Monthly Archives: May 2010

Twitter Weekly Updates for 2010-05-29

In Defense of Carried Interest

Gerry Langeler, managing partner of OVP Venture Partners in Portland, OR, writes in defense of carried interest in today’s New York Times.

When we’ve written on this subject, we’ve tried to emphasize the adverse impact this proposed tax hike will have on an already distressed economy.  In short, we’ve argued that venture capital is critical to economic growth, new job creation, and innovation – and if you tax those things you are certain to get less of them.  Furthermore, venture capital is a long-term investment that doesn’t ask for (or need) bail-outs.

Langeler worries that the heated political rhetoric about “punishing Wall Street” is interfering with basic consistency, and draws several parallels to the financing and profitable sale of a typical home: (more…)

Crowding out private investment


Fontana Reservoir

In The Library in St.Pete you will find Amity Shlaes’ The Forgotten Man, in which Shlaes recounts how the TVA crowded out Wendell Wilkie’s Commonwealth & Southern, a private-equity-backed company ($400 million as reported in Wilkie’s testimony before a House committee) that was in the process of bringing electricity to the rural South.

Since the TVA could borrow unlimited funds at low interest, and did not have to turn a profit, C&S eventually had to sell its properties in the Tennessee Valley to the TVA in 1939 for $78.6 million.  (Fwiw, those events led to Wilkie’s 1940 presidential run.)  71 years after that transaction comes a new study which explores government spending on economic development and its effects on private investment.

Harvard professors Lauren Cohen, Joshua Coval, and Christopher Malloy look at increases in local earmarks and other federal spending that flow to states after the senator or representative rose to the chairmanship of a powerful congressional committee.  The surprising result:  as a result of government spending in their states, companies actually  retrenched by cutting payroll, R&D, and other expenses.

In Companies Retrench When Government Spends, the authors offer three potential explanations:

Some of the dollars directly supplant private-sector activity—they literally undertake projects the private sector was planning to do on its own. The Tennessee Valley Authority of 1933 is perhaps the most famous example of this.

Other dollars appear to indirectly crowd out private firms by hiring away employees and the like. For instance, our effects are strongest when unemployment is low and capacity utilization is high. But we suspect that a third and potentially quite strong effect is the uncertainty that is created by government involvement.

…Our findings suggest that they should revisit their belief that federal spending can stimulate private economic development. It is important to note that our research ignores all costs associated with paying for the spending such as higher taxes or increased borrowing. From the perspective of the target state, the funds are essentially free, but clearly at the national level someone has to pay for stimulus spending. And in the absence of a positive private-sector response, it seems even more difficult to justify federal spending than otherwise.

The implications of these findings for how best to nurture the growth of entrepreneurial companies are interesting.  There will no doubt be private growth companies that benefit from government subsidies in areas such as cleantech and alternative energy, given the magnitude of the dollars being spent.  But it would seem government could do far more to encourage sustainable entrepreneurial activity more broadly by insuring that the proper tax incentives are in place for new company formation and then also working to keep the regulatory burdens at a minimum.  If government does that consistently over a long period of time, the right incentives plus greater certainty will encourage a surge in new entrepreneurial ventures.  


Twitter Weekly Updates for 2010-05-22

Capturing an enemy bureaucracy

Master & CommanderLast Friday’s WSJ features an op-ed entitled Incentives vs. Government Waste in which John Steele Gordon argues that incentives could be better structured and used by bureaucracies.

While we have mixed feelings about the idea – we’re certainly believers in incentives, but it’s hard to believe any incentive plan could withstand the gamesmanship of a skilled bureaucrat (see: Fannie Mae) – we enjoyed the historical analogy the author employs:

But it is possible to incentivize public (and nonprofit) employees to find ways to save money rather than waste it, to find new and better ways of doing business. There is no better example of how to go about that than the British Royal Navy in the age of Admiral Lord Nelson (1758-1805).

The navy’s job in the endless wars of the 18th century was to capture enemy warships and to sweep enemy commerce  from the seas. As the novels of Patrick O’Brian [see below] and C. S. Forrester so vividly bring to life, the Royal Navy was exceedingly good at doing exactly that.  No small reason was that the navy gave its officers and men an enormous incentive to capture enemy warships and merchantmen: the whole value of the ships and cargoes they captured.

(NB: we also learned that this is why so many British warships of that era had french names.)

Gordon goes on to suggest that employees of bureaucracies be awarded bonuses equal to the first year’s cost savings on a dollar-for-dollar basis (the “prize” akin to the Royal Navy’s in the 18th century).  Furthermore, best practices could be shared and healthy competition encouraged amongst bureaucracies to be the ones who capture the savings (and “prizes”).

Now, to be sure, bureaucracies can’t sally forth, capture an enemy bureaucracy, and sell it to the highest bidder. But they can certainly find new ways of doing their jobs that are cheaper and better than the old ways, especially if they are handsomely rewarded for doing so.

In any case, it occurs to us that as government grows larger and more and bigger bureaucracies (e.g. the delivery of health care) directly affect our businesses, it would make sense to start focusing on how we at least make these institutions as efficient as possible.

Improving Corporate Governance: A Memo to the Board

John J. Brennan, chairman emeritus of Vanguard, writes in the 5/10/10 WSJ on how to improve corporate governance.   Based on a recent speech he delivered at the Drexel University LeBow College of Business Center for Corporate Governance, he offers both conceptual and concrete recommendations:

1. Know that you are the shareholders’ first line of defense
2. Build value through mutual respect
3. Communicate
4. Measure your success
5. Compensate yourselves in equity
6. Share your metrics
7. Hold yourselves accountable
8. Establish an “owners relations committee”

In the venture world, our long term reward is in equity (#5), and there are far fewer investors, so owners are more “meaningfully engaged” (#8) than in a large public company with diffuse ownership.  The balance of Brennan’s recommendations are also sound, but as we’ve written before, good governance hinges on ‘robust social systems’ – i.e., the members’ informal  modus operandi ensure that all those well-designed systems function properly.  While the “owners” of public companies often get to pick their board members more in theory than in practice, owners of private companies get to pick both their investors and their board members.  If entrepreneurs pick great partners (broadly defined) to fund their business and make sure both financial incentives and long term goals are aligned, they will have achieved “high performance” corporate governance that will contribute substantially to their eventual success.

Twitter Weekly Updates for 2010-05-15

  • Mortgage Banking magazine features National Infusion Technologies CEO Rich Rollins #

Twitter Weekly Updates for 2010-05-12

Venture capital stimulates economic growth

We’ve written before on a recurring thread found in Thomas Friedman’s recent columns:  the importance of keeping the entrepreneurial spirit strong as a uniquely American source of economic prosperity.  While finding ourselves in agreement, in broad terms, we’ve also noted that Friedman seemed to not connect the dots between increasing taxes on venture capital and hurting job growth.

In yesterday’s New York Times, he connects the first few dots in his conclusion.  The “other taxes (to cut) to stimulate growth” ought to specifically include the carried interest.

“My takeaway is that U.S. and European politicians — please don’t laugh — are going to have to get a lot smarter and more honest.

To be the Regeneration, they’ll have to figure out how to raise some taxes to increase revenues, while cutting other taxes to stimulate growth; they’ll have to cut some services to save money, while investing in new infrastructure to grow economic capacity.”

The federal government, searching for sources of revenue, would be making a costly and short-sighted mistake to do it by dramatically increasing taxes on the one asset class – venture capital – that consistently creates high quality new jobs, even in a terrible recession.

UPDATE 5/24/10:

John Rutledge in today’s WSJ – Congress’s Carried Interest Tax Folly

Tax rates matter. And what matters about them is what activities get taxed, not who gets taxed. When you increase the tax rate on an activity, you get less of it. The only question is how much less of it you will get.

Congress should be asking one question: “Is long-term investment something we really want less of, especially now?” Unfortunately, in today’s political climate, tax policy discussions focus almost exclusively upon who, not what, gets taxed. This means singling out specific groups of people—bankers, Wall Street, “the rich,” the owners and executives of insurance, oil and drug companies—to punish for our economic difficulties. This may be politically popular but will have bad consequences for the economy.

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