Last week I heard some interesting gossip from a high profile Silicon Valley CEO.He said the Bush Tax cuts are going to have a big impact on the startup landscape this year.
It was the first I’d heard of it, so I asked around. I asked a few venture capitalists if this was in fact happening, and they confirmed it. I went to a research analyst who covers publicly traded technology companies and he said the same thing.
So, what’s happening?
At the end of 2012, the USA is scheduled to eliminate the Bush Tax Cuts. This means that capital gains taxes will jump from 15% to 20%. Given what President Obama has been trying to push with the Buffet Rule and other taxes, many people fear that if re-elected, Obama will try to push capital tax rates to at least 30% and as high at 39%.
Because of all this uncertainty, the people who invest their money in venture capitalists (Limited Partners) are asking venture firms to be more aggressive in selling start-ups in 2012. They want to maximise their capital gains in 2012 and take advantage of the smaller tax rate. The founding entrepreneurs running start-ups are also going to be subject to a higher capital gains tax on their founder stock beyond 2012. They also have an interest in selling this year, at the right price.
The VCs themselves are also motivated to extract as much gain as possible in 2012. Since it’s uncertain if the “carried interest” fee charged by venture firms will still be taxed at the capital gains tax rate beyond 2012.
On the other side of the equation, with Facebook going public in May, they will be flush with even more cash on their balance sheet. This will allow them to make multiple acquisitions at any price they want. Which is why companies like Twitter, Google, and Yahoo are preparing to battle it out with Facebook for promising start-ups.
What you might see for the rest of 2012 is a lot of M&A activity driven by startups and venture capitalists wanting to get exits and big tech companies hungry to beat each other out for promising start-ups. In short, you have buyers ready to pay a premium and sellers motivated to quickly close transactions over the next six months.
During this research, I talked with several shareholders of Facebook stock and they said with the uncertainty going into 2013, they plan to sell a lot of their Facebook shares as soon as the six month lock-up period ends after the company goes public. They also want to take advantage of the lower tax rate in 2012. With Facebook scheduled to IPO on May 17th, you might see a massive sell-off of Facebook stock beginning December 17th, 2012. Just in time to get that lower tax rate.
While the topic of taxes and how to treat capital gains is a subject onto itself, I tend to agree with one thing that Timothy Geithner, United States Secretary of the Treasury, said to congress a few months back during the debt ceiling debate: “The USA, with all it’s size and responsibility, cannot continue to have uncertain tax policies from year to year”. That is something that no one from either party can dispute.
We need a long-term, stable tax policy so that individuals and corporations can plan their activities accordingly. I bet some of the start-ups that will be sold in the next several months might have not been sold if the above situation was not playing out.
It’s sad, since a few of them might have become the next Google or Facebook. Which, in the end, would have be a better outcome for both the country and the start-up ecosystem.
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