What VCs need most: A shift in policy

The Obama administration has already done a lot to re-ignite small business growth, raising guarantees on SBA loans to 90 percent, eliminating costly fees for borrowers and lenders, and introducing a series of beneficial tax cuts and incentives. But when it comes to venture-backed small businesses, current policy once again falls short, and some proposed regulations may have damaging ramifications.

These regulations are well-intentioned, but some (purported to reduce risk or promote “fairness”) could easily stifle the creativity and entrepreneurship that have the potential to kickstart our economy. We should be getting out of the way, not meddling with carried interest and capital gains taxes, not threatening firms and businesses with SEC involvement or Sarbanes-Oxley constraints, or limiting their talent pools with restrictions on H-1B visas. These rules will only drive innovators –- and their investors — overseas.

We need to be encouraging more risk in the VC community, and we need to promote initiatives that will start taking companies public and get the economic engine firing again. To do this, we need to significantly ease the requirements for newly-listed companies that come in below a certain market capitalization threshold. Requiring twice-yearly instead of quarterly financial reporting and easing up on lock-up restrictions would be a great start.

Venture capital firms invest in technologies we need: Clean tech and life science, the very things that will help preserve the environment, increase energy efficiency and enable better healthcare. But if the intent to tax carried interest at ordinary income rates (35 percent as opposed to 15 percent), is enacted, VCs may very well change the types of companies they back in favor of “safer” investments. They will have far less incentive to wait years for a return on their more creative selections.

If more regulation is required, let it be balanced against government initiatives that increase the number of IPOs, ending the dry spell that has squelched venture financing for nearly a decade. According to an April 2009 report from Dow Jones VentureSource, the U.S. venture capital industry is suffering through its worst period on record, with not a single venture-backed company going public in nearly eight months. In the 1990s, seldom did a week go by without the launch of a successful IPO vying to be the next Microsoft or Intel.

So what should we be doing?

First, we need to loosen the stranglehold of Sarbanes-Oxley. Instituted in 2002 to shield shareholders from accounting errors and abuses in the wake of the Enron and WorldCom scandals, Sarbox has done nothing to “protect” investors in smaller technology companies. The SEC has hobbled companies in this bracket by forcing them to count the cost of issuing stock options twice, both as dilution and expense.

Instead, the recent stimulus package should be used to provide government backed loans and equity investments to follow VC funding. So far, this blend of public and private capital has generated a reasonably positive response. And if the government were to match some percentage of VC investments in growing businesses, this stimulus funding would unleash a near instant and significant level of investment, spending and jobs.

We must also ease restrictions on H-1B work visas, a non-immigrant classification that allows companies to employ foreigners possessed of distinguished merit and ability in what are termed “specialty” occupations. Many are highly trained engineers. The H-1B program, as noted recently by the San Francisco Chronicle, is more than a political flashpoint; it has a real and adverse impact on our economy and our society.

Limitations hurt the tech community and the foreign students and workers these companies need to employ. Those who might prefer to stay in the U.S. are often forced to return home, where they find themselves working for companies that compete with American startups. Either that or venture backed companies are forced to open overseas offices and hire the talent they need over there – where their salaries are then spent on apartments, restaurants and shopping trips to the mall in Bangalore or Shanghai, not Cupertino. The monies spent by the tech community on lobbying, administrative and legal fees to get these policies changed would be more productively used as investment in infrastructure, R&D, marketing or management.

The biggest mistake we can make right now is to weaken incentive for investment in innovation, or otherwise suffocate its potential through overregulation. The tech sector has demonstrated its ability to deliver enormous job growth and wealth creation for many, and we can’t lose sight of the fact that the roster of small, venture-backed companies over the last twenty years has included names like Cisco and Google

Larry Harding is founder and president of High Street Partners, an advisory services firm that offers cross-border accounting, finance and human resources services to venture-backed technology companies and international organizations.