sympathetic, I find their presentation self-serving and overly optimistic, rather than really engaging with any complexity.

Since the Reagan Administration, our tax code has been relatively effective at encouraging patient, long-term investment, but on net has been hostile to entrepreneurial companies. For example, punitive loss limitation rules punish startups for hiring or investing in innovation, while benefits such as the R&D credit are inaccessible to startups. Unfortunately, tax reform conversations in Washington have ignored these challenges while at the same time proposing to raise taxes on long-term startup investment to pay for unrelated priorities.

For instance, carried interest has been an important feature of the tax code that has properly aligned the interests of entrepreneurs and venture investors since the creation of the modern venture capital industry. Increasing the tax rate on carried interest capital gains will have an outsized impact on entrepreneurship due to the venture industry’s longer holding periods, higher risk, smaller size, and less reliance on fees for compensation. These factors will magnify the negative impact of the tax increase for venture capital fund formation outside of the traditional venture regions on the coasts.

No startup founder cares about loss limitation rules. The tax code has never been a factor in whether we hire or invest in R&D. Why? Because startups lose money. It only matters later, when the startup starts making money, that the company doesn't get as big a deduction for its previous losses. (Those banked losses are an asset... but any startup for whom that is material is failing or doing it wrong.)

That's just a leadup to the NVCA's real concern: Trump's stance against the "carried interest loophole". VC's get paid 2-and-20 like other fund managers. 2% of fund assets annually (sometimes negotiated downwards) and 20% of fund income. The fund manager's 20% is counted as long-term capital gains because it is treated as their "share" of the multi-year investment rather than just a management fee.

There are some reasonable arguments that this arrangement is the proper way to think of VC compensation, but VCs often fall back on the "we won't do it if we're taxed higher than 15%" line which is in fact what NVCA says in their letter. This is nonsense. What else are they going to do? Work for salary and pay the same tax rate they're complaining about, only for less money? Engage in less risky investments and let somebody else get the big payoffs instead? Become hedge fund managers and live off the 2% management fee? (oh, wait, that's taxed as normal income too.)

Complaints about the IPO process being burdensome are fair, but it's not clear that is what's driving companies to stay private longer. NVCA is not clear at all what they'd like to do about it.

Debate during the election often focused on illegal immigration, but unfortunately not how legal immigration can create jobs for American citizens, including in underemployed areas. This can be accomplished by attracting the world’s best entrepreneurs to our country through creation of a Startup Visa and allowing more high-skill immigrants to help build startups.

Disingenuous. Startup-founding immigrants have little incentive to go to (and stay in) the Rust Belt.

Basic research: I'm in favor of that too, but the request here is also self-serving. The more applied research gets performed in universities, the less risk for venture-backed firms to develop it from zero. And in fact that's exactly what they want:

In addition to funding basic research, encouraging the commercialization of more technology will lead to increased job creation and economic growth. Many states with economically distressed areas can better utilize research universities to spread startup activity. High-growth startups frequently come out of university-funded research that is commercialized and become private companies.

This is a subsidy, and should be judged against other forms of public investment. (If that's the only way we can get more funding for public universities, I'm for it!)

Unfortunately, while our competitors have upped their game, American policymakers have taken our leadership in entrepreneurship for granted, as we detail below. Consequently, whereas twenty years ago U.S. entrepreneurs received approximately 90 percent of global venture capital investment, that share has fallen over time to only 54 percent in 2015. Further, in three of the last four years, at least half of the top ten largest venture investments in the world have occurred outside the U.S.

How much leadership in venture investments is "enough"? 75%? 90%? 95%? This relative comparison is meaningless. Venture funding in the U.S. has not dropped. The rest of the world is just growing faster. That's a good thing, and possibly inevitable. When China has a lot of cash, it's going to make a lot of investments.

Partner with states to spread startups in areas of economic distress. Your administration has an incredible opportunity to bolster public-private partnership economic development efforts to spur entrepreneurship. Ohio is one state that is leading the way to transform their economy and create opportunity. Third Frontier in Columbus is providing access to business expertise, mentorship, capital, and talent to turn great ideas into growing companies, and JumpStart in Cleveland provides equity-based capital to help startups grow, matches talented individuals with growing companies, and provides expertise to startups.

This is both helplessly vague and disingenuous at once. These seed efforts mean little unless coastal VCs are willing to cut checks for mid-stage and late-stage capital. That's happening somewhat. But the language used here is often code for "investment tax credits" which I feel are of questionable value. The bigger issue is that the Rust Belt often lacks the worker base to benefit from the technology startups we're talking about here. Or to put it another way, the jobs that are created are ones where the workers are already in high demand, not substitutes for the displaced manufacturing jobs. If Colombus creates a 1000 new programming jobs, they probably will act more to stop brain drain than to help rural Ohio.
Tags: economics, rant, venture capital
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