Start up companies are supposed to be the economic engine that gets us going when we come out of recession. The Obama administration has gotten behind the Start Up America program. In case you have forgotten, in June of 2010, he allocated 2 billion to Solar Energy start ups.
Encouraging start ups is the right thing for the government to do. However, these private/public partnership things rarely work out.
I would rather see a broad based tax incentive to invest and build start ups. It would look something like this;
1. Tax credit for all angel investors to invest in a start up. (this incents risk capital to go to start ups. Investors get a write off on their income-but in return they are putting money into a risky enterprise that may or may not pay off. If it pays off, it’s better for everyone)
2. Flat tax of 5% on any gains associated with a profitable exit of a start up business-as long as a portion of that gain (assume 10%) is reinvested in start ups.
3. If the investor decides to totally exit the funding of start ups, they pay a 15% tax on all gains.
Let’s look at an extreme example. Groupon. Two founders invested a million bucks in Groupon as a start up. (I am assuming that number, can’t find the data anywhere) They get an immediate write down in their ordinary income of 1million. This costs the federal government 35%, or $350,000.
Groupon grows. From 2008 to 2011 it adds 5000 jobs. Not only that, those 5000 jobs have spillover effects into the broader economy-employing even more people. The government gets back far more than the $350,000 that it gave up. By the way, Groupon doesn’t quit adding jobs. It currently adds hundreds every month.
Groupon exits (they haven’t yet-so risk is still on the table), let’s assume $20 billion. There have been other financings in between the original start up cash and the exit, so it’s not exactly clear how much the founding capital clears, but let’s assume they still own 20% of the firm. They get 4 billion, of which they pay 5% to the Feds-$200 million, and 20% goes to invest in new startups, or $380 million goes into new companies. If they decide to exit the start up funding world and rest on their laurels, they pay 15% of the 4 billion, $600 million. Odds are good they will set up philanthropic charitable trusts that fund a lot of good programs. Most highly successful venture capitalists and investors have.
But, if they choose to stay in the game, do you realize how many new companies could be seeded with $380 million?
Most of the start ups in the world come in looking for cash in a range of $250,000 to $1.5 million, depending on the business. The first venture investment in Facebook was $400,000. Google was started with $100,000.
99.9% of start up companies never IPO. Most fail. The ones that are successful are bought by other companies. Some become nice lifestyle businesses for their founders. The point is that tax policy can be used to put incentives in place to encourage start up formation.
Encourage intelligent investors to assume risk with good tax policy. Companies and jobs will be created. Right now, the risk/reward to invest in a start up for a lot of people leans to tossing your money in a bond.
What are the consequences? Some people are going to get rich. But, isn’t that part of the American dream?