Would A Capital Gains Hike Under Biden Be A Loss For Investors?

With control of the U.S. Senate still somewhat unknown, it is unclear what tax changes President-elect Joe Biden may be able to push. But investors say some of the talked about policy changes could have an effect on the venture capital world.

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While much has been made of Biden’s proposal to raise long-term capital gains taxes from 20 percent to up to 39.6 percent for high earners, the Senate likely is to remain in Republican hands—pending the outcome of the two Georgia runoff elections on Jan. 5—making changes to the tax code unlikely at best.

“Obviously, you’d like to pay less tax, not more” said Aziz Gilani, managing director at early-stage venture capital firm Mercury Fund in Houston.

Gilani agrees that he sees the rate likely staying where it is, but said raising capital gains could hurt some locations where the investing ecosystem is more immature, such as in Texas and other parts of middle America, Gilani said.

Higher rates make it more difficult to attract high-net-worth individuals for investing, which already has the drawbacks of long investment horizons and no immediate liquidity, Gilani said. For those used to investing in public equities and real estate, it also can be hard to convince them to invest in unfamiliar venture funds, he added.

Lanham Napier, co-founder of venture capital firm BuildGroup in Austin, said a higher capital gains tax could lead to two changes in the startup market: where they are located and when they sell.

Just this year, companies such as Charles Schwab and commercial real estate giant CBRE already have fled California, where there is an additional 13.3 percent capital gains tax on top of what Uncle Sam takes. An increase in the federal capital gains tax may make more entrepreneurs look at states with no capital gains tax like Texas, Nevada and others, he said.

However, California holds so many advantages for tech entrepreneurs—such as a plethora of investors and good exit options through acquisition—Gilani said he does not foresee a mass exodus anytime soon. However, Gilani also pointed out the COVID-19 pandemic has reduced many of these advantages for entrepreneurs in the state, with everyone working from home and lessening entrepreneurs ability to network in the cash-rich state.

Capital gains and the impact on exits

An uptick in the capital gains tax also may lead to fewer entrepreneurs looking for early exits, instead leveraging their companies more and more, especially with interest rates around zero right now, Napier said.

In theory, that would allow companies to grow—creating more value for founders despite the higher capital gains tax—but it also would bring debt onto startups’ balance sheets and delay liquidity for investors, he added.

One aspect to remember, however, is that an increase in the capital gains tax will not affect everyone associated with venture funds, noted Napier. Many venture capital funds include money from universal endowments and pension funds, which are not subject to taxes, he said.

The capital gains tax also will not be the only issue inventors watch closely under a Biden White House. Carried interest eventually could be another issue investors watch, Gilani said. Biden could call for eliminating the carried interest tax loophole, which would then tax investors’ profit as ordinary income.

Positives for investors

Some positives for investors also could emerge under a Biden presidency.

Graham Brown, a partner at Lerer Hippeau firm in New York, said since former President Barack Obama supported favorable tax policies to invest and develop entrepreneurial endeavors —including complete exemption from capital gains tax for qualified small business stock—he does not believe the incoming Biden administration would deviate from that.

A Biden presidency also may offer other benefits to investors, including being much more welcoming of immigrants and likely increasing interest in clean tech, green tech and technologies that combat climate change, he added.

Most agree there will be some degree of change for the tech sector and investing under a Biden presidency, how much remains to be seen and likely could depend on the outcome of Georgia’s  runoff elections.

Illustration: Li-Anne Dias.