Fortune Magazine Fight Fest: Private Equity vs. VC
Just came back from a lunch for about 50 people that Adam Lashinsky of Fortune Magazine hosted. The topic de jour was the whole carried interest taxation debate. Adam moderated a great panel that included Mike Moritz from Sequoia, Dave Roux of Silver Lake and Prof. Darryll Jones, a tax law expert.
The panel had some pretty interesting things to say and also revealed some very stark divisions amongst the various players in the carried interest drama. A few quick take aways:
- Surprisingly, it seemed like the biggest debate took place not between the investors and the Professor, who was outright opposed to any capital gains break for carried interest, but between Roux, a private equity guy, and Mortiz, the VC. Mortiz took great pains to distance Venture Capital from private equity while Roux tried to argue that the two basically did the same thing, albeit for different stage companies.
- Between Mortiz's comments and those from Ted Schlein (the current head of the NVCA, who was sitting at one of the tables) it's crystal clear that A) the NVCA believes some kind of legislation on this issue is going to pass (probably by December) and B) they are moving as hard and fast as they can to try and cut their own deal with Congress that exempts Venture Capital from some or all of the tax increases (while presumably still sticking it to Stephen Schwarzmam & Co.) Personally I think the "every man for himself" strategy being followed by the NVCA is a mistake. Political fights are won by horse trading enough to build as big and broad a coalition as possible and as such the NVCA should be trying to pull more groups into the fight (especially small business owners), not selling everyone else out in the hopes that some kind of high minded argument about the "public good" of venture capital vs. other kinds of investment capital wins the day. The politicians are looking for money and votes and the only way to win that fight is to fight fire with fire. That said, it will be very interesting to see if the NVCA's gambit pays off and one has to imagine that the NVCA wouldn't be pursuing this strategy if they didn't have a bunch of votes already lined up for it. My guess is that it won't work and all the NVCA will have to show for it is a lot of pissed off Private Equity guys, but I also hope that I am wrong! Kind of ironic given that the lines between the two industries seem to blur daily, but for now the battle lines are clearly drawn.
- The curent wild card in the debate appears to be that the Joint Tax Committee has yet to report on how much money they expect the proposed changes to carried interest will add to the treasury. Prof. Jones said one early estimate out of the University of Pennsylvania was that the changes would only add $2-$3BN in tax revenue/year and that was before any strategies were devised for avoiding the new taxes. This is important because many Congressmen are apparently hoping that this change will offset most if not all of the $50BN in taxes lost to a likely AMT tax repeal. However if changing the carried interest provisions only generates a few billion in revenues, the political calculus is likely to get a lot tougher for Congressmen because they will risk alienating a decent number of their best campaign contributors to generate what, from the government's perspective, is a tiny piece of revenue that doesn't even come close to solving their main political problem. Thus it would appear to me that in the near term the single most important thing to watch out for in this debate is just how much cash the committee estimates the proposed tax changes will generate.
- I continue to be struck by the fact that the "pro-tax" side of this debate, is basically taking a position which denigrates Labor at the expense of Capital. Prof. Jones was actually the first person I've seen on this side to express some reservations on this point, but besides him almost everyone else on that side of debate seems to be oblivious of the tremendous irony and contradictions inherent in their position. As is often the case in politics, principles are no match for money.
- One other interesting thing to note: I asked the Prof. if a VC should have to pay ordinary income tax on carried interest even if they received no salary or cash compensation at all, and he said "yes" because the carry was still compensation for labor, even if it was delayed and at risk. Then I asked if that same reasoning applied to entrepreneurs, i.e., should entrepreneurs that invest time/effort/IP have to pay ordinary income on the profits from sales of their stock and he once again said "yes" because, just like VC's, this was compensation for services provided, not capital. I give the Professor a lot of credit for being logically consistent, because it seems crystal clear to me that those who advocate eliminating capital gains for carried interest are logically compelled to have the same position when it comes to other forms of sweat/intangible equity, but I think the Professor is one of the few people on that side of the debate that have the courage to be upfront with the logical consequences of their position. Based on this, it's clear to me more than ever, that the carried interest debate is just a prelude to eliminating the concept of sweat equity/intangible capital from the tax code altogether. This means that entrepreneurs laughing at the sight of "rich" VCs trying to maintain their cushy tax breaks had better stop laughing because you guys are clearly next on the hit list. Don't believe me, just do the math: would the government generate more revenue by taxing all the profits generated by all the people who get sweat equity stock or all the 20% of the profits generated by VCs who get carried interest? Before you answer this consider that if you changed the tax treatment for "founding stock" to ordinary income than the Google Founders alone would generate at least another $4BN in incremental taxes on their $20BN+ stake. Doesn't take Einstein to figure out what's the quicker way to fill a $50BN hole.