A proposed tax hike on private equity firms and hedge funds is set to snare venture capitalists in its net.
Congress is considering a measure that has local venture capitalists worried about a potential dent in their profits. Whether the added tax will dampen future investing is a matter of debate.
The tax increase could come in the next six weeks, according to Mark Heesen, president of the National Venture Capital Association in Arlington, Va.
It’s unclear whether President Bush would veto it.
Enormous gains at private equity and hedge fund firms in the past year or so have brought their profits under scrutiny. To respond, Congress introduced a tax bill that would more than double the tax rate, bringing it up to 35%.
By default, an increase in taxes on private equity and hedge funds would include venture capital firms, which haven’t necessarily seen the same surge in profits.
Democratic Congressmen Charles Rangel and Sander Levin have proposed taxing profits at investment firms as income for their partners,at a rate of 35%,rather than at the 15% capital gains tax.
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Stevenson: like others, fears hike would discourage people from joining venture firms |
The potential tax hike is worrisome to Sharon Stevenson, managing director of Okapi Venture Capital LLC in Laguna Beach.
Lower profits at venture firms could prompt them to shift their focus to more mature companies with proven businesses and less risk, she said. That could hurt startups in need of funding, according to Stevenson.
About 35% of venture capital funding in Orange County is for early stage companies, according to Heesen.
Another threat: Higher taxes on venture profits could deter talented people from getting into the venture investing business, she said.
“If you’re a bright person, why would you do it?” Stevenson said.
Stevenson said her company hopes to make two or three deals in the next year. Okapi recently invested in medical company Helixis Inc. of Carlsbad and has funded San Clemente-based electronics maker RF Nano Corp.
Bruce Hallett, partner of Corona del Mar-based Miramar Venture Partners LP, said a tax hike could make life harder but wouldn’t cause him to pullback on investing.
“We’re in the business of making investments, if things got tougher I can’t say we’d stop,” he said.
Hallett said he also worries about the impact on attracting people to venture capital.
“These people could be CEOs or other professionals,” he said. “Why would they want to come here for less money?”
John Garcia, managing partner of Angel Strategies LLC, said he sees little fallout from a tax hike.
“Getting in early is tough, but it’s not going to stop people from doing it,” he said.
A typical fund will invest in about 10 early-stage companies. Of those, six may go bust, three may break even and one may be profitable, Garcia said.
Once a company has been sold and initial investments are recouped, the left over money is typically split 20% to the venture capital firm and 80% to the investors who back the venture capital firm.
A tax hike would not affect investors, just the venture capitalists, according to Garcia.
So money for venture investing from big players such as the California Public Employees’ Retire-ment System isn’t likely to dry up with a tax hike, Garcia said.
Where Garcia does see a change is from investors demanding better odds for their money.
They are putting pressure on mega funds, which are losing ground to small and more focused firms that create better returns, according to Garcia.
Heesen of the National Venture Capital Association is trying to make the case that venture capital firms are different than the private equity and hedge fund investors that have brought on the tax hike proposal.
Venture capital investing has a more lasting effect by building companies that can end up adding to a healthy economy, he said.
“We invest for the long haul, growing companies from nothing into bigger ones that employ a lot of people,” Heesen said.
He said he’s met with every member of the House Ways and Means Committee on the issue.
