Monday, July 09, 2007

Higher Tax, Fewer Deals?

The IN VIVO Blog has been somewhat mum on the carried interest debate. Frankly, this topic is being covered to death elsewhere (The link goes to PE Hub but there's no shortage of discussion.)

This topic is important, no doubt, crucial even, but Mom always told us if you don’t have something fresh and interesting to blog about than it’s better not to blog at all. (Well, she would have said that.)

So we’ve been asking around a bit, trying to get a sense from our VC community on the potential impact of these changes. To be honest, the change put forth by the Democrats didn’t really sound the alarm bells in our virtual hallways. But the same apparently isn’t true in the actual hallways of VC firms investing in life sciences. IN VIVO Blog expected VCs to answer queries with a “Congress will be Congress” attitude similar to the one put out when discussing changes at the FDA or CMS.

But there’s some genuine concern here. No question, much of that concern most likely has to do with a diminished paycheck. But there’s some fear surrounding the impact these changes could have on the availability of capital.

An email from one West Coast VC:

I really believe that these proposed new taxes will make it so that some new companies will not get funded. These taxes essentially raise the cost of capital and if the returns are not there to the GPs then they will not get funded eliminating many high risk or sometimes questionable deals. One has to remember that often deals look promising and then don’t make it while the opposite is true as well but maybe not to a greater extent. If the cost of capital is high then those marginal/high risk deals won’t get done.

It is the same concept as lower interest rates and lower borrowing hurdles allowed the housing market to boom. If the cost of capital rises then it eliminates those who are at the margin. The same is true in our business. Those on the margin lose—fewer jobs and lower growth

The suggestion that this could eliminate “many high risk or sometimes questionable deals” rings true and does sound an alarm. After all, doesn’t that describe most biopharma deals and a good deal of device companies as well.

Could this change in taxation have a particularly detrimental impact on the life sciences industry, pushing VCs even further away from funding true start-ups? Even worse, would this aggravate the diversion of dollars away from smaller, venture capital firms looking to do these deals. Or perhaps, as A VC Blog suggests, the best VCs will just invest their own money, forget the institutional dollars.

A VC Blog also had what I thought to be a very thoughtful position later on.
Mom did teach us not to covet other people's stuff, so the "Tax the Rich" crowd won't get a sympathetic ear here. Still, the suggestion that the GP's carry on "other people's money" goes beyond that simplistic idea. The idea that this income should be taxed as salary isn't that far out (or far left) as some would like it to appear.

We’ll update with interesting points of view as we continue to talk to folks. But don't feel like you need to wait for a phone call. Consider this an open invitation to opine on what impact the suggested changes will have on the life sciences industry.

1 comment:

Anonymous said...

That taxing the carry should have an impact on which deals are done is bogus - or political spin. Shedding a tear and fear-mongering for new start-ups.

VCs are in the business of making money for their LPs (which is what they get paid for and taxed for), making happy companies is secondary, creating jobs is tertiary. No LP will pay a bonus for more jobs created or less, however, he will be concerned with performance, which is why marginal deals don't get done by good VCs and and shouldn't get done at all. Conversely, there is an abundance of deals that should get done and don't get done. So the carry debate is really so far removed from the investment decision (typically 5-10 years, which is the time from investment to exit...), that it is disingenious to create a link.

Funny enough, if life sciences would have PE investors, there would be a link, because (a) the PE investors would have more money (personally as well) that they could deploy but now would not because it has been taxed away, and (b) the life cycle for PE investments is much shorter. But then again, PE does not do life sciences because of (b).