|IVCA Feature: 2017 National Legislation Perspectives from the National Venture Capital Association, Small Business Investors Alliance & American Investment Council|
IVCA Feature: 2017 National Legislation Perspectives from the National Venture Capital Association, Small Business Investor Alliance & American Investment Council
February 1, 2017
With the new year, the new Trump administration and the new Congress, there is always a question as to what legislation and regulations will come to the forefront for the Venture Capital and Private Equity industry. The IVCA went to the industry's three advocacy organizations in Washington, D.C., to gain their perspective on what to expect.
The National Venture Capital Association (NVCA), the Small Business Investors Alliance (SBIA) and the American Investment Council (AIC) all weighed in.
The IVCA asked four questions regarding the upcoming federal legislative year, within the context of a brand new Congress and presidential administration, and each organization answered those questions from their point of view. The questions are:
IVCA: What were the legislative victories for the organizations in 2016, and what are the legislative priorities for 2017?
National Venture Capital Association: We saw a number of legislative victories for the venture industry in 2016, such as a 5-year extension of key small business funding programs with the SBIR [Small Business Innovation Research] and STTR [Small Business Technology Transfer], increased funding for the National Institutes for Health and precision medicine initiative with the ‘21st Century Cures Act,’ the creation of a small business advocate within the Securities and Exchange Commission with the ‘SEC Small Business Advocate Act,’ and new basic research and technology commercialization opportunities with the ‘American Innovation and Competitiveness Act.’
2017 will be an incredible year of impact for venture capital and entrepreneurship policy. Tax reform is one of the top priorities in Washington, and something we are actively engaged on. We have been having conversations with policymakers and the new administration about how tax reform can encourage new company formation. We are also likely to see action on immigration enforcement and the NVCA is focused on making sure immigration measures do not harm the entrepreneurial ecosystem. We will continue to be the leading advocate in Washington for a job-creating immigration idea called the Startup Visa so that talented immigrant entrepreneurs can grow successful companies here in the U.S. We also see opportunities to right size the regulatory environment for startups and their investors.
Small Business Investor Alliance: We came into 2017 with a beautiful problem. In the last Congress [2015-16], we successfully passed into law most of our legislative priorities. While other financial associations were shooting for the moon and getting nothing, we were picking our shots and scored wins. We were able to broaden the scope of the investor-advisor registration exemption for managers that had both conventional funds and SBIC [Small Business Investment Company] funds. We were able to legislate the creation of the Office of the Small Business Advocate at the SEC to force them to look at the impact on the lower middle-market when regulating. We were able to make permanent two targeted tax provisions for VC/PE and BDCs [Business Development Companies]. We were able to repeal a new Ohio tax on lower middle market investments.
We also were able to make progress on the ‘Investment Advisers Modernization Act,’ which provides regulatory relief for private fund advisers. The bill passed out of the House Financial Services Committee in July, and came to the House floor in September 2016, all with bipartisan support. We will continue to work on this bill, as well the rest of our priorities for 2017.
American Investment Council: In 2016, our main legislative issues were the maintenance of the current tax treatment of carried interest as a long-term capital gains for Private Equity, to maintain full interest deductibility and to maintain the current tax treatment of pass-through businesses. And during 2016 we were dealing with the campaign cycle, in which many of these issues were raised in the trail. We effectively pushed back on mischaracterizations, and championed what would actually be good policy moving forward. As far as our victories, we had a good opportunity – and seized upon it – to educate lawmakers in the House, Senate and the former administration to explain why current tax treatments are appropriately categorized as they are.
In 2017, we want to continue the work that we’ve done, and we’re making good progress already on educating incoming lawmakers and members of the new administration as to why these issues are important and why they’re currently treated as they are in the tax code.
IVCA: What are the key wish-list legislative issues for the industries and associative industries you represent, and how does the organization impact those issues?
NVCA: We strongly believe that, in order to best achieve the goals of job creation, economic growth, and expansion of economic opportunity, tax reform must encourage new company formation. While the tax code has been effective in encouraging patient, long-term risk investment, it has been somewhat hostile to entrepreneurial companies. For example, the benefit of the R&D credit remains largely inaccessible to startups while punitive loss limitation rules can arbitrarily punish startups for hiring or investing in innovation. Unfortunately, tax reform proposals so far have ignored these issues while at the same time proposing to increase taxes on the entrepreneurial ecosystem in order to pay for unrelated priorities.
We are advocating that tax reform must protect successful policies such as carried interest capital gains and Qualified Small Business Stock [QSBS] rules which encourage capital formation for startups, and dedicate a section in tax reform that would encourage new company formation.
On immigration, we are working closely with members of Congress on the Startup Act. We back the ‘Attracting and Retaining Entrepreneurs Act’ by Senator Jeff Flake [R, Arizona] that would create a Startup Visa and will push for that bill to be included if there is movement on immigration reform. We are also working with Senators Jerry Moran [R, Kansas] and Mark Warner [D, Virginia] – two champions of our industry – on reintroduction of their ‘Startup Act,’ which includes a startup visa and visas for foreign-born STEM graduates.
We impact these issues by educating lawmakers on the positive impact of young, high-growth companies on the Americans economy and just how critical the relationship is between entrepreneurs and venture capitalists. We find the most effective way to make these points is by being actively aligned with VCs across the country so members of Congress understand how federal policy affects their local economy.
SBIA: We are going to build upon our successes and our reputation of being an honest broker. SEC regulatory relief for PE, comprehensive pro-growth tax reform, and modernization of BDC regulations are at top of our priority list. Smaller PE fund investments create value and jobs. Lower middle-market PE needs to be the face of the industry and not let us get branded as the Wall Street/Too-Big-To-Have-Sympathy-For crowd. Middle and lower middle-market investing is the heartbeat of a growth economy, yet we are burdened by the high cost of compliance created under the ‘Investment Advisers Act.’ We propose, for example, significantly raising the registration threshold to help ease the burden on private fund advisers so they can spend more time creating opportunities than filing paperwork. Scale matters and the regulatory burden should scale down with fund size. Similarly, on the BDC front, regulations must be modernized so that small and mid-sized American businesses can get more capital flowing into the market.
On tax reform, the industry better buckle up, sharpen their pencils, and get to the table. Being a free rider and hoping someone else will be the voice for your fund may be one of the most expensive mistakes of your professional career. Everything is on the table this session...absolutely everything. If you don’t think that there are hordes of lobbyists trying to protect their industry by shifting the cost to private equity, you are profoundly naïve. If you are not at the table, you will be on the menu. Taxes are on the table, and the knives are out. Tax reform may be the closest thing to a guaranteed outcome of this Congress, and you absolutely must look at Speaker Paul Ryan’s tax plan in its entirety to see how it will affect your fund, your business model, and your portfolio companies. Go to abetterway.speaker.gov.
There will be changes in corporate tax rates, the deductibility of interest expense, depreciation, the treatment and taxation of pass-through entities, and more. Don’t look at each part as being mutually exclusive, look at how all the parts works together. Once you’ve taken a deep look and really run the numbers, let us at SBIA know what parts you like and what parts you don’t.
The SBIA has been the most successful voice of private equity for a reason. The middle market has a great story to tell, and we tell it. Understanding what’s going on in Washington and formulating next-level strategies earn tangible results.
AIC: In 2017, we expect to see tax reform. We’re not sure yet as to the scope of this tax reform, but we hope within the new code we maintain full interest deductibility. This is not just a private equity issue, it's for companies of all types and sizes – it's simply a cost of doing business. We also feel that carried interest, as it relates to private equity, venture capital, real estate and other long term investments, is appropriately categorized as a long term capital gain, and we want to see that maintained as tax reform takes place. And finally, we hope to see no adverse policies put into place that would be harmful to the tax burden of pass-through businesses.
IVCA: The new administration of President Donald Trump is business focused and oriented. What impact do you think this will have on the legislative and executive agenda for industries that your organization represents?
NVCA: We know that many parts of the country feel left behind by the economy and we have expressed our strong interest in working with President Trump to spread entrepreneurship in these areas of the country. The reality is we are seeing exciting startup ecosystems popping up in many atypical places and federal policy should support these areas.
We also see a great opportunity to work with President Trump on a variety of regulatory matters. One example is the Registered Investor Advisor [RIA] rules that were designed to get some transparency on hedge funds but that unfortunately affect growth-equity VCs. RIA rules are causing unnecessary compliance costs and headaches and we hope to work with the new administration on relief.
SBIA: Predicting President Trump is not an easy thing to do, but this administration has the potential to make significant pro-growth change to our tax and regulatory structure. The biggest changes will stem from the fact that ‘people are policy.’ As heavy-handed regulators are replaced by people who have done business and understand business, you will see a very different approach to how the laws and regulations are applied. This will be true for the SEC as well as for many bank regulators. Finally, there will be real checks on regulators.
AIC: One of the promising signals we’ve seen from the new Trump administration is that he has surrounded himself with key business leaders, including a number of current or former private equity executives. We think they will provide sound advice in the area of tax reform moving forward, and there is more of a pipeline in place for private sector CEOs, founders and executives to be advisors to the administration – whether it’s directly to the White House, or Treasury or the Department of Commerce.
Those are promising signs to us, and generally speaking I think this administration will be focused on growing the economy, and driving a pro-jobs reform package. We think not only will we see the maintenance of our key tax reform issues, but also regulation that is more tailored and focused on issues that matter to the private equity industry and the alternative investment space in general.
IVCA: Since legislation is the art of compromise, what compromises in Congress might work against the legislative agenda that your organization represents, and how can the industries you work with contribute to the conversation regarding legislative action on a national level?
NVCA: One of our biggest jobs is making sure Congress and the Trump Administration understand the value of venture capital to the American economy and to innovation. It is essential we spend time educating Washington about venture so that our members are not the victims of a compromise or of unintended consequences.
Members of NVCA and IVCA can help fight for the industry by coming to Washington to meet with policymakers, plan regional events with members of Congress, and by organizing Op-Ed pieces in local papers. NVCA can help with all these. We also strongly encourage you to attend the NVCA Annual Meeting in Washington on May 10th. We will be joined by policymakers that are critical to our industry and spend the next day talking to lawmakers on Capitol Hill.
SBIA: Overreach is the Republicans’ – and the industries wanting regulatory relief – biggest Achilles Heel. The Republicans won’t compromise with the Democrats on tax reform because they won’t have to. However, they will be forced to compromise with their fellow Republicans. The growth hawks and the deficit hawks must find an understanding on the budget to get tax reform, and intra-party fights can get ugly. While massive, fundamental changes to Dodd-Frank can pass the House, they likely will not all get through the Senate with the eight Democrat votes needed to become law. Democrats won’t stop being Democrats, just because they are in the minority...they are willing to bend, but they won’t break. Reasonable changes to Dodd-Frank have a decent shot, but swinging for the fences will result in no joy in Mudville. The industry needs to pick its shots to score some wins.
The best way to get involved and help the industry is to join an association that is looking after your interests, keeps you informed, and efficiently helps you communicate your priorities to policymakers. IVCA does an extraordinary job of this at the state level – the best in the country. Over the next two years, you will need something similar at the federal level too. Finally, your portfolio companies have a lot at stake as well. They should be part of their specific industry’s trade association to make sure they understand the changing tax and regulatory landscape in which they will be operating. A great investment can swing to a poor investment by changes in the tax law or regulation. The government is fully capable of accidentally destroying businesses.
AIC: The first and most glaring compromise that is being proposed is replacing full interest deductibility with 100% expensing, which is in the House Republican blueprint. This would be detrimental to companies that use debt financing, so we’re still fully supportive to maintaining full deductibility. We are working with the members of the House and the Senate to articulate the reasons why we feel that 100% expensing is not a serviceable substitute for interest deductibility.
Fortunately for us, we think the new administration recognizes that this isn’t a good trade off; they would prefer to see some optionality in place. For example, a manufacturer could choose to use 100% expensing or interest deductibility for their business. So we think the concept of optionality is a good compromise, although our preference would be to maintain full interest deductibility.