Greycroft’s Patricof goes against the grain on carried interest

Veteran investor Alan Patricof bucked the National Venture Capital Association at an event the group co-sponsored, opposing taxation of carried interest at the capital-gains rate.

A conversation between Patricof, 81, and NVCA President Bobby Franklin was the keynote interview of SHIFT NYC, an Oct. 28 conference focused on “bridging the gap” between corporate VC and venture partnerships. After a few introductory questions, Franklin told the crowd, “I would be remiss if I didn’t bring up tax policy, having Alan Patricof here.”

Patricof, founder of Greycroft Partners, has been “very vocal” on the issue, in addition to having “provided a lot of service to our country,” Franklin said.

In contrast to the “nuanced” arguments on the other side, Patricof explained his position in frank terms. “Socially, we’re living in an environment now focused on income inequality” and GPs’ earnings should be taxed as ordinary income “in the interest of fairness,” he told the crowd.

Earlier, Patricof’s microphone had stopped working and was replaced. Franklin at this point interjected that he ought to “give you the bad microphone back.”

Patricof went on: Though the attitude isn’t popular, he said, “there are a lot of VCs who have stepped up privately and said” that changing the rules is the right thing to do.

As an example of favorable tax treatment for early-stage investing that he finds appropriate, Patricof mentioned the Qualified Small Business Stock exclusion, which was “designed originally to help the biotech industry” and excludes certain industries (such as oil and gas and real estate).

In making his case, Patricof recalled an op-ed he wrote for The New York Times in August, published under the headline “Close My Tax Loophole.”

He reiterated several points from that article, including an anecdote about his accountant telling him, after his first exit, “‘We’re going to take this as capital gains because that’s the way it’s being done, but sooner or later they’re going to make it ordinary income.’ And it’s 46 years later and nothing’s happened.”

At this point, Patricof changed the subject to strategic investment: “Is that okay if I ask myself my own question?”

“As long as you don’t go on more about carried interest,” Franklin replied.

It was a good-humored exchange, but the tension underlying it felt real. Franklin expressed the anxiety of a profession that sees its lucrative compensation model threatened by both major parties’ candidates for president.

The fact that Patricof, a major figure in the development of both venture capital and private equity, sides publicly with the industry’s critics on this sensitive question seemed discomfiting to the NVCA president. Franklin complained at one point, half-jokingly, of having to field emails from VCs outraged by Patricof’s advocacy.

However, on the main subject of the day, the changing role of corporate venture, Patricof sounded a positive note.

When he started out, he said, that world was limited to General Electric,  Exxon, International Nickel (which invested with Patricof’s firm in AOL) and Citicorp Ventures. Patricof recounted how Exxon “always held back” a certain voice-response startup by insisting that its representative on the company’s board not vote on any issue before consulting with corporate headquarters. (At Greycroft, he added, “we don’t take board seats unless we have to.”)

“It’s a whole new wave now,” Patricof said, after reading a partial list of today’s corporate venture groups, “a much more positive contribution that’s being made.”

Unlike a lot of firms, Greycroft is “very open to strategic investors,” since they help companies get access to business customers. Concerns include turnover and a lack of follow-on investments. “There’s nothing worse than a young company having to deal with an extended financing time, waiting and waiting for Amazon or General Motors.”

During the Q&A, an attendee from General Motors Ventures asked Patricof whether VC is in a bubble, with “way too much money chasing way too few companies with value. Does it come to an end next year?”

Patricof thought not. “There’s a lot more smart thinking in the venture industry today, in terms of how companies are financed and how well they’re financed,” he answered. “I think everyone learned from the late ’90s, including me, I made plenty of mistakes at that time.”

Patricof allowed that the current startup wave is the biggest he’s ever seen, so big that “there just isn’t enough money in the world” to finance every company. “We’re going to have a lot of disappointed people.”

Without calling it a bubble, he expressed some concern over the large amount of late-stage capital, coming mostly from hedge funds, PE firms and mutual funds; intended as short-term engagements, these investments could wind up being long-term marriages.

“We’re gonna need a lot of public financers to take out a lot of these investments that have been made at high valuations,” Patricof cautioned, a challenging prospect if business falls off.

But overall, he asserted, this time is different. “There’s a rationality in the venture business today. I do not think there’s a wild excess.”

Photo of Alan Patricof speaking at PartnerConnect East in New York taken for VCJ.