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The Weekend Pitch |
May 16, 2021 
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Presented by Vendr |
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Hello and welcome back to The Weekend Pitch. Adam Lewis here. Guess what? Monday marks the deadline to file your 2020 tax returns.
For private equity and venture capital firms, it might also mark one of the final opportunities to take advantage of a carried interest loophole politicians have pledged to close for more than a decade. That could force some investors into making some big decisions about their investment models and perhaps paying as much in income tax as their admin assistants. Crazy, right? So let's just get right to it. And if you have feedback, hit me up at adam.lewis@pitchbook.com or on Twitter at @AdamLewisPI. |
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| Private equity and venture capital investors could be facing a much bigger tax bill in the near future. (Scott Olson/Getty Images) |
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Private equity and venture capital professionals in the US are a step closer to being taxed at a much higher rate on their income.
Democratic senators earlier this week introduced a new bill that aims to close the carried interest loophole, setting the stage for top earners to see their tax rates on investment gains roughly double.
The National Venture Capital Association and the American Investment Council, the lobbying groups for the VC and PE industries, have denounced the proposed hikes. But that doesn't change the reality: Investors should easily be able to sustain the higher tax burden, in part because they've never had more money in their coffers.
North American venture capital has beat out every competing asset class in three-year IRR performance, at 18.51%, according to PitchBook data. And North American private equity ranked second at 15.09%, besting real estate, secondaries, private debt and more. Plus, private investors collectively had about $1.5 trillion in dry powder at the end of 2019, according to reports. A higher tax rate won't keep them from deploying capital, despite the NVCA's claims that higher taxes will disincentivize long-term investments.
After all, firms have contractual obligations with limited partners to deploy their money. If anything, the threat of a higher tax rate should motivate general partners to do everything to maximize profits.
Investors knew this change was coming. Even before the latest legislation was unveiled, tax fund advisers in the private equity industry expected a hike in capital gains taxes and began advising clients to be prepared.
"We know what's going to change," said CohnReznick managing principal Jeremy Swan, referring to the hike in capital gains. "We just don't know how bad it's going to be."
Critics of private equity have lobbied for years to increase the capital gains tax rate for fund managers. And calls for change intensified after President Joe Biden announced a provision to end the loophole as part of his "American Families Plan," a $1.8 trillion spending package that seeks to expand access to childcare, education and more.
The Democrats' new tax measure would raise roughly $15 billion over the next decade. But those who have decried Wall Street greed have seized on the bill's symbolic nature, pointing to the country's widening income inequality. Sens. Joe Manchin (D-W.Va.), Tammy Baldwin (D-Wis.) and Sherrod Brown (D-Ohio) introduced the legislation, which has a similar version circulating in the House.
"The carried interest loophole is yet another example of Wall Street executives exploiting our tax code to pad their pockets rather than invest in workers and Main Street," Brown said in a statement.
Dubbed the Carried Interest Fairness Act, the legislation would raise the carried interest tax for individuals to 39.6%, the top proposed federal income tax rate. Current tax laws treat carried interest profits as long-term capital gains, which can be as low as 20%. To put that in perspective, a single filer making about $41,000 annually pays 22% in federal income tax. Not exactly a balanced system.
Yet when Biden introduced his plan, it was unclear whether he could garner support from Republicans and Democrats, many of whom have deep ties to venture capital and private equity. Doing away with carried interest tax treatment has been floated for years but never received enough support in Congress to pass. Former President Donald Trump campaigned to end the loophole before ultimately agreeing to leave it out of tax cuts passed in 2017.
But circumstances have changed with Democrats in control of the presidency and Congress. The good news for general partners: Biden has signaled a willingness to negotiate on tax rates, leaving hope that a compromise might be reached.
"I expect it might be likely that you find some sort of middle ground there, you know, maybe you're talking about 25%, 28% raise, something like that, as opposed to going all the way to 39.6%," said Robert Richardt, a CPA and partner at CohnReznick.
Some venture capitalists have signaled support for the principle of a tax hike. Khosla Ventures founder Vinod Khosla said last month that "sharing the benefits of capitalism is not terrible."
Make no mistake. Change is coming.
Biden has also proposed raising the corporate tax rate to 28% from the current 21%, and the top income tax rate to 39.6% for individuals earning more than $400,000 annually. That would cut into the income of fund managers, not to mention publicly traded buyout shops such as Blackstone, KKR, The Carlyle Group and Apollo Global Management. But that hasn't made firms jittery. At least not yet.
"I haven't seen a lot of current changes in behavior," Richardt said. "And it's a little bit difficult at this point, with a lack of clarity on exactly what the changes are going to be." |
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"We have quite enough cash in hand. It's not that we don't invite third-party investors at all, but we don't have to beg for participation."
—SoftBank CEO Masayoshi Son, on the company's intention to do its own funding of its tech-focused Vision Fund 2 |
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| (Maja Hitij/Getty Images) |
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Cryptocurrency followers could use a rest. Even by the standards of the wild world of digital currencies, things seemed especially volatile thanks to digital coin news ranging from Elon Musk to a high-profile money-laundering probe to a stellar debut of a new currency and then back to Musk for good measure.
- First was the reaction to the Tesla CEO making his much-hyped star turn on "Saturday Night Live." Dogecoin, the digital currency that has soared to global fame in part because of Musk's public musings about it, took a dive in value after he poked fun at it on the show.
- Later came word that US authorities have opened an investigation into VC-backed crypto giant Binance as part of a crackdown on illegal transactions done through crypto exchanges. The startup told Bloomberg it collaborates with law enforcement and has built a "robust" compliance program.
- On a more hopeful note for crypto bulls: A new digital token known as Internet Computer shot to a debut market capitalization of about $45 billion, making it one of the world's top cryptocurrencies.
- An electric jolt brought the market back down to Earth after Musk made a stunning announcement: Tesla has decided to stop accepting bitcoin for vehicle purchases, citing concerns about environmental costs of mining the coin. The program had helped fan global excitement and coincided with bitcoin's leap this year to record levels. Bitcoin, which had previously touched an all-time high of over $63,000, tumbled below $48,000 before returning on Friday to the $50,000 range.
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| ... That as flying-taxi startups seek to get off the ground, investor dollars have funneled into late-stage companies recently, led by businesses based in the US and Germany. Powered by a slew of SPAC mergers and related PIPE investments, those bets totaled $3.8 billion in Q1 for the likes of US-based Joby Aviation and Archer Aviation and Germany's Lilium, according to PitchBook data. |
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| These are flush times for the five publicly traded private equity giants. Trailing 12-month returns are on the upswing, with annual gross performance surpassing 40% for each of the firms. At Apollo Global Management, returns topped 66% for the year. In a new research note this week, PitchBook analysts Wylie Fernyhough and Rebecca Springer took a deeper look at the industry's remarkable run of earnings growth. |
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| (the_burtons/Getty Images) |
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Amazon's global empire can be measured in many ways. One notable indicator is the flood of capital going to companies that acquire small sellers of goods through ecommerce marketplaces, primarily Amazon.
Consolidators of third-party Amazon direct-to-consumer sellers have been growing—and fundraising—at a significant clip.
- Joining the parade earlier this week was Acquco, an ecommerce roll-up company that announced a Series A of $160 million in equity and debt from investors including CoVenture, Singh Capital Partners and Crossbeam. Led by founders who previously worked at Amazon, Acquco told TechCrunch it owns a brand portfolio that's already doing $100 million in revenue for its first year in business alone.
- Acquco is chasing bigger companies like Thrasio, which earlier this year said it turned a profit of over $100 million on sales exceeding $500 million during 2020. The company, founded in 2018, has raised hundreds of millions of dollars this year alone—including a $750 million round in February—from PE firms and other institutional investors.
- Branded, another operator of third-party sellers, raised $150 million in February from investors including Tiger Global.
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Recommended reads
Airbnb was at a crossroads—financially and spiritually—when the pandemic hit. Inside Brian Chesky's plans to conquer a reopened world. [Fast Company]
It's said that only 44 people have reached the summit of all 14 of the world's tallest peaks. But have they really? [The New York Times]
An exploration of the many benefits of practicing kindness in the workplace. [Harvard Business Review]
As borrowers—particularly those in Europe—sell debt at low rates and with easier terms, investors are rushing into "pick-your-poison" junk bonds. [The Wall Street Journal]
A day in the life of Wall Street shows that New York City is on the cusp of a comeback from the pandemic. [Bloomberg]
The housing market is still incredibly strong, but the post-pandemic boom could finally be reaching its climax. [Fortune] |
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"Founders have figured out that they can raise capital from their kitchens, bedrooms, and offices in weeks vs roadshows that lasted months. I don't think we will see founders going back on the road in any material way ever again."
—Fred Wilson, Union Square Ventures partner
"Seeing more $50m rounds for companies that don't have a product yet. We're at that point in the cycle where investors will gladly take on pre-seed risk at a Series A price ..."
—Soona Amhaz, Volt Capital general partner
"One surprising thing I've noticed living in the UK is that Twitter gets angrier when people in the US wake up, and especially once they wake up in San Francisco."
—Paul Graham, co-founder of Y Combinator
"In all this time, I did not know that you could drag & drop people around in @Zoom. Mind blown."
—David Chang, entrepreneur |
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This edition of The Weekend Pitch was written by Adam Lewis, Alec Davis and James Thorne. It was edited by Alec Davis and Angela Sams.
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