# Presentation: 082980

## President’s Advisory Panel on Federal Tax Reform

- Robert E. Grady
- Managing Director
- The Carlyle Group
- March 31, 2005

## About the NVCA

- 460 member firms
- Majority of all professionally managed venture capital in the United States
- American Entrepreneurs for Economic Growth:  14,000 growth company CEOs
- United States = 72% of all venture capital professionally managed worldwide

## About the Carlyle Group

- $24.8 billion under management in 26 funds
- 24 offices in 14 countries
- $1.8 billion in 5 venture capital funds
- 377 portfolio company investments
- Total of 151,000 employees
- Annual sales = $31 billion
- 34.2% gross internal rate of return on realized investments since founding

## Agenda

- The Role of Venture Capital and Entrepreneurial Start-ups in The U.S. Economy
- Venture Capital Investing
- Suggestions for Tax Policy

## The Role of Venture Capital and Entrepreneurial Start-ups in the U.S. Economy

## Venture Capital: America’s Job-Creating Engine

- Companies backed by venture capital since 1970:
- Provide 10.1 million US jobs
- Had 2003 sales of $1.8 trillion
***10% of US GDP on under 2% of capital invested***
- Venture-backed companies outperform others:
*Between 2000 and 2003:*
- US private sector jobs down 2.3%;
- Venture backed companies grew jobs by 6.5%.
- Sales nationally up 6.5%;
- Sales at venture backed companies up 11.6%.
- Venture backed wages grow faster than national average

*Source: Venture Impact 2004 by Global Insight (Wharton/DRI)*

## The Increasing Role of Startups in U.S.-Led Innovation

- Venture backed firms spend twice as much on R&D as non-venture backed firms
- Share of US R&D performed by firms with <500 employees:
- 1984:  5.9% ($4.4B)
- 2003: 20.7% ($40.1B)
- Major source of productivity growth
- CAD/CAM, JIT, Auto-ID, payments, POS, e-Tailing, internet travel
- Major source of U.S.  Competitiveness:
- 72% of all venture capital worldwide is in the US

***Source: Venture Impact 2004 by Global Insight; ***
***              ******National Science Foundation***

## Whole New Sectors Have Been Created...And Will Be Created

- Biotechnology
- Network Security
- Package Delivery
- OnLine Retail
- Health Care Devices
- CRM
- Intelligent Merchandising
- ERP Software
- Medical Devices

- Auto ID
- WiFi Networks
- Genomics
- Wireless Messaging
- Security Technology
- Web Services

## The US Venture Industry Has Grown

***Source: 2004 NVCA Yearbook,/Venture Economics***

## Venture Capital Investing

## The Venture Capital Investment Cycle

- Investment:
- Series A, B, C Preferred Stock
- Expansion, Pre-IPO Capital
- Use of Proceeds:
- R&D, Product Development
- Expansion of Sales Force
- Realization
- M&A, IPO
- Valuation Metrics:
- Price/Net Income Ratio
- Price/Revenue Ratio (More Prevalent in Late 1990s Bubble)
- Control Premium to Shareholders (in M&A Transactions)

## Characteristics of the Start Up Sector

- Higher Proportion of Ownership/Options
- Attractiveness of Opportunity Tied to Potential Gain in the Stock
- NVCA Survey:  70% of Member Firms Portfolio Companies Award Options to 100% of Employees
- Prior to IPO, M&A Transaction, or Institutional Financing, Many Firms Are Flow Through “S” Corps

## Carlyle Venture Partners Example

- Fund I:  1997
- 31 Investments
- 6 Trade Sales
- 6 IPOs (3 Unrealized)
- 7 Write Downs
- 12 Remaining Private Unrealized Investments
- Fund II: 2001/2002
- 29 Investments
- 4 Trade Sales
- 2 Write Downs
- 23 Remaining Private Unrealized Investments
***Employees at 38 Active Companies:  4,100***

## Suggestions for Tax Policy

## Key US VC Building Blocks

- Capital formation
- Prudent man rule – enabled pension investment
- 1978 Steiger capital gains tax cut
- Capital gains tax reductions
- Empowered entrepreneurs
- Stock options/team building tools
- Reasonable bankruptcy laws
- Protection of intellectual property
- Abundant customers willing to do business with small and medium enterprises
- Exit markets – the NASDAQ
- Face-to-face investing/proximity
- Cultural acceptance

## Tax Reform Objectives: The Entrepreneurial Sector

- Policies Friendly to Capital Formation
- Availability of Risk Capital Has Driven Innovation and Job Creation
- Make Permanent Low Capital Gains Tax Rate
- Simplicity
- Complex Provisions Distort Capital Flows
- Most Entrepreneurial Companies Have Modest Finance Departments
- Low Rates
- Corporate Tax Rates Largely Left Out of Debate
- Most Small Companies Valued on Multiples of Net After Tax Income

## Conclusion

- Low Rates Enhance U.S. Competitiveness
- Attract Capital
- Attract Companies
- Attract People
- Job-Creating Sector Decision-making is Growth-Driven Not Tax-Driven
- Complex Provisions Create More Annoyance Than Value
- Technology and Capital Flows Increasingly Global
- U.S. Will Have to Compete to Remain the Home of Innovation, Growth and Job Creation

_***www.nvca.org***_