The Burnham Room of the Chicago Club was the location for the annual Illinois Venture Capital Association (IVCA) and National Venture Capital Association (NVCA) Luncheon on May 21st, 2014.  The second half of the presentations at the luncheon featured an expert panel of our industry’s trade associations from the nation’s capital, talking about the vital topics affecting Venture Capital and Private Equity.
The 2014 IVCA/NVCA luncheon was sponsored by legal film Ropes & Gray, LLP and accounting/advisory firm Baker Tilly. The panel discussed “Federal Issues Affecting Venture and Private Equity,” moderated by IVCA Chairman Lee Mitchell of Thoma Bravo. The trade association panelists from Washington, DC, included:
  • Bobby Franklin of the NVCA New (new President and CEO)
  • Brett Palmer of the Small Business Investor Alliance
  • Ken Spain of the Private Equity Growth Capital Council
Below are a few highlights of the panel discussion.
Lee Mitchell: Let’s turn to the tax issues first. We’ll start with the new President and CEO of the National Venture Capital Association, Bobby Franklin...
Bobby Franklin: The Chairman of the House Ways and Means Committee put together a proposal on how to radically reform the tax system, and announced his retirement. The Chairman of the Finance Committee did the same with some reform proposals, and then immediately got sworn in as an ambassador. So what we have is a lot of tax ideas on the table, with no inkling of them becoming law anytime soon.
On one hand, there are a lot of ideas within these proposals that are bad for Venture Capital. When you’ve been in Washington for 25 years, as I have, anytime a bad idea is put on the table it’s best to immediately address it. Otherwise it gets picked up, and a lame duck session comes along, and if nobody has said anything negative about the idea, then we’re at risk of it going through very quickly.
Cleaning Up Bad Proposals
Franklin: We spend a lot of time educating the House Ways and Means Committee and the Senate Financing Committee on how bad these proposals are. When you talk about carried interest and capital gains differential, it’s important to know for long term investing in Venture, that they are putting together ways to re-characterize income, and instead of being a capital gain it simply becomes ordinary income.
They allow for that change to be off-set, but in the Venture industry there are no offsets. For example, if you have a fund for eight years or longer, then you are suddenly penalized for investing long-term risky capital that is vital to the entrepreneurial ecosystem. We sat down with the staffs, but because they do not feel the bill will mover forward there is no incentive to change anything.  We want to clean it up, so it doesn’t get picked up.
Brett Palmer: To add to that, our tax code is a mess. It’s so complex and burdensome that it isn’t a pro growth tax code. But in fixing it, it’s about simplification and lower rates. Again, it has no chance of passing right now, but it becomes a road map to the future for increasing certain taxes. And this is being put forth by Republicans, who are historically more anti-tax than their Democratic counterparts.
So there is a constant a la carte menu of proposals on the table, and then something will come along that needs new tax revenue – and so it’s critical that we start talking about what these things mean and what they do. The initial reaction is that the bill is going nowhere. I am emphatic about this being the exact wrong interpretation of that reaction. This is about the Republicans beginning to wave the white flag, they don’t want this fight anymore.
Changes in Attitudes
Palmer: The Republicans are being beaten up for being the party of rich white guys, and Private Equity funds are the territory of rich white guys. This should be a wake-up call on the carried interest portion, and since they exempted it on the real estate side that should be a double warning. ‘We like them, but we don’t like you.’ It’s not uniform, it’s not a basic argument across all levels of Congress. You have to talk to your representative in Congress, and it’s just not an intellectual exercise. At some point, it will become the baseline of discussion, and we have to communicate our side of the story.
Lee Mitchell: Ken, you represent some of the largest Private Equity firms. What is your take?
Ken Spain: There are three issues. One is carried interest. Two, the deductibility of interest on debt. And three, adding a tax for publicly traded mergers. I think Brett’s point is crucial, that because it’s not up for a vote that it’s case closed on tax reform. We look at it differently, we think it’s the opening salvo on tax reform. This is a debate that will last three to four years. My personal feeling is that there will be tax reform. We will have two new chairmen on both the House Ways and Means Committee and the Senate Finance Committee, and all proposals will be on the table.
Lee Mitchell: Brett, what kind of initiatives is your organization working on today?
Palmer: The Small Business Investor Alliance used to be just small business investment companies. Now we’ve crossed over to Private Equity, Limited Partners and investors in the lower middle market. What we’ve found is that there is much more sympathy for the small businesses and their access to capital. We are working on raising the Family Funds limit, actually a bill has an outline to raise that limit to $350 million which is significant for anyone doing interaction with the Small Business Investment Company (SBIC) program.
There is the SEC itself. Some Private Equity funds, which are large and complex, now are being normalized through the SEC Investor Adviser Registration. The SEC is getting their legs underneath them, and they are educating themselves regarding their audit fashion – and their on-site audits – and we’re going to get a lot more of them. They are discovering things that they consider a problem, and other things that are okay. But with those efficiencies will come more invasive audits in some cases. And it will start other discussions regarding fees and LP agreements, and whether they are being adhered to properly. It’s a function of scale and trend.
We spend a lot of time educating the SEC and our member funds about what the SEC is looking for. People are going to get in trouble through the smaller funds, because of the complexity of back logging. The government does have limited resources, but as this begins to develop they will get their knowledge base up.
Franklin: At the NVCA, we think about issues two different ways – horizontal issues (which directly affect us) but there are also the vertical issues, such as within investments in life sciences and technology. When we think about issues that are not horizontal, we talk about the talent and lack of talent. We need more highly skilled workers. We have this incredible ecosystem and yet there are so many people who want to come and start a company in our country, and we basically say to foreign students, ‘we’ve given you a world class education, now go home.’
We are close on Immigration Reform, and have a small window of opportunity with the election coming up, with some Congressional and Senate races that can make a difference. Maybe we can get some folks on the House side to soften up a bit. There have been some recent and interesting coalition events. We go up to Capitol Hill with Venture Capitalists, Evangelicals, Agriculturalists, Big Business, Law Enforcement – all those groups together to talk about Immigration Reform, to get it across the goal line.
Patent Reform
Franklin: We’re also seeing movement on Patent Reform, especially on the Senate side. This makes it interesting as a trade association, because it’s interesting to have investors with portfolio companies that rely on patents, and other investors that think we shouldn’t have patents at all. It’s a debate, and we’re trying to find to find the voice for entrepreneurs and the small companies to help policymakers understand, that while they are talking about theoretical outcomes, in reality it doesn’t work for smaller companies. We want the voice of the small start-ups in the patent fight.
Investor Advisor
Spain: We want carried interest to be brought back to the conversation. There is potential for that in the Highway Bill. I think the second thing is the registration for investment advisors. We’re trying to remove that requirement for Private Equity funds. That might have hit a head wind, but right now we’re looking for the companion bill in the Senate – but we are looking at an uphill battle.
Palmer: To that point, when Dodd-Frank was being debated, there was talk of eliminating some regulatory agencies, and the existence of the SEC was up for review. In reaction to that, the SEC as an entity strove to become a super regulator, to put everything under their tent, and that’s what they’ve done. They don’t have the resources to do most of it, and some folks on the Hill have asked them why they’re doing so much with Private Equity and Venture investing, when there wasn’t much of a structural problem. They now have to justify it all, and you’re going to see a concerted effort from the SEC to justify these powers.
Lee Mitchell: Are we going to see more regulations?
Spain: I think we are. What we’re seeing right now, particularly with the SEC, is an uptick in the scrutiny of Private Equity and Venture. And we’re going to be facing it for a very long time. During the 2012 presidential campaign, and Mitt Romney, there was a lot of focus on the industry itself, and it followed that more interest came from the regulatory side, because we’re not seeing as much on the legislative side.
Palmer: Last year in Congress was one of the least productive ever, being productive is a subjective measure, as far as any bills getting through. On the regulatory side, as far as the SEC looking at the PE and VC industries, they are going to find something. Those audits will continue, even if it doesn’t make sense for the type of investing that you do. It’s absurd, but it happens. It’s important not to disregard too much, and to take seriously enough what this regulatory atmosphere means, because at some point it could mean the end of your career.
Lee Mitchell: What about the Jobs Act 2.0, will there be something that gets done that will actually improve the situation we now have?
Franklin: There are a lot of pieces to it, with items that are attached to it. When companies want to go public, there are few more potholes in the road. Hopefully there will be more help for smaller cap companies, to make that on-ramp smoother. That’s important for us, and we’ve spent time on that.
Spain: In an agency like ours, which operates both in Public Relations and government affairs, perception impacts policy. What we’re seeing here is that a lot of our members love the ‘private’ part of Private Equity. From a P.R. perspective, when the headlines are positive the legislators want to stand next to you and get their picture taken. If the headlines are bad, they want to haul you in front of Congress for a tongue lashing. You want to be on the right side of public opinion. If you’re not telling your story to Congress, and you don’t have a strong P.R. side, ultimately the policies will catch up with you. Never let the terms of the debate be controlled by critics.
Palmer: I think the IVCA deserves a lot of credit. They released a brochure entitled ‘How a Private Equity or Venture Capital Fund’ works. I’ve handed that out, it’s great and very helpful information for legislators. That matters. Plus, you need to let your legislative representative know who you are, and you want to become a resource for them. You don’t have to be a full time lobbyist, you don’t have to be a lawyer, but you do have to tell legislators what you are doing in the industry. Congress wants to have a better relationship with you, so I encourage you to tell your story. The best stories are from gatherings and groups like this.
Lee Mitchell: Here we have represented the National Venture Capital Association, the Small Business Investor Alliance, the Private Equity Growth Council and the Illinois Venture Capital Association. If you’re not a member of one of these, you ought to be, and you should probably be a member of more than one of them. They all have political access, so you will get some as well.
QUESTION: One of the things that dried up Venture Capital in the Midwest was the Dodd-Frank Act, because of banking regulations. Do you see that ever changing?
Palmer: I personally think that Dodd-Frank, as it relates to smaller and more community oriented banks, has been a disaster. Not just from the investment side, but the normal lending and regulation side. There is very significant sympathy on both the Republican and Democratic side, but the question is how do they change it.
The Volcker Rule, part of the Dodd-Frank Act, which is incomprehensible to anyone – including a lawyer – has statutes that are a mess and regulations that are a bigger mess. The bankers want to pull their hair out. The SBIC is the only thing specifically allowed within the Rule – we didn’t ask for it – but when the hammer came down we were creating an escape hatch. We’re seeing more banks investing in SBIC than Venture, but it doesn’t fix the underlying issues for the banks.
Spain: There is bipartisan agreement that there should be changes to Dodd-Frank, but the Obama administration is afraid that if one thing changes, it will be like pulling a string and unraveling the whole thing. So as of now, no changes are occurring. So the short answer to your question is ‘no.’
QUESTION: One thing that seems missing from political and media dialogue, is that the wealth of Private Equity funds often flow to help pensions funds, other public investments and Main Street. Will we ever see that, or have I missed it?
Lee Mitchell: The IVCA is doing just that, by taking the initiative to proactively publish their brochure (“How a Private Equity or Venture Capital Fund Works” and our just published “IVCA POV: I am a Private Equity Investor” which features the ultimate beneficiaries of investments and makes the point that 43% of the money invested with VC/PE firms comes from public and private pensions.
Palmer: I guess I would say have you ever come across a Limited Partner who likes to be on the front page? Particularly if they’re managing state or union money. There is no upside to that scrutiny, they don’t like it. Pensions are underfunded in general, so it’s a challenge and mixed message. One message that doesn’t get out there is the job creation side. It’s like pulling teeth to get data, even if the data is great. That’s an important story, and we all need to tell it better. If we don’t tell it, somebody else will.
Click here for Part One of the IVCA/NVCA Luncheon, speaker Mark Kvamme on “The Case for Outsized Returns from Venture in the Midwest.” The next IVCA Toolkit Event is June 5th, 2014, regarding “Developing Top C-Suite Talent.” Click here for more details.