Carry controversy divides asset classes

At yesterday’s Senate Finance hearing on carried interest tax, National Venture Capital Association board member Kate Mitchell took pains to distance venture capital from other alternative asset classes under the Congressional microscope.

Kate Mitchell, a board member of the National Venture Capital Association and managing director at Scale Venture Partners, yesterday stressed to the Senate Finance Committee that venture capital differs greatly from private equity and hedge funds.

“We do not rely on leverage; we do not rely on financial engineering, nor do we buy and sell publicly traded securities,” she said. “Instead, we help entrepreneurs create new companies and sometimes new industries, with all the jobs and economic growth that come with them.”

Asked to testify about the economics of carried interest within a venture capital partnership, Mitchell repeatedly emphasised that venture capital is a small industry and less attractive to limited partners than other alternative asset classes because of its cyclical, high-risk, long-term nature.

“We’re an asset class that’s less attractive because we’re less efficient for them,” she said.

Taxing carry as ordinary income at 35 percent instead of as capital gains at 15 percent would increase the cost of doing business, result in less capital going into venture, and create fewer Googles, eBays and Genentechs, she said.

Slides in the 70-page PowerPoint presentation that accompanied Mitchell’s written testimony stressed that buyout and mezzanine funds typically out-raise venture funds by “2x to 4x”, and that venture pales in comparison to hedge, mutual and buyout funds in terms of capital raised each year.

The controversy surrounding the tax on carried interest – as well as on publicly traded partnerships – is also dividing Capitol Hill.

“On the carried interest issue, knowledgeable people cannot even agree on the problem, let alone a remedy,” Senator Ron Wyden, a Democrat from Oregon, said at the Senate Finance hearing.

Senate Finance Chairman Max Baucus, a Democrat from Montana, and Charles Grassley, a Republican from Iowa, have introduced legislation that would tax publicly traded partnerships as corporations, yet Treasury Secretary Henry Paulson has opposed the legislation, saying it unfairly singles out certain industries, Wyden noted.

“What does it say about the grotesque complexity of the tax code when the Chairman of the Finance Committee and the Secretary of the Treasury cannot agree on whether the legislation eliminates an existing tax preference to level the playing field, or singles out one type of business for different tax treatment?” he asked.

Though the majority of senators and witnesses in attendance at yesterday’s hearing voiced concerns that a change in tax treatment of carry could have adverse affects, the committee has yet to make a decision and plans to continue to study the issues.