By Tom Still
MADISON – On the same day the Blackstone Group became the first private equity firm to trade its shares on the New York Stock Exchange, a bill was introduced in Congress to make it very difficult for such a market event to ever happen again.
U.S. Rep. Sander Levin, D-Mich., wants to dramatically raise taxes on so-called “carried interest,” which is used widely in the private equity industry to compensate investment managers – the folks who take risks and (with patience, skill and hard work) succeed on behalf of their investors and themselves.
Introduced in June 2007, the Levin bill was a populist hit because it seemed aimed at the excesses of Blackstone’s chief executive, Stephen Schwarzman. He’s been described in the press as an “ungracious, vain yutz” for throwing a multi-million-dollar party at the time his company was using a legal loophole to avoid many more millions of dollars in taxes.
Defending the boorish behavior of every hedge fund manager in the United States is bad policy, but so are bills that overshoot the mark of reasonable tax reform.
As written, the Levin bill (HR 2834) is a potential innovation killer at a time when America needs all the economic advantage it can muster. It would make it harder to attract private-equity investments to emerging Wisconsin businesses, as well as similar businesses in America’s entrepreneurial and high-tech sectors.
The bill would boost the tax paid by private-equity firms, such as venture capitalists, on the profits made on long-term investments. That tax would rise from the current 15 percent to the regular income rate of 35 percent.
The biggest problem with the Levin bill is that it fails to distinguish between huge buyout or “hedge funds” – where capital gains beyond a certain level may arguably be viewed as ordinary income – and venture capital funds.
Carried interest for venture capital firms does not have the characteristics of ordinary income, and should not be treated as such. Carried interest is not a guaranteed payment to fund managers, unlike salaries or other payments received on a regular schedule. What makes carried interest unique, especially in the case of venture capital funds, is that it is non-guaranteed payment for “sweat equity” at a future and uncertain date. It captures the very real risk associated with the long-term outcome of the project or investment – and makes the risk worth taking.
The history of Venture Investors LLC, a homegrown Wisconsin venture capital firm, is a solid example. Venture Investors Early Stage Fund II Limited Partnership was formed in May 1997. The general partners each invested $156,000 in the fund, no small commitment for them at the time. It has taken more than 10 years for one of the firm’s investments, TomoTherapy, to mature to the point that it will yield a return on the carried interest.
Venture Investors recently announced its latest fund: $117 million dedicated to early-stage investments in Wisconsin and the Midwest. It is not alone. Other homegrown funds such as the Kegonsa Fund, the NEW Fund and more focus on smaller firms with the potential to grow into large companies. That is not activity we should discourage through the tax code.
The statistics on the importance of venture capital to the U.S. economy are beyond impressive – they are astounding. According to Global Insight, companies started with venture capital since 1970 accounted for 10.4 million jobs and $2.3 trillion in revenues in the United States during 2006 alone. Revenues from venture-backed companies represented 17.6 percent of U.S. gross domestic product and 9.1 percent of private-sector employment in 2006. As a whole, these companies grew 2.5 times faster than their non-venture counterparts during the period 2003 through 2006.
Wisconsin needs more private equity investments – especially from outside the state. Wisconsin ranks about 33rd among the 50 states in venture capital investments, but we’re seeing more early-stage activity due to Act 255 tax credits passed by the Legislature and the creation of the Wisconsin Angel Network. Unless those promising angel-backed firms can attract venture capital, however, most will simply die on the vine.
The passage of HR 2834 as written would make Wisconsin less attractive to private-equity investors, particularly from outside Wisconsin, at precisely the time we are beginning to build momentum. Let’s not punish the entire innovation economy for the excesses of the very few.
Still is president of the Wisconsin Technology Council. He is the former associate editor of the Wisconsin State Journal in Madison.