Tag: Tax Reform

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McNair Center Weekly Roundup

Weekly Entrepreneurship Roundup 4/14

Weekly Roundup is a McNair Center series compiling and summarizing the week’s most important Entrepreneurship and Innovation news.

Here is what you need to know about entrepreneurship this week:

How to Make Texas More Startup-Friendly

Iris Huang, Research Assistant, McNair Center for Entrepreneurship and Innovation

McNair Center’s Huang interviews Blake Commagere, entrepreneur, angel investor and startup mentor in the San Francisco Bay Area on how to improve an entrepreneurial ecosystem. Commagere graduated from Rice University in 2003 with a degree in Computer Science. Upon graduation, Commagere moved to Austin to begin his career as an entrepreneur and soon decided to move to Silicon Valley. Commagere has raised over $12 million in VC, started seven companies and sold five.

Commagere describes the pull of talent toward San Francisco as “a virtuous cycle,” where “former successful startup founders become the next generation angel investors and venture capitalists, who fund and help more startups succeed.” Silicon Valley’s concentrated network of VC firms and tech startups provide struggling entrepreneurs with a vast pool of mentorship opportunities, funding resources and talent. Budding startups heavily rely on local tech networks for early-stage support and advice. In order to develop its entrepreneurial ecosystem, Texas cities need to focus on building its tech space.

Additionally, the state’s cities must expand their VC presence. Otherwise, there will always be too many startups fighting for too little capital (as if this isn’t a problem already), and startups will continue to move to cities like San Francisco. Startups depend on local VC firms because many firms refrain from investing in companies outside their primary city. When firms do invest in outside companies, the qualification bar is set much higher.

Medical Device Startups and the FDA

Iris Huang, Research Assistant, McNair Center for Entrepreneurship and Innovation

McNair Center’s Huang takes a look at the FDA approval process for medical devices. The medical device industry is a $140 billion market. For many companies in the industry, obtaining FDA approval is a long and costly path. For some, it’s a barrier. Of the 6,500 companies in medtech, 80 percent are composed of fewer than 50 employees.

A Stanford University survey of over 200 medtech companies found that the average cost for a low-to-moderate-risk 510(k) product to obtain FDA clearance was $31 million. The same survey found that it took these products 31 months from initial communications with the FDA to obtain clearance. For startups, these costs pose significant barriers to entry. Huang aptly summarizes this dilemma: “as the cost of getting to market approaches the average exit value, the medtech funding equation looks less attractive to venture capitalists.”

The FDA approval process acts as an essential screening point in the medtech industry. However, Huang recommends that policymakers consider possible ways to alleviate the significant burdens placed on the businesses involved in the development of these critical technologies.

First Data Joins Silicon Valley Bank In Fintech Accelerator

Tom Groenfeldt, Contributor, Forbes
Silicon Valley Bank (SVB) recently announced a collaboration with First Data, a global payments technology solutions company, on Commerce.Innovated, its fintech accelerator. Commerce.Innovated, founded in 2014, is a four-month long virtual accelerator for startups in the financial services and technologies sector. The accelerator, unlike most early stage accelerators, focuses on startups that have already secured or are in the process of securing seed or Series A funding.

According to SVB’s Reetika Grewal, the accelerator looks for firms with “five to 10 people with an idea they are committed to.” In this stage, startups usually require help with the “operational,” rather than conceptual, front of development. Commerce.Innovated helps fintech firms bring their solutions to market. Since these startups already possess strong leadership with a clear vision for their product, a virtual platform makes sense.

A $150 Million Fund, The Engine, Will Back Startups Others Find ‘Too Hard’

Lora Kolodny, Contributor, TechCrunch

The Engine is a venture fund and accelerator for “advanced technology startups.” The new fund recently closed its debut round at $150 million. Startups in The Engine’s portfolio gain access to one of MIT’s unique resources, The Engine Room, a laboratory for small startups to develop and test their technologies. In addition to to The Engine Room, startups also receive access to laboratory equipment and technologies from organizations in the greater Boston area.

Despite its close affiliation to MIT, The Engine invests “in teams and technologies that hail from a variety of industry and academic backgrounds, not just from the MIT ecosystem.” The Engine supports companies involved in the development of “hard-tech” – so basically anything “from advanced materials and manufacturing technologies to medical devices, robotics, artificial intelligence, nuclear energy, fusion and more.”

Hard-tech startups typically face higher costs, more risk and a longer development period than most B2B or consumer-focused software. These startups often find it difficult to find VCs willing to invest in their innovative, but risky technologies. The Engine, according to the fund’s CEO Katie Rae, is dedicated to lowering the costs of development and testing “hard-tech” and encouraging more entrepreneurs to go into the field.

Tax Reform Must Help Small Businesses, Too

Laurie Sprouse, Reporter, The Wall Street Journal

Laurie Sprouse, a small business owner from Dallas, covers tax reform and small businesses for The Wall Street Journal. As Sprouse points out, small businesses have added two thirds of new jobs to the U.S. economy in recent years. Still, analysts and policymakers continually propose tax overhauls that largely ignore the plight of small firms. Instead, politicians and reporters alike focus on alleviating financial burdens for larger corporations and providing helpful, but insufficient, tax credits for small businesses. According to Sprouse, “Only a plan that benefits businesses of all sizes equally will create the broad economic growth President Trump and Congress seek.”

Stripe Acquires Indie Hackers in Bid to Strengthen Relationship with Entrepreneurs

Ken Yeung, Contributor, VentureBeat

Founded in 2010, tech company Stripe delivers application programming interfaces (APIs) that support electronic payments for consumers and businesses. Recently, the firm announced plans to acquire Indie Hackers, a startup dedicated to creating an internet community for entrepreneurs to share their success stories and lessons. While the financial terms of the deal remain unclear, it seems that site will operate as an independent subsidiary of Stripe.

Indie Hackers founder, Courtland Allen, describes his site as a “community where successful founders could share their valuable stories and insights, and where aspiring entrepreneurs could go for inspiration and advice.” Meanwhile Stripe executives view the deal as an opportunity to grow “the GDP of the internet” by increasing the “overall number” of successful businesses.

In an interview with VentureBeat, a Stripe spokesperson revealed that the company wants to support Indie Hackers’ mission by taking on some of the budding site’s financial burden. In just under a year, the site already runs a monthly profit of $6,000. Going forward, Allen hopes to see Indie Hackers take on a similar role as Y Combinator’s Hacker News.

The Weekly Roundup will return in June. 

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McNair Center Weekly Roundup

Weekly Roundup on Entrepreneurship 4/7

Weekly Roundup is a McNair Center series compiling and summarizing the week’s most important Entrepreneurship and Innovation news.

Here is what you need to know about entrepreneurship this week:

The Carried Interest Debate

Tay Jacobe and Jake Silberman, Research Assistants, McNair Center for Entrepreneurship and Innovation

McNair’s Jacobe and Silberman analyze the ongoing discussion surrounding carried interest. A complicated concept in the financial sector, carried interest refers to the profits earned on a private investment fund that are paid to fund managers. Private investment funds include VC, PE and hedge funds.

Debate arises from carried interest’s subjection to the capital gains tax rate. The capital gains tax rate caps taxes on carried interest at 20 percent. Critics of the so-called carried interest “loophole” argue that the government should tax carried interest at the standard federal income tax rate of 39.6 percent. Supporters of maintaining the capital gains tax rate for carried interest claim that it acts as a performance incentive for fund managers.

During the 2016 presidential campaign, Trump criticized the massive profits that investment fund managers earned from carried interest. Since taking office, President Trump has not commented on his administration’s plans for taxation on carried interest. The House Republican’s 2016 Tax Reform Proposal proposes a “reduced but progressive” capital gains tax on carried interest. As Jacobe and Silberman note, such a plan would likely cause fund managers’ net incomes to go up.

Looking Forward: Why the VC Industry Needs More Female Investors

Dana Olsen, Reporter, PitchBook

PitchBook’s Olsen analyzes the need for promoting gender diversity in VC firms. Despite modest gains in diversification at many VC firms, most firms are yet to make substantial change. In 2016, only 17 percent of global VC deals involved companies with female founders, while only 9 percent were female-led at the time of backing. Admittedly, these statistics reveal improvements from 2007, when these numbers stood at 7 and 6.8 percent, respectively.

According to Olsen, “the most efficient way to increase the number of female-founded companies that receive VC funding is to have more female venture capitalists.” Aileen Lee, prominent venture capitalist and founder of Cowboy Ventures, believes that “women who have more numbers on the investment team invest in more women.” Another obvious way to increase rates of female entrepreneurship is to introduce educational programs that spark girls’ interest in STEM-related fields at an early age.

A Dearth of I.P.O.s, but It’s Not the Fault of Red Tape

Steven Davidoff Solomon, Contributor, The New York Times

University of California, Berkeley School of Law’s Professor Davidoff Solomon writes for the New York Times on the recent decline in IPOs in the U.S. Many politicians point to over-regulation of the private market as an explanation, evidenced by the line of interrogation at the confirmation hearing of President Trump’s nominee to head the SEC, Jay Clayton. Since 1996, the number of publicly listed firms on the NYSE has been cut by nearly half. Furthermore, the number of IPOs has decreased from 706 in 1996 to only 105 in 2016.

Professor Davidoff Solomon proposes a number of theories for explaining the dropoff in deal-making activity – none of which involve government regulation. Firstly, Davidoff Solomon suggests that “structural changes in the market ecosystem” might be encouraging increased mergers and acquisitions in public and private markets, respectively. Alternatively, the dropoff in IPOs could potentially be caused by a decline in attractiveness of small offerings as the public. In 1996, 54 percent of new offerings were considered large, compared to only 4 percent in 2016. According to Davidoff Solomon, the “market for new issues has moved toward liquidity and bigger stocks.”

And in the Startup News…

New Clerky Tools Help Startups Hire and Raise Funds without Running into Legal Problems

Lora Kolodny, Contributor, TechCrunch

Founded in 2011, Clerky is a San Francisco-based startup that builds software to assist startups and their attorneys with legal paperwork. The startup, founded by former attorneys, focuses almost exclusively on providing legal templates and software for high-growth startups. Originally, Clerky’s services centered around helping startups incorporate their company online. Now, Clerky is looking to expand its services beyond business formation, with its latest two online tools Hiring and Fundraising.

By using Clerky, startups can spend their cash on higher level services and advice, rather than costly legal paperwork. For example, many startups spend thousands of dollars on attorney’s fees for handling seed rounds finances. With Clerky, however, companies can pay $99 in return for six months of unlimited issuances of SAFEs and convertible notes. Many of Y Combinator’s co-founders have used Clerky’s Formation tool to launch their business. Now, they can also rely on the firm’s software throughout their various growth stages and funding rounds.

Dropbox Secures $600M Credit Line with IPO on Horizon

PitchBook News & Analysis

Last week, the Weekly Roundup series covered a PitchBook article on a relatively recent trend in startup financing: debt. Debt financing is not uncommon for startups that are looking to go public. IPO are costly, and opening up lines of credit gives a company some cash without “diluting equity stakeholders.” However, many startups without IPOs in their near future are increasingly accumulating debt; according to PitchBook News and Analysis, funding rounds that were at least partially debt brought in $14 billion in deal value in 2016.

Dropbox, the latest tech unicorn to announce debt financing ahead of an upcoming IPO, is a well-known startup that provides users with cloud-based storage services. Dropbox reportedly secured the $600 million line of credit ahead of a possible offering in 2017.

With Mulesoft’s successful IPO in March, 2017 could deliver a good year for tech enterprise. Cloud-based identity management firm Otka is another enterprise tech firm set to go public within a few weeks.

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Government and Policy McNair Center

The Carried Interest Debate

In the 2016 election, carried interest and its taxation was a hot topic. Often explained as a “loophole” that allows the rich to exploit tax codes, carried interest is not a political issue that clearly fits within party lines. Lobbying by the financial sector occurs on both sides of the political aisle, and there are opponents and supporters within both parties. What are the dynamics of this debate, and what are the arguments for whether carried interest should be taxed differently?

Private Investment Funds

In the 2016 election, both Donald Trump and Hillary Clinton rallied against “hedge-funds” for paying so little tax. However, these comments were misleading. Clinton and Trump were actually talking about a tax rule that applies to a range of private investment funds.

A private investment fund invests capital with the goal of making returns for its investors. But within this description there is a lot of variety in the types of funds. Funds vary in their sources of capital, the targets of their investments and the roles they play in the economy.

https://commons.wikimedia.org/wiki/File:Fund_Structure.pngPrivate investment funds are typically set up as limited partnerships, rather than limited liability companies (LLCs). They organize themselves as general partners and limited partners. The general partners are the funds’ managers, which may be structured as a managing firm. Managing firms are often incorporated as an LLC. The limited partners are the funds’ investors. They are called limited partners because they are required to have limited involvement in the funds day-to-day activities. These investors are usually financial institutions, pension funds, insurance companies and wealthy individuals.

Rewarding General Partners

General partners invest in their own funds (typically contributing less than 5 percent of the capital) to make money. However, their compensation comes through management fees and carried interest. Usually around 2 percent of a fund’s raised capital goes to management fees.  Management fees are paid regardless of the fund’s performance and are there to cover operating costs and base salaries.

When a firm is set up it negotiates how excess returns – those paid after invested capital has been repaid – are shared. An 80/20 split between investors and managers is typical. Managers with strong track records can and do negotiate for more, sometime even offering to forgo management fees.  This 20 or so percent that goes to the managers is called “the carry” or, formally, the carried interest.

Types of Private Investment Funds

Common types of private investment funds include private equity funds, venture capital funds, hedge-funds and mutual funds.

Private equity funds generally invest in large companies with the intent to restructure and sell the firms for a gain. These investments usually mean acquiring controlling interests in public companies through stock purchases. The fund will then take the company private. Private companies can then be sold to another buyer or back to the public with a new initial public offering. However, private equity firms do also sometimes acquire private companies.

Venture capital funds invest in high-tech startup companies with high-growth potential. Once the fund purchases a stake in the company, it also provides coaching and other services to the company in order to increase its chances of success. Venture capital funds sell their positions at initial public offerings or when their portfolio companies get sold to incumbents or private equity firms.

Hedge funds focus on achieving high returns through risky investments. They differ from mutual funds in the diversity of their strategies and their underlying assets. Mutual funds typically only take long positions in stocks and bonds. Hedge funds can invest in anything. Their underlying assets include stocks, bonds, commodities, derivatives, warrants, futures, options, currencies, land, real-estate and much else besides. Hedge funds will often simultaneously take both long and short leveraged positions.

Tax Treatment

The carried interest controversy stems from its tax treatment. Carried interest is subject to a maximum capital gains tax rate of 20 percent (the long-term capital gains rate). This is compared to the maximum ordinary income tax rate of 39.6 percent, which is also the maximum short-term capital gains rate.

Those in favor of the current system believe that a higher rate would reduce the incentive for general partners to take risks. They sometimes specifically claim that greater taxes on carried interest could discourage innovation and efficiency in markets.

Those opposed to a reduced tax rate for carried interest frequently argue that carried interest is performance-based compensation.  Comparing it to a bonus, they say that it should be subject to the ordinary income rate.

The controversy surrounding carried interest has faced increasing media scrutiny since the 2012 election. Former Presidential Candidate Mitt Romney paid taxes of just $1.9 million on $13.69 million in income in 2011, an effective rate of 14.1 percent  Perhaps in response to the media and public uproar, the American Taxpayer Relief Act of 2012 raised what was then the long-term capital gains tax rate of 15 percent to 20 percent. President Obama signed this change into law on January 2, 2013.

The Economics

To economists the key question is one of efficiency: Would free markets achieve the efficient outcome without the additional incentive that carried interest provides? The answer probably depends on the type of private investment firm.

Venture capitalists face enormous information problems when trying to assess their potential investments. And many of their portfolio firms create value for outsiders who aren’t investors and who don’t use the firm’s products themselves. Each of these reasons leads to inefficient under-investment, which carried interest could help address.

Hedge-funds may make markets more complete by allowing investors to place capital into a wider range of underlying assets. Private equity firms may provide a “market for management” that disciplines publicly-traded firms. It is possible that without these types of investment vehicle there would be market failure, but it is unclear that they need additional incentives to address it.

Because mutual funds just aggregate and manage stock and bond portfolios – a job done by brokers and investors themselves – it is hard to see why they need subsidizing.

Looking to the Future

The House Republicans’ 2016 Tax Reform Proposal includes no explicit mention of carried interest. However, it does advocate for “reduced but progressive” capital gains taxes. If the administration chooses to adopt this plan, carried interest tax breaks could become even larger.

However, it is difficult to predict the fate of carried interest tax breaks, especially given President Trump’s past statements. During his campaign, Trump was highly critical of these tax breaks. He claimed that fund managers were “getting away with murder” by taking advantage of the rule. However, since taking office, Trump Administration has made no mention of its plans to address this tax code provision. The administration plans to reform U.S. tax law in the coming year, so carried interest is definitely a topic to look out for.

See the McNair Center’s wiki page on Carried Interest for further explanation of the dynamics of carried interest.

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McNair Center Weekly Roundup

Weekly Roundup on Entrepreneurship 3/31

Weekly Roundup is a McNair Center series compiling and summarizing the week’s most important Entrepreneurship and Innovation news.

Here is what you need to know about entrepreneurship this week:

Business Groups Hope Trump Can Change Health Law by Administrative Action

Jeffrey Sparshott, Reporter, The Wall Street Journal

Juanita Duggan, CEO of the National Federation of Independent Businesses, described the unraveling of the American Health Reform Act as “a dismal failure.”

Despite several nationwide organizations like the National Retail Federation, the U.S. Chamber of Commerce and the National Association of Manufacturers pushing lawmakers to support the plan, Republicans could not build a consensus for the bill.

Not all small business owners favored the GOP bill. According to Tom Embley, CEO of Precision AirConvey Corp., a Newark manufacturing company that employs 40 workers, the proposed plan wouldn’t have done “anything to lower costs” for his firm.

More Than Obamacare Repeal, Small Businesses Want Congress to Rein in Costs

Stacy Cowley, Reporter, The New York Times

The New York Times’ Cowley reports on health care reform as told from the perspective of small businesses. While small businesses have been some of the most outspoken critics of the ACA since its passage in in 2010, the group as a whole is actually fairly divided on the issue; according to Manta and BizBuySell, approximately 60 percent of small business owners want the ACA to be repealed.

As Cowley points out, “every business is uniquely affected by the complex law.” She spoke to small business owners across the country, representing a variety of regions and industries. Two themes were common: The lack of sustainability of the status quo and the need for bipartisan reform. One thing Congress’s recent health care drama did accomplish was to reveal small businesses’ growing disdain for Congress’s inability to find common ground and deliver policy stability.

Early-Stage Investment for Software Startups Holds Steady

Alex Wilhelm, Editor In Chief, Crunchbase News

A recent Crunchbase report reviews the performance of younger SaaS companies after a year of relatively illiquid market for late-stage SaaS startups in 2016.

SaaS, or software as a service, refers to “firms that sell software products on a recurring basis.” As Wilhelm notes, SaaS firms constitute an “important part of the modern startup landscape.” According to Crunchbase analysis, early and mid-stage SaaS startups experienced relatively tame Series A and B funding rounds last year, despite the sector as a whole putting on a poor showing for enterprise IPOs when compared to 2015.

Wilhelm suggests that the better-than-expected fundraising aggregates indicate investor confidence that “the late-stage and public markets would figure out SaaS, or a blind willingness to follow a plan that was supposed to work.”

Kushner to Oversee Office of American Innovation at White House

Michael C. Bender, Reporter, The Wall Street Journal

President Trump recently announced the opening of a new White House office, the Office of American Innovation (OAI). The new White House office, tasked with mimicking “private-sector efficiency inside the federal government,” will be led by Jared Kusher, senior policy advisor and son-in-law to President Trump. The office will oversee a number of ambitious task forces, including the taskforce that will be headed by Governor Chris Christie to address the opioid epidemic.

According to Press Secretary, the OAI will address both long-term and urgent needs, such as” modernizing information technology” and “streamlining the Department of Veteran Affairs.” Additionally, the office will conduct communications with many executives, including prominent Silicon Valley CEOs who visited the White House in recent months.

 

Ask a Female Engineer: How Can Managers Help Retain Technical Women on Their Team?

Cadran Cowansage, software engineer at Y Combinator Blog

Y Combinator’s Cowansage attempts to understand why women tend to step out of technical positions more frequently than their male counterparts. Cowansage asked several female engineers about their past decisions to leave their technical position at a specific company or the industry entirely. Interestingly, many of the responses don’t specifically address gender-driven workplace conflicts or discrimination. Instead, many of the women attribute their departures to irreconcilable differences with company management.

Startups often lack formal HR departments. Impartial organizational roles, like senior HR employees, who are distanced from the executive team are valuable resources; these positions offer employees an outlet for voicing their complaints without fear of jeopardizing their job status. Additionally, many women left their previous engineering positions due to lack of shareholder attention to the project they were dedicated to. Another commonly voiced problem during the interviews was rejection of requests for a promotion or raise. The interviews revealed that many women were willing to leave their company when they learned that employees with less experience were earning higher salaries or bonuses.

Startups Increasingly Turning to Debt Financing Despite Dangers

Mikey Tom, Reporter, PitchBook

PitchBook’s Tom shares some insight from  2016 Annual VC Valuations Report. According to the report, median early-stage valuations and the tally of firms that exited the market at a lower valuation than their most recent valuation reached an all-time high. As Tom points out, “rather than raising a new equity round at a sub-optimal valuation or seeking a premature liquidity event,” startups are increasingly relying on debt financing for cash. In fact, excluding 2016, the number of startups composed of debt has increased since 2008. Notably, many of the massive tech unicorns, like Airbnb and Uber, raised billion dollar loans in recent years.

Tom acknowledges the attractiveness of debt financing for many startups, but he forewarns founders of the dangers of accumulating too much debt: “if a startup is unable to achieve the amount of growth it forecasts, the debt ends up acting as more of a time bomb than growth equity.”