The current congress was elected by Americans on the platform of fixing the economy, but, more specifically, under the slogan “jobs, jobs, jobs.” The mishandling of the current budget crisis shows how little that voice was heard. Just as Republicans accused the administration of focussing on social policy (health care) when the mandate was about jobs and the economy, you have now done exactly the same thing when put in power. Rather than tackling the real issues pointed out by the bipartisan commission (such as entitlements and tax policy), you persist in living in a fantasy world that the economy can be fixed with cuts to discretionary spending.

No matter how this crisis resolves itself – whether it is with a government shutdown or a last minute deal – congressional leadership has failed the American people by creating a crisis out of short term political opportunism and appeasement of the extreme wing of the Republican party to push through social policy.

No one believes that even the entire $40-65 billion in cuts being negotiated comes remotely close to reversing a $1 trillion deficit (or, if they do, they seriously need the additional educational programs proposed by the President.) To claim that the crisis and potential shutdown is based on Democrats refusal to accept a percentage of those cuts doesn’t pass the sanity test. It is clearly about trying to ram social policy through without debate.

Perhaps the most humiliating and tragic part of this is that it will result in financial insecurity for the men and women in uniform who are in harm’s way around the world defending America and our interests. Please think about them when you take your decisions and consider the consequences of this political opportunism and appeasement.

Sincerely,
Daniel Ratner

Billie was a lifelong enthusiast of gardening and antiques and delighted in her involvement with the Edgewood Garden Club, Pottery and Porcelain Society, and many charitable organizations, including Brown University and the R.I. Hospital Guild.

Although Billie’s travels and always adventurous spirit took her around the world, she was happiest at home near her garden, friends, and family.

In lieu of flowers, contributions to the Edgewood Garden Club would be gratefully appreciated.

Pretty much everyone in the startup community would agree that founding companies requires a step up on a three legged stool where the legs of the stool are talent, ideas and money. No amount of any one makes up for the others, but they do tend to work in a self-reinforcing (or self-destructive) cycle.

It starts with ideas. Everyone has ideas. How many times have you heard a friend say “I wish someone would start a company to…” and identify some kind of personal need or pain point? What makes entrepreneurs is that they don’t say “I wish someone would start a company to…” they say “Maybe I should start a company to…” and then figure out if the idea has, well, for lack of a better term, legs.

But ideas even in the minds of the dedicated often go nowhere. You need people that have done it before, know the ropes, know the industry and know how to run a business. For all you hear about the college whiz kid starting something in his garage (who knew college kids had garages?), there are a lot of experienced men and women behind him who you don’t hear about setting up technology, processes and marketing plans, managing people, forging partnerships and creating sophisticated models and projections. The 23-year-old CEO is part of the vaunted mythos of Silicon Valley (I know, I was one), and has some basis in reality, but less than you might think. For an entrepreneurial ecosystem to thrive, you need experienced people to join companies and mentor new founders. Oh, and also to raise money. These people are smart and know that it takes money to start a business, so they tend to go where the money is. When I ask entrepreneurs why they take their companies to Silicon Valley, I sometimes get a sassy comment about the weather, but mostly I get a rant about horrible traffic, ruinous housing costs and endless strip malls being the price of admission for access to formation capital.

And that is certainly a good part of it. Yes, you can start a company on a shoestring. Yes, it’s cheaper to do than perhaps at any time in history. But it still isn’t free, especially if you are pursuing a big idea like a new drug, electronic device or big data company. Even social media companies require money to build up a base. Facebook may not have gotten to 500 million friends without making some enemies, but to get there they also took more than 500 million dollars. Closer to $900 million, actually.

The companies that can be built on fifty cents can usually be copied for a dollar and undercapitalized companies remain vulnerable with their ideas in the wild but without the resources they need to execute and build sustained competitive advantage. Counter-intuitively, the more money you want to raise, the easier it is. What’s really hard it to get people to back you for your first $500k-$1mm when it’s just you and an idea.

So formation capital is important. What can regions do to solve the problem? Two things.

First, and most important, invest at home. For example, all municipalities and states invest money on behalf of pension funds. And venture capital and private equity are asset classes represented in each of those funds. Most regions export the money to California, having somehow gotten the idea that it can’t be successfully invested anywhere else. (An odd point of view given that the whole strength of the Internet and new media is geographic independence and ubiquity.) This is part of the self-destructive cycle. They export money which leads to exporting talent which leads to exporting ideas and ultimately companies. If you want to break that cycle, you need to require that money to be invested near home.

The counter argument to this is that the money, especially people’s retirement money, should always be invested where it’ll get the best return. That’s fatuous. These are long term investments and by investing the money at home, the region gets the benefit of the self-reinforcing cycle of investment. Talent stays local, companies stay local, jobs stay local. If a local investment strategy were also publicized within all the branches of government, it would creates a positive incentive for all government employees invested through these vehicles to promote their local startups. In effect, it creates stock options in the region.

And investing in a California fund doesn’t necessarily mean it’ll return better. Just like every place else, for all the top-decile funds, California has its nine that didn’t make the cut. A California-only strategy would be like refusing to buy into a hedge fund that isn’t in New York or an energy company not based in Texas. And for out-of-staters, you often only get access to what’s left after the local elite and Calpers took the first picks.

There’s an important footnote to insert here. It isn’t enough to invest in local funds (governments usually don’t directly invest in companies – that’s as it should be). Governments have enough money to make a market for local entrepreneurship, but only if they require that funds receiving capital from them deploy a certain percentage (say half) of their money locally.

At first, the investors may object, saying that there aren’t enough opportunities locally. Over time, however, they can do a lot to promote the local ecosystem, hosting events, creating visibility, and, most of all, doing deals. Entrepreneurs will stay and others will return when they realize that a region is open for business. But the money involved has to be significant. New York’s recent $25 million investment has done a great job creating visibility, but it is still too small and too direct to really move the needle. Cities are still better off putting their money in the hands of investors and to really make a difference, the amounts need to be hundreds of millions.

Crazy? Maybe. But many states have fund sizes of many tens of billions so it isn’t so outrageous (Calpers, while admittedly the largest, is current approximately $200bn). Most advisors would suggest somewhere between 2 and 5% of asset allocation into this type of investment. In fact, virtually all the states already make these

There is also another thing regions, especially New York and Chicago, can do. In these two places perhaps more than anywhere else in the country, there are individuals with high risk-return appetites who have virtually no exposure to early stage technology companies and the job creation they bring with them. In particular, traders and real estate investors are two obvious examples, but more generally the World Business Chicago types. There’s very little cross-pollenization between them and tech entrepreneurs and, if there were, that might help close the gap. This is also something regional government has been good at.

One thing that won’t work. Despite everyone from congress to the White House talking about it, banks aren’t the solution for early stage tech companies. Even in the first dot com boom when people would write $5 million checks on a domain name and PowerPoint deck, I didn’t see many bank loans to tech startups. They can’t get their heads around the concept of a collateral free business and the vast majority of tech companies’ costs are people and marketing, neither one of which gets an entry on the balance sheet. Time spent trying to get bankers to change behavior is time wasted.

The region that first figures out the formation capital challenge will reap the rewards of tech company growth. And might make a handsome ROI as well.

If taxes were sharp and pointy, it’s likely that governments would be always sucking their fingers from playing too dangerously. I don’t mean that they’re too high – let that be a debate for another time – but that they aren’t well thought through in terms of what they seek to promote or discourage. While taxes are governments’ tool of choice for incentives, tax policies that have sought to promote entrepreneurship are, for the most part, complete useless. It needn’t be that way.

I won’t spend much time on the subject of whether government should be in the business of using tax policy to promote corporate development. In an ideal world, it wouldn’t be necessary. Growth companies would borrow or raise capital and develop just like any other commercial enterprise. What makes it necessary for government to tinker is that, despite what you may have heard to the contrary, the world isn’t flat. Many countries use either massive tax incentives (such as Germany’s for wind power) or sovereign wealth and trade policy (see Google’s problems in China) to promote their own agendas. So far the US Government and International trade organizations have either ignored these policies or been ineffective in stopping them. The best answer to a pure capitalist would be for everyone to stop and let the chips fall where they may, but that isn’t realistic. A more liberal mind might suggest that a certain amount of this is appropriate to encourage difficult, expensive but strategically necessary enterprises such green energy. Either way, the US needs to decide how far we’re willing to go to level the playing field. My suggestions are just possible ways to do it.

When diving into the question of tax incentives, it’s easy to rapidly end up in a quagmire of loaded terms and policy wonkiness and find yourself feeling like a camel in quicksand sinking to a slow and very painful demise. In fact, arguably the best single reform to tax policy would be to simplify it, but rather than making an argument that would put legions of tax accountants and lawyers on the streets, I’ll stick to what I know: what motivates entrepreneurs. And I’ll try to stay general. Of course there are minor exceptions and inconsistencies to these ideas, but nothing that can’t be sanded off with a little work.

So let’s start with what doesn’t work at all. By and large, corporate income tax deductions and even credits don’t work. Why? Because most startups positioned for high growth have to spend their first few years investing in developing and commercializing their products. And even once their products are ready to roll, the startups need to raise capital to get them into the market before they become profitable. That means the companies run a loss and don’t have a tax bill to deduct from. Instead, deductions and credits tend to go straight to mid-market and bigger companies or to startups in non-growth market sectors that get to profitability more quickly.

Is there a way to fix these credits so they do work? Sure. The new biotech company incentives in the Healthcare Reform Act are much better thought out if oddly limited to biotech only. They allow not just for a credit, but for direct reimbursement of certain R&D expenses that will cut costs and allow for more rapid expansion of early stage companies. An even better way would be to allow early-stage companies to sell or trade their tax credits to their bigger, profitable corporate brethren. That would stop the government from writing checks to companies, provide some relief to startups and also encourage big companies to take an interest in the startup community relatively early on resulting in more strategic investment and research partnerships.

Unfortunately, Healthcare Reform did more damage than to help to small business tax incentives by imposing onerous 1099 requirements. No good deed goes unpunished, eh?

Another set of programs that really doesn’t help startups is TIFs (Tax Incentive Financing) and property ownership tax deductions and credits. While every program in every region works a little differently, the idea is that either 1) the tax rate on your offices stays the same even if you do massive improvements (which would ordinarily cause your property to appreciate in value and thus in taxation), 2) your taxes are diminished in some way for locating in a challenged zone or region or 3) that you get some kind of tax relief on the mortgage you pay on your building.  To be clear, high growth startups don’t own buildings. If they do, they are mismanaged.  When your company is growing 500-1000% per year and your staff is doubling or tripling is size what you need above all is low cost and flexibility.  You don’t buy – you rent, and that on the shortest term basis you can get while getting enough leasehold improvements to demo the walls and move in a pool table, industrial coffee machine and a server rack.  If you own property you’re like the Ancient Mariner with the albatross dragging him down.

So how can taxes be used effectively? There have been a few good programs. Small employer tax credits that reimburse portions of FICA and other payroll-related tax contributions for new hires are complicated, but align incentives well – every employer pays these taxes and a reduction helps align the interests of government and startups – hiring more people more affordably.  Unfortunately not much more affordably since these programs only reduce the cost of new hires by a couple of percent and only the biggest companies make hiring decision on that kind of basis.

This brings us to the subject of capital gains. Tom Friedman has argued specifically that reducing the capital gains rate for startups would be effective in pushing more entrepreneurs into the race.  At a high level, he’s probably right. Reducing capital gains rates would encourage entrepreneurs to stint their salaries and grow their businesses more quickly. It might also get more people to start businesses, but that’s less clear – people either have the entrepreneurial gene or they don’t.  Taxes aren’t what gets them over the edge.  It might have more impact for investors, but even that’s a bit uncertain.  It would probably be just as effective to raise the capital gains rate on other types of transactions that just make money from money.  That’d push more money towards productive businesses, probably add total tax revenue and help reign in Wall Street with one fell swoop. I’m just saying.

Having said that, the chances of a tax rise on traders are about as high as rainfall in the Sahara. Given that, an informed tax policy would emphasize low capital gains rates for two groups – holders of a company’s common stock (founders and executives – investors always take preferred stock) and those who invest the first $1 million in a new company. The first money is always the hardest to raise and this would help shake loose independent angel investors. Larger venture funds (and many of them are far too large, making money on management fees rather than sound investing) would get less benefit. Similarly, it’s actually the founders and startup execs who take the most risk (unlike investors they can’t diversify) so this would make the currency used to attract talent (stock options) more valuable.

This last point is particularly important. Right now, executives tend to be compensated with options that vest over a period of time. While that vesting schedule may be accelerated under some conditions, for the most part they can’t be exercised until the company sells or IPOs. This means execs pay short term capital gains taxes while investors (who got their shares when they wrote the check) pay long term capital gains taxes. In other words, capital pays half the taxes of talent even though the talent takes more risk. This is an inequity (if you’ll excuse the expression) that could use righting.