Menlo Ventures managing director Venky Ganesan, who became chair of the National Venture Capital Association’s board in May, took office at a potentially crucial moment in the history of the venture investing sector.
The name “Wall Street” has become a shorthand term for corruption in the populist mood of the presidential election campaign. And the way VCs reap their personal incomes has emerged as a particular political football, Ganesan (pictured) says. He understatedly calls the current situation “unique.” The candidates of both parties, Republican Donald Trump and Democrat Hillary Clinton, intend to nearly double the personal tax rate VC partners pay on carried interest, which is their share of the profits from their funds’ investments.
Ganesan is now on the stump himself, calling reporters like me and roaming Capitol Hill to defend the current 20 percent tax rate on carried interest against charges that it unfairly saves investment professionals billions of dollars while working class people with modest incomes pay the IRS a higher percentage of their wages. Private equity firms, some hedge funds, and other partnerships that manage wealth also benefit from the IRS regulations, under which asset managers’ profit shares are taxed as capital gains rather than as salaried income. (They also pay a 3.8 percent net investment income surtax.)
Attempts since 2007 to change the tax rules on carried interest have foundered in Congress. But Ganesan isn’t counting on the same outcome this time. The populist outrage influencing the presidential campaign is also evident in Congress, on both sides of the aisle, he says.
“I’ve been surprised when I’ve been on Capitol Hill how fervently and emotionally they’re looking at this,” Ganesan tells me. “I think there’s a change in both parties.”
Coming from a Bay Area thriving on the growth of tech companies, where early-stage startup investors are dubbed “angels,” Ganesan says he is grappling with a public urge to “demonize” and “castigate” people like him. The task before him, the NVCA, and its political action committee is to sell legislators on an alternate narrative that casts venture capital firms as catalysts of innovation, startup formation, job creation, and economic growth.
Ganesan’s logic goes like this: It’s risky to invest in the groundbreaking startups that later become big businesses like Apple, Amazon, and Genentech, which got their early financial backing from venture capital firms. The biggest payoff to venture capital partners comes when the young companies they’ve supported go public or find buyers that hand them buckets of cash in an acquisition. These VC’s may wait for years before a startup rewards them, and the investors in their venture funds, with such an “exit.” And 40 percent of startups backed by VC’s never yield investment income for venture firms, Ganesan says. Taking such risks should be rewarded, the argument goes.
If the government takes away part of the payoff by doubling the tax on the VCs’ share of the profits, we’ll have fewer venture capital firms, Ganesan predicts. Those investment professionals will move into real estate trading or hedge funds with shorter-term goals, rather than nurturing and guiding entrepreneurs for years, he says.
“This change of incentives is going to reduce access to capital,” Ganesan says.
But will it really? I asked Ganesan if he himself would get out of the venture capital business if his share of carried interest were taxed as income (at a top rate of 39.6 percent.)
“No, I would not,” Ganesan says. But that’s because he has already benefitted from years of success at Menlo Ventures, he says. His concern is the future development of venture capital activity outside established tech clusters—in states like Michigan, Oklahoma, and Texas. “We want entrepreneurs all over America to have access to capital,” he says.
Ganesan acknowledges that the incomes of venture firm partners wouldn’t be utterly flattened by the proposed tax changes. Venture capital firms are compensated by investors in their funds in two ways. First, they routinely earn fees of about 2 percent of the capital under management. For example, a fund managing $200 million would get $4 million to run the business and compensate fund managers. Second, if the investments yield a return above a certain threshold percentage, the outside investors take the bulk of the profit, but give the venture firm general partners a 20 percent share—the carried interest. This is the less predictable source of compensation for fund managers, but also the largest, Ganesan says.
Some venture firms earn many millions of dollars a year in carried interest. Let’s say a venture firm has made some good bets, and a partner’s slice of the profit in a certain year is $1 million, just to give a round number. If that $1 million is taxed as income at the top rate of nearly 40 percent, rather than as carried interest at 20 percent, the VC could pay extra tax of close to $200,000. But he or she still takes home about $600,000. To a Trump or Bernie Sanders supporter, that might sound like real money.
And that testy wedge of the electorate isn’t the only faction advocating for a change in the tax regs on carried interest. Some of the critics are other VCs and financial professionals. Fred Wilson, a partner at Union Square Ventures, argued in a 2010 blogpost that taxing his and fellow VCs’ carried interest as income would only be fair, and would not stem the flow of capital to startups. Pension funds, endowments, and wealthy families would still find asset managers willing to help them maximize their after-tax returns on investment, he wrote.
Other prominent investors, from Berkshire Hathaway CEO Warren Buffett to Sam Altman, president of noted Silicon Valley startup accelerator Y Combinator, have also argued that the current tax rules on carried interest are unfair to other taxpayers. The public at large has become much more versed in the complex issue, due to a series of research papers, blogs, and a long New Yorker article in March called “The Billionaire’s Loophole.”
The NVCA and its opponents in the debate over carried interest have presented warring statistics on the total cost to the Treasury of keeping the tax rules as they are. Ganesan says the cost is about $2 billion a year, or nearly $20 billion over a ten-year period, citing a report from the Congressional Budget Office. A much larger estimate comes from Victor Fleischer, a professor of tax law at the University of California San Diego School of Law, whose research papers on the subject since 2006 are considered a major catalyst of the political drive to revise the current tax rules on carried interest.
In a June 2015 commentary in the New York Times, Fleischer estimated that the Treasury could receive about $180 billion in extra revenue over a 10-year span if the IRS taxed carried interest earned by investment partnerships of all types as income. In July, Fleischer became co-chief tax counsel for the Democratic Party’s members on the Senate Finance Committee. Fleischer’s appointment was greeted with pleasure by Patriotic Millionaires, a group of finance professionals and other wealthy people who also oppose the current tax rules on carried interest. They’ve been lobbying Congress on the issue since June.
Ganesan, speaking for the NVCA, is trying to persuade the public and Congress that allowing VCs to keep a tax break of at least $2 billion a year is a tradeoff worth making.
“For that $2 billion, we create an incredible impact on the economy,” Ganesan says.
The NVCA chair makes the case that VCs deserve
