As expected, the so-called Blackstone Bill may have just been an opening salvo in Congress’ attempt to shake more tax revenue from the private equity tree. The New York Times is reporting that legislators may soon introduce a bill that changes the tax classification of carried interest from capital gains to ordinary income. This would apply to all types of limited partnerships, including venture capital funds, mezzanine funds, buyout funds, growth equity funds, hedge funds and real estate funds.
The best organized of the above groups are venture capital funds, via the longstanding National Venture Capital Association. I spent some time on the phone today with NVCA president Mark Heesen, and here is a partial transcript:
Dan: What are your thoughts on the possibility of a bill that would change tax treatment of carried interest?
Mark: Everyone says it’s a carried interest bill, but it would be more than that. It would be a fundamental change in tax policy, and how the government taxes partnerships. It also is much broader than just private equity. It means any type of entity that takes a carried interest, which means that huge swaths of industry would be affected.
Dan: Do you think a bill will actually be introduced?
Mark: Bills get dropped every day. The big question is who specifically introduces it, and if the person is doing it for political reasons or because they seek fundamental changes to the tax system.
Dan: Why should venture capitalists continue to receive capital gains treatment for their carried interest?
Mark: Because if anything looks like a long-term investment – which is the purpose of capital gains – it’s investing in an entrepreneur in a garage, and then growing that company to the point where it can be a good acquisition for a large public company…
Dan: What about the argument that VCs should not receive capital gains benefits because it’s not their capital – not their risk – being invested?
Mark: Basic partnership law says it’s irrelevant how much you put into a transaction. Partnership law is about working as partners, and the agreement is immaterial in terms of tax consequences. If you take this to its logical conclusion, a totally passive investor is able to get capital gains, but the investor who works to add value is not.
Dan: But isn’t that what the fund management fee is for? To compensate the VC for his time and effort?
Mark: No. The management fee is just to keep the office running. Pay the staff, keep the lights on. A 2% management fee on a $200 million fund actually isn’t as much money as many people are making it out to be.
Dan: If a carried interest bill were to pass, would it significantly decrease the number of U.S. venture capitalists?
Mark: Certainly. I’m already hearing from VCs who have never seen carry, because they joined five or seven years ago just adfter the bubble. Now, when they’re finally nearing the light at the end of the tunnel, you’re telling them it’s worth a hell of a lot less. Some people might just return to jobs where they are guaranteed to make a lot of money.
Also, venture capital has gone from an industry dominated by white males born in the U.S., to one full of people of all colors and all nationalities. If you increase the carry tax, someone from India or China might just go back home, and start a fund there.