Despite the name calling and mud slinging, Donald Trump and Hillary Clinton agree on one thing: A tax reform measure that would hit the wallets of venture capitalists.
The proposal would nearly double the taxes VCs pay on proceeds from successful startup investments.
But the proposed reform has prompted an outcry from some in the venture capital community, who argue it would be an attack on the innovation engine that powers the red-hot Bay Area economy.
“You’re going to see less activity than what you otherwise would,” warned Bobby Franklin, president and CEO of the National Venture Capital Association trade group. “If you want less, tax it.”
While it’s rare for Trump and Clinton to agree on anything, both candidates have promised to close what they call the “carried interest loophole” — a deduction VCs, hedge funds and private equity firms receive on proceeds from their long-term investments. Politicians, especially Democrats, have been touting such a move for years and so far have made little headway in Congress. But after both Trump and Clinton endorsed carried interest reform in speeches last month, the VC community sat up and took notice.
When a startup goes public or is bought by another company, VCs who backed the startup receive a portion of the revenue from the IPO or the sale, money that’s referred to as “carried interest” by industry insiders. Venture capitalists typically walk away with about 20 percent of the cash such a deal rakes in — after paying out a portion to the limited partners who invested in the fund. The payout for a VC can be thousands or even millions of dollars, and it generally comprises the majority of his or her income.
But not every deal is a moneymaker. It often takes eight or more years for investments to pay off, and in 40 percent of deals, VCs end up in the red, said Venky Ganesan, managing director of Menlo Ventures and chairman of the NVCA board of directors.
Taxes VCs pay on income from successful investments would nearly double if Trump or Clinton were to succeed with their proposed reform, jumping from about 24 percent under the current capital gains deduction to the 43 percent Americans in the top income bracket pay on regular income. Trump also has promised to lower the regular tax rate for most Americans and to reduce the taxes paid by businesses.
Venture capital funding has helped launch such powerhouse companies as Google, Facebook and Uber. Public companies with VC backing employ 4 million people and account for one-fifth of the value of all public U.S. companies, according to a Stanford study released in November. But VC money flooding into Bay Area startups also has contributed to rising housing prices and a growing sense of a region divided into haves and have-nots.
“They’re making a lot of money off everyday people, and there’s a question of equity there. Are they paying their fair share?” Maria Poblet, executive director of the nonprofit Causa Justa/ Just Cause, asked about venture capitalists. Her organization, which is dedicated to challenging displacement and gentrification, recently backed the failed “tech tax” measure that would have imposed an additional tax on San Francisco tech companies.
Opponents of Trump and Clinton’s proposed carried interest tax reform say such a change would lessen the incentive for new VCs to get into the market. And because the payoffs would be smaller, they say, VCs would be less likely to seek high-risk/high-reward investments, such as the biotech companies that make lifesaving cancer drugs.
“There will be less venture capital here,” Ganesan said. “More venture capital will move to other places. And the incentive to create companies in India and China and Singapore … will continue.”
Heather Field, a tax law expert and professor at UC Hastings College of the Law in San Francisco, agreed higher taxes could lead to fewer VCs in the U.S. market. But she doesn’t foresee a doom-and-gloom scenario.
“I don’t think that it would be as dramatic as maybe they say,” she said, “but it wouldn’t surprise me to see some contraction in the industry.”
Of course it’s possible the tax proposal will never come to fruition, no matter which candidate is elected president. Such a change likely would have to go through Congress, Field said. And, so far, congressional attempts over the years to increase taxes on carried interest have failed.
But with both presidential nominees attacking the “carried interest loophole” this election season, the old drama has a new twist and may give VCs more reason to worry.
“It’s very real, and I think people should take it seriously, get educated and be concerned,” said Ted Schlein, a partner at Menlo Park VC firm Kleiner Perkins Caufield & Byers who opposes the reform. “I’m hoping that sanity prevails.”
Marisa Kendall covers startups and venture capital. Contact her at 408-920-5009 and follow her at Twitter.com/marisakendall.
