Taxing Carry Could Hurt Charities

I’ve already written about how taxing venture capital carry could stymie innovation and hurt the economy, but it may also be bad for educational institutions, non-profits, and charities.

Take Sequoia Capital’s sale of YouTube to Google last year. Universities and their related funds made $114 million on the deal. The Ford Foundation, a New York-based charity that supports democratic causes, got Google shares worth $11.8 million, the Barr Foundation, a Boston-based non-profit which promotes educational and environmental causes in Boston, got shares worth $6.8 million and the Gordon and Betty Moore Foundation, a San Francisco-based charity that promotes science and environmental protection, got shares worth $6.8 million.

That’s not to say that Sequoia’s partners invest out of altruism. They walked away with a nice chunk of change themselves, taking shares worth $48.3 million.

But what happens when that take-away is taxed at the personal income tax rate instead of the capital gains rate? Sequoia partners’ additional liability might cause the firm to drop its limited partners all together and invest only its own money. “If self funding means 15%, or working for the Ford Foundation, MIT or Stanford means paying 40%, guess what happens?” says Jack Biddle, a general partner at Novak Biddle Venture Partners.

Self-funding may seem implausible, but there is precedent. Some of the most successful venture capitalists have already done this. Vinod Khosla financed Khosla Ventures exclusively with his own money, for example.

Only a few VCs are successful enough already to float that kind of bank. What will happen to the rest? “The very good, but second level GPs will start a few companies as entrepreneurs instead of being the key catalyst in dozens of success stories,” Biddle says. “The ones who will stay in the game will be the worst guys who only get management fees anyway.” That’s not going to help universities, non-profits or charities.