VCs Want Capital Gains Tax Break –

NEW YORK – Would reducing the capital gains tax help struggling young companies?

The venture capital industry is the most recent business group to stand in line and ask for assistance from the U.S. government.

On Oct. 22 the industry added its voice to those calling for a reduction in the capital gains tax. By reducing the tax, the National Venture Capital Association (NVCA) said, the U.S. government could provide an extra incentive to venture capitalists and other investors, such as angels, to invest in emerging growth companies.

The industry’s plea came just a few days after Federal Reserve Chairman Alan Greenspan told Congress that a cut in capital gains tax would have only a minimal stimulative effect on the economy.

But the VC industry wants relief nonetheless. “Reducing the capital gains tax is one thing that is very key to helping emerging companies grow in the near term,” said Mark Heesen, president of the NVCA. The industry group’s position is not new. It was one of the backers of the successful effort several years ago to reduce the capital gains tax rate to 20% from 28%.

The group made its comments as Congress and President George W. Bush are trying to hammer out an agreement on an economic stimulus package that is intended to keep the U.S. from further falling into economic malaise following the terrorist attacks on Sept. 11. Currently House Republicans have called for a $100 billion economic stimulus plan, which includes an effective cut on capital gains tax rates to 18% for most taxpayers. Other legislation that would effectively cut the capital gains tax has been introduced in the Senate. Under Bush’s plan, spending would be limited to $75 billion.

The VCs want the capital tax rate to go down because they argue that it will make investors more willing to invest more money. Right now that’s a problem, as VCs have had trouble raising funds since returns have been sinking. The one-year return for venture capital investments at the end of the second quarter was a negative 18.2%, while in the first quarter returns declined 6.7%, according to the NVCA and Venture Economics.

Indeed, the capital gains tax is not deterring investors today as VC investors have no gains to be taxed. But the industry is looking ahead, and is trying to impress upon the government the strong role the industry has in the creation of companies.

“The companies that these VCs have funded during the last 30 years are the ones that will move this country forward,” said Heesen. To back up the NVCA’s claims, the study showed that $273.3 billion of venture capital investment during the 30-year period created companies that were responsible for 5.9% of the jobs in the U.S. and in 2000 were responsible for 13.1% of the country’s gross domestic product. “Little seeds of venture capital have grown into very large companies in terms of sales and employment,” said Andrew Hodge, senior vice president of DRI-WEFA, formerly Wharton Econometric Forecasting Associates.

But right now, the VC industry is in a slump. For the second quarter in a row, annual returns for the U.S. venture capital and private equity industry were in negative territory. Not surprisingly as of June 30, $45 billion is sitting on the sidelines waiting to be invested.

And the amount of funds raised and invested by VCs is down sharply from the record levels raised last year. Third-quarter fund-raising numbers were down 78% from last year, while disbursements were off 73% from the same period.