The Patricof article echoes pretty much exactly the position of the National Venture Capital Association (its statement to congress is here: http://bit.ly/M92Ux [PDF]).
Essentially:
1. Venture capital firms are not interdependent with the world financial system - we don't trade public markets, we don't rely on banks, we don't insure things
2. The venture capital industry is small in size and thus not "systemic" in relevance
3. Venture capital firms do not use long-term leverage or rely on short-term funding - i.e. we don't punch above our "equity" weight
4. Regulation under the currently proposed act would significantly increase costs and change the way venture could operate - insofar the parallels drawn to SOX or anti-money laundering are correct
In particular, we'd have to add more administrative staff and would potentially face issues in performance-based contractual relationships with some of our investors (limited partners).
The argument in a nutshell is that the Act seeks to address problems caused by buy-out and hedge funds. We're being lumped into something because of our similar structures, not because of what we do. Transparency is a laudable goal and I think the venture capital industry as a whole would be more open to thinking about making itself more transparent if such regulation recognized that venture is actually not a part of the problem, but an essential catalyst for growth in our economies.
I am personally a subscriber to a libertarian, subsidiarist principle of legislation. There is no need to regulate VC in the way intended by congress: why should we erect barriers to entry, dissuade new investors into venture capital, make it less profitable (than it already is)?
Figure out and adapt a fundamentally different legal structure and this issue goes away. The cost of writing a law full of loopholes that allows hedge and PE funds to "look" like VC funds is higher than the added costs to firms like Atlas. (Let's be honest: this ain't gonna drive Atlas out of business, nor will it affect angel investors. It would only kill the crappy $20-50MM funds.)
And if anyone thinks I'm crazy, I want to point out that Mitt Romney has always described himself as a "venture capitalist," as far back as his 1994 Senate run, although everyone knows that Bain Capital is a PE shop.
Disclaimer: I did my time on the dark side at a healthcare VC firm, and now I'm on the entrepreneur side.
Ok, so you want to force existing VC's to adopt a different legal structure (probably a less efficient one) and kill the smaller players in the market (the "crappy $20-50MM funds").
What's the benefit of all of this? Getting a bunch of legalese reports from surviving VC's that say "we have no leverage?"
You can have leverage without debt through the use of options and other derivatives. The leverage is the systemic structural issue, not the notional amount of debt.
True, leverage comes in many forms. But what form of leverage could a VC firm engage in that they could not easily be restricted from in order to qualify for less onerous regulation?
Restrictions on the use of derivatives is as easy to restrict as debt instruments.
People often don't consider how regulation decreases the number of new entrants into a field.
In the present case, we tend to spend all our time talking about how this will impact current VC firms. Existing VC firms have the advantage. The real question is how this will impact VC firms yet to be formed (or even yet put on a napkin).
At some level of regulation, new competition will be completely thwarted (imagine having to spend the first $10M and the first year of your startup achieving regulatory compliance), but what is often missed is the marginal effect. Any marginal increase in regulation will create a corresponding marginal decrease in new entrants just as assuredly as if you could artificially raise their expected cost to get to profitability (because that's exactly what regulation does).
This is why existing players in a market often lobby for regulation of their own market, or at least acquiesce to it without too much of a fight.
Is there any reason to believe that regulators who can't figure out how to handle institutions that they've been regulating for decades will know how to handle VC firms?
We know how this is going to play out. VC firms with ties to congress critters are going to get special treatment, just like banks with such ties do. Firms that don't make such ties are going to be penalized.
Well, we have some decent regulators. The issue was one of regulator-shopping. You've got AIG, the world's largest insurer, under the Office of Thrift Supervision exactly because AIG bent the rules to qualify for OTS oversight.
Reading Felix Salmon et al, the solution is for one large regulator with the sophistication to match the large and diverse financial institutions, to eliminate the turf wars and jurisdiction shopping of the past. Combine the SEC and the CFTC (which, guess what, knows how to regulate derivatives), and give the new SEC sufficient enforcement powers.
Furthermore, the regulation only makes VC shops (as well as PE and hedges, which all have the same GP/LP structure) file the exact same stuff that Vanguard, Fidelity, and other mutual fund companies already file. I love how the VCs never once mention this. Probably because it sounds so reasonable.
Which will always be a problem, so you've just told us one of the mechanisms for regulatory failure.
> You've got AIG
Bzzt - AIG was not just under OTS, they were also under insurance regulation and a couple of others. And they were regulated in several countries, often in multiple ways, not to mention states. And these agencies cooperated.
AIG was pretty much a best case for regulatory success.
And now it's a conduit for payoffs to Goldman Sachs. (Yes, I know the collateral story. I'm hoping that someone will post the details so I can show how it doesn't mean what they think it does. GS should have been left holding the collateral.)
> Since the IRS and other arms of the government already have this insight
Actually, they don't. The IRS doesn't get much of anything that isn't directly tied to income and expense.
Note that this regulation treats VC funds more harshly than criminal enterprises.
Yes, criminal enterprises can report income and expenses and pay taxes through the IRS without any fear that the said reports will be used against them. (In fact, in some cases one can even pay the drug-for=recreational-use tax and avoid most/all of the criminal sanctions. Few bother because the tax is extremely high. However, I suspect that a few rich stamp collectors have paid for the relevant stamps just to build their collection.)
Not only would there be costs associated with complying with regulations, but simply from a capitalist standpoint there is little reason (as discussed in the article) for the government to have a say in VC practices. Investors know the risk they are undertaking, have a solid financial standing, and are not trading in public securities.
I feel like the article wanted to point out the side-affects of this new legislation as it applies to VC funding. I don't think the intention of the law was to necessarily monitor VC operations, but with such a broad regulation that's what's going to happen.
Keep in mind though that at the same time there are some things the government is doing to promote small business, such as providing billions in funding for the Small Business Association. Not all bad I guess, but still not a fan...
The article you quote there to make your point clearly states that the 1.7 million dollar figure is an average taken over a group of companies, to make a meaningful statement about this you'd have to take in to account how big the revenue streams were in order to gage the impact.
taken by itself the 1.7 million figure is useless.
There is a cost to running a VC operation, reporting is part of that cost. if - and it remains to be seen if it really will go that way - these laws will be made to bear on VC companies then you can bet that the cost of compliance will be a small fraction of the size of the fund.
No need to start saying that 'venture capital is in danger'.
Venture capital companies possibly slightly less profitable would be a better title.
The problem with SOX is that it has a large fixed cost component. This disproportionately hurts smaller companies. You may bet that costs will be proportional to the size of the fund, but I see no reason to expect that.
There are also knock-on effects: if VC becomes less profitable, some investors will put their money into other instruments. The problem isn't just that we might get smaller profits on existing VC funds, the problem is that we might get fewer investments into VC.
The sole benefit is that congress and the president get to pretend they are doing something about the financial crisis.
If you want to say my title was a little overblown, fine. But it doesn't change the fact that this proposed regulation poses a significant risk of reducing the amount of VC invested into startups.
You would think that an article like this would answer exactly these questions, but no- just a string of generalities with no details. Mourn the death of such a glorious news source!
The Patricof article echoes pretty much exactly the position of the National Venture Capital Association (its statement to congress is here: http://bit.ly/M92Ux [PDF]).
Essentially:
1. Venture capital firms are not interdependent with the world financial system - we don't trade public markets, we don't rely on banks, we don't insure things
2. The venture capital industry is small in size and thus not "systemic" in relevance
3. Venture capital firms do not use long-term leverage or rely on short-term funding - i.e. we don't punch above our "equity" weight
4. Regulation under the currently proposed act would significantly increase costs and change the way venture could operate - insofar the parallels drawn to SOX or anti-money laundering are correct
In particular, we'd have to add more administrative staff and would potentially face issues in performance-based contractual relationships with some of our investors (limited partners).
The argument in a nutshell is that the Act seeks to address problems caused by buy-out and hedge funds. We're being lumped into something because of our similar structures, not because of what we do. Transparency is a laudable goal and I think the venture capital industry as a whole would be more open to thinking about making itself more transparent if such regulation recognized that venture is actually not a part of the problem, but an essential catalyst for growth in our economies.
I am personally a subscriber to a libertarian, subsidiarist principle of legislation. There is no need to regulate VC in the way intended by congress: why should we erect barriers to entry, dissuade new investors into venture capital, make it less profitable (than it already is)?