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
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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
At Year
End
1970
1980
1990
2001
2003
# Venture Capital Under
Firms
Mgt
28
$1B
89
$4B
399
$31B
943
$257B
919
$257B
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
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– 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