Seeing Both Sides

Sloppy Reporting from The New York Times on Carried Interest Debate

I swore I would go offline for much of Memorial Day Weekend.  But I cheated and peeked at my email late Saturday afternoon and discovered an email from a friend saying, "I'm surprised to see you take such a public stance on the capital gains tax rates," with a link to a New York Times article on the topic.

I read the article in The New York Times on the carried interest debate and was shocked to see my name and a reference to me that read:

"As the Senate Democrats sent signs that they were open to a tax increase, investors and their lobbyists mobilized quickly, warning that the proposal could stifle investments that create jobs.  A group of 80 venture capitalists traveled to Boston to urge Senator John Kerry and Representative Barney Frank, Democrats of Massachusetts, to exclude their business from the tax change, according to Jeffrey Bussgang, a partner at the Boston venture capital firm Flybridge Capital Partners."  

Um...here's the problem.  I never spoke to the reporter, David Kocieniewski, who wrote the article (although I later found a voice mail from him).  Other than the fact that my name and firm name are accurate, nothing else in that sentence is correct.

I guess this is just another example of sloppy reporting, but I expect better from the New York Times.  

Since the reporter never spoke to me, I can only assume that the reporter was referring to a blog post I did regarding a trip to Washington DC (not Boston) with 80 business leaders from Massachusetts regarding an organization I co-chair called the Progressive Business Leader Network (PBLN).  In fact, the trip had nothing to do with carried interest taxes and there were only three or four VCs as part of the business delegation from PBLN.  If he had actually read the blog post, he would have realized that it was a trip with a wide range of topics, including cap and trade, innovation investment, deficit reduction and financial reform.  We did not meet with John Kerry, although I did report that we talked to Barney Frank about financial reform and that he did articulate his own position that venture capital would be exempted from the carried interest tax.

If I had actually been interviewed for the story, I would have given a more nuanced position.

Because of the Bush tax cuts, two wars, and the recent economic crisis, we are facing the worst long-term structural deficit in US history.  If we want to avoid the path of Greece or Spain, we need to act quickly with a blend of (unfortunately) higher taxes and lower spending. The only question is what taxes should go up and what spending should be cut.  

In debating what taxes should be increased, we should take a strategic approach.  Personally, I'm willing to and expect to pay higher taxes.  But having those higher taxes be levied against venture capital investments in small businesses strikes me as self-defeating when it is the single largest job growth area.  I'd personally rather see us put in place a carbon tax and/or a gas tax.  Perhaps we should reduce the mortgage exemption in order to shift incentives away from home ownership (how'd that work out?) towards investment and job creation.

Anyway, that's what I would have said if I had actually been interviewed by the New York Times.  Next time, I hope they either actually get my point of view, or leave me out of it and let me enjoy my Memorial Day weekend.

Why Is Four The Magic Number?

No, this post isn't about achieving four wins in the NBA Playoffs.  It's about a historical anomaly in start-up compensation that I'm struggling with.  Although I know this risks being an unpopular post with entrepreneurs, I confess that I no longer get why we have four year vesting schedules for stock option grants at start-ups.  Let me explain.

Vesting is known as the time period during which you unconditionally own the stock options that are issued to you by your company.  Until you vest the stock options, you forfeit them if you were to leave the company.  Typically, that time period is four years.  There is typically a one year "cliff", which means that you don't vest for a year and then "catch up" by vesting 25% of the stock options on the one year anniversary.  Subsequent vesting happens monthly or quarterly, depending on the stock option plan your company has put in place.

I was explaining to a friend the typical vesting at venture capital firms is 8-10 years.  That is, if you leave a fund before 8-10 years from the start of the fund, you risk forfeiting some of your unvested profit interest in the fund, or carry.  I explained to my friend that this vesting schedule made sense given venture capital funds take 8-10 years from managing initial investments through to exits.

Then I realized that vesting at start-ups should also logically match the time it takes from inception to exit.  In looking at the data, it appears that the average time to exit in start-ups during the 1990s was 4-5 years, so the traditional 4 year vesting period made sense.  But since then, the average time to exit has creeped up meaningfully from 4-5 years to 6-8 years.  So why shouldn't vesting schedules reflect this reality?  Why shouldn't the vesting schedule for stock options be 6 years?  Boards are finding that they have to reissue options every 3-4 years because once an employee is fully vested, they naturally come back to the table with their hand outstretched asking for more incentive options to stick around.

In fact, why can't vesting schedules be flexible and simply a part of the overall compensation negotiation?  A CEO would benefit from having the tools at their disposal to adjust vesting dates alongside share amounts and other compensation levers.  In the very early days, you might have six year vesting on stock options.  After a few years, that date might be reduced to four or five, depending on the situation.  Some form of accelerated vesting upon change of control (i.e., a sale) is often a part of the package for senior executives, so if a quick exit were navigated, there wouldn't be a meaningful penalty.

So maybe you can explain it to me, but I just don't get why our industry clings to a historical magic figure of four years.

Barney Frank says: Don't Mess with VCs or Angels

Barney Frank was crystal clear in his briefing with a group of CEOs that I participated in this afternoon:  he is going to make sure that the final Financial Reform bill that gets worked out with the Senate won't mess with the angel or VC communities.

I came to Washington DC today with the Progressive Business Leaders Network (PBLN) group that I co-chair.  It was our group's annual trek to DC where 80 CEOs and business leaders from Massachusetts had the opportunity to dialog with the leadership from the congressional and executive branch.  We met with Congressman Markey to talk about cap and trade (Senator Kerry is releasing his bill tomorrow and one of his staffers briefed us on its content), Senator Warner to discuss innovation investments and deficit reduction, and Congressmen Frank and Capuano to talk about financial reform.

On Financial Reform, Barney Frank was very direct when I pressed him on the myriad restrictions that are being discussed in the Senate bill around angel investing and the discussions about taxing carried interest.  Here's what he said:

• "We will exempt venture capital from the carried interest tax."
• "We will not tighten the regulations on angel investing."
• "We will fight back on any attempts to regulate or register venture capital funds."
• "When this is passed, we will look to loosed RegA to facilitate IPOs."

He confidently stated that the Senate would pass a bill by Memorial Day and that the reconciliation process would be done such that the President would sign a bill by the 4th of July. 

Encouraging support from a powerful source - let's hope he follows through!

If you want to lend your support on this issue, keep track of the NVCA's activities and write your own representative.  Mark Heesen, NVCA executive director, wrote an email to thousands of VCs today stating: "This morning we delivered the letter to every U.S. Senator with more than 1700 signatures from 41 states plus the District of Columbia. You can view the letter here and our corresponding press release here."

President Obama's staffers told us:  "We understand that start-ups and entrepreneurs are the key to leading the US out of the recession."  Again, let's hope both sides of the aisle get the message.

Book Wars - Amazon, Apple and Now Google All Enter The Fray

The book wars are really now in full swing and the publishing industry will be changed forever.

Google announced yesterday that they were going to become a book retailer.  Crazy, right?  What's a search engine company that derives its revenue from advertising doing aspiring to become a book retailer?  But the world's largest source of information "gets it".  Content is king and if they are the source for great content, they will attract more advertising dollars.

Amazon's Kindle was the first disruptive force, but Amazon effectively had the market to themselves and had the market power to dictate terms to publishers and set terms with retailers.  Then, Apple's iPad was released, and suddenly the power shifted away from Amazon to the publishers.  With 1 million iPads in the market after only a few short weeks of sales, it is clear that the iPad is going to be a highly utilized book reading device.  Suddenly, the publishers had a bit more leverage, even though 3 million Kindles have been sold and not all iPads are being used as reading devices...yet. 

The negotiations between the various parties have started getting nasty.  I'm a victim of that, as are other authors.  My book, Mastering the VC Game, is published by Penguin and not available on the Kindle.  That's right, a technology venture capitalist writing a book about entrepreneurship can't produce a book available on the Kindle.  Idiotic, right?  But Amazon and Penguin are locked into contract negotiations and so an April 1st deadline has come and gone and all books released after April 1 are now blocked from Kindle access.

Now, Google is getting into the act.  Their announcement yesterday at a panel entitled "The Book on Google: Is the Future of Publishing in the Cloud?", indicated that Google was still deciding whether it will allow the publishers to set book prices or whether Google gets to set price.  That's a big part of the issue with Amazon as well - who gets to set price?  Does Amazon get to set $9.99 as the retail price or does the publisher set price, just like any manufacturer would with a typical retailer?

Books in the cloud.  Music in the cloud.  Video in the cloud.  Multiple devices accessing diverse content irrespective of location.  The future we've all envisioned is finally here.  The winner in all this?  The consumer.  Now could you just settle up on that Kindle edition thing, already?