VCs’ love-hate relationship with the GOP

November 4, 2010, 6:55 PM UTC
Fortune

Venture capitalists hate their taxes but love green energy. Here’s how the issues stack up for the financiers now that the Republicans run the House.



VCs had a victory in California for clean energy.

Venture capitalists are difficult to define politically. On the one hand, they are wealthy financiers who fit snugly in the Republican wheelhouse. On the other, most of them live in Democratic bastions like suburban Boston and Silicon Valley.

This partisan split also appears in the specific policies that affect the VC industry. In terms of taxes, a GOP-controlled House of Representatives is more likely to produce VC smiles come April 15. In terms of energy policy, however, Tuesday’s election will result in broken dreams. On immigration, healthcare and financial regulatory policy, it’s mostly a wash.

Here’s how the biggest issues break down with the venture capital community:

Taxes

For the past two years, venture capitalists have been operating under the assumption that their taxes were going to significantly increase. This was not only because of the expiring Bush tax cuts – including those nifty ones on capital gains – but also because Democrats had promised to change the tax treatment of carried interest (the percentage of profits that VCs keep for themselves, before distributing the rest to investors).

Now, they have reason to be optimistic.

The last serious attempt at filling the carried interest loophole came this past spring, when a so-called “tax extenders bill” went down in flames. Harry Reid didn’t even bring it up for a final vote in the Senate, after Republicans objected to unemployment insurance provisions tied into the same legislation (Democrats later passed that insurance, but not the carried interest change).

Conventional wisdom says that a GOP-controlled House means even bigger trouble for carried interest legislation, which is good news for venture capitalists. This isn’t to say, however, that VC lobbyists have counted all of their chickens.

One possible scenario is that Republicans could use carried interest taxation as an olive branch in order to get Democrats to sign onto larger tax reform or budgetary measures. They could position it as closing a tax loophole (i.e., not a tax increase), and save face at home since very few of them hail from VC-laden states like California or Massachusetts. Were this to happen, expect VC, PE and hedge fund managers to get hit, and real estate and energy partnerships to be exempted.

But, again, the most likely outcome is maintenance of the status quo. For VCs, that’s a win.

Energy

A growing number of VC firms have launched energy investment practices over the past few years, with a particular emphasis on “clean” technologies and infrastructure.

Their general hope was that Congress would pass comprehensive climate change legislation, or at least an energy bill that includes things like renewable energy standards and the formation of a Clean Energy Deployment Administration (CEDA).

The former now looks dead, while the latter is on life support. The National Venture Capital Association says it will likely be at least two years before any bills will even be considered.

But energy VCs got a big win the state level, in the form of Prop 23 in California. The ballot initiative was designed to suspend the state’s landmark air pollution bill signed by Gov. Schwarzenegger in 2006, until California proves able to sustain a 5.5% unemployment rate for one year (it’s currently above 12%). The measure, which was defeated by voters, was strongly opposed by the VC community, which felt that the anti-pollution law had turned California into the nation’s most successful incubator for cleantech companies (and, in turn, cleantech jobs).

Immigration

Venture capitalists have a serious interest in immigration, albeit not in hot-button topics like border security, amnesty or undocumented housekeepers. Instead, they want to reduce to hurdles to legal immigration among entrepreneurs and related technologists.

Earlier this year, for example, Senators John Kerry (D-Mass.) and Richard Lugar (R-Ind.) introduced the Start-Up Visa Bill, which would have created special visas for immigrant entrepreneurs who had received venture capital to launch companies in the United States.

Venture capitalists lobbied hard for the measure, but so far it’s gone nowhere. Much of the blame has been pinned on the White House and Democratic leadership, for insisting on comprehensive immigration legislation that would cover both legal and illegal matters. The rest goes to Republicans, who have refused to entertain such comprehensive proposals.

In other words, this is a bi-partisan problem. Things like the Startup Visa Act may finally get passed during this Congress, but it’s unlikely to be because of a change in control.

Healthcare

Approximately half of all venture capital dollars are invested in life sciences companies, the vast majority of which are overseen by federal regulators. The massive healthcare reform bill – which many Republicans have promised to amend or repeal – certainly has an impact, but VCs are more concerned with three less controversial policy efforts:


SBIR grants
: These are small research grants given to companies by large federal agencies like the National Institute of Health and Department of Defense. Excluded, however, are companies with 49% or more of their shares being owned by venture capital firms or their affiliates. This seems to be about how one defines “small business,” and has no discernable partisan leaning.


Patent reform
: This is an issue that splits VCs, with biotech-focused VCs wanting more patent protections and software-focused VCs wanting less. Congress seems relatively uninterested in doing either.


FDA reform
: VCs are hoping that the GOP will take its regulatory scalpel to the FDA, in order to help reduce the costs and time associated with bringing a healthcare product to market. Even odds here, since Republican Party principles can run into fears of being seen as soft on safety.

Financial regulation

The Dodd-Frank financial reform bill requires that private equity funds of a certain size register with the SEC. Venture capital funds were specifically exempted, with “venture capital” to be defined at a later date by the Financial Stability Oversight Council. Congress technically has oversight responsibilities here, and could intervene if the Council makes the “venture capital” definition too narrow. But it’s not a partisan issue, as both Democrats and Republicans tend to hold VCs up as exemplars of job creation.

Beyond that, some VCs hope that the GOP will try to relax some parts of Sarbanes-Oxley, in order to facilitate more IPOs by smaller companies.