Venture Capital in Danger
nytimes.com
nytimes.com
The Patricof article echoes pretty much exactly the position of the National Venture Capital Association (its statement to congress is here: http://bit.ly/M92Ux [PDF]).
Essentially:
1. Venture capital firms are not interdependent with the world financial system - we don't trade public markets, we don't rely on banks, we don't insure things
2. The venture capital industry is small in size and thus not "systemic" in relevance
3. Venture capital firms do not use long-term leverage or rely on short-term funding - i.e. we don't punch above our "equity" weight
4. Regulation under the currently proposed act would significantly increase costs and change the way venture could operate - insofar the parallels drawn to SOX or anti-money laundering are correct
In particular, we'd have to add more administrative staff and would potentially face issues in performance-based contractual relationships with some of our investors (limited partners).
The argument in a nutshell is that the Act seeks to address problems caused by buy-out and hedge funds. We're being lumped into something because of our similar structures, not because of what we do. Transparency is a laudable goal and I think the venture capital industry as a whole would be more open to thinking about making itself more transparent if such regulation recognized that venture is actually not a part of the problem, but an essential catalyst for growth in our economies.
I am personally a subscriber to a libertarian, subsidiarist principle of legislation. There is no need to regulate VC in the way intended by congress: why should we erect barriers to entry, dissuade new investors into venture capital, make it less profitable (than it already is)?
And if anyone thinks I'm crazy, I want to point out that Mitt Romney has always described himself as a "venture capitalist," as far back as his 1994 Senate run, although everyone knows that Bain Capital is a PE shop.
Disclaimer: I did my time on the dark side at a healthcare VC firm, and now I'm on the entrepreneur side.
Debt is a complex subject, but FASB has well-defined means to determine whether a security instrument is debt or equity.
Restrictions on the use of derivatives is as easy to restrict as debt instruments.
What's the benefit of all of this? Getting a bunch of legalese reports from surviving VC's that say "we have no leverage?"
In the present case, we tend to spend all our time talking about how this will impact current VC firms. Existing VC firms have the advantage. The real question is how this will impact VC firms yet to be formed (or even yet put on a napkin).
At some level of regulation, new competition will be completely thwarted (imagine having to spend the first $10M and the first year of your startup achieving regulatory compliance), but what is often missed is the marginal effect. Any marginal increase in regulation will create a corresponding marginal decrease in new entrants just as assuredly as if you could artificially raise their expected cost to get to profitability (because that's exactly what regulation does).
This is why existing players in a market often lobby for regulation of their own market, or at least acquiesce to it without too much of a fight.
We know how this is going to play out. VC firms with ties to congress critters are going to get special treatment, just like banks with such ties do. Firms that don't make such ties are going to be penalized.
Reading Felix Salmon et al, the solution is for one large regulator with the sophistication to match the large and diverse financial institutions, to eliminate the turf wars and jurisdiction shopping of the past. Combine the SEC and the CFTC (which, guess what, knows how to regulate derivatives), and give the new SEC sufficient enforcement powers.
Furthermore, the regulation only makes VC shops (as well as PE and hedges, which all have the same GP/LP structure) file the exact same stuff that Vanguard, Fidelity, and other mutual fund companies already file. I love how the VCs never once mention this. Probably because it sounds so reasonable.
Which will always be a problem, so you've just told us one of the mechanisms for regulatory failure.
> You've got AIG
Bzzt - AIG was not just under OTS, they were also under insurance regulation and a couple of others. And they were regulated in several countries, often in multiple ways, not to mention states. And these agencies cooperated.
AIG was pretty much a best case for regulatory success.
And now it's a conduit for payoffs to Goldman Sachs. (Yes, I know the collateral story. I'm hoping that someone will post the details so I can show how it doesn't mean what they think it does. GS should have been left holding the collateral.)
That seems like a pretty stretchy way of using the word 'danger'.
If venture capital would truly be in danger then that would imply that funds would be forbidden to operate, but that is not the case at all.
There is simply a shifting of allowing funds to operate without oversight to one where the authorities have an inside view at what is going on.
Since the IRS and other arms of the government already have this insight what is wrong with allowing the SEC access to similar information ?
http://fei.mediaroom.com/index.php?s=43&item=204
While (hopefully) this regulation won't be as burdensome, it doesn't need to be that large to cause problems. VC funds aren't that large.
There is no benefit and potentially large cost to regulating VC.
taken by itself the 1.7 million figure is useless.
There is a cost to running a VC operation, reporting is part of that cost. if - and it remains to be seen if it really will go that way - these laws will be made to bear on VC companies then you can bet that the cost of compliance will be a small fraction of the size of the fund.
No need to start saying that 'venture capital is in danger'.
Venture capital companies possibly slightly less profitable would be a better title.
There are also knock-on effects: if VC becomes less profitable, some investors will put their money into other instruments. The problem isn't just that we might get smaller profits on existing VC funds, the problem is that we might get fewer investments into VC.
The sole benefit is that congress and the president get to pretend they are doing something about the financial crisis.
If you want to say my title was a little overblown, fine. But it doesn't change the fact that this proposed regulation poses a significant risk of reducing the amount of VC invested into startups.
I feel like the article wanted to point out the side-affects of this new legislation as it applies to VC funding. I don't think the intention of the law was to necessarily monitor VC operations, but with such a broad regulation that's what's going to happen.
Keep in mind though that at the same time there are some things the government is doing to promote small business, such as providing billions in funding for the Small Business Association. Not all bad I guess, but still not a fan...
Actually, they don't. The IRS doesn't get much of anything that isn't directly tied to income and expense.
Note that this regulation treats VC funds more harshly than criminal enterprises.
Yes, criminal enterprises can report income and expenses and pay taxes through the IRS without any fear that the said reports will be used against them. (In fact, in some cases one can even pay the drug-for=recreational-use tax and avoid most/all of the criminal sanctions. Few bother because the tax is extremely high. However, I suspect that a few rich stamp collectors have paid for the relevant stamps just to build their collection.)