The Carried Interest Tax Debate (continued)
First, I want to thank Bill, Steve and Hey for the excellent debate they carried (no pun intended) on in public in the comments section of my post this morning.
Second, I want to implore Hey to stop posting anonymously. His writing is too good, his opinions are too strong, and his voice is too valuable to go on anonymously. I've been getting comments from Hey for years and I've always felt that he needs to come clean.
Third, I want to be very clear about my position on founders' sweat equity versus limited partnership carried interest. We have worked very hard in many of our investments to structure them so that the founders can get basis in their founders stock and qualify for capital gains treatment. It's not that hard to do. The other people's money (OPM) doesn't usually show up in a startup until the company has been formed and the founder has bought (often for a nominal amount) the founders' stock. At that point, the founder has already or is in the process of taking the capital risk that establishes the basis for long term capital gain.
What I don't buy is the argument that the venture capitalist is doing the same thing as the founder. The founder takes the risk at the start and then uses OPM to fund the business going forward. And the founder does not take a share of the profits on the OPM.
My friend and college buddy Mike Feinstein, himself a VC, waded into this debate today with a post on his blog. Mike argues for proceeding with any change cautiously. Always a good suggestion when you are tinkering with an incredibly successful model.
I think I've said my piece on this topic and will now move on to something more interesting, like can the Mets continue their winning ways against the Redbirds this week. Now there's a topic that should bring out some real passion.
Fred,
Like all topics that you post about, this IS an intresting one, and one so covered in everything from The Deal.com to WSJ, and Dealbook.com, that it's hot, and it deserves (or we do) a response and opinion from you!
I happen to agree with your take.
By the way, KKR wants a broker/dealer license. Just an interesting take on the direction PE firms are headed i n (Blckstone has one).
Posted by: Stephen L. McKay | June 25, 2007 at 10:02 PM
Not sure about the Mets, but the Yankees look like they've got a boatload of depreciation they should try to write off.
For the record, I'm just not persuaded by Bill Burnham's arguments here. If you follow the logic, VCs should be willing to pay a tax on the fair value of what they have received in exchanged for their "investment" of their time and intangibles (i.e., 20% of the value of the securities they purchased). I don't see that happening anytime soon.
Posted by: JayR | June 25, 2007 at 10:55 PM
The legal and policy arguments behind the proposed changes to the tax treatment on carried interest are being covered nearly exclusively by an active blogger/law professor, Victor Fleischer. He writes at http://www.theconglomerate.org, and has garnered notoriety in the WSJ, Times, and other publications.
Posted by: Ryan Kalamaya | June 25, 2007 at 11:49 PM
Er, thanks Fred, but I'm staying pseud. I'm not in a position to go posting my opinions on the internet and I'm still not entirely sure of the route I want to go down. I live in fear of Google and the Internet archive.
Multiple career paths, a few more years of working for other people, and family interests that require discretion politically keep me in the shadows. Plus, I don't have the time to get comments to the quality level necessary for my professional reputation. The not quite so negligble chance I might have to raise funds for some tech startups and ask you or your friends for money doesn't help!
Posted by: Hey | June 26, 2007 at 02:04 AM
I think the pun at the beginning was actually intended.
And who are the Mets? Go Cards!!!
Posted by: jim parker | June 26, 2007 at 09:22 AM
Hey--nice display of courage and teh strength of your convictions. I'm just sayin.
The value of people is greater than the value of capital. Chart it. Give me $1 million and an idea, and it's just money to burn unless there are people to turn it into something valuable. Capital will never match the value of commitment, tenacity, human values, initiative, innovation, and drive.
Investing in good people is a very, very cheap way of getting tremendous value out of otherwise lifeless, boring capital.
Posted by: Charlie Crystle | June 26, 2007 at 09:41 AM
Fred,
I suggest you read a PE Hub post by Mary Kuusisto of Proskauer Rose on the tax debate. Rather than repeating her arguments here, I will just say it is the most thoughtful and insightful piece I have seen on the subject. We have worked with Mary for many years and believe she is among the most talented tax attorneys in the business. Her piece can be found here: http://www.pehub.com/wordpress/?p=1164
Best,
jay
Posted by: Jay Houlihan | June 26, 2007 at 04:21 PM
To say that founders take "capital risk" may be a bit of an overstatement. They certainly take "income risk" by forgoing a safe salary from another employer, but nearly every founder I've ever advised has bought stock at $0.001/share or less. The whole point, actually, is to minimize capital investment by founders.
The whole point of this comment, then, is that parsing issue is tricky. To tax the carried interest correctly, Congress will need to carefully distinguish General Partner contributions to a business (cash-based, but active role) from those of the LP investors (pure cash, passive role) and the business principals (little cash, active role).
The devil is in the details, and just like with AMT and other tax initiatives, there are sure to be unfortunate unintended consequences.
Posted by: Jay Parkhill | June 27, 2007 at 12:01 PM