Budget Deal Won’t Greatly Impact VCs… Yet

The last-minute agreement to raise the U.S. debt ceiling doesn’t appear to contain any surprises that will impact the venture capital industry. But many expected effects – including cuts in federal research funding and reduced revenue for government contractors – will make it harder down the road for venture-backed companies to stay competitive.

That’s the takeaway from a conversation earlier today with Mark Heesen, president of the National Venture Capital Association.

Heesen says the agreement on the table is pretty much what beltway insiders expected – an 11th-hour deal with about $2 trillion in long-term savings and, for the time being, no new taxes. And while the final product of the tumultuous negotiations isn’t exactly something to celebrate, it’s certainly good for VCs that the current chapter of the debt ceiling debate is near a close.

“This whole exercise, over two months, added instability into a marketplace that didn’t need instability,” Heesen says. “Things were getting better. You saw more acquisitions, and you saw the IPO market getting better. But the last two months added unwarranted uncertainty, so I think that our exits will be a little less strong than we were anticipating in the third quarter.”

Heesen says he also believes the debt imbroglio had a negative effect on fundraising, with many limited partners reticent to enter into new, long-term commitments.

Going forward, Heesen says, he expects the debt deal will usher in something he’s long been predicting: very deep budget cuts across virtually all areas of government. This will have an impact on both venture portfolio companies and the companies that tend to acquire them, as both often rely on contracts with federal state agencies for a large portion of revenues. He’s also predicting very heavy slashing of research and development funding for universities and federal labs. The impact of this may not be as strong immediately, but will be felt down the road, with fewer technologies germinated through government-funded research available for commercialization.

As for taxes, at the moment carried interest for venture firm partners will still be taxed as a long-term capital gain, rather than income. But that could change, as the agreement does create a small bipartisan, bicameral committee that will examine further ways to reduce the deficit — including tax reform. Heesen says he anticipates that all areas of tax reform will be on the table, including carried interest and capital gains as well as partnership and corporate tax structures.