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IVCA Feature: Part Two Highlights of the 2015 IVCA/NVCA Luncheon, Featuring a Panel on “Federal Issues Affecting Venture and Private Equity.”

May 26, 2015

The 2015 IVCA/NVCA Luncheon took place on May 19th, 2015, in the Burnham Room of the Chicago Club, and the large gathering anticipated the coming together of the Illinois Venture Capital Association (IVCA) and National Venture Capital Association (NVCA), for the annual overview of venture capital and private equity issues. The first presentation at the luncheon featured an expert panel of industry association representatives from Washington, DC, talking about the vital topics of the current tax and legislative atmosphere.

The 2015 IVCA/NVCA luncheon was sponsored by legal firm Ropes & Gray, LLP and accounting/advisory firm Baker Tilly. Representing Baker Tilly was Bill Chapman, who remarked, “We believe very strongly in the IVCA efforts to not only support its membership, but also the education that they continue to provide regarding the venture capital and private equity community.” Matt Richards of Ropes & Gray added, “We’ve been happy to sponsor the luncheon for the last six years.”

The panel discussed “Federal Issues Affecting Venture and Private Equity,” which was moderated by IVCA Chairman Lee M. Mitchell, Managing Partner of Thoma Bravo. The trade association panel from Washington, DC, included...

  • Bobby Franklin, President and CEO of the NVCA
  • Chris Walters of the Small Business Investor Alliance
  • Steve Judge of the Private Equity Growth Capital Council

Lee Mitchell: We’ve talked about carried interest, and the possible taxation of it, what it the status of that issue?

Steve Judge: I think there was a risk of a decision either this year or next year. I think the reason it is off the list for the next year or two is because organizations like mine, and those represented here, has pushed back against it. We got some pretty good news today. Congressman Paul Ryan, the Chairman of the House Ways and Means Committee, said in a public statement that he had no intention of passing any legislation on carried interest for the next two years. That’s a solid affirmation from the House, and I think that’s a positive.

I’d think we’d be foolish if we didn’t spend time reinforcing that message. It’s important for our firms, our investments and for the national economy in the next 18 months. It’s not completely safe, and will become a challenge in 2017, but the only way we’ll stay on top of the issue going forward, is to do the work today.

Bobby Franklin: I agree with Steve’s evaluation, but I feel like it may be a death sentence that has been given a date. What we worry about every year is that Congress wants to pass some new spending bill, and those things need to paid for, and carried interest is on everybody’s list as a new way for potential funding.

What we’re doing at the NVCA is trying to change the dialogue, we’re trying to talk about the entrepreneurial ecosystem. I say it as often as I possibly can in Washington because I want to change the perspective of policymakers, so they begin to understand the innovation within the economy of the United States shouldn’t be taken for granted, and tax policy matters.

And right now, if you’re following the tax reform conversation, it’s all about math. And it’s all about creating a more competitive economy, that brings down the corporate tax rate. We have to do all the additions and subtractions, to make sure that rate comes down. The point we make to these policymakers is to say, you’ve got to think about the new U.S. companies, because they could be the next big corporations. If we keep playing with the corporate tax rates, we take away incentives to form capital in the long term, for new and innovative companies. We stress that, so policymakers are not short sighted, in thinking about what tax policy should be. The dialogue has to happen now, and we have to continue to push and educate.

Chris Walters: At the SBIA we do believe the threat is very real. As was said, we have to do the work now to educate policymakers on the Hill, and our members are smaller private equity funds, and depend on carried interest much more than management fees. So we’re continuing the dialogue as well.

Mitchell: This is not the only tax issue being discussed in Washington today, another is taxation of partnership entities...

Walters: We spend a lot of time educating Capitol Hill on that tax law, and what it does to private equity funds. It was just last year that there was a proposal that would have really done horrible things to the partnership tax law. One of things that would have occurred was at the first round, a withholding at the entity level. So before partners receive their income passed through to them, the entity would for the first time require a withholding. We thought that was a real threat to private equity and venture funds. We weighed in with tax riders, and fortunately they removed that withholding in a later version of the bill. These are the ‘secret’ things that get into bills, and while it would have only created a relatively small amount of extra revenue, what it would have done to partnerships would have been a real loss.

Another change that was proposed was to limit the way that partnerships could allocate among their partners, and we also saw that as a threat. For example, if there are five partners, under the proposal it would require all the partners to allocate in the same way, if one wanted to put it toward capital gains or interest income, they couldn’t do that anymore. These are some of the issues in tax reform.

Judge: I think besides the issues that Chris made, is that the Obama administration has twice floated a tax on the entity level of the partnership itself. This has been about the larger partnerships as well, up to 50 million dollars in gross receipts. There is a desire to finance corporate tax reform, reduce those rates, but you have to find a pile of revenue elsewhere, and there have been a tremendous growth in the number of businesses formed by partnerships. ‘C corporations,’ for example, are always directing the House and the Senate tax reform toward the partnerships. Some of the big players should be taxed like everyone else is taxed. The C corps would like to see lower rates for themselves, financed by partnerships.

Mitchell: Another subject of interest, to the persons dealing with buyouts in this room, is interest deductibility...

Judge: It’s about maintaining the current deductibility, and the current deductions are a huge number, 600 to 700 billion in the next ten years. That’s about half of what it takes to reduce the corporate rates. Interest deductibility is a pot of money, that can be used to applying the reduction on corporate rates. Senator Marco Rubio has just proposed that the tax on capital gain be eliminated, but also eliminated the deductibility of interest. This is an area we’re very concerned about, and we’ve created a coalition of interested industries and firms who want to defend the current interest deductions on business debt. It’s a real issue, and something we have to watch.

Mitchell: How do some of these tax issues affect new company formation?

Franklin: My blowback for a lot of these issues, is at least for some of these issues we had people on Capitol Hill that would tend to help us out. Now there is a bipartisan effort opposing us, because they need to find revenue. In this case, I like to say that a good defense starts with a good offense.

We want to make sure we inject into the conversation, what these legislators should be thinking about, that will help the growth of businesses. And even if you can’t get them to think about it, the position is to defend issues like carried interest and the tax structure. At the NVCA, we’re playing upon both sides, Republican and Democratic, on both offense and defense. We want policymakers to be thinking of innovation in formulating business, so vital to the growth of the economy.

Mitchell: What about the taxation issues for small businesses?

Walters: I will tell you a story about offense. On qualified small businesses – less than 50 million of gross assets – there is an 100% exclusion on gains realized on sale or exchange of stock, a provision that has been in the tax law since 1993. What were trying to do is change the definition of what is a small business. We can try and increase that 50 million threshold, and we’re also trying to expand types of small business, adding the LLC designation to the current C Corp qualifier. We want to make this provision a lot more useful.

Mitchell: I know that the NVCA is also working on the patent troll issue [outside entities suing registered patent holders for rights]. What update do you have on that issue?

Franklin: There was a bill regarding patent trolls that passed in Congress, in 41 days, and caught people by surprise. The legislation that was proposed to solve the troll issue goes a bit further. If you are a patent dependent small business, your costs have gone way up, in defending your intellectual property. What I hear also from smaller concerns is that they don’t necessarily have a patent troll issue, but a bigger company competition issue. So basically will the legislation protect them from bigger companies, especially if the bigger company feels threatened by the new product? We’re trying to raise awareness on both trolling and competition, and we work on both sides of it.

Mitchell: What is new on Securities and Exchange Commission (SEC) regulations?

Judge: It’s about the allocation of resources in a deal, turning away from due diligence and toward the application of SEC regulatory processes, which have very little benefit – it’s a real frustration. We have used our organization resources to push back against the SEC, mostly on regulations that don’t make much sense, and yield unproductive results.

The largest activity we’ve seen in the last three years has been about regulation. Most of the Dodd-Frank Bill has gone through the cycle, except for the compensation systems. Carried interest, for example, is being viewed as a incentive compensation, and they’re looking at it to be regulated like investment banks. That should not apply to private equity. Going forward, the SEC has announced they are going to look at a series of things, like valuations and fees. They stress that they just care about transparency. My concern is that they will just set the bar themselves, without any associative representation from our side. They still don’t completely understand the private equity industry.

Mitchell: Bobby, on the other side, what is the SEC saying about capital formation?

Franklin: It was reported a couple weeks ago they did take part of our recommendations, to make a two year pilot project, and they are putting their provisions in there, so we’ll all see if it makes a difference. That’s a positive development.

Mitchell: What is the feeling in Washington right now regarding an anti-Wall Street stance and the income inequality issue?

Franklin: The challenge we have regarding income inequality, is that it resonates with policymakers. It’s an extra opponent in every debate. If you are in an industry that has successful people, you almost have to fight against the backlash of that success. Defending something like that is challenging, especially when the president compares kindergarden teachers salaries versus top hedge fund managers, it become a class warfare issue. Will it become part of the presidential campaign debate? Probably. It’s an extra layer of burden on us, to make sure legislators make the best decisions regarding the issue.

Judge: It’s become an important issue in Washington, and it’s not just Democrats. There is a suspicion of large institutions, the financial services sector and Wall Street, and if we don’t have a continuum of viewpoints the debate just goes in a circle. This is a consistent theme that we deal with all time. You cannot deny the fact that there is a growing income disparity, but you can deny the fact that changing the tax code one way, toward one income group, will solve the problem.

We have to be affirmative and positive regarding what we do. The way to do that is to explain who the beneficiary is, and how it expands outward over the whole economy. The real beneficiaries remain the endowments, the foundations and the public pensions like teacher, police officers and firefighters. That gives those groups a secure retirement, and we need that class of people to speak up for the industry, because it changes the discussion. And we also need to push the companies that have benefited from private equity and venture investments, with new products and more jobs. We need to use our portfolio companies and investors as spokespersons for the industries, it’s part of playing offense. Let’s not deny the problem, let’s become part of the solution.

Mitchell: Final question, if any one of the persons here are interested in these issues, and wants to have an impact, have should they participate, and what should they do?

Judge: Talk to your investors and talk to your portfolio companies. Also join an associative group, whatever is appropriate for your business join up with an association that speaks for you. Get your voice heard, and be active in the debate.

Franklin: I will add there are hundreds of thousands of registered lobbyists in Washington. When we go into the door, it’s just another lobbyist. When you go through the door, you are a constituent. You have an investment in their district or state. What you say has more impact than what we say. So get involved in the organizations, because we can tell you the state of play, and can help you with the message that you can deliver.

Walters: Gatherings in Washington, with our membership and vendors, really helps the the information flow to both the overall industries and the legislators. Getting your portfolio companies involved is very important, as well.

Click here for Part One of the 2015 IVCA/NVCA Luncheon, “A Conversation with Bon French,” moderated by John A. Canning, Jr.