VCs challenge Obama plan to up carried interest tax

February 27, 2009 | Camille Ricketts | Comments | |

Earlier this week, president Obama announced his intention to raise taxes on carried interest for hedge funds and private equity firms as part of his bold new budget plan. Not surprisingly, members of the venture capital community have been quick to speak out against the change, arguing that it will discourage investors from taking risks on potentially important startups, and ultimately weaken the economy.

Obama’s proposal would hike the tax on carried interest (the percentage earned on investment profits used to pay general partners at firms) — from the current 15 percent capital gains rate to 39 percent, more than the regular income tax rate, starting in 2011. Mark Heesen, president of the National Venture Capital Association, estimates that about 500 venture capitalists received carried interest checks in the last year. This might not seem like a lot, but further substracting from this number could dissuade bright young business minds from choosing private equity as a career, he says.

Beyond brain drain, he suggests the shift in policy could fundamentally change the types of companies investors choose to back. “When you look at venture capital, we are investing for the very long term in technologies that may or may not play out — ironically, the very technology that the administration is saying we need more of than ever, lifescience and cleantech,” Heesen says. “But as a VC, if you are going to get ordinary income tax on your carry, there is much less incentive to wait around for seven, eight, nine years.” The capital gains rate essentially gave firms a buffer to weather failures while waiting for something like Google or Genentech to hit the big-time.

This has been the general consensus among investors, who say the industry will probably place its bets on safer, less innovative concepts if the Obama plan is implemented — and the results will run counter to the administration’s other major goals, namely energy efficiency and cost-effective health care. Many are also concerned that VCs will be less inclined to invest as much time working alongside portfolio companies to help refine their business models and foster growth. As Heesen puts it, “We are involved in long-term job creation, and if that’s not worthy of capital gains taxes, I don’t know what is.”

In the administration’s view, taxing carried interest at a higher level could bring in up to $2.7 billion in 2011 and $4.3 billion in 2012. And those supporting the measure believe the current policy allows some wealthy firms to dodge paying their fare share, reports the Washington Post.

When asked what he would advise Obama to do — considering the loss of public faith in Wall Street and the country’s dire financial situation — Heesen said the administration should motivate investors to hold onto portfolio companies for longer periods of time. “There are ways to raise revenues in this area,” he says. “If you increased a long-term capital gains period so that VCs would hold onto assets for two to three years, that would set policy in the right direction.”

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About the Author, Camille Ricketts

Camille is the lead writer for GreenBeat. She came to VentureBeat from Google where she worked on its traditional platforms team, particularly in TV. Before that, she was a reporter for the Wall Street Journal in New York and London. Follow her on Twitter at @camillericketts, and follow VentureBeat on Twitter at @venturebeat.

With GreenBeat 2009, VentureBeat's all-star conference on all things Smart Grid, coming up in November, Camille will be expanding coverage of this exciting space. Stay up to date by following @greenbeat2009 on Twitter or by becoming a fan of the event on Facebook here.

  • Alan
    Imagine that! Just a few months ago, Obama was that answer to everything and most of the VC community vocally supported him (despite this being one of the things he said he would change).
  • RC
    I'm assuming that Heseen is speaking of the number of NVCA members receiving carried interest payments which would be less than 5%. This hardly seems like a big concern for the NVCA members. As this will only affect partners and not the investors how exactly will this prevent risk taking? Partners aren't using their own money most often.
  • John
    Agree with RC.

    This won't affect the LP's, just partners. It also won't affect an LP's ability to fund a decent venture firm. The industry is so pedigree-happy right now that a shake up like this could be good for investors and, more importantly, entrepreneurs.

    I guarantee this will have no impact on attracting bright young minds. If anything, you'll get a few more people that are actually motivated by entrepreneurship than money, which again, is good for everyone.
  • Max
    The bottom line is the idea that the Administration thinks it can tax its way out of a recession. 39% is a confiscatory tax -- regardless of how many people are affected, it's the wrong tax at the wrong time. Of course, this does prove that most VC's are complete idiots, since the majority of the industry actually supported this buffoon for President.
  • Joe
    Venture Capitalists are paying a lower tax rate than people earning the same income in other occupations. This makes their current tax rate a subsidy. Are Venture Capitalists so hard up we need to subsidize there income? Will they have to trade down from a 7 Series to a 5 Series BMW? FYI, the tax changes have nothing to do with investment in private equity or distribution to startups, just eliminating the current subsidies to Venture/Hedge Fund Management. If you are a venture capitalist and are really going to quit now, please forward your resignation, I'm sure we can find a replacement.
  • Jeremy
    Few people recognize that the carried interest, by definition, is still a capital gain. This tax increase is actually treating a capital gain like ordinary income. Yes, the VC didn't have the basis for the gain, but the LP did and allocated that gain to the VC contractually. It's not a "subsidy" or "giveaway" to the VC partner or a sneaky way of avoiding taxes. This is actually a sneaky way of taxing capital gains as ordinary income.
  • Joe, no one said anything about quitting. The bottom line is that the "tax for the rich" and this tak hike on carried interest are creating LESS incentive to innovate and invest in the USA.

    It has nothing to do with personal riches, it is about deploying capital efficiently.

    Maybe GPs should just raise and establish their fund elsewhere and then America will get zero tax from VC industry.

    And on top of that, the result will be that America has a net loss of new innovative companies, less funding available for American entrepreneurs, less jobs and lower growth.

    VCs and every other American should be able to choose the path of success and riches, it improves America. If that option is snuffed out by government then where is the American Dream?

    This isn't about the personal wealth of VCs, it is about supporting innovative companies in America and the American Dream. Something Obama is set out to kill.
  • elliottdahan
    Capital gains should only represent Your Own Money at risk - not the money of limited partners. Regular income tax represents money you make from others - limited partners money.

    As for Mark Heesen's comment - "Mark Heesen, president of the National Venture Capital Association, estimates that about 500 venture capitalists received carried interest checks in the last year. This might not seem like a lot, but further substracting from this number could dissuade bright young business minds from choosing private equity as a career, he says."

    Not only is his comment disingenuous and horribly faulted in its logic - Mr. Heesen is also a day late and a dollar short when it comes to the Merrill Lynch/Wachovia/AIG/Northern Trust . . . . . . arguments that we have to pay real big bonuses to the very people that got us into this mess.

    The reality is that just as many financial institutions have gone under, so will many VC firms.

    I am sure that the actual productive and hard working members of these failed VC firms would be more than happy to take new jobs at functioning VC firms.

    What really scares me is that VCs and Mark Hessen/NVCA Pres - have the money, entree and power to lobby for Bailout Money.

    It scares the hell out of me that John Doerr was appointed to Obama's Economic Advisory Board.

    It scares the hell out of me that Eric Schmidt is in too many pictures w/Obama (http://blog.wired.com/business/2008/1...) as the Google founders play around in a 747 while cutting childcare support for the Google workers.

    It scares the hell out of me that "Venture capitalists are lobbying members of Congress to include the companies they own in one of the federal government's key programs for funding small companies. The program is called the Small Business Innovation Research program (SBIR), and opponents of opening the program to venture capitalists claim this is part of a larger effort by big business to get a share of small-business set-asides." (npr.com article - http://www.npr.org/templates/story/story.php?st...)

    Elliott Dahan
  • Joe
    @Jeremy the bottom line is this will have no effect on the VC industry NONE. It will not effect how much money statups get, it will not effect capital inflow from LP and no VCs will quit.

    The Bush era/error of cutting taxes and increasing spending doesn't work. If he had kept the same taxes in place from Clinton with spending caps we would have had a balanced budget for the last 8 years instead of doubling the deficit. Massive banking mismanagement and foreign wars have to be paid for sooner or later. Taxing hedge funds at the same rate I pay is a good way to do it.
  • Rag
    equality anyone? Subsidizing tax on someone who risked his capital for the development of technology (or other "noble" causes) is acceptable, but a subsidy for investing a suckers money?? I just cannot believe how mean these people can be, your secretary pays more tax than you, do they have any shame?
  • Heh. Serves you right to be less gullible next time.
  • headlocal
    Jeremy and Chad have it substantially right. Astute VCs probably have 20 IQ points on the politicans, and it should take virtually no time for "carry interest" to morph into forms that populists won't even recognize, forms both legal and homeomorphic. It serves no purpose to openly debate these with Joe, who can engage his own counsel, tax-deductible if ...yada^n...

    More to Chad's point, most students interested in ventures I've met recently are foreign nationals, to whom carry-interest attacks and bill-of-attainder taxation ("progressive" to redistributionists) signal a US intent to lower its comparative advantages in a global economy. Either as VC or as entrepreneurs, they will ruthlessly judge the degraded US value proposition, and create economic activity in the most fertile soil, along with its multiplier effects, public-dole offloads etc.

    The typical 4-7 years to bring VC investments to fruition are sufficient to wait out a 1-term Obama regime, create deferred-recognition or staged exits, or even go offshore, which precipitate departure is already encouraged under the HEART Act's exit tax recitals.

    Bertrand Russell famously asserted that with the support of a good carpenter he could defeat any definition of the word CHAIR. With the collapse of the CDO/CDS industry, talent in "structured products" is in ample supply to deal with CARRY INTEREST.
  • Funded CEO
    Heesen states that VCs will change their behavior and not be patient to wait "7,8, or 9 years" for an exit. They will look for "safer" bets. Has Heesen looked at his industry lately? They guys are chicken-sh*t VCs who are afraid to invest in anything which doesn't come with an iron clad guarantee of a 5X return in about a year or two......
  • RF
    Oh please, quit the sobbing. The vast beer-fueled, otherwise-useless hordes in any MBA program will trip over themselves to grovel and beg for VC PE jobs even if the tax rate was 90%. VC PE carry is about the closest thing to sin - investors carry the risk, GPs carry the upside. Its about as shameless a career as any on this planet - sit and pretend like you can predict and judge the future, and invest other people's money. Network, schmooze, trade favors with buddies, then get paid 2 and 20 with zero risk for essentially just putting people together with some money. People have a hard enough time predicting cashflows on a public corporation with a 20 year operating history, and these tweedle dees think its their brilliance that picked the googles of the world. They are the most over compensated duffers on the planet and they deserve to pay 40% if not more.