House Increases Taxes On Venture Capital At A Time When More Investment In Innovation Is Needed

from the bad-thinking dept

For a little while now, we've noted various plans among politicians to change tax laws for private equity fund managers -- which is supposed to close some loopholes that allowed some bad investment decision making to happen. But one of the serious problems with those efforts are that they lump together all types of private equity, including hedge funds (which do have some issues) and venture capital, which functions entirely differently. Despite numerous warnings about this, it looks like the House has still gone forward with passing a bill that will greatly increase the taxes on venture capital partners, taxing part of the money they make as profits from investments as traditional income, rather than as capital gains (which is taxed at a much lower rate).

While I don't think this change will be as devastating as some have made it out to be, it could chill some aspects of investment. And, while I also don't believe that venture capital is the only way to build an innovative business these days, I do think it has an important place in the ecosystem, and is quite helpful for many companies. Taking away some of the incentives for venture investments, right at a time when we need greater innovation seems like a fundamentally short-sighted move. I understand the argument on the other side, that the partners are investing other people's money, and thus it's not "their" investment from which to earn capital gains, but to some extent that's misleading. The setup of most venture funds with carried interest (i.e., the profit share for venture partners) is to effectively trade their time and effort in the investment for a part of the investment. So it might not be their cash, but they do invest in other ways, and for that they get a share of the profits.

There are certainly lots of problems with our financial system today, and many questions about the private equity space. But lumping in venture capitalists who do long-term, high risk investments in private companies to help them grow, with hedge funds that do short-term, highly speculative gambling-type investments without much focus on the underlying business or prospects, is a dangerous move. There are problems with the venture capital model, but for the most part it works quite well in funding all sorts of innovative companies. Putting this kind of speed bump into the market won't stop venture capital investments, but it could have some pretty serious consequences, especially in terms of the type of companies VCs are willing to invest in. The Senate still needs to vote on this issue, and hopefully they recognize that this is not the time to punish venture capitalists.

Filed Under: capital gains, innovation, investment, taxes, venture capital

House Moves Forward Plans To Change How VCs Are Taxed

from the good-or-bad? dept

For the past year or so the venture capital world has been up in arms over proposals to change how a portion of their income is taxed. The key issue is whether the "carry" that VC's get on profits should be taxed at regular income tax levels or at much lower capital gains rates. Since risk capital is an important fuel for innovation, some VC's make the case that a change in taxation rates could limit the interest in investing institutional money. However, others, such as VentureBeat, make a compelling case that while profits on your own invested money should (and would, under the plan) remain as a capital gain, the carry (which comes from the profits VC's make by investing someone else's money) do not deserve capital gains rates. While the argument goes on, it appears that our Congressional Representatives have not yet been convinced by the VCs, as they've passed a new tax bill that would, in fact, change the treatment for VCs. It still needs to pass the Senate and get signed by the President -- both of which seem less likely to approve this change -- but some of the venture capitalists you know may be holding off a bit on buying anything big and expensive for a little while.

Filed Under: capital gains, carried interest, taxes, venture capitalists