Monthly Archives: February 2009

VCs challenge Obama’s plan to up carried interest tax

This article appeared in Venture Beat today. I’ve been meaning to write about this topic for a while, but waited to see how it would develop. As it turns out, Obama, who received a lot of support from several prominent venture capitalists on Sand Hill Road, thought it would be a good idea to tax carried interest as ordinary income. He believes, wrongly, that this would bring in billion of tax revenues each year. Umm… he’s got to be kidding, right? Sure, maybe it works in theory, but whoever advised him on this clearly has no understanding of how carried interest works. His proposal applies to both buyout firms and venture capital firms, but I’ll focus mostly on VCs.

First of all, with the economy the way it is now, only a fraction of VCs will receive carried interest. If that’s the case, President Obama is not going to see billions of tax dollars flowing into government coffers like he hoped he would.

Secondly, carried interest is what motivates these guys to take big bets and invest in world-changing ideas. If you are a post-MBA associate at a prominent venture firm whose working her tail off to make partner, would you still want to put in all that hard work if you found out that the government was going to tax your shirt off? Management fees just pay salary and bonuses. No venture capitalist works for that. They want carry so they can make bank when they get 5x return on their fund.

Thirdly, private equity investments are long-term investments, especially in venture. It’s not as though VCs invest in a company one day and sell it the next day. It takes as many as 7 to 10 years to invest, grow, and harvest a company. This means that it may take as long as 7-10 years before they get their money back. Mark Heesen, the president of National Venture Capital Association, makes a great point when he says that carried interest works as a buffer to weather failures while waiting for the next home runs.

Yes, I do realize there is a difference between angel investors who invest their own money and VCs who invest institutional capital. But if, for that reason, the government taxes the VCs’ carried interest as ordinary income, then those who can will just start investing their own money. And those who can’t wouldn’t have made much money anyway so taxing their carry as ordinary income wouldn’t have been an effective move anyway.

Entrepreneurs and investors, who risk their money and time in an attempt to create new (or almost new) businesses and employee hundreds of thousands of people (here’s where VCs and PE shops differ in a major way) and make life more convenient, should be awarded.

Maybe Mr. Obama is right. Maybe his system will bring in more tax money. But think of the opportunity cost of killing the next google or ebay. That would have been a shame wouldn’t it?

By: Jonathan Lee
Twitter: @hi5at5


Fuel for inspiration

Randy Komisar, a successful entrepreneur and now a partner at Kleiner Perkins, wrote a powerful book called The Monk and the Riddle. Published back in 2000, Randy’s book is a must read. Anyone serious about launching his or her own company should definitely read this book. I first read it as a reading assignment for one of my classes at Babson College. I finished the book in one sitting.

Here’s a quotation from the book regarding risk that has stuck with me for the past several years and to this day helps me fuel my entrepreneurial ambition:

“Personal risks include the risk of working with people you don’t respect; the risk of working for a company whose values are inconsistent with your own; the risk of compromising what’s important; the risk of doing something you don’t even care about; and the risk of doing something that fails to express- or even contradicts- who you are. And then there is the most dangerous risk of all- the risk of spending your life not doing what you want on the bet can you buy yourself the freedom to do it later.”

By: Jonathan Lee
Twitter: @hi5at5

cool start-ups

Here are some cool start-ups I’ve been reading about lately:

  • HubSpot is an inbound marketing system that helps SMEs become more visible to their target customers on the web. I think it’s a pretty cool concept especially in this economy when no one is spending money on anything! Check out their blog to get their latest thoughts on Internet marketing. This company seems to be well financed, having received $12 million back in May from Matrix Partners in addition to the $5 million it received from General Catalyst last year.
  • Tripit is a startup that allows its users to create open travel itineraries and link up with friends, family, and business contacts. Tripit lets you know who may be traveling to the same city as you are.
  • Tripit would go well with, which is like for business meeting venues. For example, through Tripit, you find out that the person you wanted to set up a meeting with is passing through the city that you happen to be in. Why not use worktopia to find a meeting place and have the meeting right then and there instead of flying all the way across country to meet that person?
  • Spring Pad offers free online notebooks to help its user become more organized (e.g. track notes, photos, maps, to-dos, contacts, etc). It sounds almost too simple- and it is- but that’s what I like about it. It’s super intuitive and easy to use. What’s really neat about Spring Pad is that you can share your content with others and integrate webs services to your pad for added convenience. See a demo here and a blog with a detailed description here.
By: Jonathan Lee
Twitter: @hi5at5

We’ve all heard it… is the venture model dead?

I won’t beat this question to death since many prominent venture capitalists and investors have talked about this. I think it’s too early to tell, but if you force me to answer the question directly then my answer is, “No, it’s not dead.. just somewhat broken.”

From the investors’ perspective, an allocation to venture capital still makes sense, but only if they can gain access to high-quality managers. In an uncertain economy, there’s something to be said about investing with managers who have a proven track record. According to some estimates, about 10-20% of all VC managers are responsible for most of the industry returns and that even a smaller percentage of that group has generated sizable returns (2x or greater) more than several times. This is like saying there are only few real players and the rest are posers.

While there are numerous problems in the industry, such as excessive capital overhang (between $60-$70bn according to some), increasing fund sizes, and lack of liquidity (6 VC-backed IPOs in 2008 according to the NVCA), there are still plenty of talented entrepreneurs and innovative technologies and services that can have a huge impact on the market. I really believe in the American entrepreneurial spirit!

In a way, I think the recession could be a good thing for the venture community. Sure, some 1st or 2nd time funds may not be able to raise capital, but that would a) decrease the capital overhang and b) kill bad start-ups, resulting in a lower pre-money valuation. There are simply too many venture firms pumping in too much money into too few investment-worthy companies.

By the way, if you want to know why excessively large funds aren’t good for the investors, go here. This article does a great job of explaining why venture funds should remain small. It makes a lot of sense both for the VC manager and the investors.

Now let’s all pray for a better 2009… though I don’t see things improving until at least 2010. But I’m often wrong.

By: Jonathan Lee
Twitter: @hi5at5

I’m really going to update this blog

I’ve kept several blogs throughout the past few years, but they were mainly personal and… sporadic. I would post a few blogs here and there and eventually get lazy and let the blog die out.l I’m determined to not let that happen this time. It’s a lousy excuse, but I have legitimately been busy. Planning a wedding, going through the b-school application process and looking for a place to live while working a full-time job leaves little time for blogging. So in the spirit of keeping the momentum going (or should I say reviving?) I’ll talk briefly about a cool start-up called Echo Nest I came across recently.

Now, I’ll be the first to admit that I’m not a technology-guru. I don’t exactly understand the details behind how the technology works, but basically, Echo Nest is capable of “listening” to hundreds of thousands of songs and converting them into XML files. It also has the ability to scour the web for articles, reviews, and blogs about certain songs or artists. This allows them to gain a holistic view of all sorts of songs of various artists and genres. As Echo Nest puts it, it has a “musical brain.” Echo Nest is sort of like Pandora Radio, but it my opinion, I think it might be better from a pure business standpoint. Pandora has its limitations because it takes real people to analyze music. I have no doubt that the experts who analyze songs based on hundreds of musical attributes covering melody, rhythm, lyrics, style, etc. can do a great job of helping listeners customize their radio station. However, it has its limitations since people can listen to only so many songs. What makes me think Echo Nest has the potential to be even better is the fact that it can listen to a lot more songs.

Also, I believe Echo Nest isn’t end-consumer-facing. And I believe that’s the correct strategy. There are many established channels like Amazon, Best Buy, and iTunes that would love to get their hands on this technology. Whether Echo Nest licenses its technology or sells its technology to top music distributors, it can stand to make a lot of money if its technology is all that is hyped up to be. There have been other start-ups like Echo Nest that have flopped. Let’s see if Echo Nest can do what others weren’t able to do.

By: Jonathan Lee
Twitter: @hi5at5