Corporate Organisation of VC Firms in the US
Most mainstream firms or wealthy individual investors invest their capital through funds organized as limited partnerships.

Exiting a Venture Capital Investment
Exit routes consist of an IPO (initial public offering), trade sale of shareholdings, merger or acquisition.

The US Tax Regime for Venture Capital
The overall tax regime for venture capital investment in the US is reasonably benign.

The US Tax Regime for Venture Capital

Unlike many other countries that seek to foster venture capital investment, the US provides no federal tax breaks as such - that's to say, no deductions are allowed of initial capital expenditure against current income. However there are such deductions at the state level in many cases - whether this matters depends on income tax levels in a particular state. They vary from 1% to 12%.

Still, the overall tax regime for venture capital investment in the US is reasonably benign, which is why the absence of specific federal tax breaks has not impeded the growth of a successful venture capital sector.

Important features of the US federal tax system for investment are that interest expense involved in investment is deductible against investment returns and to some extent against regular income, capital losses are offsetable against gains, and losses on passive investments (less than 10% of a company, and including investments held through a limited partnership) are deductible against investment income (income within the passive 'basket').

Capital gains are included within income in the US and are subject to income tax; however, the maximum rate of tax on gains from investments held for more than 12 months is 20% at the time of writing, and this is reduced to 18% if the hold is for more than 5 years. If a qualifying small-business asset is held for more than five years, there is a 50% exclusion of capital gains on disposal.

The corporate forms used for venture capital investment are almost always 'pass-through', ie the limited partnership or similar is fiscally transparent, so that its gains or losses are attributed to investors without intervening taxation. Evidently, this does not apply to publicly-listed venture capital funds which take the form of mutual funds (often, funds of funds), and are taxable in their own right.

As examples of state-level schemes favouring venture capital investment we will take Virginia, which passed a fairly typical law resembling that in other states where there is a substantial high-tech community.

In Virginia, the 1998 so-called 'angel investor' law gave people who invest in small high-tech, biotech and manufacturing firms a state income tax credit for 50 percent of their investments. The investment must be for cash and neither the investor, the investor's family nor the investor's affiliates can receive any type of compensation from the business for one year. The maximum credit is was $50,000 at the time of introduction, and, although the investment must be held for five years, the investor can apply for a tax credit immediately. The credit is available for individuals and estates only - businesses cannot receive the credit.

Eligible businesses receiving the investments must have annual gross revenues under $5 million, must operate principally in Virginia and cannot be in the fields of or related to banking, finance, construction and consulting.

Some states allow the deduction against business income tax as well as giving it to individuals.

The 'Carried Interest' Debate

Over the past few years there has been constant pressure from Democrats in and out of Congress to change the basis of taxation of fund managers (including venture capitalists). Currently, the standard basic fee structure for managers of hedge and private equity funds is 20% of gains made by the fund, plus a 2% management fee. The profit element is known as 'carried interest' and is normally taxed as a long-term capital gain at 15%, rather than as income at 35%.

In April, 2009, Democratic lawmaker Sander Levin reintroduced legislation into the US House of Representatives that would tax fund managers' carried interest compensation at the same rates as ordinary income.

This issue is explored at greater length in the Policy Issues section of this site.

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Corporate Organisation of VC Firms in the US
Most mainstream firms or wealthy individual investors invest their capital through funds organized as limited partnerships.

Exiting a Venture Capital Investment
Exit routes consist of an IPO (initial public offering), trade sale of shareholdings, merger or acquisition.

The US Tax Regime for Venture Capital
The overall tax regime for venture capital investment in the US is reasonably benign.