22 posts categorized "May 2010"

The Debate on Taxation of Carried Interest is Over

While I and others were calling out the hypocrisy of the NVCA and critiquing their heated rhetoric as they defend VCs's existing tax break on carried interest, Fred Wilson yesterday cut right to the chase and spoke to the policy on its merits.

And in eight well paced paragraphs on his blog, Fred calmly ended the debate.

The fairness arguments aside (and I'm not suggesting Fred pushed fairness aside, I just think his other arguments were less obvious), Fred gave three reasons why eliminating the tax break for hedge fund managers, private equity managers and VCs is good policy. Here's a distillation of those three reasons:

  1. ending the tax break will make financial services companies compete for talent on a level playing field with industries that produce things;

  2. invested capital will still receive capital gains treatment and have every incentive to seek the highest returns; and

  3. investment managers will have more incentive to have more skin in the game, i.e., to invest or co-invest more of their own capital.

I find it very interesting that what Mark Heesen of the NVCA portended as a threat (if the tax break is eliminated, "you will see many venture capitalists turn into angels"), Fred would find to be a positive.

Post-script: some VCs feel principled about the carried interest tax break, and I admire rather than fault them for that. Where I get my back up is the hysterical flag waving about entrepreneurship and jobs and American innovation from people who couldn't be bothered when startup seed financing and angel investing was in genuine peril.

Your New Investor, the Commonwealth of [Fill in the Government]

Jim Hamilton's World of Securities Regulation blog reports (thanks @joewallin for the linking tweet) that US Senators want state and local governments to be included in the SEC's definition of "accredited investors."

I surmise that the investments the senators want governments to be eligible to participate in are probably hedge funds and deals packaged and shopped by broker dealers. But it still struck me as fairly odd.

A government as an accredited investor, looking at Reg D private placements...

Let's suppose a government, emboldened by its new "accredited investor" status, decides to invest directly in a startup, as an angel or VC might. When might the misgivings start?

THE GOVERNMENT OBSERVER, a play in one very short act

Here's an imaginary dialogue among the board of directors of NuVenture, Inc., which (let's posit) has just completed a Series B round of financing in which the Commomwealth of New Nottingham has participated.

Scene: a modest conference room in a class B office park.

Founder/Chairman: "Okay, folks, let's get started. I'd like to welcome Tom Smith, who as you know represents the Commonwealth and their investment the company..."

Tom Smith (representing the Commonwealth of New Nottingham) [interrupting]: "Just to be clear, I am here only as an observer, and I want to be very clear that I will not in any way be attempting to sway the deliberations of this board. It really wouldn't be appropriate for New Nottingham to try to tell a private business how it should conduct its affairs. As you know, the Governor is very pro-growth and just doesn't want the Commonwealth to meddle in private affairs."

Founder/Chairman: "Uh, right, okay, thanks Tom. So, before we get to the items on the agenda, I thought I'd ask Kerry to give us a quick update on the security breach that occurred yesterday, what we know about it so far."

Tom Smith [coughing]: "Ahem."

Founder/Chairman: "Yes, Tom?"

Tom Smith: "Uh, should I really be hearing this? I mean, I don't want the company to think I might be sitting here, thinking of who I need to tell back at the Capital about what laws or regulations might have been broken here. Although of course as a public official I might have to. I mean, was there personal information compromised? No, don't tell me that!"

[The Board of NuVenture finds it can't even approve the minutes of the last meeting without moving into executive session.]

The New Cool in Finance (Non-Systemic Risk Variety)

Notice that it's suddenly cool to be an angel investor?

At the Angel Capital Association Summit in San Francisco last month, NVCA President Mark Heesen said that if the rules change on the taxation of carried interest, as is currently being proposed, "you will see many venture capitalists turn into angels."

Well, some VCs haven't waited for the outcome on that debate. And for folks who could arguably label themselves either VC or angel, it's fashionable now to establish you're the latter and downplay your bona fides as the former.

And why not! There's a certain swagger -- or is it earnestness? no, call it authenticity -- in backing ventures for your own account. Marry your own cash with your time and attention, and you're a professional investor without the baggage of LPs!

But it's not whether you're VC or angel that determines whether you are a cool investor. I think the investors we like most, angel or VC, are humble and approachable and open about what they think. There is the scorecard to keep an eye on, for sure, but no one knows what tomorrow brings.

The point is to stay in the game to be able to hang out with the entrepreneurs.

The Attack on Reg D: The Armistice

A series of posts on this blog have run under variations of the title, "The Attack on Reg D." Some have taken a Q&A format. Now that the Senate has fixed the Dodd bill, I thought we might revisit the last Q&A and redline it, to underscore the "terms of the peace."

What is Reg D? Reg D sets up a system of rules that all in the startup financing ecosystem -- entrepreneurs, angels, venture capitalists and lawyers -- know, rely on, and self-police. The process is amazingly efficient, protects investors, and supports innovation, economic growth and jobs. It is a success story, of which our nation should be proud. Reg D worked to help angels and venture capitalists support startups throughout the financial crisis and has not let us down.

What is was the renewed attack on Reg D? The renewed attack on Reg D is was contained at Section 926 and Section 412 of Sen. Christopher Dodd's "Restoring American Financial Stability Act of 2010," before those sections were amended by SA 4056 last week. The renewed attack has had three offensives: 

  • one, to stop startups and other private companies from closing on financings until the SEC or a state regulatory authority has reviewed a regulatory filing; 
  • two, to end federal preemption of state authority over smaller financings (exact size and scope to be determined by SEC rulemaking) exempt under Rule 506 of Reg D; and
  • three, to change the existing thresholds for "accredited investors" so that most existing angel investors can no longer participate in the private financing of startups and other private businesses.

I thought Sen. Dodd's bill was about ending federal preemption over Reg D offerings. What is this about a 120 day waiting period? Through Section 926 of the March 2010 version of his bill, Senator Dodd would have ended the ability of startup companies and other private issuers to raise funds in reliance on their own self-policing of Rule 506. Instead, startups and other issuers would have had to wait or escrow funds potentially for 120 days or more, pending SEC and possible subsequent state regulatory review. It is true that there was no such review period under the prior version of Sen. Dodd's proposed legislation; the prior initial version left the notice filing system intact.

Is Was there something wrong with the current startup financing system, that requiresd this such a proposal for reform? No. As noted in a recent letter from the Angel Capital Association to Senator Dodd, there is virtually no fraud among angel financings for startups. The system works, and there are good reasons that it should. If you claim the exemption fraudulently, then anyone can come after you, personally: the SEC; the relevant states whose resident investors are hurt (federal preemption never stopped the states from pursuing fraud); and the investors themselves.

Why is Reg D so important?  Reg D does not slow down capital formation, and speed is essential to startups. While you do indeed need to make a Reg D filing in connection with each offering, you can do so concurrent with or shortly after closing a first sale. States need to be notified, too, but can't impose "merit review" or otherwise slow down the capital raising process.

Is there a way to stop this? Yes, and it happened. Individual senators, including Senators Bond of Missouri and Brown of Massachusetts, may offered amendments to the bill. The Angel Capital Association and private individuals are working worked hard to contact senators to tell them of their concerns and to offer alternative changes to the law that would not devastate startup seed financings and angel investment in the United States.

Who would want to kill Reg D? For all intents and purposes, state "blue sky" registration and review of seed financings for startup tech companies ended in 1996, when the National Securities Markets Improvement Act preempted state authority over offerings meeting the criteria for federal exemption under Rule 506 of Regulation D. State securities administrators, speaking through an organization called NASAA, have long sought to repeal this federal preemption to restore their former authority. In the end, after an intense process of education and cooperation, no one did, at least not for now. NASAA supported the compromise that was reached and expressed in the final amendment.

How does imposing a 120 wait period help restore state authority that existed prior to 1996? It doesn't. This is supposition, but it may be that the 120 waiting period feature of Sen. Dodd's bill is one of those misbegotten attempts at compromise that pleases no one and fundamentally misunderstands the very purpose of a registration exemption. It is not clear that NASAA even wants this. Dow Jones Newswires reported that the president of the organization, Denise Crawford, acknowledges that a 120 day waiting period is too long. In the end, no one supported the proposed 120 day wait period.

Would there be another way to address abuses that state regulators are worried about? "Get rich quick" scam artists and ponzi scheme promoters have used Reg D to attempt to shield themselves from state jurisdiction, and in the end this problem might be was fairly addressed by legislation the bill as passed by the Senate. However, r Rather than gut Reg D, which facilitates the safe and efficient formation of startup capital for tech and other entrepreneurs in this country and is not abused by the participants in this industry, the rules could be Dodd bill as passed calls for Reg D to be reformed to match the practice that works disqualify "bad actors." For instance, SEC and state regulators could be further empowered to regulate offerings that may pay lip service to Rule 506 under Reg D, but don't actually meet existing Reg D requirements. If Reg D were clarified to underscore that an issuer must have a pre-existing business relationship with its investors, or to not allow federal preemption when broker dealers participate in a private seed financing, the current, successful and prevalent practice of the tech startup community would be preserved.

Why is the National Venture Capital Association ambivalent on this? They were more concerned with taxation of carried interest. Early this month, together with the ACA, the NVCA did write a letter to Sen. Dodd, protesting the attack on Reg D. Since then, the ACA and other angels, entrepreneurs, lawyers and individual venture capitalists have taken the lead. It may be that the NVCA will become more active on the issue as Sen. Dodd's bill is considered by the full Senate. Some believe that many venture capitalists still may think that the attack on Reg D is primarily an "angel issue," and will not impact venture capital firm financing rounds that materially (costs and delays for VC-led rounds would be more manageable). Furthermore, with most angels eliminated from the startup ecosystem, some perceive that VC firms will have more 'leverage" over entrepreneurs with regard to financing terms.

How can I help? 

  • You did. Learn more about the issue, and find links to important news articles and blog posts on this issue, at the Save Reg D website.
  • Contact You contacted your senators and representatives in Congress and it worked. tell them of your concerns. However you may feel about financial regulatory reform in the United States, the provisions in Sen. Dodd's bill that attack startups, entrepreneurs and angel investors are not necessary.
  • 1199 of us signed If you like, sign the petition against the attack on Reg D (widget link below).
  • In particular, If you are an angel investors see used the resources on the ACA site and get got involved, either through the organization, a regional angel group, or on your their own.
  • If you are a member of the NVCA, lobby the leadership of that group and let them know the NVCA should follow the instinct it had earlier this month and work for entrepreneurs on this issue. On the day that Reg D, startup seed financing and angel investing in America was saved, the NVCA launched a PR campaign to save capital gains tax treatment on VC carried interest.
GoPetition

Founders Who Set Out Alone

I don't know the FounderDating program, taking place in Seattle tonight, but the mention of it in Jaremy Rich's Seattle StartupDigest has me thinking about the entrepreneurs I know who have started their ventures on their own, without co-founders.

At the Right Side Capital Management presentation in Seattle last month, a solo-founder (I presume) in the audience asked the question, "how do you evaluate founders who are going it alone?" She was picking up on the theme of Right Side's prospective investment criteria, which, at the risk of oversimplifying, was all about evaluating the founding team. Without skipping a beat, David Lambert gave a matter of fact response, to the effect that not being able to recruit a co-founder was, in and of itself, indicative of the founder's (lack of necessary?) team-building skills.

As an investment screening thesis, on a volume play, that makes some sense.

And yet I can think of exceptions. Solo-founders who have taken their ventures for a year, and into a second, perhaps a bit longer, with no partner, sometimes even no C-level peer. I don't countenance this, for lots of reasons, but it does happen.

But it's never the case that a successful founder does everything on his or her own. He or she may lead every "department" (coding, marketing, testing, deploying, selling, fundraising, controlling, reporting), but will be outsourcing like mad, leveraging the talents of many, outsourcing more than the typical venture.

It's a recipe for fatigue, not sustainable forever (for one thing, it's too hard on families). But viable companies can start that way, and they do.

You Just Can't Please Some People!

John Myer sent me a link to a WSJ opinion piece about how angel investing was saved at the last minute through an amendment to the Dodd bill, as reported here and elsewhere.

The WSJ piece is succinct and accurate, and notes that the Monday night amendment was indeed a victory for startup entrepreneurs and angel investors in America.

But then the piece tacks on a bit of knee-jerk pessimism that doesn't follow from the news and analysis just relayed:

"Still, the fact that such a destructive provision made it that far shows how little the Members and staff now running Congress understand about wealth creation and the sources of American prosperity."

Sheesh! Some people won't take "I get it" for an answer!

But in all seriousness, being downbeat about how the Senate corrected the mistake in the Dodd bill, how it recognized the attack on Reg D and stopped it, is to short-shrift the longer reading of the significance of what has happened. I blogged about the long term significance of this experience, here. I tried to make the same point in the comment I just left on the WSJ site, copied and pasted just below.

I say "bravo" to your coverage on this, with one constructive criticism:

Your last paragraph strikes the wrong chord, saying that members of Congress don't get it, when in fact the process just completed shows that, in this case, they certainly did! What's more, the Senate went from 0 to 60 (stasis to up-to-speed) in a really, really compressed time frame. It's fair to say that Congress now understands, in a way that they did not before, that startups in America come from an ecosystem that is far more broadly based than Congress had assumed; before, members of Congress would more typically associate startups with the venture capital industry.

You wrote the right concluding paragraph for the story that didn't happen, the story you could have written if they had blown it. But they didn't blow it! And I say amen to how they were educated, the balance they struck in the final amendment, and what this portends for the future with other policy matters that will impact startups and innovation in America.

AVC Seattle Meetup, June 6

In celebration of his 5,000th blog post, Fred Wilson announced on his blog yesterday that there would be "meetups" on Sunday, June 6, at different locations around the world.

As of this writing (Monday night, for posting Tuesday), there are 102 planned meetup locations.

Signed up for Seattle so far are Tolis Dimopoulos, Alex Koloskov, Niall Smart, Ruchit Garg and me. Puget Sounders, indicate that you will join in, here!

Here's some background from Fred's post about the technology being used to organize the meetups: 

"Meetups Everywhere is a new feature being launched today by our portfolio company Meetup. This community is one of many that are using this new feature to bring all the relationships that are getting built online into the real world. I am very excited about Meetup Everywhere and what it can do to facilitate even more Meetups and real world relationships. As Scott Heiferman, founder of Meetup, is fond of saying, 'the internet is a great tool to get people off the internet.'"

I signed up and volunteered to organize the meeting for Seattle, and within about 30 seconds, received the following email. 

From: info@meetup.com [mailto:info@meetup.com]
Sent: Monday, May 24, 2010 12:58 PM
To: William Carleton
Subject: You're now the host of the AVC meetup!

You'll find the latest info. for the Meetup here:
http://www.meetup.com/AVC/1704/

Spread the word and make the meetup happen! 

So this app ain't fooling around!

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